MUTUAL INVESTMENT BASICS, DON'T INVEST BEFORE READING

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Mutual Fund Investment basics

By MS; Copyrights

What is a Mutual Fund:

Mutual Fund is an investment portfolio composed by a group of investors that buy shares from several companies. The fund is controlled by the Fund Administrator or Manager, the Fund by itself become a public investment entity regulated and controlled by the SEC. Security and Exchange Commission

They are many types of Mutual Funds but these concepts and definitions apply basically to all of them:

What is NAV?

NAV = Net Asset Value, is the price of a single ownership in a fund it’s like a single share in a company. NAV price is calculated only at the end of the exchange closing date, not in function of offer and demand happening during a normal stock trading day.

How a NAV is Calculated?

NAV= (Value of all stocks, bonds, cash and other securities in the fund portfolio - manager salary and operation expenses / (Number of fund shares) NAV= Total stock values / Number of shares:

Example:

What is the NAV value of a Mutual Fund composed of 10 millions in stock + 3 million in cash and 2 million in bonds with 200,000 shares

on it? Solution: NAV= Total Securities / 100,000 = $15,000,000/200,000 = $75 NAV value

Mutual Funds Total Returns:

Mutual funds total return is composed of two portions:

1) From yields

Yields % = [(Distribution per share) / (Price per share)] x 100

2) From Capital Appreciation

Note: For high yield funds you must select a fund with low expense ratio that charges 1% or less per year because this expense is deducted from the income before it is paid.

How the Total Return is calculated:

The Totals return is calculated = (Ending total gains - original investment) / (Original investment) X 100 = Total Return %

Be aware that in the ending total gains, all fees, commission and costs have to be deducted.

Distributions:

Distribution is when the fund makes payment to the shareholders, these distributions are composed by the income they receive from:

1) Stocks and bonds

2) From their holdings capital gains (holdings capital appreciation).

When these gains are passed to the shareholders, the NAV loose value because money is subtracted from the total assets value.

Example:

A NAV valued at $20 makes $5 cash contribution, the NAV value drops to $15

When there are gains but contributions rather than be paid to the shareholders are reinvested in the fund, the fund NAV increases in value.

Annualized Return:

Annualized Return is the average annual compound return given in a specific year or years period, per say the last 5 years.

Total Return:

The total return of a fund is the complete gain or losses in an specific period of time. Normally Total Return reports assumes that your contributions are reinvested in the fund.

Mutual Funds Cost:

All funds have a cost associated to them, and can be charged when you make the investment or when you receive the returns.

Some expenses are charged as one time fees at the purchasing or sale of the fund, and other are charged on ongoing bases, some funds do not charge one time fees but they do charge ongoing fees. This can be very expensive.

Sales Commissions:

Front End Load.

If you pay a fee or commission when you buy shares in a fund it called a Front End Load

Back End Load

If you pay a sales fee when you sell your shares on a fund, you are charged Back End Load, some back end load are reduced or eliminated if you hold the shares on the fund for some specified time or more.

Funds shares classes:

Class A: Normally carries front end loads and 12b-I fees

Class B: Normally carries back end loads and 12b-I on going fees

Class C: These funds shares, don charge any loads but their fund are charged with too high on going 12b-I fees, This making them in most cases the more detrimental on annual return.

Front End Load Example:

A person invest $100,000 in fund with 1% Front End Load, what will be the actual investment in his portfolio after the Front End Load commission had been taken?

Answer: $20,000 X (1.0-01) = $19,800 so this is the money that will be invested, the 1% or $200 will go to the fund administrator. It is important to know the charges that any fund will charge, otherwise could be very expensive, some funds can charge much more than 1% and go beyond 5% to a max of 8.5%

Back End Load Example:

What will be the price to pay for an investment that grew up from $10,000 to $10,500 in four months, if the fund has a Back End Load of 7% if the shares are sold before the agreed 4 year period?

The charge will be $10,500 X 0.07 = $735

As can be seen from this example it can be very expensive, and this can be worst if the fund looses value rather than making gains, if this is the case you will have to accumulate the loses from the fund shares plus having to pay the Back End Load.

Redemption fees:

Redemption fees are similar to Back End loads in the sense that they are charged when the the shares in the fund are sold before the contracted period.

The redemption fees are normally reinvested back into the fund rather that going to the broker pocket.

Fund maintenance fees:

Some funds charge account maintenance fees in annual or monthly bases, if the account drops below a certain level, per say $5,000 , $10,000 or any other amount preset in the prospectus, once the investment level has reached the required minimum , the fee is waived.

Expense Ratio:

The Expense Ratio, is a summary of all charges and fees that a fund charge to their investors and normally is given as percent of the total fund value.

Example:

One fund with 100 millions in assets has a Expense Ratio of 1% how much money is the fund expense 100,000,000 X 0.01 =1 million Dollars.

12b-I fees:

About 50% of funds charge this fee, these funds charges are authorized to be used to cover distribution cost, advertising and other promotional and administrative related expenses. This fee could be very expensive and could be around 1% of total fund value.

Conclusion:

Don’t invest in funds with Expense ratio of More than 1.0%. Funds with Expense Ratio Less than 0.75 could be reasonable.