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A GUIDE TO UNDERSTANDING MUTUAL FUNDS |
About Mutual Funds Establishing an Investment Plan Becoming an Informed Investor Related Links Establishing an Investment Plan · Establishing Goals Establishing Goals Determining your financial goals is the first step to successful investing. You may have immediate goals, such as making a down payment on a home, paying for a wedding, or creating an emergency fund. You may also have long-term goals, like paying for college or retirement. Establishing goals will help assess how much money you need to invest, how much your investments must earn, and when you will need the money. The next step is to make an investment plan designed to meet your goals. A plan paints a broad picture of your financial situation now and where you want it to be in the future. In addition to goals, your plan should reflect your time horizon, financial situation and personal feelings about risk. Establish your goals and create an investment plan now-the sooner you begin investing, the longer your money has to work for you. · Goals and Time Horizon Generally, goals will dictate how much time you have to invest. For example, if you're 35 years old and investing for retirement at age 65, then you have a time horizon of 30 years before you plan to begin withdrawing money. Time horizon is important because it influences how you invest your assets. Typically, a shorter time frame necessitates conservative investments, while a longer period allows you to handle more risk. · Risk/ Reward Tradeoff Making an informed decision to assume some risk also creates the opportunity for reward. Nevertheless, all mutual funds involve investment risk, including the possible loss of principal. This fundamental principle of investing is known as the risk/reward tradeoff. When forming a plan, examine your personal attitude toward investment risk. Is stability more important than higher returns, or can you tolerate short-term losses for potential long-term gains? · Measurement of Performance Total Return It is generally regarded as the best measure of fund performance because it is the most comprehensive. Total return includes dividend and capital gain distributions along with any changes in the fund's NAV. A dividend distribution comes from the interest and dividends earned by the securities held by a fund; a capital gain distribution represents any net gains resulting from the sale of the securities held by a fund. Total return, expressed as a percentage of an initial investment in a fund, represents the change in that investment's value over a given time period, assuming any distributions were reinvested in the fund. Yield It is the measure of net income (dividends and interest less expenses) earned by the securities in the fund's portfolio during a specified period. Yield is expressed as a percentage of the fund's NAV (including the highest applicable sales charge, if any). · Key considerations for Performance Past performance cannot predict future results This year's top-performing funds aren't necessarily going to be next year's winners. Short-term returns may not tell the whole story Looking at fund performance over a longer time period, such as 10 years, can give you a better picture of how the fund has performed during market fluctuations. · The risk of inflation It seems logical that the safest kind of investment is the kind that seeks to preserve your money. Nevertheless, these types of investments may not offer enough protection against an often-overlooked risk: inflation. The invisible Tax Think of inflation as an invisible tax that erodes the purchasing power of any investment. For example, $1,000 in a deposit account earns 5 percent interest, but inflation is 2 percent per year. Although this money will earn $50 in interest after one year, inflation cuts the actual worth of this $50 down to $49. In addition, the initial $1,000 will also erode by 2 percent to $980. Therefore, after one year, the account has a balance of $1,050, but due to inflation, its purchasing power is only $1,029. This is the effect of inflation risk. To maintain an investment's purchasing power, its total return must keep pace with the inflation rate. · The Annual Review At least once a year, it's a good idea to review your investment plan. Because different investments grow at different paces, your current distribution of money among stock, bond and money market funds may no longer correspond with your original allocations. If this happens with your investments, you will probably need to redistribute some money to bring your allocations back in line with your plan. Becoming an Informed Investor · Glossary of MF Terms Annual and Semiannual Reports -Summaries that a mutual fund sends to its shareholders that discuss the fund's performance over a certain time period and identify the securities in the fund's portfolio on a specific date. Appreciation -An increase in an investment's value. Asked or Offering Price-(As seen in some mutual fund newspaper listings, see p. 25.) The price at which a mutual fund's shares can be purchased. The asked or offering price includes the current net asset value per share plus any sales charge. Average Portfolio Maturity -The average maturity of all the bonds in a bond fund's portfolio. Assets -The current dollar value of the pool of money shareholders have invested in a fund. Automatic Reinvestment -A fund service giving shareholders the option to purchase additional shares using dividends and capital gain distributions. Bear Market -A period during which security prices in a particular market (such as the stock market) are generally falling. Bid or Sell Price -The price at which a mutual fund's shares are redeemed, or bought back, by the fund. The bid or redemption price is usually the current net asset value per share. Bond -A debt security, or IOU, issued by a company, municipality or government agency. A bond investor lends money to the issuer and, in exchange, the issuer promises to repay the loan amount on a specified maturity date; the issuer usually pays the bondholder periodic interest payments over the life of the loan. Broker/Dealer (or Dealer) -A firm that buys and sells mutual fund shares and other securities from and to investors. Bull Market -A period during which security prices in a particular market (such as the stock market) are generally rising. Capital Gain Distribution -Profits distributed to shareholders resulting from the sale of securities held in the fund's portfolio. Closed-end Funds -A type of Investment Company that has a fixed number of shares, which are publicly traded. The price of a closed-end fund share fluctuates based on investor supply and demand. Closed-end funds are not required to redeem shares and have managed portfolios. Commission -A fee paid by an investor to a broker or other sales agent for investment advice and assistance. Compounding -Earnings on an investment's earnings. Over time, compounding can produce significant growth in the value of an investment. Contingent Deferred Sales Charge (CDSC) -A fee imposed when shares are redeemed (sold back to the fund) during the first few years of ownership. Credit Risk -The possibility that a bond issuer may not be able to pay interest and repay its debt. Custodian -An organization, usually a bank, that holds the securities and other assets of a mutual fund. Depreciation -A decline in an investment's value. Diversification -The practice of investing broadly across a number of securities to reduce risk. Dollar-cost Averaging -The practice of investing a fixed amount of money at regular intervals, regardless of whether the securities markets are declining or rising. Exchange Privilege -A fund option enabling shareholders to transfer their investments from one fund to another within the same fund family as their needs or objectives change. Typically, fund companies allow exchanges several times a year for a low or no fee. Expense Ratio -A fund's cost of doing business-disclosed in the prospectus-expressed as a percent of its assets. Face Value -The amount that a bond's issuer must repay at the maturity date. Family of Funds -A group of mutual funds, each typically with its own investment objective, managed and distributed by the same company. Hedge Fund -A private investment pool for wealthy investors that, unlike a mutual fund, is exempt from SEC regulation. Income -Dividends, interest and/or short-term capital gains paid to a mutual fund's shareholders. Income is earned on a fund's investment portfolio after deducting operating expenses. Inflation Risk -The risk that a portion of an investment's return may be eliminated by inflation. Interest Rate Risk -The possibility that a bond's or bond mutual fund's value will decrease due to rising interest rates. Investment Adviser -An organization employed by a mutual fund to give professional advice on the fund's investments and asset management practices. Investment Company -A corporation, trust or partnership that invests pooled shareholder dollars in securities appropriate to the organization's objective. Mutual funds, closed-end funds and unit investment trusts are the three types of investment companies. Investment Objective -The goal that an investor and mutual fund pursue together, e.g., current income, long-term capital growth, etc. Issuer -The company, municipality or government agency that issues a security, such as a stock, bond or money market security. Large-cap Stocks -Stocks of large-capitalization companies, which are generally considered to be companies whose total outstanding shares are valued at $2 billion or more. Liquidity -The ability to have ready access to invested money. Mutual funds are liquid because their shares can be redeemed for current value (which may be more or less than the original cost) on any business day. Long-term Funds -A mutual fund industry designation for all funds other than money market funds. Long-term funds are broadly divided into equity (stock) and bond and income funds. Management Fee -The amount paid by a mutual fund to the investment adviser for its services. Maturity -The date by which an issuer promises to repay the bond's face value. Mutual Fund -An investment company that stands ready to buy back its shares at their current net asset value, which is the total market value of the fund's investment portfolio divided by the number of shares outstanding. Most mutual funds continuously offer new shares to investors. Net Asset Value (NAV) -The per-share value of a mutual fund, found by subtracting the fund's liabilities from its assets and dividing by the number of shares outstanding. Mutual funds calculate their NAVs at least once daily. No-load Fund -A mutual fund whose shares are sold without a sales commission. Open-end Investment Company -The legal name for a mutual fund, indicating that it stands ready to redeem (buy back) its shares from investors. Operating Expenses -Business costs paid from a fund's assets before earnings are distributed to shareholders. These include management fees and 12b-1 fees and other expenses. Portfolio -A collection of securities owned by an individual or an institution (such as a mutual fund) that may include stocks, bonds and money market securities. Portfolio Manager -A specialist employed by a mutual fund's adviser to invest the fund's assets in accordance with predetermined investment objectives. Portfolio Turnover -A measure of the trading activity in a fund's investment portfolio-how often securities are bought and sold by a fund. Prepayment Risk -The possibility that a bond owner will receive his or her principal investment back from the issuer prior to the bond's maturity date. Principal -see Face Value. Prospectus -The official document that describes a mutual fund to prospective investors. The prospectus contains information required by the SEBI, such as investment objectives and policies, risks, services and fees. Quality -The creditworthiness of a bond issuer, which indicates the likelihood that it will be able to repay its debt. Redeem -To cash in mutual fund shares by selling them back to the fund. Mutual fund shares may be redeemed on any business day. You will receive the current share price, called net asset value, minus any deferred sales charge or redemption fee. Reinvestment Privilege -An option whereby mutual fund dividends and capital gain distributions automatically buy new fund shares. Risk/Reward Tradeoff -The investment principle that an investment must offer higher potential returns as compensation for the likelihood of increased volatility. Rollover -The shifting of an investor's assets from one qualified retirement plan to another-due to changing jobs, for instance-without a tax penalty. Sales Charge or Load -An amount charged for the sale of some fund shares, usually those sold by brokers or other sales professionals. The charge may vary depending on the amount invested and the fund chosen. A sales charge or load is reflected in the asked or offering price. Series Fund -A group of different mutual funds, each with its own investment objective and policies, that is structured as a single corporation or business trust. Shareholder -An investor who owns shares of a mutual fund or other company. Short-term Funds -Another term for money market funds. Small-cap Stocks -Stock of small-capitalization companies, which are generally considered to be companies whose total outstanding shares are valued at less than $1 billion. Stock -A share of ownership or equity in a corporation. Total Return -A measure of a fund's performance that encompasses all elements of return: dividends, capital gain distributions and changes in net asset value. Total return is the change in value of an investment over a given period, assuming reinvestment of any dividends and capital gain distributions, expressed as a percentage of the initial investment. Transfer Agent -The organization employed by a mutual fund to prepare and maintain records relating to shareholder accounts. Underwriter -The organization that sells a mutual fund's shares to broker/dealers and investors. Withdrawal Plan -A fund service allowing shareholders to receive income or principal payments from their fund account at regular intervals. Yield -A measure of net income (dividends and interest) earned by the securities in the fund's portfolio less fund expenses during a specified period. A fund's yield is expressed as a percentage of the maximum offering price per share on a specified date. Related Links |