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Reflections: Mutual Funds and Real Estate Investments

Reflections: Mutual Funds and Real Estate Investments. Principles of Finance BUS 219 Dr. Coty Keller. What is a Mutual Fund?. An investment alternative where money from investors is pooled to buy stocks, bonds, and other financial securities selected by professional managers.

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Reflections: Mutual Funds and Real Estate Investments

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  1. Reflections: Mutual Funds and Real Estate Investments Principles of Finance BUS 219 Dr. Coty Keller

  2. What is a Mutual Fund? • An investment alternative where money from investors is pooled to buy stocks, bonds, and other financial securities selected by professional managers. • Many people choose mutual funds for their retirement account investments. • 401(k) or 403(b) • IRA • Roth IRA • MANY other financial objectives too 16-2

  3. Mutual Funds are Popular • 92 million individuals in 54 million households in the U.S. own mutual funds. • Over 8,000 mutual funds by 2004. • Over $8 trillion in assets owned by mutual funds in the U.S. by 2004. 16-3

  4. Why Investors Purchase Mutual Funds • Professional management. • Who is the fund’s manager? • Managers can change. • Be aware of the scandal involving late trading. • Diversification. • Investors funds are used to purchase a variety of investments. This variety provides some safety. 16-4

  5. Closed- and Open-End Funds • Closed-end funds (7% of funds). • Shares are issued by an investment company only when the fund is organized. • After all original shares are sold you can purchase shares only from another investor who is willing to sell. • Traded on exchanges and over-the-counter. • Open-end funds (91% of funds). • Shares are issued and redeemed by the investment company at the request of investors. • Investors can buy and sell shares at the net asset value (NAV). 16-5

  6. Net Asset Value (NAV) Value of the fund’s portfolio - Liabilities Number of shares outstanding For most mutual funds, NAV is calculated at the close of trading each day. 16-7

  7. Load Funds and No-Load Funds • Load Fund. • Investors pay a commission (sales charge) up to 8.5% every time they purchase shares. This is sometimes called a front load. (Class A shares) • Average charge is 3-5% for which an investor can get purchase advice and explanations. • No-Load Fund. • Investors pay no sales charge up front. • You deal directly with the fund with 800 numbers or web sites, or from discount brokers. 16-8

  8. Management Fees and Other Charges • Contingent deferred sales load (back-end load) • Charged upon withdrawal of funds (1-5%). • Generally decreases on a sliding scale depending on the number of years shares are held. • Management fee. • Charged yearly (.5%-1.25% average) based on a percentage of the funds asset value. 16-9

  9. Number of Mutual Funds by Type* *Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2001, page 744. 16-10

  10. Classification of Mutual Funds • Stock funds. • Aggressive growth funds buy stocks in small, fast-growing companies. • Equity income funds invest in stock of companies with a long history of paying dividends. • Growth buy stock in companies with higher-than-average revenue and earnings growth. • Global funds buy stock in companies in the U.S. and other countries, while international funds buy stock only in companies outside the United States. • Index buys stocks that mirror an index. • Large-cap funds invest in companies with capitalization of $5 billion or more. • Mid-cap funds buy stock in companies whose capitalization is between $1 and $5 billion. 16-11

  11. Classification of Mutual Funds (continued) • Regional funds buy stock in companies in a specific region of the world. • Sector funds buy stock in companies in a particular industry such as biotechnology. • Small-cap funds buy stock in lesser-known companies with a capitalization of less than 500 million. • Socially responsible funds avoid investing in companies that produce harmful products. 16-12

  12. Classification of Mutual Funds • Bond funds. • High-yield (junk) bond funds buy corporate bonds that are higher risk and higher yield. • Index bond funds invest in a sampling of bonds included in an index. • Intermediate corporate bonds (5-10 years). • Intermediate U.S. bond funds buy treasury notes with maturities of 5-10 years. • Long-term corporate bonds (> 10 years). 16-13

  13. More Classification of Mutual Funds • Long-term U.S. bond funds: U.S. Treasury and U.S. zero-coupon bonds with maturities > than 10 years. • Municipal bonds: Invest in municipal bonds that provide investors tax-free interest income. • Short-term U.S. bond funds invest in U.S.Treasury issues of 1-5 years. • Short-term corporate bond funds: Investment grade bonds with maturities of 1-5 years. • World bond funds buy bonds of foreign companies and governments. 16-14

  14. Classification of Mutual Funds • Other funds. • Asset allocation funds: invest in various asset classes, such as stocks, and bonds, with precise amounts within each type. • Balanced funds: Invest in both stocks and bonds, with the primary objectives of conserving principal, providing income as well as growth. • Money market funds: Invest in CD’s, government securities, and other safe investments. 16-15

  15. Families of Funds • A family of funds exists when one investment company manages a group of mutual funds. • Each fund in the family has a different financial objective. • Exchange privileges allow you to move your money from one fund to another within the fund family with little or no charge. 16-16

  16. Steps to Evaluate Mutual Funds • Are you ready to invest in mutual funds? • Determine your risk tolerance. • Determine your investment objectives. • Obtain the money you need to invest. • A fund’s objective should match your investment objective. • Evaluate any mutual fund before buying or selling (www.morningstar.com) • Consider managed funds vs. indexed funds 16-17

  17. Internet Sources of Fund Information • Use web sites to research a fund. • http://finance.yahoo.com • www.businessweek.com • www.morningstar.com (also other advisory services, such as Value Line). Subscription fees. Public libraries often give access for free) • www.smartmoney.com • Check mutual fund companies Internet sites. • www.trendstarfunds.com • www.vanguard.com 16-18

  18. Reading a Mutual Fund Quotein the Newspaper • Net asset value and asset value change. • The fund family and fund name. • Fund objective. • Total return over various time periods. • Ranking among funds with the same objective. • Sales load fees if any, or no load (NL). • Annual expenses. 16-19

  19. Other Sources of Fund Information • Mutual fund prospectus tells the funds objective and: • A statement describing the risk factors. • A description of the fund’s past performance. • A statement describing the type of investments in the fund’s portfolio. • Information on how to open an account. • Dividends, distributions and taxes. • Information about the fund’s management. • The process for investors to buy or sell shares. • Services provided to investors. • The turnover ratio of the fund’s investments. 16-20

  20. Other Sources of Fund Information • Mutual fund annual report. • Performance, investments, assets and liabilities. • Financial Publications. • Business Week, Forbes, Kiplinger'sPersonalFinance and Money are sources of information. • Business Week’s mutual fund survey includes information such as the... • Fund’s overall rating compared to all other funds, and to funds in the same category. • Fund size, sales charge and expense ratio. • Performance for best and worst quarters. 16-21

  21. Mutual Fund Transactions • You can open an account from $250 to $3,000 and up depending on the fund & family (Some will let you in for $50 if you commit to recurring purchases – a good idea: dollar cost averaging) • Open-end, no-load directly from the investment company by phone, mail, online, or from a discount broker. • Closed-end or exchange-traded funds are purchased through a broker; traded on stock exchanges and over-the-counter. 16-22

  22. Mutual Fund Returns There are several ways you can get a return on your investment (Income & Growth) • Capital gains: sell shares at a price > than you paid (Report on Schedule D and 1040). • Income dividends: earnings funds pay to shareholders from dividend and interest income (Taxed as regular income). • Capital gain distributions: Payments to shareholders from sale of securities held by the fund (Show on Schedule D and 1040). • Income and capital gain distributions can be automatically reinvested (should be to take advantage of the magic of compounding). 16-23

  23. Mutual Fund Features • Automatic investments: Money is taken from your checking account monthly and invested in a fund. (Dollar Cost Averaging) • Telephone Switching: Call your fund and move money from one fund to another in the same family. • Withdrawals: Various withdrawal options; you can withdraw funds by phone, letter, online, etc. 16-24

  24. Mutual Fund Project? • Find a fund that you feel would be a good investment for you, given your financial goals, investment objectives and tolerance for risk • Research can include going online to www.morningstar.com, www.cbsmarketwatch.com or other sources • No too late to change your learning agreement. Just send me another proposal. 16-25

  25. Real Estate Investments • Types • Examples • Advantages • Disadvantages

  26. Real Estate Investment Types • Direct. • As the investor, you hold legal title to the property. • Your home as an investment. • A place to live. • A major asset of most households. • Shelter income from taxes if you have a large mortgage - interest is deductible. • Possible hedge against inflation.Be aware of possible real estate “bubbles.” 17-2

  27. Examples of Direct Real Estate Investments • Your primary home. • A vacation home. • Tax advantages depend on if the IRS views it as your second home or as a rental property. • If you don’t rent it more than 14 days a year you can write off mortgage interest and property tax. • Primary reason to own a vacation home is because you want to use it. 17-3

  28. Examples of Direct Real Estate Investments (continued) • Undeveloped land. • Can be tremendous gains but this type of investment poses enormous risks. All the money is riding on a single parcel of land. • Most people buy land with the idea of subdividing the land. 17-4

  29. More Examples of Direct Real Estate Investments • Commercial property: land and buildings that produce lease or rental income. Examples are: • Most common investment of this type is a duplex or small apartment building. It also includes hotels, office buildings, stores, and many other types of commercial establishments. • Will income be greater than expenses? • Tax deductions, such as depreciation and property taxes are limited to the amount of rental income you receive 17-5

  30. Real Estate Investments Types • Indirect • Real estate syndicates. • A syndicate is a temporary association of individuals or firms organized to perform a specific task that takes a large amount of capital. Can be organized as a corporation, trust, or limited partnership. • Provide professional management and limited liability for its members, and diversification, if several properties are owned. 17-6

  31. Examples of Indirect Real Estate Investments • Real estate limited partnerships. • A limited partnership has a general partner who has unlimited liability and sells participation units to the limited partners. The partner’s liability is limited to the extent of their initial investment, such as $10,000. 17-7

  32. Examples of Indirect Real Estate Investments (continued) • Real estate investment trusts (REIT). • REITs are similar to a mutual fund or investment company and trade shares. • May buy properties and/or invest in first and second mortgages. • Equity REITs own properties; mortgage REITs own mortgages; hybrid REITS own both properties and mortgages • Participation certificates. • A risk-proof real estate investment. • Equity investment in a pool of mortgages that have been purchased by one of several government agencies, such as Ginnie Mae and Freddie Mac. 17-8

  33. Advantages of Real Estate Investments • A hedge against inflation & risk of stocks & bonds (Diversification!) • Easy entry as in REITs or as a limited partner (such as investing $5,000 to own part of an apartment building) • Limited financial liability—limited partners. • No management concerns -REITs • Direct Ownership offers • Financial leverage -using borrowed funds • Tax shelters (mortgage interest & real estate taxes are deductible) 17-9

  34. Disadvantages of Real Estate Investments • Illiquidity except REITs • Declining property values. • Lack of diversification- if real estate is all you have • Lack of a tax shelter for real estate syndicates. • Long depreciation period. • Management problems—direct real estate. 17-10

  35. Richest Man in Babylon • Spend less than you make • Save the difference - regularly • Diversify • You will accumulate wealth • Time proven method: Regular savinging into mutual funds (and REITs)

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