Mutual Funds

Question 1

Define

“Mutual Funds”

Answer 1

• MF is a collection of investment money pooled from many investors to be invested for a specific objective.
• Consider a mutual fund a bucket that contains other investments such as stocks, bonds, cash, etc.
• When you invest in a fund, you buy shares of the fund, therefore you become a shareholder of the fund.
• Keep in mind that when you buy or sell a mutual fund, the transaction occurs at the closing price on the day that you place the trade
  
  • ( that is if the trade is placed before the market closes).
• The fund manager and his team of assistants determine which specific securities they should invest the shareholders’ money into to accomplish the objectives of the fund.

Question 2

Define

“Exchange Traded Funds”

Answer 2

• Exchange-traded funds (ETFs) are a very close relative of mutual funds and differ from them in one particular way.
• ETFs trade like stocks on a stock exchange and thus can be bought or sold during the trading day when the financial markets are open.

Question 3

How are funds categorized?

Answer 3

• Funds broadly categorize by their investment objective, like the way an automaker labels a car a sedan or a sport utility vehicle.

Question 4

Describe

“lending type of investment”

Answer 4

• Lending investment is a type of investment in which the lender (you) charges the borrower (bank, etc) a fee (interest) until the original loan (the principal) gets paid back.
• Familiar lending investments include bank certificates of deposit (CDs), United States (U.S.) Treasury bills, and bonds issued by corporations, such as Chipotle.

Question 5

Describe

“ownership type of investment”

Answer 5

• Ownership investments can generate profits in two ways:
  
  • Through the investment’s own cash flow/income (e.g. dividends)
  • Through appreciation in the value of the investment
• When you purchase an asset you’re an owner.
  
  • Whether a building or part of a multinational corporation, that has the ability to generate earnings or profits.
  • Real estate and stock are common ownership investments.

Question 6

Describe

“Money Market Funds”

Ref:

Answer 6

• A money market fund is a kind of mutual fund that invests only in highly liquid near-term instruments such as cash, cash equivalent securities, and high credit rating debt-based securities with a short-term, maturity—less than 13 months, such as U.S. Treasuries.
• As a result, these funds offer high liquidity with a very low level of risk.

Question 7

Define

“Publicly Held Companies”

Answer 7

• Companies that sell stock to the general public
• When you hold stock in a company, you share in the company’s profits in the form of annual dividends (although some companies don’t pay dividends) as well as in an increase (you hope) in the stock price if the company grows and makes increasing profits.

Question 8

Why should an investor contribute to an employer-sponsored plan instead of an annuity?

Answer 8

• Annuities also charge relatively high fees.
• That’s why it makes sense to consider contributing to an annuity after you fully fund the tax-deductible retirement accounts that are available to you.

Question 9

Describe

“Annual Return”

Ref: https://www.investopedia.com/terms/a/annual-return.asp

Answer 9

• An investment’s return measures how much the investment has grown (or shrunk, as the case may be).
• Return figures are usually quoted as a rate or percentage that measures how much the investment’s value has changed over a specified period of time.
• So if an investment has a five-year annualized return of 8 percent, then every year for the past five years that investment, on average, has gotten 8 percent bigger than it was the year before.

Question 10

Describe

“Volatility”

Answer 10

• Volatility is the size of the fluctuations in the value of an investment

Question 11

Describe

“Diversification”

Answer 11

• Diversification is one of the most powerful investment concepts.
• It requires you to place your money in different investments with returns that aren’t completely correlated.
• With your money in different places, when one of your investments is down in value, the odds are good that at least one other is up
• A fund owns stocks or bonds from dozens of companies, diversifying against the risk of bad news from any single company or sector

Question 12

Describe

“Closed-end Funds”

Answer 12

• Closed-end funds are those where the mutual fund companies decide upfront before they take on any investors, exactly how many shares they’ll issue.
• After they issue these shares, the only way you can purchase shares (or more shares) is to buy them from an existing investor through a broker.

Question 13

Describe

“Net Asset Value”

Answer 13

• The NAV represents the per share/unit price of the fund on a specific date or time.
• Mutual funds don’t trade in real-time. Instead, mutual funds are priced based on the end of the day methodology based on their assets and liabilities.

Question 14

Describe the fund’s risk levels

Answer 14

• Stock funds: If you want your money to grow over a long period of time (and you can put up with some bad years thrown in with the good), select funds that invest primarily in stocks
• Bond funds: If you need current income and don’t want investments that fluctuate as widely in value as stocks do, consider bond funds
• Money market funds: If you want to be sure your invested principal doesn’t drop in value because you may need to use your money in the short term, you can choose a money market fund

Question 15

Describe a loss in a Mutual Fund

Answer 15

• That’s not to say that you can’t lose money in a mutual fund or exchange-traded fund. The share price of a fund is tied to the value of its underlying securities: If the underlying securities, such as stocks, decrease in value, so, too, does the net asset value (share price) of the fund.
• you can’t lose all your investment in a fund unless every single security owned by that fund simultaneously becomes worthless — an extraordinarily unlikely event.
• specific stocks and/or bonds that a mutual fund buys are held by a custodian — a separate organization or affiliate of the fund company. The employment of a custodian ensures that the fund management company can’t embezzle your money

Question 16

Why should you invest in retirement accounts before investing in non-retirement accounts?

Answer 16

• Some investors make the common mistake of neglecting to take advantage of retirement accounts in their enthusiasm to invest in nonretirement accounts.
• Doing so can cost you hundreds of thousands of dollars over the years.

Question 17

Why is it important to identify investors’ tax brackets before investing in non-retirement accounts?

Answer 17

• When you’re investing in mutual funds outside of tax-sheltered retirement accounts, the profits and distributions that your funds produce are subject to taxation.
• If you’re in a high-income tax bracket, give preference to mutual funds and exchange-traded funds, such as tax-free bond funds and stock funds with low levels of distributions (especially highly taxed short-term capital gains).
• In other words, focus more on stock funds that derive more of their expected returns from appreciation rather than from taxable distributions.

Question 18

Define

“Asset Allocation”

Answer 18

Asset allocation simply means how your investments are divvied up among the major types of securities or funds, such as money market, bond, United States (U.S.) stock, international stock, and so on.

Question 19

Define

“Time Horizon”

Answer 19

In other words, how much time you have between now and when you need the money.

Question 20

Describe the tax deferment for 401(k) contributions.

Answer 20

Your contributions to a 401(k) are excluded from your reported income and are free from federal and state income taxes but not from FICA (Social Security) taxes.

Question 21

Describe the consequences of delaying retirement savings

Answer 21

• Each decade you delay approximately doubles the percentage of your earnings that you should save to meet your goals.
• For example, if saving 5 percent per year starting in your early 20s would get you to your retirement goal, waiting until your 30s may mean socking away 10 percent; waiting until your 40s, 20 percent; beyond that, the numbers get troubling.

Question 22

Define

“Emergency Fund”

(aka “Pillow Fund”)

Answer 22

It’s a fund to cushion your fall when life unexpectedly trips you up. Call it your pillow fund. You’ll be amazed how much of a stress reducer a pillow fund is.

Question 23

Describe

“SEP-IRA”

Answer 23

• Self-employed or a small-business owner, you can establish your own retirement savings plans.
• Simplified employee pension individual retirement account (SEP-IRA) plans require little paperwork to set up.
• They allow you to sock away 25 percent of your self-employment income (business revenue minus expenses) up to a maximum of $57,000 for 2020.
• Contribution limits for 2019 is $56,000

Question 24

How can you tell whether you’re participating in a retirement plan at work?

Answer 24

• To know for certain whether you’re an active participant, look at the W-2 form that your employer sends you early in the year to file with your tax returns.
• Little boxes indicate whether you’re an active participant in a pension or deferred compensation plan.
• If either box is checked, you’re an active participant.

Question 25

What guidance is given to individuals who want to invest in stocks?

Answer 25

If you really want to invest in individual stocks and bonds, I suggest that you limit your purchase of individual securities to no more than 20 percent of the total money you’ve invested in stocks and bonds (including those you’ve invested in via mutual and exchange-traded funds).

Question 26

Define

“Unit Investment Trust”

Answer 26

• UITs take an amount of money (for example, $100 million) and buy a number of securities (such as 70 large-company U.S. stocks) that meet the objectives of the UIT.
• Unlike a closed-end fund (and mutual funds in general), however, a UIT does not make any changes to its holdings over time — it simply holds the same, fixed portfolio.
• This holding of a diversified portfolio can be advantageous because it reduces trading costs and possible tax bills.

Question 27

What are some of the major flaws of

“Unit Investment Trust”

Answer 27

• Significant upfront commissions
• Lack of liquidity: Especially in the first few years after a particular UIT is issued, you won’t readily find an active market in which you can easily sell your UIT.
• Lack of ongoing management oversight: Because UITs buy and hold a fixed set of securities until the UIT is liquidated (years down the road), they’re more likely to get stuck holding some securities that end up worthless.

Question 28

Describe

“Wrapped or Managed Accounts”

Answer 28

• Wrap accounts, or managed accounts, go by a variety of names, but they’re the same in one crucial way: For the privilege of investing your money through their chosen money managers, they charge you a percentage of the assets that they’re managing for you.
• These accounts are quite similar to mutual funds except that the accounts don’t have the same regulatory and reporting requirements as do mutual funds

Question 29

Describe

“Robo-Advisors”

Answer 29

• Robo-advisors (Robo-Advisors, Robo-Advisers) are digital platforms that provide automated, algorithm-driven investment services with little to no human supervision.
• Robo-advisors most often automate and optimize passive indexing strategies that follow mean-variance optimization.
• Robo-advisors are often very inexpensive and require very low opening balances so that nearly everybody can benefit from a Robo-Advisor if they choose.
• In my opinion, Robo-Advisors are good for those individuals with smaller contribution amounts.
• The problem with Robo-Advisors is that they encourage nonretirement account investing because that’s where they make their money.

Question 30

Describe the erosion of

“Operating Expenses”

Answer 30

• YOU CAN AND SHOULD EXAMINE A FUND’S EXPENSES AND FEES BEFORE YOU BUY INTO IT.
• The charges you pay to buy or sell a fund and the ongoing fund-operating expenses have a big impact on the rate of return you ultimately earn on your investments because fees are deducted from your investment returns.

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• One cost of fund ownership that you simply can’t avoid is operating expenses. Every fund — load and no-load — has operational costs: paying the fund manager and research assistants, employing people to answer the phone lines and operate a website, printing and mailing prospectuses, buying technology equipment to track all those investments and customer-account balances, and so on.
• A fund’s operating expenses are quoted as a percentage of the fund’s assets or value. The percentage represents an annual fee or charge.
• All other things being equal, high fees and other expenses reduce your returns.
• A fund’s operating expenses are essentially invisible to you because they’re deducted before you’re paid any return

Question 31

Define

“Load”

Answer 31

• A load is a sales charge or commission charged to an investor when buying or redeeming shares in a mutual fund.

Question 32

Describe

“High Returns vs High Risk”

Answer 32

• Realize that funds with relatively high returns may achieve their results by taking on a lot of risks.
• Those same funds often take the hardest fall during major market declines.
• Remember that risk and return go hand in hand; you can’t afford to look at return independent of the risk it took to get there

Question 33

Describe

“Share Class Loads”

Answer 33

• Shares with the traditional front-end load are usually sold as Class A shares.
• Class B, C, and D shares are the classes for which the mutual fund marketers deploy tricky techniques, such as back-end loads or ongoing commissions known as 12b-1 fees. These commissions often end up being more expensive than the old upfront loads.
• Take the back-end sales load, for example, which is the typical technique of Class B shares. Instead of assessing a load when you purchase these shares, you’re charged a load when you sell them.
• But wait, the broker tells you, the more years you hold on to the shares, the lower the sales charge when you sell. In fact, if you hold on to the shares long enough — usually five to seven years — the load disappears altogether. This deal sounds a lot better than the Class A shares, which charge you an upfront load no matter what.
• Not so fast. The broker selling the Class B shares still gets a commission. The company simply raises the fund’s operating expenses (much higher than on Class A shares) and pays the broker commissions out of that.
• One way or another, the broker gets his pound of flesh from your investment dollars.

Question 34

Describe

“Fund Performance”

Answer 34

• Fund performance numbers are the same: They don’t mean much until they’re compared to the averages.
• The trick is picking the correct benchmark (relevant index market average) for comparison.
• The resources and capabilities of the parent company should be equally important in your selection of which funds to invest in.

Question 35

What is the importance of a

“Prospectus”

Answer 35

• The most valuable information — the fund’s investment objectives, costs, and performance history — is summarized in the first few pages of the prospectus.

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• Some prospectuses describe more than one fund in a particular fund family.

READ THESE!!!

Question 36

Describe the sections of the prospectus

Answer 36

• The fund profile pages (beginning with Figure 8-2) contain a synopsis of the main attributes of the fund, such as a description of the fund’s investment objectives and the strategies (the types of securities the fund invests in) that it employs to accomplish its objectives.

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• The performance information also shows the impact of taxes (which assumes the deduction of taxes at the highest federal rates) and comparison of the fund’s returns to relevant market indexes.
• Operating expenses are fees charged on a continuous basis by all mutual funds; they cover the expenses of running a fund and include the fund company’s management fee — out of which it earns its profit.

Question 37

Describe the “Other Information” sections of the prospectus

Answer 37

The next section of the prospectus (see Figure 8-4) presents you with a hodgepodge of facts about the fund, some of which may be important to you: who manages the fund, how long the fund has been in existence, what the fund’s total assets are, what its minimum initial investment amount is, and how to purchase and redeem shares.

Question 38

Describe the “Investment Objectives and Risks” sections of the prospectus

Answer 38

This next section on investment strategies explains in detail what the fund is try- ing to accomplish and what risks the fund is subject to.

Question 39

Define

“Net Asset Value”

Answer 39

• The Net Asset Value (NAV) is the price per share of the fund

Question 40

Describe the “Investment Advisor” sections of the prospectus

Answer 40

• This important section provides background about the investment adviser — the folks actually managing the investments of this fund.
• You can read about the firm that makes the fund’s investment decisions.

Question 41

Define

“Total Return”

Answer 41

• The Total Return represents what investors in the fund have earned historically.
• The returns on this type of fund, which invests in stocks and bonds, bounce around from year to year.
• You can see how the total investments (Net Assets) in the fund have changed over time.
• Assets can increase from new money flowing into the fund as well as from an increase in the value of a fund’s shares.

Question 42

Define

“Annual Operating Expenses”

Answer 42

• This section of a prospectus also shows you how a fund’s annual operating expenses (Ratio of Total Expenses to Average Net Assets) have changed over time.
• The line Ratio of Net Investment Income to Average Net Assets shows the annual dividends, or yield, that the fund has paid.
• The Turnover Rate tells you how much trading takes place in a fund. Specifically, it measures the percentage of the portfolio’s holdings that has been traded over the year:
  
  • A low turnover number (less than 30 percent or so), such as the one for this fund, denotes a fund with more of a buy-and-hold strategy.
  • A high turnover number (100 percent plus) indicates a fund manager who does a lot of trading. Rapid trading is costlier and riskier and may increase a fund’s taxable distributions.
• Assets can increase from new money flowing into the fund as well as from an increase in the value of a fund’s shares.

Question 43

Describe

“Statement of Additional Information (SAI)”

Answer 43

Brokerage expenses are disclosed in a fund’s Statement of Additional Information (SAI).