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Chapter14Investing in MutualFunds, Real Estate,and Other Choices

14.1 Investing in Mutual Funds

14.2 Investing in Real Estate and Other Choices

Consider THIS

Patrick works 20 hours a week, lives at home, and can save $100 a month. Hedoesn’t have a large lump sum to invest, but he’s sure that he can set aside thisamount permanently.

Patrick told his financial adviser, “I’ve thought about several kinds ofinvestments. I researched several mutual funds online, and I think I’m ready tobuy shares in a fund that specializes in growth stocks. The one I’m mostinterested in has averaged a 12 percent annual return over the last 15 years.That’s good, considering the ups and downs of the stock market. Animportant benefit I’ll have is the ability to check my account daily, if I want,by logging onto the fund’s web site. I can transfer my money from one fund toanother electronically if I see that this would be a wise thing to do. And, once Ibuy in, I’m guaranteed to be able to keep buying shares of the fund, even if thefund is closed to new investors later on.”

300 Unit 3 Financial Security

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14.1

Investing in Mutual FundsGOALS

n Discuss mutual funds as an invest-ment strategy.

n Explain how to buy and sellmutual funds.

TERM

S

n growth fund, p. 302n income fund, p. 303n growth and incomefund, p. 303

n balanced fund, p. 303n money market fund,p. 303

n global fund, p. 304n index fund, p. 304n net asset value, p. 304n prospectus, p. 305n load, p. 305

EVALUATING MUTUAL FUNDS

A mutual fund is a professionally managed group of investments bought usinga pool of money from many investors. Individuals buy shares in the mutualfund. The fund managers use this pooled money to buy stocks, bonds, andother securities. The kinds of securities they buy depend on the fund’s statedinvestment objectives. For example, some mutual funds specialize in aggressivegrowth stocks. Others specialize in more conservative investments, such asbonds or money market securities.Most mutual fund companies offer a family of

funds, which is a variety of funds covering awhole range of investment objectives. You canchoose the family member or members that bestmatch your own goals. You are allowed to moveback and forth among the company’s funds. Youcan purchase one type of fund (such as a stockfund) and later switch to another (such as a bondfund), all within the same family of funds.Professional mutual fund managers perform the

following duties:

n Research individual stocks and bondsn Interpret market conditions, financialstatements, industry trends, and othermarket data

n Buy and sell individual stocks, bonds,and other financial instruments

n Match good investments to meettheir investors’ objectives

Fund investors share in any profits made bythe mutual fund. They receive profits as divi-dends and as capital gains, both of which maybe reinvested in the fund or distributed to

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Is a family of funds a good investment? Why or why not?

Chapter 14 Investing in Mutual Funds, Real Estate, and Other Choices 301



investors as cash payments. Capital gains come from the profits made whenthe managers sell some of the fund’s securities for more than they paid forthem.For most mutual fund investing, you will have to make an initial purchase of

$500 to $3,000 or more. Once you buy into a fund, you can make additionalpurchases as often as you like. Many people make regular purchases of $50 to$100 a month. To take money out of your fund, you simply call the companyand place an order to sell your shares or make your request online at thecompany web site.

ADVANTAGES OF MUTUAL FUNDSInvestors often choose mutual funds for several good reasons.

n Professional Management. When you hire someone who knows how toinvest, you don’t have to worry about following stock and bond marketsor looking for hot new investments. Professionals are doing the work foryou.

n Liquidity. You can get your money quickly if you need it, though there issome risk of loss if the fund’s price is low when you choose to sell.

n Diversification. When you invest in mutual funds, you are diversifyingbecause mutual funds purchase a variety of stocks and bonds. When youhave enough money to invest in more than one fund, you can furtherdiversify by buying shares in funds with different investment objectives.In the same way that you would diversify individual stock purchases, youcan buy some shares in riskier, aggressive mutual funds and limit the riskby also purchasing shares in more conservative funds.

n Small Initial and Ongoing Purchases. Another advantage of mutual funds isthat you need not have a lot of money to invest. Many funds require only asmall minimum investment. Also, through pooling your money with otherinvestors in the fund, you can own, for example, part of a $10,000 gov-ernment bond without having $10,000 to buy the whole bond yourself.

MUTUAL FUND RISKIndividual funds within a family have different investment goals and risk

levels. In their publications and on their web sites, investment companiesdescribe the investment goals and level of risk for each fund. You can choosefunds that match your goals and risk tolerance. As with any investment, thegreater the potential return, the higher the risk. Figure 14.1 shows the generalrisk/return profiles for general categories of mutual funds.

Growth Funds

A growth fund is a mutual fund whose investment goal is to buy stocks thatwill increase in value over time. To do this, the fund’s managers select stocks incompanies that reinvest their profit in the company rather than distribute it toinvestors as dividends. Investors in growth funds earn their return throughcapital gains rather than through dividends. An aggressive growth fund invests instock of new or out-of-favor companies and industries that the fund managersthink will achieve above-average increases in value. The philosophy behindaggressive growth funds is to accept high risk of loss in exchange for a chance toearn high returns. Other growth funds follow a less risky philosophy. They




invest in more stable companies that the fund managers expect to increase invalue but at a slower, steadier rate than the stocks of aggressive growth funds.

Income Funds

An income fund is a mutual fund whose investment goal is to produce currentincome in the form of interest or dividends. At times, these investments will alsoshare money with investors in the form of capital gains distributions. In thiscase, the investor receives a check or deposit to his or her account. Investors inincome funds are looking for income from their investments now rather thancapital gains later. Income funds are considered to be of low-to-moderate riskand less risky than growth funds. Some income funds specialize in tax-exemptbonds. Their goal is to provide tax-free income for investors. Tax-exempt bondfunds appeal to investors in high-income tax brackets.

Growth and Income Funds

A growth and income fund is a mutual fund whose investment goal is to earnreturns from both dividends and capital gains. Managers of these funds try toselect stocks that pay dividends as well as stocks that increase in market valueover time. The risk level of this type of fund is moderate—between the riskiergrowth funds and less risky income funds, as you can see in Figure 14.1.A balanced fund is a mutual fund that seeks both growth and income but

attempts to minimize risk by investing in a mixture of stocks and bonds ratherthan stocks alone. Like growth and income funds, the goal of a balanced fundis to earn returns from current income and capital gains. Balanced funds havemoderate risk. They are a little less risky than growth and income funds thatinvest only in stocks.

Money Market Funds

A money market fund is a mutual fund that invests in safe, liquid securities,such as Treasury Bills and bonds that mature in less than a year. These short

FIGURE 14.1 Risk and Return Pyramid

GrowthFunds

Higher risk/higherreturn potential

Lower risk/lowerreturn potential

Growth andIncome Funds

Income Funds

Money Market Funds




maturities provide modest current income with little risk. The goal of anymoney market fund is the preservation of principal and very high liquidity.Many investors choose to put their money into money market funds while

they are “waiting out” unfavorable market conditions. For example, returnsfrom income funds may be dropping. An investor might then transfer hisor her balance to a money market fund until the income funds are risingonce again.

Global Funds

A global fund is a mutual fund that purchases international stocks and bondsas well as U.S. securities. Global funds fall into a variety of risk categories,depending on the investment objective of the individual fund. For example, aglobal fund can be very risky if its goal is to invest in aggressive growthinternational stocks. A global fund that invests in a conservative mix ofinternational stocks and bonds would be less risky. However, most globalfunds have risks that U.S. stock funds do not have. Fluctuations in currencyexchange rates and political instability in other countries can affect the value ofglobal stocks. These uncertainties make global funds generally more risky thanU.S. stock funds.

Index Funds

An index is an average of the price movements of certain selected securities.Investors use indexes as benchmarks for comparison to judge how well theirinvestments are doing. An index fund is a mutual fund that tries to match theperformance of a particular index by investing in the companies included inthat index. For example, an index fund might invest in companies included inthe Standard & Poor’s 500 index or the Dow Jones Industrial Average index.The risk level of an index fund depends on the index to which it is tied. Sincethe Dow includes only blue chip stocks, funds tied to this index would berelatively low risk. The NASDAQ Composite Index, on the other hand,averages stocks of some volatile high-tech companies. Funds tied to this indexcould be relatively risky.

BUYING AND SELLING MUTUAL FUNDS

There are thousands of mutual funds covering the whole range of investmentobjectives and risk levels. To choose the mutual fund that is right for you, youmust know your own investment objectives and risk tolerance. Do you wantincome from your investments now, or can you wait for capital gains in thefuture? Do you need a tax-free or tax-deferred investment to reduce yourcurrent income taxes? Are you comfortable with risking your investment for achance at big returns, or do you prefer a safe but lower return? Once you knowyour own requirements, you can read about the objectives and risk profiles ofdifferent funds and find one that matches your requirements.

NET ASSET VALUEUnlike stocks, mutual fund prices are not determined by what people are

willing to pay for them. They are determined by net asset value (NAV). The netasset value tells you the market price for a share of a mutual fund. The NAV is




the total value of a fund’s investment portfolio minus its liabilities, divided bythe number of outstanding shares of the fund.

NAV ¼ Value of Portfolio� Liabilities

Number of Shares

For example, suppose the value of all stocks in a fund’s portfolio is currently$100,000. The fund has $90,000 in liabilities and has sold 500 shares of itsfund to investors. The price for one of its shares, or its net asset value, wouldbe $20 at this time.

$100; 000� $90; 000

500¼ $20

Because the value of the portfolio changes as the stocks and other securitiesare traded throughout the day, the NAV is calculated at the end of eachbusiness day. Thus, the value of your investment depends on that fund’sperformance in the securities market.Although a mutual fund provides professional management, you should mon-

itor your fund’s performance. Some funds consistently outperform the averageamong those with the same objective and risk. For example, if you own an incomefund, you can compare its performance to that of other income funds.

THE PROSPECTUSBy law, investment companies must provide detailed information about their

funds. A mutual fund company must provide a prospectus for each fundoffered. The prospectus is a legal document that offers securities or mutualfund shares for sale. It must contain the terms, a summary of the fund’sportfolio of investments, its objectives, and financial statements showing pastperformance. You can usually find this information on the investment com-pany’s web site as well. Before choosing a mutual fund, read the prospectuscarefully. Compare the fund’s objectives with your own, and compare its pastperformance with that of other funds you are considering.

COSTS AND FEESIf you buy a mutual fund through a broker, you will likely have to pay a sales

fee, called a load. The broker’s commission comes from this fee. A front-endload is a sales charge paid when you buy an investment. Sometimes you pay

VIEW PointsSome investors believe thatonce you have selected amutual fund or other type of

long-term investment, youshould check on it only periodi-

cally and resist making changes.Others believe that it is important to

check your account balances almost daily. Theseinvestors frequently move their balances from

one fund to another as they constantly look forchoices that pay higher returns.

THINK CRIT ICALLY

Which view do you agree with? The Internetprovides a very convenient way to checkbalances. How often should you check yourbalances?




this fee on reinvested dividends as well. A back-end load is a sales charge paidwhen you sell an investment. Either way, loads can range from 2 to 8 percentof the value of the shares purchased.In some cases, you can buy mutual funds directly from the investment

companies. This kind of fund, called a no-load fund, does not charge a sales feewhen you buy or sell because no salespeople are involved. You buy directlyfrom the company by telephone, mail, or through the company’s web site.Mutual funds make money by charging fees to their customers for the

professional services provided. Funds often charge an annual management fee,which averages about 1 to 1½ percent of a fund’s total assets. This charge is forthe services of professional fund managers and for maintaining your account.The fund may also charge a “12b-1 fee” to cover the costs of marketing anddistributing a mutual fund. These fees are part of the fund’s expense ratio,which is expressed as a percentage of assets deducted each year for fundexpenses. Mutual funds publish their expense ratios with their fund descrip-tions. When you consider investing in mutual funds, compare expense ratiosas part of your evaluation.

THE MUTUAL FUND COMPANYThe most important decision you will make with mutual fund investing is

selecting the right mutual fund company or companies. You can read about afund in its printed material. You can compare its costs and fees. You canresearch published comparisons about funds of the same type. But, you stillhave no guarantees that a mutual fund will make money or that the mutualfund company itself will not fail. To reduce these risks, choose a mutual fundcompany that has the following characteristics:

n It has been in business for 20 or more yearsn It has a solid track record of returning good solid returns to its investorsn It is a large company that manages investments for millions of investorsn It is a well-known company that is highly respected among investmentadvisers and experts

n It exists both in brick-and-mortar and in cyberspacen It is customer friendly and responsive to customer questions and needsn It provides customers with easy-to-read statements and reports and offersdaily online access

SOURCES OF MUTUAL FUND INFORMATIONFinancial publications, such as Forbes, Fortune, and Money, regularly review

and rank mutual funds. They compare one-year, five-year, and ten-year per-formances of various funds with similar objectives. They also show the expenseratios of each one, so that you can make comparisons. Occasionally, entiresections of business magazines are devoted to listing, describing, and rankingmutual funds.You can also find a great deal of information online. For example, the Morning

Star web site issues reports that compare mutual funds. You can also search forthe sites of fund families by name, such as Vanguard, Fidelity, and Dreyfus. Attheir sites, you can find detailed descriptions, including risk/return profiles for allfunds in their fund families. At the Yahoo! Finance web site, you can search forfund information by its ticker symbol. Another good web site for educationalinformation on mutual funds is the Mutual Fund Investors Center.




ISSUES IN YOUR WORLD

HOW TO READ THE MUTUAL FUNDS LISTINGS

Mutual Fund Quotations

1 2 3 4 5 6 7 8ReturnInv.

Obj. NAVOfferPrice

NAVChg. YTD 26 Wks. 4 Yrs.

Ables Fund:

AciBt1A GRO 9.63 10.11 … 0.0 �0.1 NA

BiClo BND 1.51 NL �.01 �2.9 �1.6 þ8.9

CoxDli SML 8.61 NL þ.01 þ1.6 þ1.5 þ18.6

DrixLt G&I 26.54 NL �.07 þ6.1 þ4.0 þ18.0

BB&B Fund:

Globl B WOR 6.25 6.25 �.03 �4.3 �4.3 þ2.7

MtgLtd MTG 2.80 2.80 þ.02 �2.3 �1.4 �1.0

n Column 1. The sponsoring mutual fund company’s name is listed first. Its fundsappear below in alphabetical order.

n Column 2. The investment objective of the fund family is identified here.These companies offer investors a choice of growth (GRO), bond (BND), smallcompany growth (SML), growth and income (G&I), global (WOR, for “world”),and mortgage (MTG) funds.

n Column 3. NAV stands for net asset value. It is the dollar value of one share of thefund, based on closing quotes.

n Column 4. The offer price reflects the net asset value plus sales commission, ifany. An “NL” indicates a no-load fund.

n Column 5. NAV change indicates the gain or loss in the price for a share of thefund, based on the previous NAV quotation.

n Column 6. YTD stands for “year to date.” It tells you how much this fund hasgone up or down since January 1 of the current year.

n Column 7. Total return, 26 weeks, shows the average earnings the fund hasreturned to investors in the last six months, stated as a percentage return oninvestment.

n Column 8. Total return, 4 years, shows the average earnings the fund hasreturned to investors for the last four years, stated as a percentage returnon investment.

THINK CRIT ICALLY

1. Which of the mutual funds in the listing seems to be the best investment ascompared to the other choices given? Why?

2. Why is it important to know the investment objective?




14.1

Assessment

KEY TERMS REVIEWMatch the terms with the definitions. Some terms may not be used.

1. A mutual fund whose investmentgoal is to produce current incomein the form of interest or dividends

2. A mutual fund that invests in safe,liquid securities

3. A mutual fund that tries to match theperformance of a particular index

4. A mutual fund that purchasesinternational stocks and bondsas well as U.S. securities

5. The sales fee charged for buyingmutual funds

6. A mutual fund whose goal is to buystocks that increase in value over time

7. A mutual fund that minimizes risk byinvesting in a mixture of stocks and bonds

8. The legal document that offers securities or mutual fund shares for sale

9. The market price for a share of a mutual fund

CHECK YOUR UNDERSTANDING10. Why might you choose a mutual fund over investing directly in stocks?

11. What is NAV, and how is it computed?

APPLY YOUR KNOWLEDGE12. Describe the type of investor (in terms of goals and risk tolerance) who

would be interested in each of the following types of mutual funds:(a) growth funds, (b) income funds, (c) growth and income funds, and(d) money market funds.

THINK CRIT ICALLY

13. Where is a good place for young and inexperienced investorsto start buying mutual funds?

14. How can you lower risks while choosing mutual funds?

15. Why is it important to choose a mutual fund company that has been inbusiness for a long time?

a. balanced fund

b. global fund

c. growth and incomefund

d. growth fund

e. income fund

f. index fund

g. load

h. money market fund

i. net asset value

j. prospectus



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14.2

Investing in Real Estate andOther Choices

GOALS n Explain real estate investing, both

direct and indirect.n Describe other investments,including metals, gems, collec-tibles, and financial instruments. T

ERM

S n real estate, p. 309n duplex, p. 310n condominium, p. 310n mortgage, p. 312

n depreciation, p. 313n precious metals, p. 314n gems, p. 314

REAL ESTATE INVESTING

When you invest in real estate, you are buying land and any buildings on it.Investing in real estate is considered a good way to combat inflation, because itusually increases in value over the years at rates equal to or higher than inflation.However, real estate is one of the least liquid investments you can make, since aproperty can take months oreven years to sell. Also, somereal estate investments arespeculative and can result in asubstantial loss.Commercial property is land

and buildings that producelease or rental income. Suchproperty includes office build-ings, stores, hotels, duplexes,and multi-unit apartments.You can invest in real estate

directly or indirectly.

BUYING REALESTATEThere are many types of real

estate properties you can buydirectly, such as vacant land,single-family houses, duplexes,apartments, condominiums,and recreation or retirementproperty. With direct invest-ments, the investor holds legaltitle to the property.

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Why would you invest in a vacant lot?




Vacant Land

Vacant land, or unimproved property, is usually considered a speculativeinvestment. Investors hold the property expecting it to go up substantially invalue over time. Other people purchase a vacant lot with plans for building ahouse on it later, either when they can afford it or at retirement. In either case,you will likely have to pay cash for vacant land. Because it is consideredspeculative, banks are often unwilling to make loans on vacant land.

Single-Family Houses

In addition to owning your own home, you might wish to purchase a single-family house and rent it to others. Because the property is not owner-occupied,you may find banks reluctant to grant you a mortgage loan to buy a house asrental property. As a condition for a loan, you may have to make a larger downpayment or pay a higher interest rate. When a renter takes possession of yourhouse, you still have responsibilities. For example, as the owner, you mustmaintain the premises in a livable condition. You must provide running water,electricity, sewer or septic hookups, and normal repairs and maintenance. Ifthe roof leaks or a pipe breaks, it is your responsibility to fix it.

Rental Properties

There are several other types of rental properties, or real estate designed forowners to rent to tenants.

n A duplex is a building with two separate living quarters. A duplex may beside-by-side living quarters with separate entrances, or it may be upperand lower floors of the building.

n A triplex (three units) and a quad (four units) are buildings with three orfour individual housing units. They often have common walls and sur-rounding areas.

n An apartment complex is a group of many apartments with commonfacilities such as recreation areas, clubhouses, and parking lots.

n A condominium, or condo, is an individually owned unit in an apartment-style complex with shared ownership of common areas. The owner of acondo owns the individual apartment as well as a proportional share ofcommon areas, such as the lobby, yard, and hallways.

Condo owners usually pay a monthly fee for the upkeep of the commonareas, such as for mowing the lawn and maintaining a shared swimming pool.Condos are generally less expensive than single-family houses because theyhave less land and private areas and share roofs, walls, plumbing, and so on.By pooling your cash with that of other investors, you can afford to buy

larger and more expensive pieces of property. For example, if you and threeothers formed a partnership to buy an eight-unit apartment building, each ofyou would have to pay only one-fourth of the total costs of buying andmaintaining the property.

Recreation and Retirement Property

Many people buy second homes for vacations or for their retirement years.Often, the owners rent these properties out to others to generate income duringthe times when they are not using them. Of course, rented property will not bein brand-new condition when the owner retires to live there full time.




Recreation property includes beach and mountain cabins and even vacantland near vacation sites such as rivers, lakes, or an ocean. The owner can useand enjoy the property on weekends and during vacations, and at other timesrent out the property. However, absent owners may need to arrange forsomeone to take care of the property and manage the rental process. Realestate companies in popular vacation areas often provide these services forabsent owners for a fee.

INVESTING INDIRECTLYWith indirect investing, investors have a third person do the actual buying and

selling of property. A trustee is an individual or institution that manages assetsfor someone else. The trustee holds the title to the property. Real estatesyndicates, real estate investment trusts, and mortgage pools (in the form ofparticipation certificates) are examples of indirect investments using a third-party trustee.

Real Estate Syndicates

A real estate syndicate (often called a limited partnership) is a group of investorswho pool their money to buy high-priced real estate. This is a temporaryassociation of individuals organized for the purpose of raising a large amount ofcapital. The organizer of the syndicate is called the general partner or syndicator.The people who contribute the capital are called limited partners.In a real estate syndicate, the general partner forms a partnership and assumes

unlimited liability for all the obligations (debts) of the partnership. By assumingunlimited liability, the general partner’sresponsibility extends beyond the initialinvestment to his or her personal assets ifthe investment incurs debt. The generalpartner then sells participation units tolimited partners whose liability is limited tothe amount of their investment. This meansthat the limited partners can lose no morethan they invested if the investment fails.Limited liability is especially important inreal estate partnerships because the mort-gage acquired to purchase real estate oftenexceeds the net worth of the individualpartners.A real estate syndicate often owns several

properties for diversification. The com-mercial properties acquired are usuallyprofessionally managed.

Real Estate Investment Trusts(REITs)

A real estate investment trust (REIT) issimilar to a mutual fund. It is a corporationthat pools the money of many individualsto invest in real estate. Like a mutual fund,the REIT makes all buy-and-sell decisions

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Why might an investor choose an indirect real estate investment?




for properties. You can buy and sell REIT shares at will. REITs are traded onstock exchanges or over the counter. Like stocks, REIT shares fluctuate withmarket conditions, and dividends are paid when the real estate investments dowell. There are many types of REITs, investing in everything from rentalproperties for monthly income to mortgages for long-term income. REITs arefound in the financial section of the newspaper along with stock, bond, andmutual fund price quotations.

Participation Certificates

A participation certificate is an investment in a pool of mortgages that havebeen purchased by a government agency. Participation certificates are sold byfederal agencies such as the Government National Mortgage Association(Ginnie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac),and the Federal National Mortgage Association (Fannie Mae). At one time,you needed $25,000 to invest in these certificates. However, many mutualfunds invest entirely in them, making it possible to buy shares for as littleas $1,000.

BUYING AND OWNING RENTAL PROPERTYWhen buying real estate, most people make a down payment and get a

mortgage to pay the balance. A mortgage (also called a trust deed) is a loan topurchase real estate. Most people borrow money to buy property because largesums of cash are needed. Borrowing money to buy an investment is calledleverage, which means only a small amount of the purchase price is your ownmoney. For example, if you buy a duplex for $300,000 and make a downpayment of $60,000 (a 20 percent down payment is usually required for rentalproperty), you are borrowing $240,000 from the bank. As the property gainsin value, the mortgage remains fixed. When you eventually sell the property,you keep the difference between the sales price and the mortgage. This dif-ference is the equity, or ownership interest.

Monthly Payments

As your tenant makes rent payments, you make the mortgage payments tothe bank. You would use the difference between the amount of rent collectedand the mortgage payment to pay property taxes and the cost of upkeep on theproperty. If you have money left over after paying these expenses, you have apositive cash flow. If, however, you cannot collect enough rent to pay themortgage, property taxes, repairs, and maintenance, then you have a negativecash flow and must make up the shortfall from your own pocket.

Monthly Management

To manage your property, you can be a resident landlord or hire a residentlandlord or property manager. A resident landlord lives at the rental site, takescare of all repairs and maintenance, collects the rent, and assures suitable livingconditions. A property manager collects rent, hires and pays people to makerepairs and maintain the property, charges a fee for his or her services, andremits the difference to the owner of the property. Property managers do notlive on site, but usually manage a large number of rental properties at thesame time.




Tax Advantages

Depreciation is the decline in the value of property due to normal wear andtear. Even though your property may be increasing in overall value, you candeduct depreciation expense on your rental property using Schedule C of theForm 1040 tax return. In addition, property taxes and other expenses ofmaintaining rental property can be deducted to help reduce the taxes you haveto pay on your rental income.

Selling Rental Property

When you sell your property, you will have to pay taxes on the capital gain.Real estate can be difficult to sell. During slow economic times when peoplehave difficulty obtaining low-interest loans, you may have to lower the price ofyour property substantially in order to sell it.

Risks of Owning Rentals

You should consider the risks of owning and renting property. Renters candamage or destroy your property to a degree far exceeding what a securitydeposit can cover. When your units have vacancies, your rental income willdecline, yet you still have to pay the mortgage and other expenses, thus cuttinginto your profits.Real estate is also subject to zoning laws and other local use restrictions.

Cities have laws that regulate what type of structure (for example, single-familyresidence, apartment complex, office building) can be built in each area of thecity. Before buying property, you should check the applicable zoning laws tomake sure you will be allowed to use the property as you intend.

OTHER INVESTING CHOICES

You may be willing to invest yourmoney in just about anything youthink will bring you a return in valueover time or some other form ofincome. Often these choices dependon personal values and tastes.

METALS, GEMS, ANDCOLLECTIBLESInvestments in this category are often

speculative. They can return large prof-its or losses when sold. In some cases,the enjoyment of having the invest-ment will far exceed any resale value.Although not inexpensive, preciousmetals, gems, and collectibles are easyto purchase. However, they can bevery difficult to sell in a hurry and donot provide any current income in the

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Why are gems considered risky investments?




form of interest or dividends. So be cautious when making this type ofinvestment.

Precious Metals

Gold, silver, and platinum are examples of precious metals. Precious metalsare tangible metals that have known and universal value around the world.They are usually natural substances that people value. However, prices ofprecious metals can swing widely over time. These swings are what makeinvestments in precious metals very risky.You can buy gold and silver as coins, medallions, jewelry, and bullion.

Storing precious metals safely may be a problem because of bulk and weight.Instead of storing your investment yourself, you can buy gold and silver in theform of a certificate stating how much you own of the metal being stored foryou. You also can own gold indirectly by investing in gold-mining stocks or inmutual funds specializing in these stocks. Other metals in which you caninvest include aluminum, tin, copper, lead, nickel, and zinc. Prices for metalscan be found in the financial section of newspapers and online.

Gems and Jewelry

Gems are natural, precious stones, such as diamonds, rubies, sapphires, andemeralds. Their prices are high and subject to drastic change. Precious metalsand gems have their greatest value as jewelry. However, when you purchasejewelry at retail prices, you are paying markups of 50 to 500 percent or more.Prices must increase substantially in the world market before you can recoverthe cost and make a profit from reselling your jewelry.The biggest disadvantage of investing in gems is the risk that you won’t be

able to resell them. The gems market can be very small and unpredictable. Noready market may exist when you decide to sell. Often you have to go out onyour own to find a buyer, such as selling on the Internet or advertising in thepaper. The process of buying and selling can also be hazardous, as most suchtransactions require the use of cash.

Collectibles

Collections of valuable or rare items, such as antiques, art, baseball cards,stamps, and comic books, are called collectibles. They are valuable because theyare old, no longer produced, unusual, irreplaceable, or of historic importance.Coins are the most commonly collected items. Silver coins (rather than today’salloy coins) often are worth more than 20 times their face value.

COMMUNICATION ConnectionReview the collectibles sec-tion(s) in your local news-paper’s classified ads. You will

find all types of things offeredto buy, sell, and exchange. These

often represent items people andfamilies have collected for years.

Sometimes you find these items at swap meetsor other types of collectible shows. They attracta certain type of “investor.”What types of items are offered for sale? In

contrast, what items are people looking tobuy? Prepare a summary of your findings toshare in a class discussion.




People like to collect favorite items,from porcelain figures to hubcaps,and hope that someday their collec-tion will be valuable. Collecting canbe a satisfying hobby. Unfortunately,collectibles can be hard to sell andmay not increase in value. You mayfind it difficult to locate a buyer whois willing to pay you the value of yourcollection, even when the value iswell known. If you want to be acollector, buy what you can person-ally appreciate and enjoy through theyears, knowing that your collectionmay or may not result in a profitwhen you decide to sell it.

FINANCIALINSTRUMENTSFutures are contracts to buy and sell

commodities or stocks for a specifiedprice on a specified date in the future. Commodities include farm products(such as wheat, corn, and cattle) and metals (such as gold and silver). Com-modity prices are volatile because supply and demand for commodities aredisrupted by all kinds of mostly unpredictable situations, from politicalupheaval to the weather.Commodities may be sold for cash (the local farmer’s market) or traded in

the futures market. For example, a farmer could sell a futures contract todeliver 5,000 bushels of wheat one year from today. The futures market wascreated for those who want to know in advance what they will be paid.Farmers enter the futures market only for protection against volatile prices.Futures contracts are like an insurance policy against changes in prices. In thiscase, the farmers like knowing in advance what they will be paid for theirwheat.An option is the right, but not the obligation, to buy or sell a commodity or

stock for a specified price within a specified time period. A call option is theright to buy shares of stock at a set price by a certain expiration date. You canexercise the right at any time before the option expires. A put option is the rightto sell stock at a fixed price until the expiration date. An investor who thinks astock’s price will increase during a short period of time may decide to purchasea call option. On the other hand, an investor who feels a stock’s price willdecrease during a short period of time may purchase a put option to safeguardthe investment. Options are risky business and not for the inexperiencedinvestor. Options also apply to the purchase and sale of futures contracts.Investors who choose to buy and sell financial instruments are taking very

high risk. While large gains are possible, the investor must be prepared to takelosses as well as gains. It is feasible that you could lose your entire investment.Over time, those who specialize in financial instruments make profits, becausetheir gains exceed their losses.

Buying comic books as an investment is relatively new.Most people buy comics for the enjoyment of readingthem. As they have grown more and more popular,some comics have become quite valuable. A single, mint-condition issue of Action Comics #1, which introducedthe world to Superman, is worth over $1 million. Accesswww.cengage.com/school/pfinance/mypf and click onthe link for Chapter 14. Read the article about comicscollecting. List the three factors that determine a comic’svalue. According to the author, where are good places tofind investment-grade comics? What does the authorseem to think is the best way to sell comics?

www.cengage.com/school/pfinance/mypf




Planning a Career in... Stock Brokerage

The most common type of securitiessales agent is the stockbroker. Theseare the people who sell securitiesto everyday people, called investors.Stockbrokers provide investingadvice and help their clients buyand sell at the right times tomaximize their profits.

Beginning stockbrokers spendmuch of their time finding clientsand building a customer base. Theyrely on networking and social con-tacts to build their business. Theyjoin civic organizations and socialgroups to expand those networks.

After stockbrokers are estab-lished, they do most of their businessthrough referrals. A referral is arecommendation from an existingcustomer. Stockbrokers work forcommission income. They earncommissions each time theybuy or sell a security.

Employment Outlookl A much faster than average

rate of employment growthis expected.

Job Titlesl Securities brokerl Floor brokerl Independent stockbrokerl Investment banker

Needed Skillsl A bachelor’s degree in busi-

ness, finance, accounting, oreconomics is required; an MBAis preferred and required forhigher-level positions.

l Intensive on-the-job trainingis required for entry-levelemployees.

l Brokers must be licensedand pass a licensure exam.

l Maturity and ability to workindependently are critical.

What's it like to work in. . .Stock BrokerageAlysha is a stockbroker who worksfor a top investment company thathas a seat on the New York StockExchange. She works in a regionaloffice, has more than two dozenclients, and is responsible for bro-kerage accounts worth more than$5 million.

Alysha works hard to helpher clients meet their investmentobjectives. She advises clients aboutmutual funds and other investmentoptions to help them attain therisk level and the returns they desire.When clients have selected stockin which to invest or sell, Alyshamakes the transactions.

Alysha is at the office dailybefore the stock market opens.She talks with her clients mostly byphone but sometimes meets withthem for consultations.

What About You?Would you like working independ-ently and on commission? Do youenjoy social groups, civic organ-izations, and other networkingevents? Would you consider acareer as a stockbroker? Why orwhy not?




14.2

Assessment

KEY TERMS REVIEWMatch the terms with the definitions.

1. A loan to purchase real estate

2. Tangible metals that have knownand universal value worldwide

3. Land and the buildings on it

4. The decline in the value of propertydue to normal wear and tear

5. Natural, precious stones, such asdiamonds, rubies, sapphires, andemeralds

6. An individually owned unit in anapartment-style complex with sharedownership of common areas

7. A building with two separate living quarters

CHECK YOUR UNDERSTANDING8. What are some advantages of owning real estate as an investment?

9. Why are collectibles risky investments?

10. Explain how futures contracts work.

APPLY YOUR KNOWLEDGE11. Describe what it would be like to be a landlord (your responsibilities and

duties) if you owned: (a) a single-family house rented to a family, (b) asecond home on the beach that you rented to vacationers, and (c) aneight-unit apartment building where you were the resident landlord.

THINK CRIT ICALLY

12. Owning rental property involves receiving enough money to pay expensesas you go along. Explain the concept of leverage and the need for apositive cash flow.

13. Price changes for precious metals can be very unpredictable. Why wouldanyone want to invest in these items?

14. Name some collectible items you have seen, collected, or read aboutthat have increased substantially in value over the years. What do/wouldyou like to collect?

a. condominium

b. depreciation

c. duplex

d. gems

e. mortgage

f. precious metals

g. real estate




14

Chapter Assessment

SUMMARY

14.1n Mutual funds use money pooled from many investors to buy securities

that fit the fund’s stated objectives.

n Investors choose mutual funds for the professional management, liquidity,diversification, and relatively small minimum investment required.

n Growth funds focus on stocks expected to earn future capital gains, whileincome funds invest to provide current income in the form of interestand dividends.

n Growth and income funds and balanced funds seek current income andcapital gains.

n Money market funds invest in safe, liquid securities, while global fundsinvest in more risky international as well as U.S. securities.

n Index funds try to match the performance of a particular index.

n NAV is calculated as the total value of the fund’s investments minus itsliabilities, divided by the number of outstanding shares.

n To evaluate a fund, examine the prospectus, fees, and published com-parisons among funds of the same type.

14.2n If you invest in real estate directly, you own legal title to it. If you invest

indirectly, a trustee holds legal title on behalf of the investor group.

n You can invest in real estate indirectly through real estate syndicates,REITs, or federal agency participation certificates.

n If your rental income from rental property exceeds your mortgagepayment, property taxes, and upkeep expenses, then you have a positivecash flow.

n As the owner of rental property, you benefit from tax advantages fordepreciation and other expenses. However, it may be difficult to resell,and when sold, you will have to pay taxes on the capital gain.

n Investments in precious metals, gems, collectibles, futures contracts, andoptions are very risky and not for the novice investor.

n Gems have their greatest value as jewelry. The retail price has a hugemarkup, and the resale market is small and unpredictable.

n Collectibles can be very profitable or worthless, depending on the changingtastes of consumers.




APPLY WHAT YOU KNOW

1. Why should a new investor read the prospectus of a mutual fundcarefully before investing in the fund?

2. Why would a person choose a front- or back-end load fund over ano-load mutual fund?

3. Why would you wish to buy a piece of vacant land? Describe what yourplans might be for the property in 10 or 20 years, including where youwould buy such a lot and its potential uses.

4. Describe investors who might buy a second home, such as a cabin inthe woods. Why should they purchase the property now rather thanin the future, when they plan to use it full time for retirement?

5. Explain how leverage applies to buying real estate. Why is it desirableto have a positive cash flow from rental property you own?

6. What is the meaning of the statement “Real estate is an illiquidinvestment”?

7. The Internet has provided a new way for buyers and sellers of collectiblesto find each other. Search the Internet for sites dealing with a collectiblethat interests you. How is this item bought and sold online? Is therean association or club for your collectible? If so, how does the site helpcollectors?

MAKE ACADEMIC CONNECTIONS

8. Communication Mutual funds are often the best choice for younginvestors and those wishing to get started investing for the first time.Suppose a person had $500 to invest initially and planned to invest $50a month thereafter. Write a one-page paper explaining why mutualfunds might be a better way to invest this money than collectibles(such as buying Barbie dolls or baseball cards). Explain the advantagesof investing in mutual funds.

9. Research Visit the web site of an investment company that offers afamily of mutual funds (such as Vanguard or Fidelity). Select five of thecompany’s funds that are very different from each other. Describe theinvestment objective(s) and risk level for each of the five funds. Draw agraphic that visually displays risk level, going from least risky to mostrisky. On the graph, identify the most risky fund you selected and theleast risky fund. Then place the three other funds at their appropriaterisk levels in between the two extremes. In a paragraph, summarize whatyou learned about mutual funds and risk.

10. Economics Gold is a commodity. Most of the U.S. gold supply is stored atFort Knox. Also stored at Fort Knox is the gold supply of many foreigncountries. What is meant by “the gold standard”? Do we have a goldstandard today? How much gold does the United States have? Preparea brief history of the importance of gold to the United States economy.




SOLVE PROBLEMS AND

EXPLORE ISSUES

11. Tony and Barbara have been married for three years and have managedto save some money to invest. They have decided on mutual fundsbut don’t want to take too much risk. Still, they would like to havesome additional income now and also be able sell the shares for agood profit in five to ten years. Suggest to them some types of mutualfunds that might fit their investment goals and risk tolerance.

12. Obtain a prospectus for a specific mutual fund. You can write to anaddress provided in an ad in the financial pages of your local newspaperor The Wall Street Journal, obtain one from a brokerage firm or financialadviser, or locate the information at an investment company’s website. Read the prospectus and report on your findings regarding theobjectives (goals) of the fund, risk profile, tax or tax-exempt status,and performance of the fund over the last year and last five years.

13. Alena has decided to invest in real estate. She can’t decide whetherto buy a vacant lot for $25,000 or a one-fourth interest in a four-unitapartment building selling for $400,000. Explain to her the pros andcons of both of these alternatives.

14. Your grandmother has a wonderful collection of crystal, gold coins,diamond jewelry, and silver dating back to the early nineteenth century.When purchased, it cost very little, but today it could be worth a greatdeal of money. Explain to your grandmother, using a current issue of thenewspaper or Internet resources, what today’s prices are for silver,gold, gems, and other valuables.

15. Your friend Georgia wants to buy a ruby ring at a local jewelry store.She believes that it will be an excellent investment for the future becauseshe intends to sell the ring and make a profit. Explain to her the prosand cons of this type of investment.

16. Rick is worried that the money in his savings account is not earningenough interest to keep up with inflation. He has been reading aboutcommodities and thinks that trading in commodities might be a greatway to make some quick money. Explain to him the risks involved intrading commodities.

EXTEND YOUR LEARNING

17. Legal Issues Every state has requirements for becoming a licensedreal estate broker. What are the requirements to become a licensed realestate broker in your state? Why do you think those requirements arenecessary? What other laws or regulations exist that aim to protectconsumers in real estate transactions? If these laws didn’t exist, whatlegal issues might arise?

For related activities and links, go to www.cengage.com/school/pfinance/mypf



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