A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it in securities, corporate bond, government bond and short-term money market investments. The mutual fund will have a fund manager that manages the pooled money on a regular basis. The net proceeds or losses, income earn from the invested instruments are then typically distributed to the investors annually.
Most mutual funds’ investment portfolios are continually adjusted under the supervision of a professional manager, who forecasts cash flows into and out of the fund by investors, as well as the future performance of investments appropriate for the fund and chooses those which he or she believes will most closely match the fund’s stated investment objective. A mutual fund is administered under an advisory contract with a management company, which may hire or fire fund managers.
But while you may not own the assets themselves, they are important because the value of the fund is based on the value of the assets it holds. As the stocks, bonds and so on within the fund increase in value, the fund increases in value. Conversely, as the stocks, bonds and so on within the fund decrease in value, the fund also decreases in value.
Net asset value-The net asset value, or NAV, is the current market value of a fund’s holdings, less the fund’s liabilities, usually expressed as a per-share amount. For most funds, the NAV is determined daily, after the close of trading on some specified financial exchange, but some funds update their NAV multiple times during the trading day. The public offering price, or POP, is the NAV plus a sales charge. Open-end funds sell shares at the POP and redeem shares at the NAV, and so process orders only after the NAV are determined. Closed-end funds (the shares of which are traded by investors) may trade at a higher or lower price than their NAV; this is known as a premium or discount, respectively.
Average annual return
Most of the mutual fund use following formula to measure returns
P(1+T)n = ERV
Where:
P = a hypothetical initial payment of RM1,000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value of a hypothetical RM1,000 payment made at the beginning of the 1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or fractional portion).
Types of mutual funds
Mutual funds are divided into two categories: closed-end and open-end. Closed-end funds have a limited number of shares. If you want to purchase a piece of the fund, you have to purchase an existing share. Open-end funds have an unlimited number of shares. If you want to purchase a piece of the fund, the fund creates a new share and sells it to you. There are significantly more open-end funds than there are closed-end funds.
And Mutual fund can be classified as below:
Money Market Funds
The money market consists of short-term debt instruments, mostly Treasury bills. This is a safe place to park your money. You won’t get great returns, but you won’t have to worry about losing your principal. A typical return is twice the amount you would earn in a regular checking/savings account and a little less than the average certificate of deposit.
Bond/Income Funds
Income funds are named appropriately: their purpose is to provide current income on a steady basis. When referring to mutual funds, the terms “fixed-income,” “bond,” and “income” are synonymous. These terms denote funds that invest primarily in government and corporate debt. While fund holdings may appreciate in value, the primary objective of these funds is to provide a steady cashflow to investors. As such, the audience for these funds consists of conservative investors and retirees.
Bond funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren’t without risk. Because there are many different types of bonds, bond funds can vary dramatically depending on where they invest. For example, a fund specializing in high-yield junk bonds is much more risky than a fund that invests in government securities. Furthermore, nearly all bond funds are subject to interest rate risk, which means that if rates go up the value of the fund goes down.
Balanced Funds
The objective of these funds is to provide a balanced mixture of safety, income and capital appreciation. The strategy of balanced funds is to invest in a combination of fixed income and equities. A typical balanced fund might have a weighting of 60% equity and 40% fixed income. The weighting might also be restricted to a specified maximum or minimum for each asset class.
A similar type of fund is known as an asset allocation fund. Objectives are similar to those of a balanced fund, but these kinds of funds typically do not have to hold a specified percentage of any asset class. The portfolio manager is therefore given freedom to switch the ratio of asset classes as the economy moves through the business cycle.
Equity Funds
Funds that invest in stocks represent the largest category of mutual funds. Generally, the investment objective of this class of funds is long-term capital growth with some income. There are, however, many different types of equity funds because there are many different types of equities.
The idea is to classify funds based on both the size of the companies invested in and the investment style of the manager. The term value refers to a style of investing that looks for high quality companies that are out of favor with the market. These companies are characterized by low P/E and price-to-book ratios and high dividend yields. The opposite of value is growth, which refers to companies that have had (and are expected to continue to have) strong growth in earnings, sales and cash flow. A compromise between value and growth is blend, which simply refers to companies that are neither value nor growth stocks and are classified as being somewhere in the middle.
For example, a mutual fund that invests in large-cap companies that are in strong financial shape but have recently seen their share prices fall would be placed in the upper left quadrant of the style box (large and value). The opposite of this would be a fund that invests in startup technology companies with excellent growth prospects. Such a mutual fund would reside in the bottom right quadrant (small and growth).
Global/International Funds
An international fund (or foreign fund) invests only outside your home country. Global funds invest anywhere around the world, including your home country.
It’s tough to classify these funds as either riskier or safer than domestic investments. They do tend to be more volatile and have unique country and/or political risks. But, on the flip side, they can, as part of a well-balanced portfolio, actually reduce risk by increasing diversification. Although the world’s economies are becoming more inter-related, it is likely that another economy somewhere is outperforming the economy of your home country.
Specialty Funds
This classification of mutual funds is more of an all-encompassing category that consists of funds that have proved to be popular but don’t necessarily belong to the categories we’ve described so far. This type of mutual fund forgoes broad diversification to concentrate on a certain segment of the economy.
Sector funds are targeted at specific sectors of the economy such as financial, technology, health, etc. Sector funds are extremely volatile. There is a greater possibility of big gains, but you have to accept that your sector may tank.
Regional funds make it easier to focus on a specific area of the world. This may mean focusing on a region (say Asia Pasific) or an individual country (for example, only China). An advantage of these funds is that they make it easier to buy stock in foreign countries, which is otherwise difficult and expensive. Just like for sector funds, you have to accept the high risk of loss, which occurs if the region goes into a bad recession.
Index Funds
The last but certainly not the least important are index funds. This type of mutual fund replicates the performance of a broad market index such as the KLSE. An investor in an index fund figures that most managers can’t beat the market. An index fund merely replicates the market return and benefits investors in the form of low fees.
Mutual Fund Fees and Expenses
As with any business, running a mutual fund involves costs. For example, there are costs incurred in connection with particular investor transactions, such as investor purchases, exchanges, and redemptions. There are also regular fund operating costs that are not necessarily associated with any particular investor transaction, such as investment advisory fees, marketing and distribution expenses, brokerage fees, and custodial, transfer agency, legal, and accountants fees.
Some funds cover the costs associated with an individual investor transactions and account by imposing fees and charges directly on the investor at the time of the transactions (or periodically with respect to account fees). These fees and charges are identified in a fee table, located near the front of a fund prospectus, under the heading “Shareholder Fees.”
Funds typically pay their regular and recurring, fund-wide operating expenses out of fund assets, rather than by imposing separate fees and charges on investors. (Keep in mind, however, that because these expenses are paid out of fund assets, investors are paying them indirectly.) These expenses are identified in the fee table in the fund prospectus under the heading “Annual Fund Operating Expenses.”
A. Shareholder Fees related expenses cover:
· Sales Loads (including Sales Charge (Load) on Purchases and Deferred Sales Charge (Load))
B. Annual Fund Operating Expenses cover
· Total Annual Fund Operating Expenses
A. Shareholder Fees
Sales Loads
Funds that use brokers to sell their shares typically compensate the brokers. Funds may do this by imposing a fee on investors, known as a “sales load” (or “sales charge (load)”), which is paid to the selling brokers. In this respect, a sales load is like a commission investors pay when they purchase any type of security from a broker. Although sales loads most frequently are used to compensate outside brokers that distribute fund shares, some funds that do not use outside brokers still charge sales loads.
There are two general types of sales loads:- front-end sales load investors pay when they purchase fund shares and a back-end or deferred sales load investors pay when they redeem their shares.
Sales Charge (Load) on Purchases
The category “Sales Charge (Load) on Purchases” includes sales loads that investors pay when they purchase fund shares (also known as “front-end sales loads”). The key point to keep in mind about a front-end sales load is it reduces the amount available to purchase fund shares. For example, if an investor writes a RM1,000 check to a fund for the purchase of fund shares, and the fund has a 5% front-end sales load, the total amount of the sales load will be RM50. The RM50 sales load is first deducted from the RM1,000 check (and typically paid to a selling broker), and assuming no other front-end fees, the remaining RM950 is used to purchase fund shares for the investor.
The category “Deferred Sales Charge (Load)” refers to a sales load that investors pay when they redeem fund shares (that is, sell their shares back to the fund). You may also see this referred to as a “deferred” or “back-end” sales load. When an investor purchases shares that are subject to a back-end sales load rather than a front-end sales load, no sales load is deducted at purchase, and all of the investors.money is immediately used to purchase fund shares (assuming that no other fees or charges apply at the time of purchase). For example, if an investor invests RM1,000 in a fund with a 5% back-end sales load, and if there are no other “purchase fees,” the entire RM1,000 will be used to purchase fund shares, and the 5% sales load is not deducted until the investor redeems his or her shares, at which point the fee is deducted from the redemption proceeds.Typically, a fund calculates the amount of a back-end sales load based on the lesser of the value of the shareholder initial investment or the value of the shareholder investment at redemption. For example, if the shareholder initially invests RM1,000, and at redemption the investment has appreciated to RM1,200, a back-end sales load calculated in this manner would be based on the value of the initial investment of RM1,000 on the value of the investment at redemption. Investors should carefully read a fund prospectus to determine whether the fund calculates its back-end sales load in this manner.
A Word About No-Load Funds
Some funds call themselves “no-load.” As the name implies, this means that the fund does not charge any type of sales load. As described above, however, not every type of shareholder fee is a “sales load,” and a no-load fund may charge fees that are not sales loads. For example, a no-load fund is permitted to charge purchase fees, redemption fees, exchange fees, and account fees, none of which is considered to be a “sales load.”
A redemption fee is another type of fee that some funds charge their shareholders when the shareholders redeem their shares. Although a redemption fee is deducted from redemption proceeds just like a deferred sales load, it is not considered to be a sales load. Unlike a sales load, which is used to pay brokers, a redemption fee is typically used to defray fund costs associated with a shareholder redemption and is paid directly to the fund, not to a broker.
An exchange fee is a fee that some funds impose on shareholders if they exchange (transfer) to another fund within the same fund group.
An account fee is a fee that some funds separately impose on investors in connection with the maintenance of their accounts. For example, some funds impose an account maintenance fee on accounts whose value is less than a certain dollar amount.
A purchase fee is another type of fee that some funds charge their shareholders when the shareholders purchase their shares. A purchase fee differs from, and is not considered to be, a front-end sales load because a purchase fee is paid to the fund (not to a broker) and is typically imposed to defray some of the fund’s costs associated with the purchase.
B. Annual Fund Operating Expenses
Management Fees
Management fees are fees that are paid out of fund assets to the fund’s investment adviser (or its affiliates) for managing the fund’s investment portfolio , and administrative fees payable to the investment adviser that are not included in the “Other Expenses” category (discussed below).
The fees paid by the fund out of fund assets to cover distribution expenses and sometimes shareholder service expenses.”Distribution fees” include fees paid for marketing and selling fund shares, such as compensating brokers and others who sell fund shares, and paying for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature.
Other expenses
Included in this category are expenses not included in the categories “Management Fees” or “Distribution Fees.” Examples include: shareholder service expenses that are not included in the “Distribution Fees” category; custodial expenses; legal expenses; accounting expenses; transfer agent expenses; and other administrative expenses.
Total Annual Fund Operating Expenses
The type of expenses refer to annual fund operating expenses, expressed as a percentage of the fund average net assets.
A Word About Mutual Fund Fees and Expenses
As you might expect, fees and expenses vary from fund to fund. A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time. For example, if you invested RM10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly RM49,725. But if the fund had expenses of only 0.5%, then you would end up with RM60,858.
Benefit of investing in mutual fund:
1. Mutual Funds Offer Diversification
The beauty of a mutual fund is that you can buy a mutual fund and obtain instant access to a hundreds of individual stocks or bonds. Otherwise, in order to diversify your portfolio, you might have to buy individual securities, which exposes you to more potential volatility.
2. Mutual Funds are Professionally Managed
Many investors don’t have the resources or the time to buy individual stocks. Investing in individual securities, such as stocks, not only takes resources, but a considerable amount of time. By contrast, mutual fund managers and analysts wake up each morning dedicating their professional lives to researching and analyzing current and potential holdings for their mutual fund.
3. Mutual Funds Come in Many Varieties
A mutual fund comes in many types and styles. There are stock funds, bond funds, sector funds, target-date mutual funds, money market mutual funds and balanced funds. Mutual funds allow you to invest in the market whether you believe in active portfolio management (actively managed funds) or you prefer to buy a segment of the market with no interference from a manager (passive funds and index mutual funds). The availability of different types of mutual funds allows you to build a diversified portfolio at low cost and without much difficulty.
4. Mutual Funds Have Low Minimums
Many mutual fund companies allow investors to get started in a mutual fund with as little as RM1,000. Schwab’s mutual fund family has a minimum of RM100 for many of their mutual funds.
5. Systematic Investing and Withdrawals with Mutual Funds
It is simple to invest regularly in a mutual fund. Many mutual fund companies allow investors to invest as little as RM50 per month directly into a mutual fund. Money can be pulled directly from a bank account and invested directly in the mutual fund. On the other hand, money can be regularly withdrawn from a mutual fund and be deposited into a bank account. There are generally no fees for this service.
6. Mutual Funds Offer Automatic Reinvestment
An investor can easily and automatically have capital gains and dividends reinvested into their mutual fund without a sales load or extra fees.
7. Mutual Funds Offer Transparency
Mutual fund holdings are publicly available (with some delays in reporting), which ensures that investors are getting what they pay for.
8. Mutual Funds Are Liquid
If you want to sell your mutual fund, the proceeds from the sale are available the day after you sell the mutual fund.
9. Mutual Funds Have Audited Track Records
A mutual fund company must maintain performance track records for each mutual fund and have them audited for accuracy, which ensures that investors can trust the mutual fund’s stated returns.
10. Safety of Investing in Mutual Funds
If a mutual fund company goes out of business, mutual fund shareholders receive an amount of cash that equals their portion of ownership in the mutual fund. Alternatively, the mutual fund’s Board of Directors might elect a new investment advisor to manage the mutual fund.
Before you invest, you should do your homework. Will you choose to use mutual funds, closed-end funds, ETFs, and/or individual stocks and bonds? Inevitably, your homework assignment will lead you to articles outlining the disadvantages of mutual funds. But are all of these so-called disadvantages of mutual funds really disadvantages of mutual funds? Let’s take a look at several so-called disadvantages of mutual funds, and how you can avoid them.
So-Called Disadvantages of Mutual Funds?
1. Mutual Funds Have Hidden Fees
If fees were hidden, those hidden fees would certainly be on the list of disadvantages of mutual funds. The hidden fees that are lamented are properly referred to as distribution fees. While these distribution fees are no fun to pay, they are not hidden. The fee is disclosed in the mutual fund prospectus and can be found on the mutual funds’ web sites. Many mutual funds do not charge a distribution fee. If you find the distribution fee onerous, invest in a mutual fund that does not charge the fee. Hidden fees cannot make the list of disadvantages of mutual funds because they are not hidden and there are thousands of mutual funds that do not charge distribution fees.
2. Mutual Funds Lack Liquidity
How fast can you get your money if you sell a mutual fund as compared to ETFs, stocks and closed-end funds? If you sell a mutual fund, you have access to your cash the day after the sale. ETFs, stocks and closed-end funds require you to wait three days after you sell the investment. I would call the “lack of liquidity” disadvantage of mutual funds a myth. You can only find more liquidity if you invest in your mattress.
3. Mutual Funds Have High Sales Charges
Should a sales charge be included in the disadvantages of mutual funds list? It’s difficult to justify paying a sales charge when you have a plethora of no-load mutual funds. But, then again, it’s difficult to say that a sales charge is a disadvantage of mutual funds when you have thousands of mutual fund options that do not have sales charges. Sales charges are too broad to be included on my list of disadvantages of mutual funds.
4. Mutual Funds and Poor Trade Execution
If you buy or sell a mutual fund, the transaction will take place at the close of the market regardless of the time you entered the order to buy or sell the mutual fund. I find the trading of mutual funds to be a simple, stress-free feature of the investment structure.
5. All Mutual Funds Have High Capital Gains Distributions
If all mutual funds sell holdings and pass the capital gains on to investors as a taxable event, then we have a found a winner for the list of disadvantages of mutual funds list. Oh well, not all mutual funds make annual capital gains distributions. Index mutual funds and tax-efficient mutual funds do not make these distributions every year. Yes, if they have the gains, they must distribute the gains to shareholders. However, many mutual funds (including index mutual funds and tax-efficient mutual funds) are low-turnover funds and do not make capital gains distributions on an annual basis.
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