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A mutual fund is a collection of stocks, bonds or other securities owned by a group of investors and managed by a professional investment company. Most investment professionals agree that it is smarter to diversify one's portfolio, which can be difficult. Mutual funds offer one solution: when investors put money in a fund, it is pooled with money from other investors. Since a fund can own hundreds of different securities, its success is not dependent on how a few holdings do. Managers constantly adjust the portfolio for the strongest possible performance.
A mutual fund makes money in two ways: by earning dividends or interest and by selling investments that have increased in price. Income distributions are from the money the fund earns on its investments. Capital gain distributions are the profits from selling investments.
Most mutual funds are open-end funds. That means the fund sells as many shares as investors want. Closed-end funds more closely resemble stocks in the way they are traded. They raise money only once, offer only a fixed number of shares, and are traded on an exchange or over-the-counter.
Mutual Funds fall into three main categories:
1. Stock or Equity Funds: like individuals, these funds buy blue chip stocks for income and safety; growth stocks for future gains; value stocks for stability and growth; and cyclical stocks during economic booms. Buying through a fund allows for greater diversity.
2. Bond funds: like individual bonds, they produce regulat income, but unlike bonds, they have no maturity dates and no guaranteed repayment. However, the dividends can be reinvested to increase the principal. There are investment grade corporate bund funds, and riskier junk bonds often promising higher yields. Also, one can choose long term or short term US Treasury bond funds, a combination, and even a variety of municipal bonds.
3. Money Market Funds: they resemble savings accounts. They are virtually risk free, so their return is relatively low. Most money market funds allow some check writing against those funds.
Many newer, specialized funds have been developed to appeal to those seeking specific investments. Here are some types:
1. Index Funds: designed to produce the same return that investors would get if they owned all the stocks in a particular index - like the S & P 500.
2. Tax Free Funds: this is appealing to individuals in higher income brackets. The biggest saving occurs when a person living in a high state tax such as California buys a fund that specializes in California municipal bonds.
3. Sector Funds: focus on the stocks of individual industries, like technology or heath care. Precious metal funds, similarly, are invested in mining stocks and bullion.
4. Green and other Conscience Funds: attract investors with strong political or social beliefs and allegiances. A green fund might avoid tobacco or companies with poor environmental track records.
Tracking Mutual Funds Performance:
| Net Asset Value (NAV CHANGE) |
Value of fund / number of shares = NAV
Example: 52,500,000 / 3,500,000 = $15
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It is the dollar value of one share of the fund's stock. It is found by dividing the current value of the fund by the number of shares. If a share costs $15 today and $9 a year ago, there has been a capital gain of $6 per share, or about 66%. |
| YIELD |
Distribution per share / price per share = Yield %
Example: $.58 / $10.00 = 5.8%
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It measures the amount of income as a percentage of current price. A long term bond with a NAV of $10 paying a $.58 dividend per share provides a 5.8% yield. That yield can be compared with comparable investments. |
| RETURN |
Current value / cost of initial investment = return %
Example: $85,000 / $5,000 = 17% |
It tells investors what percentage they made or lost overtime. It is found by dividing the current value of an investment (the number of shares times the NAV). An investment worth $85,000 that cost $5,000 has a return of 17%. |
A Word on International and Global Funds
International Funds are also known as Overseas Funds, they invest in foreign stock or bond markets. They spread the risk by owning securities in mature, slow growing economies as well as booming economies of small nations.
Global Funds are also known as World Funds and they include US stocks or bonds in their portfolio along with those from other countries. They usually invest 75% of their assets in US companies.
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