Assignment for Chapter Twenty-Three You are 25 years old and at your work place in their 401k they have given you four mutual funds to choose from to put your money for retirement. T. Rowe Price Cash Reserve Fund T. Rowe Price Inflation Protected Fund T. Rowe Price Equity Index 500 Fund T. Rowe Price U.S. Small Cap Growth Equity Fund You have decided that you are going to only pick one fund to start your retirement program. You will find in D2L in the Content a file with the Summary Prospectus for each of the Vanguard funds. Tell me which one of these funds you will invest your money for your financial future by answering the following questions. - Tell me about the fund type you wish to invest in by talking about the fund you have chosen and its investments. - Please, explain your reasoning for your choice over the others. - The following article talks about the advantages of mutual funds and how might they fit into your investment portfolio. What might the disadvantages of the mutual fund you have chosen? This assignment should be saved as a Word document when submitted to your drop-box in D2L. Please remember to cite your work even if it is just the text. 20 Major Advantages of Investing in Mutual Funds Austin Pryor for Sound Mind Investing Mutual funds offer many benefits that can make your investing program easier and safer. Here are 20 of their major advantages. Advantage \#1: Mutual funds can reduce the anxiety of investing. Most investors constantly live with a certain amount of anxiety and fear about their investments because they feel they lack one or more of the following essentials: (1) market knowledge, (2) investing experience, (3) selfdiscipline, (4) a proven game plan, or (5) time. As a result, they often invest on impulse or emotion. Because of their inherent design that taps professional expertise and spreads risk, mutual funds can go a long way toward relieving the anxiety associated with investing. After meeting the initial minimum to open your account, you can add just about any amount you want. To make your purchase work out evenly, mutual funds sell "fractional" shares. For example, if you invest $100 in a fund selling at $7.42 a share, the fund organization will eredit your account with 13.477 shares ( $100.00 divided by $7.42=13.477) Advantage \#4: Mutual funds reduce risk through diversification. Stock funds typically hold from 50 to 500 stocks in their portfolios; the average is around 100 . They do this so that any loss caused by the unexpected collapse of any one stock will have only a relatively minor effect on the pool as a whole. Without the availability of mutual funds, the investor with just $2,000 to invest would likely put it all in just one or two stocks (a risky way to go). But by using a mutual fund, that same $2,000 can make the investor a part owner in a large, professionally researched and managed portfolio of stocks. Advantage H5: Price movements of mutual funds are more predictable than those of individual stocks. Their extensive diversification, coupled with outstanding stock selection, makes it highly unlikely that the overall market will move up without carrying almost all stock mutual funds up with it. For example, on Sept. 8 , 2008 , when the Dow jumped 290 points, more than 95% of stock mutual funds were up for the day. Yet, of the more than 3,200 stocks that traded on the New York Stock Exchange, only 63% ended the day with a gain. The rest ended the day unchanged (2%) or actually fell in price (35%). Advantage #6 : The past performance of mutual funds is a matter of public record. Advisory services, financial planners, and stockbrokers have records of past performance, but how public are they? And how were they computed? Did they include every recommendation made for every account? Mutual funds have fully disclosed performance histories, which are computed according to set standards. With a little research, you can leam exactly how various mutual funds fared in relation to inflation or other investment alternatives. Advantage \#7: Mutual funds provide full-time professional management Highly trained investment specialists are hired to make the decisions as to which stocks to buy. The person with the ultimate decision-making authority is called the portfolio manager. The manager possesses expertise in many financial areas, and hopefully has learned - through experience - to avoid the common mistakes of the amateur investor. Most important, the manager is expected to have the self-discipline necessary to doggedly stick with the mutual fund's strategy even when events move against him for a time. Advantage #8 : Mutual funds allow you to efficiently reinvest your dividends. If you were to spread $5,000 among five different stocks, your quarterly dividend checks might amount to $10 from each one. It's not possible to use such a small amount to buy more shares without paying very high relative commissions. Your mutual fund, however, will gladly reinvest any size dividends for you automatically. This can add significantly to your profits over several years. Advantage #9: : Mutual funds offer you automatic withdrawal plans. Most funds let you sell your shares automatically in an amount and frequency of your choosing. This preplanned selling enables the fund to mail you a check for a specified amount monthly or quarterly. This allows investors in stock funds that pay little or no dividends to receive periodic cash flow. Advantage \#10: Mutual funds provide you with individual attention. It has been estimated that the average broker needs 400 accounts to make a living. How does he spread his time among those accounts? The common-sense way would be to start with the largest accounts and work his way down. Where would that leave your $2,000 account? But in a mutual fund, the smallest member of the pool gets exactly the same attention as the largest because everybody is in it together. Advantage \#11: Mutual funds can be used for your IRA and other retirement plans. Mutual funds offer accounts that can be used for IRAs and 401(k ) plans. They're especially useful for rollovers (which is when you take a lump sum payment from an employer's pension plan because of your retirement or termination of employment and must deposit it into an IRA investment plan account within 60 days). The new IRA rollover account can be opened at a bank, mutual fund, or brokerage house and the money then invested in stocks, bonds, or money market securities. These rollover accounts make it possible for you to transfer your pension benefits to an account under your control while protecting their tax-deferred status. They are also useful for combining several small IRAs into one large one. Advantage \#12: Mutual funds allow you to sell part or all of your shares at any time and get your money quickly: By regulation, all open-end mutual funds must redeem (buy back) their shares at their net asset value whenever you wish. It's usually as simple as a toll-free phone call. Of course, the amount you get back will be more or less than you initially put in, depending on how well the stocks in the portfolio have done during the time you were a part owner of the pool Advantage H13: Murual funds enable you to instantly reduce the risk in your portfolio with just a phone call. Most large fund organizations (usually referred to as "families") allow investors to switch from one of their funds to another via a phone call or over the Web and at no cost. One practical use of this feature is that is makes it easy to reallocate your capital between funds that invest in different types of asset classes (largecompany growth, large-company value, small-company growth, small-company value, foreign stocks, and fixed-income securities) as your goals and market expectations evolve. Advantage \#14: Mutual funds pay minimum commissions when buying ant selling for the pool. They buy stocks in such large quantities that they always qualify for the lowest brokerage commissions available. An average purchase of stock can easily cost the small investor 2%4% in commissions to buy and sell (depending on broker, dollar size of order, and number of shares). On the other hand, the cost is a mere fraction of 1% on a large purchase like $100,000. Many investors would show gains rather than losses if they could save almost 3% on every tradel The mutual-fund pool enjoys the savings from these massive volume discounts, enhancing the profitability of the pool. Eventually, then, part of that savings is yours. (These commission savings, however, should not be confused with the annual operating expenses that every shareholder pays.) Advantage \#15: Mutual funds provide a safe place for your investment money. Mutual funds are required to hire an independent bank or trust company to hold and account for all the cash and securities in the pool. This custodian has a legally binding responsibility to protect the interests of every shareholder. No mutual fund shareholder has ever lost money due to a mutual fund bankruptcy. Advantage \#16: Mutual funds handle your paperwork for you. Capital gains and losses from the sale of stocks, as well as dividend- and interest-income earnings, are summarized into a report for each shareholder at the end of the year for tax purposes. Funds also manage the day-to-day chores such as dealing with transfer agents, handling stock certificates, reviewing brokerage confirmations, and more. Advantage \#17: Mutual funds can be borrowed against in case of an emergency. Although you hope it will never be necessary, you can use the value of your mutual fund holdings as collateral for a loan. If the need is short-term and you would rather not sell your funds because of tax or investment reasons, you can borrow against them rather than sell them. Advantage \#18: Mutual funds involve no personal liability beyond the investment risk in the portfolio. Many investments, primarily partnerships and futures, require investors to sign papers wherein they agree to accept personal responsibility for certain liabilities generated by the undertaking. Thus, it is possible for investors to actually lose more money than they invest. This arrangement is generally indicative of speculative endeavors; I encourage you to avoid such arrangements. In contrast, mutual funds incur no personal risk. Advantage \#19: Mutual fund advisory services are available that can greatly ease the research burden. Due to the tremendous growth in the popularity of mutual fund investing, there has been a big jump in the number of investment newsletters that specialize in researching and writing about mutual funds. My Sound Mind Investing newsletter, for example, offers model portfotios geared to your risk tolerance and stage of life. We provide specific buy/ sell recommendations that are updated each month. (To leam more, go to htte:/ www. SoundMindinvesting com ) 5 pitfalls to avoid when selecting funds By Lanssa Femand 221119 | We have been getting a number of emails from investors asking us what they should do about their poor performing value funds. Their apprehension stems from the mistake in not comprehending what these funds offer in the first place. When investors assemble lineups for their portfolio, they must be cognizant of potential pitfalls that could trip them up down the road. Setting up things in a way that minimizes behavioural errors as well as exogenous investment risks can be just as important as, say, picking the right funds: JOSH CHARL SON, director, manager selection, for Morningstar Research SWrices covers some of those potential traps and errors that can arise 1. Getting blinded by the light of recent performance. When selecting funds, it's easy to get seduced by recent outperformance, but chasing short-term returns-even 3-year results-is a sucker's game. There's too much noise, with the potential for style bias or pure luck to be the swing factors in the results. In addition, mutual fund returns are notoriously mean-reverting, so that outperforming funds during one period may be equally likely to underperform in the next. Ideally, focus on strategies that have seen at least one full market cycle, and examine the fund's full record under the manager responsible for it. Rolling return periods are also a useful lens, as well as discrete periods of both market duress (such as the 2008 bear market) and success (the last bull nun). 2. Overemphasizing high active-share managers. There's an understandable tendency when picking actively run funds to emphasize managers with high active share, which is to say those who run funds that don't look like the benchmark. The basic reasoning is that if you are going to pay the fees for active management, you might as well find managers whose portfolios look nothing like the benchmark. That is sound wisdom, as far as it goes. Where it falls short is in the recognition that many investors lack the patience and discipline to stick with a strategy when it has a pronounced slump or performs at odds with the broader market, as often occurs with higher active-share funds. That doesn't mean you should avoid such funds in constructing your own portfolio, but you should make an honest appraisal of your ability to tolerate significant variance in performance, both on an absolute and relative basis. Even if you have a bias toward active managers in your portfolio, don't overlook passive options. Not only will they lower the overail cost of running your portfolio, they can help smooth out the performance bumps that the more active managers may cause and perhaps help you stick with your investment plan. 3. Gravitating to trendy strategies. The fund industry is always coming up new products, such as sector or thematic funds. In many cases, the expense ratios could be high, the product is higher-risk; or lacking in benefits over traditional, well-established categones. Moreover, they often focus on a sector that has had recently strong performance. You'd be well-advised to avoid the latest trends or buzzy funds when constructing your own fund portfolio. 4. Creating unintentional overlap. How many funds should you own in a given account in your investment portfolio? The bottom line is that there's no single number that's right for everyone. But accumulating too many funds can lead to unintentional overlap. It's impotant to look beneath the hood, viewing funds at the underlying portfolio holdings level, to ensure that one fund isn'treplicating the work of another. Some overlap is inevitable, but aim for distinctiveness in diversification: Try to identify strategies that offer different substyles or that exhibit differentiated performance patterns from one another. Your diversification may be adding no value or very limited value, and additionally introducing potential overlaps to your portfolio as well as the headaches of excessive recordkeeping: For instance, banking and financial services is a sector well represented in many funds. Taking a separate sector fund in this space won't really help. What may help is a pharma sector fund. On an average, mid-cap funds have an 8% exposure to pharma, while large-cap funds have a 3% exposure. (This is not a recommendation, it is purely for illustrative purposes). 5. Forgetting about risk. It's easy to fall into the trap of focusing solely on a fund's returns. Even taking pains to measure a fund against an appropriate benchmark or evaluate its retums over very long periods doesn't lessen the limitations of such an approach. Instead, consider integrating two other elements as you build your portfolio: your ability to handle risk and your goals. A fund's long-term annualized retums tend to smooth out the ups and downs over that time. A fund's volatility and downside performance, however, can have a significant effect on your comfort level as well as your ability to stay with an investment. Moreover, your specific investment goals can guide how much risk you can or should take. Folks investing for retirement with a very long time horizon can afford to take more risk across the portfolio, with time to ride out even large declines. If your time frame is shorter, or you expect you'll need to draw on assets for a short-term need, that argues for taking less risk both in your overall stock/bond mix and in the specific investments you choose. Assignment for Chapter Twenty-Three You are 25 years old and at your work place in their 401k they have given you four mutual funds to choose from to put your money for retirement. T. Rowe Price Cash Reserve Fund T. Rowe Price Inflation Protected Fund T. Rowe Price Equity Index 500 Fund T. Rowe Price U.S. Small Cap Growth Equity Fund You have decided that you are going to only pick one fund to start your retirement program. You will find in D2L in the Content a file with the Summary Prospectus for each of the Vanguard funds. Tell me which one of these funds you will invest your money for your financial future by answering the following questions. - Tell me about the fund type you wish to invest in by talking about the fund you have chosen and its investments. - Please, explain your reasoning for your choice over the others. - The following article talks about the advantages of mutual funds and how might they fit into your investment portfolio. What might the disadvantages of the mutual fund you have chosen? This assignment should be saved as a Word document when submitted to your drop-box in D2L. Please remember to cite your work even if it is just the text. 20 Major Advantages of Investing in Mutual Funds Austin Pryor for Sound Mind Investing Mutual funds offer many benefits that can make your investing program easier and safer. Here are 20 of their major advantages. Advantage \#1: Mutual funds can reduce the anxiety of investing. Most investors constantly live with a certain amount of anxiety and fear about their investments because they feel they lack one or more of the following essentials: (1) market knowledge, (2) investing experience, (3) selfdiscipline, (4) a proven game plan, or (5) time. As a result, they often invest on impulse or emotion. Because of their inherent design that taps professional expertise and spreads risk, mutual funds can go a long way toward relieving the anxiety associated with investing. After meeting the initial minimum to open your account, you can add just about any amount you want. To make your purchase work out evenly, mutual funds sell "fractional" shares. For example, if you invest $100 in a fund selling at $7.42 a share, the fund organization will eredit your account with 13.477 shares ( $100.00 divided by $7.42=13.477) Advantage \#4: Mutual funds reduce risk through diversification. Stock funds typically hold from 50 to 500 stocks in their portfolios; the average is around 100 . They do this so that any loss caused by the unexpected collapse of any one stock will have only a relatively minor effect on the pool as a whole. Without the availability of mutual funds, the investor with just $2,000 to invest would likely put it all in just one or two stocks (a risky way to go). But by using a mutual fund, that same $2,000 can make the investor a part owner in a large, professionally researched and managed portfolio of stocks. Advantage H5: Price movements of mutual funds are more predictable than those of individual stocks. Their extensive diversification, coupled with outstanding stock selection, makes it highly unlikely that the overall market will move up without carrying almost all stock mutual funds up with it. For example, on Sept. 8 , 2008 , when the Dow jumped 290 points, more than 95% of stock mutual funds were up for the day. Yet, of the more than 3,200 stocks that traded on the New York Stock Exchange, only 63% ended the day with a gain. The rest ended the day unchanged (2%) or actually fell in price (35%). Advantage #6 : The past performance of mutual funds is a matter of public record. Advisory services, financial planners, and stockbrokers have records of past performance, but how public are they? And how were they computed? Did they include every recommendation made for every account? Mutual funds have fully disclosed performance histories, which are computed according to set standards. With a little research, you can leam exactly how various mutual funds fared in relation to inflation or other investment alternatives. Advantage \#7: Mutual funds provide full-time professional management Highly trained investment specialists are hired to make the decisions as to which stocks to buy. The person with the ultimate decision-making authority is called the portfolio manager. The manager possesses expertise in many financial areas, and hopefully has learned - through experience - to avoid the common mistakes of the amateur investor. Most important, the manager is expected to have the self-discipline necessary to doggedly stick with the mutual fund's strategy even when events move against him for a time. Advantage #8 : Mutual funds allow you to efficiently reinvest your dividends. If you were to spread $5,000 among five different stocks, your quarterly dividend checks might amount to $10 from each one. It's not possible to use such a small amount to buy more shares without paying very high relative commissions. Your mutual fund, however, will gladly reinvest any size dividends for you automatically. This can add significantly to your profits over several years. Advantage #9: : Mutual funds offer you automatic withdrawal plans. Most funds let you sell your shares automatically in an amount and frequency of your choosing. This preplanned selling enables the fund to mail you a check for a specified amount monthly or quarterly. This allows investors in stock funds that pay little or no dividends to receive periodic cash flow. Advantage \#10: Mutual funds provide you with individual attention. It has been estimated that the average broker needs 400 accounts to make a living. How does he spread his time among those accounts? The common-sense way would be to start with the largest accounts and work his way down. Where would that leave your $2,000 account? But in a mutual fund, the smallest member of the pool gets exactly the same attention as the largest because everybody is in it together. Advantage \#11: Mutual funds can be used for your IRA and other retirement plans. Mutual funds offer accounts that can be used for IRAs and 401(k ) plans. They're especially useful for rollovers (which is when you take a lump sum payment from an employer's pension plan because of your retirement or termination of employment and must deposit it into an IRA investment plan account within 60 days). The new IRA rollover account can be opened at a bank, mutual fund, or brokerage house and the money then invested in stocks, bonds, or money market securities. These rollover accounts make it possible for you to transfer your pension benefits to an account under your control while protecting their tax-deferred status. They are also useful for combining several small IRAs into one large one. Advantage \#12: Mutual funds allow you to sell part or all of your shares at any time and get your money quickly: By regulation, all open-end mutual funds must redeem (buy back) their shares at their net asset value whenever you wish. It's usually as simple as a toll-free phone call. Of course, the amount you get back will be more or less than you initially put in, depending on how well the stocks in the portfolio have done during the time you were a part owner of the pool Advantage H13: Murual funds enable you to instantly reduce the risk in your portfolio with just a phone call. Most large fund organizations (usually referred to as "families") allow investors to switch from one of their funds to another via a phone call or over the Web and at no cost. One practical use of this feature is that is makes it easy to reallocate your capital between funds that invest in different types of asset classes (largecompany growth, large-company value, small-company growth, small-company value, foreign stocks, and fixed-income securities) as your goals and market expectations evolve. Advantage \#14: Mutual funds pay minimum commissions when buying ant selling for the pool. They buy stocks in such large quantities that they always qualify for the lowest brokerage commissions available. An average purchase of stock can easily cost the small investor 2%4% in commissions to buy and sell (depending on broker, dollar size of order, and number of shares). On the other hand, the cost is a mere fraction of 1% on a large purchase like $100,000. Many investors would show gains rather than losses if they could save almost 3% on every tradel The mutual-fund pool enjoys the savings from these massive volume discounts, enhancing the profitability of the pool. Eventually, then, part of that savings is yours. (These commission savings, however, should not be confused with the annual operating expenses that every shareholder pays.) Advantage \#15: Mutual funds provide a safe place for your investment money. Mutual funds are required to hire an independent bank or trust company to hold and account for all the cash and securities in the pool. This custodian has a legally binding responsibility to protect the interests of every shareholder. No mutual fund shareholder has ever lost money due to a mutual fund bankruptcy. Advantage \#16: Mutual funds handle your paperwork for you. Capital gains and losses from the sale of stocks, as well as dividend- and interest-income earnings, are summarized into a report for each shareholder at the end of the year for tax purposes. Funds also manage the day-to-day chores such as dealing with transfer agents, handling stock certificates, reviewing brokerage confirmations, and more. Advantage \#17: Mutual funds can be borrowed against in case of an emergency. Although you hope it will never be necessary, you can use the value of your mutual fund holdings as collateral for a loan. If the need is short-term and you would rather not sell your funds because of tax or investment reasons, you can borrow against them rather than sell them. Advantage \#18: Mutual funds involve no personal liability beyond the investment risk in the portfolio. Many investments, primarily partnerships and futures, require investors to sign papers wherein they agree to accept personal responsibility for certain liabilities generated by the undertaking. Thus, it is possible for investors to actually lose more money than they invest. This arrangement is generally indicative of speculative endeavors; I encourage you to avoid such arrangements. In contrast, mutual funds incur no personal risk. Advantage \#19: Mutual fund advisory services are available that can greatly ease the research burden. Due to the tremendous growth in the popularity of mutual fund investing, there has been a big jump in the number of investment newsletters that specialize in researching and writing about mutual funds. My Sound Mind Investing newsletter, for example, offers model portfotios geared to your risk tolerance and stage of life. We provide specific buy/ sell recommendations that are updated each month. (To leam more, go to htte:/ www. SoundMindinvesting com ) 5 pitfalls to avoid when selecting funds By Lanssa Femand 221119 | We have been getting a number of emails from investors asking us what they should do about their poor performing value funds. Their apprehension stems from the mistake in not comprehending what these funds offer in the first place. When investors assemble lineups for their portfolio, they must be cognizant of potential pitfalls that could trip them up down the road. Setting up things in a way that minimizes behavioural errors as well as exogenous investment risks can be just as important as, say, picking the right funds: JOSH CHARL SON, director, manager selection, for Morningstar Research SWrices covers some of those potential traps and errors that can arise 1. Getting blinded by the light of recent performance. When selecting funds, it's easy to get seduced by recent outperformance, but chasing short-term returns-even 3-year results-is a sucker's game. There's too much noise, with the potential for style bias or pure luck to be the swing factors in the results. In addition, mutual fund returns are notoriously mean-reverting, so that outperforming funds during one period may be equally likely to underperform in the next. Ideally, focus on strategies that have seen at least one full market cycle, and examine the fund's full record under the manager responsible for it. Rolling return periods are also a useful lens, as well as discrete periods of both market duress (such as the 2008 bear market) and success (the last bull nun). 2. Overemphasizing high active-share managers. There's an understandable tendency when picking actively run funds to emphasize managers with high active share, which is to say those who run funds that don't look like the benchmark. The basic reasoning is that if you are going to pay the fees for active management, you might as well find managers whose portfolios look nothing like the benchmark. That is sound wisdom, as far as it goes. Where it falls short is in the recognition that many investors lack the patience and discipline to stick with a strategy when it has a pronounced slump or performs at odds with the broader market, as often occurs with higher active-share funds. That doesn't mean you should avoid such funds in constructing your own portfolio, but you should make an honest appraisal of your ability to tolerate significant variance in performance, both on an absolute and relative basis. Even if you have a bias toward active managers in your portfolio, don't overlook passive options. Not only will they lower the overail cost of running your portfolio, they can help smooth out the performance bumps that the more active managers may cause and perhaps help you stick with your investment plan. 3. Gravitating to trendy strategies. The fund industry is always coming up new products, such as sector or thematic funds. In many cases, the expense ratios could be high, the product is higher-risk; or lacking in benefits over traditional, well-established categones. Moreover, they often focus on a sector that has had recently strong performance. You'd be well-advised to avoid the latest trends or buzzy funds when constructing your own fund portfolio. 4. Creating unintentional overlap. How many funds should you own in a given account in your investment portfolio? The bottom line is that there's no single number that's right for everyone. But accumulating too many funds can lead to unintentional overlap. It's impotant to look beneath the hood, viewing funds at the underlying portfolio holdings level, to ensure that one fund isn'treplicating the work of another. Some overlap is inevitable, but aim for distinctiveness in diversification: Try to identify strategies that offer different substyles or that exhibit differentiated performance patterns from one another. Your diversification may be adding no value or very limited value, and additionally introducing potential overlaps to your portfolio as well as the headaches of excessive recordkeeping: For instance, banking and financial services is a sector well represented in many funds. Taking a separate sector fund in this space won't really help. What may help is a pharma sector fund. On an average, mid-cap funds have an 8% exposure to pharma, while large-cap funds have a 3% exposure. (This is not a recommendation, it is purely for illustrative purposes). 5. Forgetting about risk. It's easy to fall into the trap of focusing solely on a fund's returns. Even taking pains to measure a fund against an appropriate benchmark or evaluate its retums over very long periods doesn't lessen the limitations of such an approach. Instead, consider integrating two other elements as you build your portfolio: your ability to handle risk and your goals. A fund's long-term annualized retums tend to smooth out the ups and downs over that time. A fund's volatility and downside performance, however, can have a significant effect on your comfort level as well as your ability to stay with an investment. Moreover, your specific investment goals can guide how much risk you can or should take. Folks investing for retirement with a very long time horizon can afford to take more risk across the portfolio, with time to ride out even large declines. If your time frame is shorter, or you expect you'll need to draw on assets for a short-term need, that argues for taking less risk both in your overall stock/bond mix and in the specific investments you choose