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Mutual Funds 101

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Mutual Funds 101

A mutual fund is a company that combines, or pools, investor's money and uses that money to buy stocks or bonds.

Each day the accounting staff of a fund adds up the value of all the securities in their portfolio, plus other assets like cash, then deducts liabilities.

Then they divide the net assets by the number of shares outstanding. This is the NAV or net asset value of each share in their fund.

Some funds have what is called a load. This is simply a sales charge for you doing business with them. A no load fund has no sales charge, although most funds do charge a very small administration fee.

All mutual funds are required by law to provide info about their fund to prospective investors. This info is called a prospectus. This describes all about the fund itself, the fund's objectives, costs, and securities they invest in.

Always read the prospectus before you invest in any fund!

Almost all mutual funds have Web sites where you can view the prospectus for each fund in their family, and you can always call and request a free copy be sent via regular mail.

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Classifications Of Funds

There are basically 4 classifications of mutual funds categorized by their investment objectives.

  1. Preservation of Capital - achieved by investing in very short term bonds.

  2. Income - achieved by investing in bonds.

  3. Balanced - achieved by investing in bonds and stocks.

  4. Growth - achieved by investing in stocks or futures.

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Some Advantages Of Mutual Funds:

  1. They are heavily regulated by the Securities and Exchange Commissions.

  2. They are diversified.

  3. Professional managers are in charge of your money.

  4. They are very convenient and easy to buy into.

  5. They will do all the accounting and paperwork.

  6. They send you a quarterly statement.

  7. You can exchange shares with a simple phone call.

  8. You do not have to constantly know market conditions or monitor your investments.

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Trading Stocks

You can go out and buy individual stocks. But this requires a very good knowledge of trading, the extreme discipline to follow your system's trading rules, and constant vigilance in staying up with your investments and market conditions in general.

Basically if you want to trade stocks or futures and don't know what you are doing, you're going to get creamed.

Plus if you own a lot of shares of one stock and it goes down, you've just lost a lot of money.

Mutual funds have solved all those problems for you. Funds typically invest in 50 to 200 different securities, so if a handful of them go down in value, it really doesn't affect your fund's performance that much because of the diversification they can maintain.

Do remember: In Bear markets typically 75% of ALL stocks will go down in value. Yours and everybody else's mutual fund will drop. This is the time when you want to buy more shares if possible.

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Risk Management

Let's talk about another aspect of funds which is risk level. No matter what investment, stocks, gold, bonds, bank CD's, their is always a risk factor.

High risk investments like stocks or futures carry the potential to make a lot of money, but they also carry the potential to lose all your money.

It's like this. If you bought shares of Yahoo when it was trading at $10.00, then sold when Yahoo topped at $220.00, you made yourself a small fortune.

But, if you bought at $220.00 thinking it was going to continue to rise.....well, at this writing, Yahoo is trading at $17.00, and you would have lost your entire investment and be deep in the hole.

On the other hand, bank savings accounts are very low risk, but the return on your investment is almost nothing.

  1. Money Market Funds are relatively low risk. They are limited to certain high quality, short term investments.

  2. Bond Funds or Fixed Income Funds are higher risk. They are not restricted to high quality investments. There are many different types of bonds, so bond funds can vary dramatically in their risks and rewards.

  3. Stock Funds or Equity Funds are higher risk than either of the above. The NAV of a stock fund can rise and fall rather quickly short term, but historically stock funds have performed better over the long term than most other types of investments.

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Types of Stock Funds

Various stock funds focus their buying on different types of stocks. Among them are: small cap, mid cap, large cap, some will have a mix or blend of these, sector fund stocks, penny stocks, new and emerging growth stocks, futures, and stocks on an index.

Don't buy sector funds that only invest in a few sectors of the economy.

An index fund consists of stocks that are in an index like the S&P 500. These will do well in a Bull market, or when the market in general is going up. In Bear markets, or when the market in general is falling, index funds will lose a lot of money, and sometimes quickly.

International or global funds are okay, but you should only consider diversifying your portfolio after your main fund is established and going well for you.

Avoid most of the very largest mutual funds. Their asset size has nothing to do with their rate of return or efficiency and in fact, a large asset size creates a problem for them in being able to remain flexible in changing market conditions or in acquiring positions in small stocks.

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What You Should Buy

The safest stock fund for long term investing is one which has a diversified portfolio. This means they don't exclusively invest in all, let's say small cap stocks, or all large cap stocks.

A good diversified stock fund will have a mix of stocks in several of the categories of stocks.

The particular fund you are considering buying into should have averaged an annual rate of return over the last 3 to 5 years of 20% or better.

The fund should also have a better than average rate of return in the latest 12 months when compared to other growth funds.

Spend $1.00 and buy a copy of Investors Business Daily.

Every day they publish a mutual funds table. Look only for growth funds that have an A or better rating.

Buy only a fund that invests in U.S. stocks.

Don't buy a fund just because it has a big name. Put your money in an investment that is a proven performance leader.

Once you find 5 or 10 funds that meet your criteria, surf on over to: http://finance.yahoo.com/?u

They have a wealth of information about the fund you are interested in plus Web addresses for the fund. When you narrow your choices down to the one you want, go to the fund's Web site and read the prospectus.

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How Funds Earn You Money

  1. When it receives income in the form of dividends from stocks it owns, the fund will pay shareholders nearly all of the profits.

  2. When the price of the securities in a fund rises, the fund may elect to sell those securities and there will be a capital gains which is distributed to you.

  3. If the securities increase in value, but the fund does not sell, the value of the funds shares increases. That will give a high NAV. Your investment has gained in value.

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When Should You Buy Shares In a Mutual Fund?

TODAY!

Market conditions will never be just right. Markets fluctuate constantly. There will never be that right time when everything in the market is just perfect.

The right time to start is today.

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To Make Big Money In Mutual Funds

  1. Buy a quality domestic fund that is a proven performance leader.

  2. Reinvest all dividends and capital gains back into it.

  3. Hold your fund for a minimum of 10 to 15 years.

  4. Regularly invest a portion of your money into it.

  5. Don't panic and sell when the Bear comes out of his cave.

  6. When the Bear does come out, buy as many shares as you can.

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Market Cycles

We need to talk a little bit about this. Recognize that there are business cycles and market cycles. These happen as a result of the law of supply and demand. High supply and little demand means prices will fall on a particular product.

When companies can't sell a product, they get over stocked and have to cut prices to get rid of their merchandise. This decreases companies earnings, which warns investors to start selling shares of that company's stock.

As more and more companies find themselves in the same position, more and more shares of stock are sold, driving down stock prices. It becomes perpetual motion and when more and more stock is sold, we say the market is falling and once it reaches a certain percent below the market top along with certain other conditions, we say there is a Bear market.

Eventually the law of supply and demand works the other way. All inventory is sold, people are beginning to want to purchase these products and manufacturers begin to get back into production. This increases earnings and investors like to buy stocks of companies that are showing growth and increased earnings.

As market conditions improve, the Bull replaces the Bear. So you need to understand that every single Bull market in the past has eventually gone down. And every single Bear market has eventually gone back up.

Buying shares of a quality stock or mutual fund in a Bear market means you are getting a lot more shares for your dollar invested than if you bought them at market tops.

You have to have faith the market will turn around and go back up. Typically Bear markets last between 9 months to 2 years. Be patient and buy through the Bear, then enjoy the Bull.

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Can People Lose Money With Mutual Funds?

People do lose money. Here are the top reasons why:

  1. They fail to hold through several market cycles.

  2. They worry about their investment.

  3. They are affected by bad news.

  4. They sell out during market bottoms instead of market tops.

  5. They don't buy when the market is down.

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Money Magic

If you save $100.00 per month, every month:

In 5 years at 4% interest, you will earn $6,756.
In 40 years at 4% interest, you will earn $118,596.

In 5 years at 20% interest, you will earn $10,716.
In 30 years at 20% interest, you will earn $1,701,909.
In 40 years at 20% interest, you will earn $10,575,155.

In less than 30 years, only saving $100 a month, and earning a return of 20% you will be a millionaire.

If you were to invest a one time sum of $10,000, had all dividends reinvested, but never put another single penny into it:

In 25 years at 20% interest, you would earn $953,962.
In 30 years at 20% interest, you would earn $2,373,763.

The compounding effect of interest on your money over time is incredible. 1 single dollar saved every day and invested at 20% interest will make you a millionaire in less than 55 years.

If you invested 1 single dollar on the day you were born at 20% interest, and then completely forgot it existed, at age 76 that one single dollar would have grown to $1,041,777.

If you would like someone to assist in planning your financial future, or need a hand in choosing the right fund for your investment objectives.....

Please write me today.


Dave Cole
Editor/Publisher
Prosperity: The Choice Is Yours
Copyright 2005
http://choosetoprosper.com

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Mr. Cole publishes a unique, exciting, & fun e-zine providing articles and content on running home based businesses, making & managing money, current internet marketing issues, and on living a life of freedom. Subscriptions are always free to any party. Send a blank email with PROSPERITY in the subject, or go to our web site and sign up, plus read more articles by Mr. Cole.

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