Q. Where did mutual funds originate?

A. Investors have pooled investment capital and hired professional management for hundreds of years. From the era of Egyptian desert caravans through the days of the great Dutch and English merchant empires, investors spread the considerable risk of such ventures by pooling their investments so that no one would be ruined by the loss of any one caravan or the sinking of any one ship.

The most famous English and Scottish pools, called investment trusts, made investments accessible to the growing middle class of modest investors. Investors with moderate means entrusted their money to the management expertise of  professional merchants and trading companies. These were the models on which modern mutual funds are based.

American mutual funds developed during the late 1800s and the early 1900s. As the American middle class grew and developed demand for investments, individuals turned their money over to financial institutions to make their investment decisions. The first mutual fund in the form we have today was established in 1924. The American mutual fund industry has grown rapidly in recent years-the number of active mutual funds increased form 68 in 1944 to 3,952 in 1994.

 

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Q. How are mutual funds formed?

A. Mutual funds are formed by a fund sponsor. The fund sponsor may be a company that specializes in marketing mutual funds, or it may be a bank or brokerage firm. Many sponsors establish several mutual funds with various investment objectives, or what is called a fund family.

An investment company is the legal term for a mutual fund. (The terms investment company, mutual fund, and fund are often used interchangeably.) The formal features of investment companies were established by the Investment Company Act of 1940, the Investment Company Amendments Act of 1970 and the Investment Company Amendments Act of 1970. These laws were designed to protect investors by requiring registration of all shares being offered and full disclosure of the fund's investment goals; its advisors, sponsors, distributors, etc; and all fees and charges. The investment company is required to issue a prospectus to fulfill full disclosure requirements. The prospectus must be provided to all investors that purchase funds.

Prospectus: A document filed with the Securities and Exchange Commission that contains material information necessary for full disclosure for solicitation purposes by the issuer and the distributor of securities. For a mutual fund, material information may include the following: investment objectives, advisors charges (fees), performance statistics, and purchase and liquidation instructions.

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Q. Who carries out the business of a mutual fund?

A. The mutual fund shareholders elect trustees who are responsible for carrying out the activities of the fund. The trustees will appoint an investment advisor, or management company, which will be responsible for the fund's investment policies and management decisions concerning the fund's portfolio. The mutual fund usually pays the investment advisor a management fee based on a percentage of the fund's assets. The trustees may also appoint a distribution company to be responsible for the sales and marketing of the fund's shares. The distribution company may work with sales organizations such as brokerage firms, banks, etc. to arrange advertising for sales directly to investors or do any combination of these in promoting the fund to investors. The trustees will also appoint a transfer agent to perform shareholder services such as accounting, communication, and administration of distributions.

 

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Q. I have heard the term net asset value (NAV). What is it?

A. Net asset value (NAV) is the value of all the assets owned by a fund, net of liabilities. The net asset value per share is the fund's total NAV divided by the number of shares outstanding.

 

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Q. Is the NAV the same as the market price of my mutual fund shares?

A. It depends on the type of mutual fund you own.

• Open-end: The market price (liquidating value) of your open-end shares is the NAV. In some open-end funds, the offering or asked price (purchasing price) may be higher than net asset value because it includes a sales charge. Some open-end mutual funds have a contingent deferred sales charge.

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• Closed-end:The market price of your closed-end fund shares may be substantially above or below their net asset value. After their initial offering, closed-end fund shares are subject to market price fluctuations based on supply and demand.

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• Unit Investment Trusts:The market price of your UIT units will generally be the same as the NAV. Most UIT sponsors provide a secondary market for the unit at NAV plus any accrued interest, if appropriate.

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Q. I have heard of mutual fund expenses and fees. What are they?

A. All mutual funds incur expenses. Generally, the expenses are deducted from income before distributions to shareholders or deducted in the calculation of NAV. Some mutual funds also charge a sales fee (referred to as a "load"), which is added to the net asset value when purchasing new shares or deducted from the NAV when selling. All expenses and sales fees are disclosed in the prospectus.

 

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Q. What sales fees may I incur when investing in mutual funds?

A. Many open-end mutual funds charge some form of sales fee, or load. Some funds offer a choice of several load structures. The types of load include:

• Front-end load.

• Back-end load.

• Level load.

• No load.

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Q. What is a front-end-load mutual fund?

A. Funds that charge a front-end load usually depend on investment brokerage firms to attract and service investors. The fund charges a sales charge up front that is added to the NAV. On an ongoing basis, the fund may also deduct yearly expenses and 12b-1 fees from the portfolio's earnings. Shares sold with a front-end sales charge are often referred to as "A" shares.

 

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Q. What is a back-end-load mutual fund?

A. Funds that charge a back-end load usually depend on brokerage firms to sell their shares to investors. Investors pay little or no commission at the time the shares are purchased. Instead, they may be subject to redemption fees, called contingent deferred sales charges (CDSC), on the "back end". If you sell shares before a certain date, your redemption proceeds will be reduced by the contingent deferred sales charge. CDSCs usually decline as the shares are held longer, disappearing altogether if the shares are held beyond a certain number of years (usually from three to seven years). Yearly expenses are also deducted from the portfolio's earnings. CDSCs are always disclosed in a fund's prospectus. The CDSC is waived upon the death of the shareholder if the prospectus contains such a provision. Shares sold with a back-end sales charge are often referred to as "B" shares.

 

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Q. How important are expenses and fees in mutual fund investing?

A. Expenses and sales charges obviously reduce a mutual fund's performance. Between two mutual funds with identical portfolio performance, the fund with lower expenses and fees will be a better investment. You must weigh the expense and fee factor against your other investment criteria, such as investment objectives and risk tolerance. How well a fund meets your investment objectives and the fund's long-term performance should be more important than expenses and fees alone.

 

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Q. Why should I consider investing in mutual funds?

A. Mutual funds are an alternative form of owning the individual investments-such as stocks and bonds-that compose the fund's portfolio. Some investors prefer to hold the individual stocks or bonds, but others invest in mutual funds for several reasons, including:

• Professional management.

• Diversification.

• Investment convenience.

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Q. How does a mutual fund's professional management benefit me?

A. While you can perform your own research and invest directly in individual securities, you may lack the resources, time, and expertise to do so. By investing in a mutual fund, you are hiring professional investment advisors who do have the resources, time and expertise to manage your assets pooled with the assets of others who have the same investment objectives.

 

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Q. How does a mutual fund's diversification benefit me?

A. The many investors who do not have large amounts of money to invest cannot buy enough individual stocks or bonds to build a diversified portfolio, Diversification, and important investment discipline, reduces an investor's dependence on any one issue's success or failure. A mutual fund offers investors instant diversification by providing a professionally managed portfolio suitable for your investment objectives.

An investor may achieve even wider diversification by holding a variety of mutual funds with different investment objectives or styles of management.

 

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Q. How can mutual funds provide me investment convenience?

A. Mutual funds offer many features that are not always available to you in other investments. Such features may include:

• Full and fractional shares. With open-end funds, you can invest or withdraw the exact dollar amount you want, since the fund will issue full and fractional shares to accommodate the dollars invested. Fractional shares are usually carried to three decimal places (for example, 181.748 shares).

• Rights of accumulation. Most mutual funds with sales charges offer discounts when larger amounts of money are invested. For example, a sales charge may decrease from 5.75 percent to 4.5 percent for investments over $50,000. This means that the sales charge would be reduced when you make a $50,000 investment. Rights of accumulation allow you the discount on additional investments if your total balance, including the amount you invest, is above the threshold, no matter how small the investment that sends the balance over the threshold. For example, if the value of your mutual fund account is $40,000 and you add $10,000 to your account, the additional investment would have a sales charge based on $50,000.

• Periodic investment plans. You may wish to invest a certain amount in several installments over a period of time. Under a periodic investment plan, you can mail checks to the fund on specific dates or the fund can arrange a withdrawal of specific amounts from your checking account for automatic investment on the dates specified.

This feature may allow you to engage in the dollar cost averaging investment method rather than investing large amounts of money at one time. Periodic investing is a particularly good method for beginning investors, as it enables them to invest nominal amounts.

• Automatic reinvestments. Most mutual funds offer you the ability to reinvest dividends and capital gains distributions into additional shares of the fund. Additionally, the fund may offer to invest the distributions in shares of another funds in the same sponsor's family of funds.

• Systematic Withdrawal features allow you to designate a specific amount you wish to receive from your fund on a regular basis. Many funds will give you a choice of how you may receive your distribution. You may receive a check, or you may have the distribution deposited directly to your bank account. If you wish to receive $200 monthly, for example, a fund offering systematic withdrawal will send you that amount whether or not your investment produced $200 in the month. If your fund investment produced more than $200, the excess will remain in your mutual fund account, adding to your fund's investment value. If your investment earned less, the shortage would reduce the value of your account. Either way, you can count on receiving your planned distribution amount.

Note: You may want to establish a specified withdrawal rate lower than the anticipated total return of the fund so the value of the fund will continue to grow despite the withdrawals. If the value increases as anticipated, you should be able to increase future withdrawals

 

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Q. How do I choose a mutual fund?

A. As with any type of investment, you should consider your needs and choose accordingly:

• Determine your investment objectives.

• Choose the type of mutual fund appropriate for your objectives.

• Gather information on the individual mutual funds within your chosen fund type.

• Choose the mutual fund that best suits your criteria for investment performance, risk, expense, etc.

• Request and review the mutual funds prospectus and consult with a GlobaLink financial consultant before investing.

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Q. What types of mutual fund investment objectives are there?

A. In recent years the numbers of mutual funds with different investment objectives have grown. You may want to select one mutual fund or build a portfolio of funds. Mutual funds can be classified by investment objectives, including:

• Growth funds.

• Aggressive growth funds.

• Value funds.

   

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Q. How can I keep track of my mutual fund's progress?

A. Mutual fund prices are quoted in the financial media on a daily basis. Prices of closed-end fund shares will be included in the stock quote section of newspapers. Open-end fund quotes have a separate section and a somewhat different format. The fund quotes are grouped together with the other funds in their family of funds. You may also call your broker or the fund directly for information such as current value, yield, and performance. Most mutual funds have toll-free telephone numbers for your convenience

In addition, you will receive regular statements from your mutual fund and/or your broker. The statements will report any purchases, liquidations, or distributions that took place in your account during the period and will provide a cumulative total of the shares your own. It is important for you to keep these statements for your records, since they contain the cost basis information on any shares you bought during the period. You may need the information they contain at a future date for income tax purposes. This is particularly true if you are continually reinvesting your income and/or capital gains distributions into more shares.

 

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Q. Will I receive a certificate for my mutual fund investment?

A. Generally, mutual fund shares are held at the fund on your behalf. However, most funds will send you a certificate if you specifically request it.

 

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Q. How do I measure my mutual fund's performance?

A. Mutual funds use various methods to measure their performance, but as with direct stock and bond investments, the most common measurement is total return. The total return of your fund consists of the income distributions you receive and the capital gains you achieve from capital gains distributions plus or minus the change in the value of your mutual fund shares.

 

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Q. How do I sell my mutual fund investment?

A. The way you sell your mutual fund shares is similar in principle to the way you bought your shares. With closed-end shares, the procedure is the same as that for selling any stock. With open-end funds, you are selling shares back to the fund itself at NAV, either directly or through your broker. Although some mutual fund companies accept telephone instructions, you will generally need to send a letter of authorization requesting either a full or partial liquidation of your mutual fund account.

 

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Q. How are mutual fund investment taxed?

A. Generally, income and capital gains distributed from your mutual fund investment will be taxed in much the same way as those from other investments. Tax regulations require your mutual fund to distribute at least 90 percent of its taxable income. You will pay income taxes on income distributions (even if you are reinvesting them ) unless your fund invests in tax-free securities such as municipal bonds. Your income distributions may include short-term gains from sales of securities in the mutual fund's portfolio. You will pay capital gains taxes if:

• Your fund makes a capital gains distribution to you.

• You sell some or all of your mutual fund shares for a gain.

Your fund will distribute capital gains when it sells securities from its portfolio and makes a net profit. You should report all capital gains distributions as long-term capital gains, regardless of how long you have owned your mutual fund shares.

If you sell shares in your mutual fund for more than you paid for them, you will pay taxes on the gains. Calculating the gains may be complicated if you have purchased shares at different times and at different prices (for example, by reinvesting your dividend and capital gains distributions). If you incur losses instead of gains, you may be eligible for a deduction from taxable income. Consult your tax advisor for methods of reporting such gains and/or losses.

 

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Note of Caution: Beware of purchasing mutual fund shares shortly before December. Since many mutual funds make their capital gains distributions in December, you could find yourself liable for taxes on the full year's gains even though you just purchased your shares.

Source: Money Investing Victor L. Harper., Arthur S. Brinkley., with Sarah E. Dale