Mutual funds are the most prevalent investment funds in use. Sometimes referred to as open-ended funds, mutual funds sell units to investors on an ongoing basis. As the number of assets in the fund increase, the fund purchases more assets accordingly. Investors can redeem their units at any time directly with the issuer.
For most investors, the biggest advantage of mutual funds is that they provide a level of diversification otherwise possible only with larger portfolios. Mutual funds allow investors to purchase “baskets” of equities, bonds, or other securities often without incurring commissions, sales charges or transaction fees. As a result they are an excellent means by which a small portfolio can obtain broad-based exposure to an entire sector or industry.
As the interest in mutual funds has increased, fund managers have introduced increasing varieties of both general and specialized mutual funds. Broadly speaking, mutual funds available to the investing public fall into one of the following categories:
· Equities
· Aggressive Growth
· Small Cap
· Sector
· Growth
· Growth and Income
· Balanced
· Global
· International
· Emerging Market
· Country/Regional
· Fixed Income
· High Yield
· Mortgage Backed
· Government Agency
· Long-Term Government
· Long-Term Corporate
· Tax-Advantaged
· Short-Term Bond
· Money Market
· Tax-Advantaged Money Market
· International Bond
This table shows the relative performance ranking achieved by 11 mutual fund categories over the past 1-, 3-, 5-, and 10-year time periods ended December 31, 2004. Note how no one category consistently outperformed all others. Past performance is no guarantee of future results.
**Source: Standard & Poor’s, 12/31/04. Based on the average total returns of all funds tracked by Standard and Poor’s within a category.
Price and Distribution
The fund’s NAVPS (net asset value per share) represents the price paid for a single unit in a mutual fund, excluding sales, commissions or redemption charges. The formula for calculating the NAVPS is as follows:
Portfolio Assets - Liabilities / Units Outstanding = NAVPS
The NAVPS is calculated daily for most funds and listed in financial publications as the daily price for that fund. Mutual funds are available from several sources. A wide range of funds from different issuers are usually available from investment dealers. In addition the major banks offer their own groups of mutual funds or fund “families” through their investment firm subsidiaries.
Independent mutual fund companies also offer mutual funds through their own independent sales force. These firms levy sales or redemption charges to investors. Mutual funds fall into one of the following kinds with respect to sales charges:
- No-load funds, which have no sales or redemption charges. Some no-load funds come with a minimum hold period to discourage investors from switching between funds.
- Front-end load funds, which levy a sales charge upon the purchase of the fund. These charges are considered to be in exchange for the advice and planning that the salesperson may do on the investor’s behalf.
- Back-end load funds, which apply a charge when the investor sells, or redeems, a mutual fund holding. The investor should be aware that the load charge is calculated as a percentage of the value of the purchase. In the case of back-end loads, the calculation will be made against fund units that have probably increased in value, Such funds may offer a declining load if kept for a predetermined number of years.
Some funds come with the choice of either front-end or back-end charges. Alternatively, the mutual fund representative may be willing to negotiate the charges in order to obtain new business. Financial institutions that sell funds of other mutual fund companies may also add sales or redemption charges for doing so.
The effect of a sales charge on the unit cost for a mutual fund purchase can be calculated as follows:
Investor’s Cost = NAVPS / (1-Sales Charge)
The payment of loads or sales charges should not be seen as being indicative of the quality of the fund or the fund portfolio managers. In fact, there are load mutual funds that are identical, except in name, to no-load funds offered by other financial institutions. These funds not only have the same selection of assets but are managed by the same portfolio managers.
Entirely separate from the load charge is the management fee (management expense ratio, or MER) that is levied by all funds as the fee charged by the portfolio manager who is responsible for making the investment decisions of the fund.
Finally, mutual fund companies also pay mutual fund representatives another type of incentive, known in the industry as trailer fees. These fees are paid by the fund to representatives for selling and maintaining account relationships, but mutual fund investors do not directly pay them.
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