A mutual fund is an investment company that pools funds obtained by selling shares to investors and makes investments to achieve the financial goal of income or growth, or both. Mutual funds invest in a diversified portfolio of stocks, bonds, short-term money market instruments, and other securities or assets. The fund might own common stock and bonds in such companies as General Motors, IBM, Sears, or Running Paws Cat Food Company (our example from The combined holdings are known as a portfolio, as we noted in and as shown graphically in Figure 15.1. The mutual fund company owns the investments it makes and the mutual fund investors own the mutual fund company. Unlike corporate shareholders, holders of mutual funds have no say in running the company, although they have equity interest in the pool of assets and a residual claim on the profits.
Net Asset Value
One measure of the investor’s claim on assets is the net asset value. The net asset value (NAV) is the price one pays (excluding any transaction costs) to buy a share of a mutual fund; it is the per-share value of the mutual fund. It is calculated by summing the values of all the securities in the fund’s portfolio, subtracting liabilities, and then dividing by the total number of shares outstanding.
Net Asset Value
One measure of the investor’s claim on assets is the net asset value. The net asset value (NAV) is the price one pays (excluding any transaction costs) to buy a share of a mutual fund; it is the per-share value of the mutual fund. It is calculated by summing the values of all the securities in the fund’s portfolio, subtracting liabilities, and then dividing by the total number of shares outstanding.
The NAV rises or falls to reflect changes in the market value of the investments held by the mutual fund company. This value is calculated daily after the major U.S. stock exchanges close, and a new NAV is posted in the financial media. If the assets held in a mutual fund increase in value, the NAV will rise. For example, if a mutual fund owns IBM and General Electric common stocks and the prices of those stocks increase, the increased value of the underlying securities is reflected in the NAV of fund shares. The increase in NAV due to rising portfolio values is price appreciation. When investors sell shares at a net asset value higher than that paid when they purchased the shares (after transaction costs), they will have a capital gain.
Dividend Income and Capital Gains
A mutual fund dividend is income paid to investors out of profits that the mutual fund has earned from its investments. The dividend represents both ordinary income dividend distributions and capital gains distributions. Ordinary income dividend distributions occur when the fund pays out dividend income and interest (monthly, quarterly, or annually) it has received from securities it owns. Capital gains distributions represent the net gains (capital gains minus capital losses) that a fund realizes when it sells securities that were held in the fund’s portfolio. Mutual funds distribute capital gains once a year, even though the gains occur throughout the year whenever securities are sold at a profit. When a fund pays out these distributions, the NAV drops by the amount paid. Figure 15.2 illustrates theses sources of mutual fund returns
Dividend Income and Capital Gains
A mutual fund dividend is income paid to investors out of profits that the mutual fund has earned from its investments. The dividend represents both ordinary income dividend distributions and capital gains distributions. Ordinary income dividend distributions occur when the fund pays out dividend income and interest (monthly, quarterly, or annually) it has received from securities it owns. Capital gains distributions represent the net gains (capital gains minus capital losses) that a fund realizes when it sells securities that were held in the fund’s portfolio. Mutual funds distribute capital gains once a year, even though the gains occur throughout the year whenever securities are sold at a profit. When a fund pays out these distributions, the NAV drops by the amount paid. Figure 15.2 illustrates theses sources of mutual fund returns
Advantages of Investing Through Mutual Funds
The type of mutual fund that is the focus in this chapter is an open-end mutual fund. Accounting for more than 90 percent of all funds, open-end mutual funds issue redeemable shares that investors purchase directly from the fund (or through a broker for the fund) instead of purchasing from investors on a stock market. They are always ready to sell new shares of ownership and to buy back previously sold shares at the fund’s current NAV. Open-end mutual funds, numbering more than 8100, outnumber companies listed on the New York Stock Exchange (approximately 2800). Mutual funds offer a number of advantages to investors
Diversification Mutual funds are broadly diversified in financial markets. They might own several hundred different securities, and all are represented in a single mutual fund share. The individual with $500 or $5000 to invest could never obtain such diversification. A diversified portfolio reduces the risk if a company or sector fails. , is reduced. Recall that random risk arises when one owns only one investment of a particular type (such as stock in one company) that, by chance, may do very poorly in the future due to uncontrollable or random factors. Many investors find it easier to achieve diversification through ownership of mutual funds that own stocks and bonds rather than picking and then owning individual stocks and bonds.
Affordability Individuals can invest in mutual funds with relatively low dollar amounts for initial purchases, such as $250 or $1000. Subsequent purchases can be as little as $50.
Professional Management Many investors lack the knowledge, time, and commitment to worry about which of their stocks and bonds to buy and sell. Mutualfund investors like the fact that professional investment advisers registered with theSecurities and Exchange Commission manage their investment portfolio. The fundmanagement company may control many millions or billions of dollars of assets. Thefund investment advisers have access to the best research, and they select, buy, sell, and monitor the performance of the securities purchased; they oversee the portfolio.Investment advisers use the most current information, analytical tools, and investmenttechniques available. Fund investment advisers (money managers, securities analysts, and traders) share the same investment objective as the individual investor: to make money by increasing the net asset value of the mutual fund.
Liquidity Mutual funds have good liquidity, a term we discussed in Chapters 5 and 13. You can very easily convert mutual fund shares into cash without loss of value because the investor sells (redeems) the shares back to the investment company. To do so, individuals simply pick up the telephone or go online. The price the investor gets depends upon the value of the portfolio and the resulting NAV.
The type of mutual fund that is the focus in this chapter is an open-end mutual fund. Accounting for more than 90 percent of all funds, open-end mutual funds issue redeemable shares that investors purchase directly from the fund (or through a broker for the fund) instead of purchasing from investors on a stock market. They are always ready to sell new shares of ownership and to buy back previously sold shares at the fund’s current NAV. Open-end mutual funds, numbering more than 8100, outnumber companies listed on the New York Stock Exchange (approximately 2800). Mutual funds offer a number of advantages to investors
Diversification Mutual funds are broadly diversified in financial markets. They might own several hundred different securities, and all are represented in a single mutual fund share. The individual with $500 or $5000 to invest could never obtain such diversification. A diversified portfolio reduces the risk if a company or sector fails. , is reduced. Recall that random risk arises when one owns only one investment of a particular type (such as stock in one company) that, by chance, may do very poorly in the future due to uncontrollable or random factors. Many investors find it easier to achieve diversification through ownership of mutual funds that own stocks and bonds rather than picking and then owning individual stocks and bonds.
Affordability Individuals can invest in mutual funds with relatively low dollar amounts for initial purchases, such as $250 or $1000. Subsequent purchases can be as little as $50.
Professional Management Many investors lack the knowledge, time, and commitment to worry about which of their stocks and bonds to buy and sell. Mutualfund investors like the fact that professional investment advisers registered with theSecurities and Exchange Commission manage their investment portfolio. The fundmanagement company may control many millions or billions of dollars of assets. Thefund investment advisers have access to the best research, and they select, buy, sell, and monitor the performance of the securities purchased; they oversee the portfolio.Investment advisers use the most current information, analytical tools, and investmenttechniques available. Fund investment advisers (money managers, securities analysts, and traders) share the same investment objective as the individual investor: to make money by increasing the net asset value of the mutual fund.
Liquidity Mutual funds have good liquidity, a term we discussed in Chapters 5 and 13. You can very easily convert mutual fund shares into cash without loss of value because the investor sells (redeems) the shares back to the investment company. To do so, individuals simply pick up the telephone or go online. The price the investor gets depends upon the value of the portfolio and the resulting NAV.
Low Transaction Costs Because mutual funds trade in large quantities of shares, they pay far less in brokerage commissions than individual investors. Lower transaction costs result in higher returns for investors. Individuals purchase mutual fund shares from the fund itself (or through a broker for the fund) instead of from other investors on a secondary market, such as the New York Stock Exchange or NASDAQ stock market. Shares bought and sold are at the NAV plus any fees and charges that the fund imposes, and these are often low. While some funds charge significant fees on purchases and redemptions, individuals need not invest in them.
Uncomplicated Investment Choices Selecting a mutual fund is easier than selecting specific stocks or bonds. Mutual funds state their investment objectives,allowing investors to select funds that almost perfectly match their own objectives.
Identifying mutual funds that meet certain investment criteria can be done easily using mutual fund screening software.
Uncomplicated Investment Choices Selecting a mutual fund is easier than selecting specific stocks or bonds. Mutual funds state their investment objectives,allowing investors to select funds that almost perfectly match their own objectives.
Identifying mutual funds that meet certain investment criteria can be done easily using mutual fund screening software.
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