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Buying Stocks Using Mutual Funds

Recent articles posted to the ITS: FYI page have focused on some of the factors to consider if you plan to invest in stocks by selecting individual company issues to buy. Doing that can be very profitable-or not-depending on the talents of you or your broker in evaluating stocks that fit the buying and selling criteria you have developed.

While this approach seems to suit lots of investors who have both a great deal of time and a high level of commitment to devote to the effort, it isn't suitable for everyone. A lot of us, maybe most of us, aren't going to spend hours each week studying companies, screening and evaluating their stock, making buy or sell decisions, and managing a broadly diverse (and you do need diversification) portfolio. That sort of time commitment just isn't going to happen for most of us because we aren't professional investors. Rather, we're teachers, doctors, lawyers, small business owners, or members of one labor force or another and investing is a sideline; hopefully a profitable one.

Chin up, my friend, there's another way to participate in the markets that's a whole lot less time intensive, and it's through using mutual funds. Most people probably know something about mutual funds, but may have a limited understanding of how they work. So, the intent of this article is to start a discussion about mutual funds, and this theme will likely carry into a number of future articles here.

Mutual Funds:

Mutual funds consist of money pooled from many investors which the fund manager uses to make investment in securities of various sorts. The fund holds the securities, and each investor owns shares in the fund.

Advantages:

There are some distinct advantages for small, individual investor that make mutual funds attractive and effective.

• You get professional management. The fund manager and his or her staff do the research, select the securities to buy and sell, keep accounts, provide customer service to you as a share holder if you have questions, and send you a statement every month so you can track how your invested dollars are doing.
• You get diversification. As an investor, you don't want to have "all your eggs in one basket," (as the saying goes) because if the basket fails, you won't have any left. So it's a good idea to have your eggs (money) spread among a fair number of baskets (securities), and mutual funds will normally hold a large number and variety of baskets (securities).
• You also get a break on transaction fees. Mutual fund transactions are large so brokerage houses can extend lower fees to them than they would to individual investors, and that's a strong plus for shareholders in terms of reduced costs.
• You can access your money easily. You can convert your share to cash easily with the money being sent to you in a matter of a few days, and you can accomplish this with one telephone call.
• You also get simplicity. It's easy to invest in mutual funds and you can also invest small amounts easily, in some cases as little as fifty dollars. You can also move money between funds with the same management company with a telephone call.
• And it's not very time intensive. Compared to buying stocks and bonds individually, that is. That doesn't mean you're completely off the hook and don't have to do anything. You're responsible for your own financial well being, so you'll want to monitor your portfolio of mutual funds, track the progress of your fund shares, and you may well decide to make changes in it from time to time.

Types of Mutual Funds:

There are three basic kinds of mutual funds, bond funds, money market funds, and equity funds.

• Bond funds, sometimes known as fixed-income funds, invest in interest bearing securities such as U. S. Treasury issues and corporate or municipal bonds.
• Money market funds also invest in interest bearing instruments including short term corporate obligations such as overnight or over-the-weekend loans.
• Equity funds invest in stock of corporations with the objective being capital appreciation for share holders.

There are also mutual funds that use various combinations of the above types in various ratios and you can usually recognize these since they will have words such as "balanced" or "asset allocation" somewhere in their name. In such funds managers make decisions about how best to allocate resources according to how they think various markets are doing or are expected to do.

Mutual Fund Costs:

As you might suspect, mutual fund managers don't take your money and grow it for you for the fun of it, at least not completely even though they probably enjoy their work. There are costs involved, and these can be pretty high or relatively low.

Management fees are charges every mutual fund will make to shareholders. This money pays manager and staff salaries-they have to eat and buy shoes for their kids to, don't you see-and administrative expenses such as those involved in record keeping, accounting, and mailing of statements to share holders. These fees are expressed as a fund's management expense ratio (MER). The average MER is about 1.5% annually of assets under management, with the range being from 0.2% to 2%. You'll want to compare management fees among the funds you are considering when you invest.

Load Funds:

Some funds also charge fees for getting your money into or out of the fund, and these are called "load" fees.

• A "front load" is a fee you pay when you buy fund shares, and can be as high as five or six percent of the money you are putting into the fund.
• A "back load" is a fee you pay when you sell shares. These often start at a fairly high rate that decreases to zero in a few years. For example, the load might be 6% the first year and then decrease by one percent per year until at the seventh year there is no back load. Obviously this fee is in place to encourage investors to leave their money in the fund for some length of time.

The problems with load funds are two.

• First, there have been lots of studies done to see if there is a correlation between higher fees and higher returns. There isn't. Higher costs DO NOT equate to higher return to the shareholder.
• Secondly, the loads reducean investor's capital quite a bit. For example, if you invest $1,000 in a fund with a 6% front load, the actual amount being invested is $940, and the missing sixty bucks does nothing at all to improve your return as we noted above. No matter how a salesperson might explain it to you,a front load is an immediate loss on your investment-an immediate 6% loss in the example above. Keep in mind that this is in addition to the reasonable and understandable one or two percent management fee we talked about earlier. If we add a management fee of 2% to the 6% front load in our example, we end up with only $920 working for us out of the $1,000 we thought we were investing.

You're probably wondering where the money you pay in "load" disappears to in the grand scheme of things. Well, it goes to pay commissions to brokers, financial advisors and others who sell the fund shares to you. So if you're buying fund shares through a third party or agency, you're paying a load.

No Load Funds:

You can again take heart, my friend; all is not yet lost because, you see, there's something called "no load funds." No load funds:

• DO charge management fees as described above.
• DO NOT pay commissions to anyone to sell their shares.
• And therefore do not charge front or back loads.

Since there's no profit advantage (but rather a profit disadvantage) to investors in using load funds and there is a huge selection of no load funds from which to choose, it makes no sense at all to use funds that carry a front or back load.

Tracking Your Fund

When you are invested in a mutual fund you'll get reports on a regular basis, usually every month, telling you how you money is doing. These will show the number of shares you hold, the value per share on the date of the report, the total value of your shares, and the paper gain or paper loss made during the reporting period. I used the term "paper" in the last sentence because whatever is on paper doesn't become a real gain or loss until you convert your shares to cash.

A common term used in mutual fund statements is "net asset value" (NAV) which is the fund's current price per share. A less commonly used term is "unit value," but it means the same thing.

Most mutual fund values are also listed in the business/financial section of newpapers, so you can check your funds, every day if you want to, between reports sent you by the management.

OK. That's it for now. I'll talk to you again later.

arley