Friday, April 22, 2005

The Fundamentals of Mutual Funds

Liquidity Investors in "open-end" mutual funds can cash in all, or some, of their shares at any time and receive the current value of their investments, which may be more or less than their original cost. Investors in such funds do not need to find buyers: the funds are always ready to buy back (redeem) their shares. Current per-share values are calculated daily, based on the market value of the fund’s underlying securities. These values change as the values of the underlying securities move up or down, and as the funds change their portfolios by buying new securities or selling others. Investors can find the per-share calculations (known as "net asset values") published each day in the financial sections of most major newspapers.

Investors in "closed-end" mutual funds, on the other hand, can cash in their shares only by finding buyers in the "open market." The term "open market" refers to stock exchanges and the over-the-counter stock market.

Diversification By purchasing many different securities with the pool of shareholders dollars, a mutual fund "diversifies" its holdings. A diversified portfolio reduces risk should some investments turn "sour," and increases the chance of choosing potential "winners." The average investor would find it difficult to amass a portfolio as diversified as those of most mutual funds.

Choice A mutual-fund investor has more options than ever before—stock, bond, and money-market funds—to fit investment strategies from the most conservative to the most speculative. In addition, specialized funds are available—for instance, those that invest only in certain geographic regions or in certain industries (such as health care, high-technology, or energy). There are also funds that have adopted certain social objectives or that follow specific investment philosophies. However, such specialization may offset some of the advantages of diversification found in other mutual-fund portfolios.

Professional Management The money accumulated in a mutual fund is managed by professionals who decide where and when to invest it. These money managers make decisions based on research into the financial performance of individual companies and specific securities issues, taking into account general economic and market trends. After analyzing such data, the managers try to choose investments that best match the fund’s objectives. As economic conditions change, the fund’s managers may adjust the mix of investments to adopt either a more aggressive or a more defensive posture corresponding to the investment objectives of the fund.

Flexibility While some investors pick a single mutual fund and stick with it, others choose a "family" of funds—several different funds which are available "under one roof." In a family of mutual funds, investors can transfer portions of their investment from one fund to another as their own needs or financial circumstances change. In some fund families, investors can do so without additional sales charges.

Growth The first U.S. mutual funds were organized during the 1920’s. By the early 1990’s, mutual funds were managing more than 54 million shareholder accounts valued at over $900 billion. Individual fund performance varies, but on average, and over the long run, the growth of stock funds has paralleled the growth of the U.S. economy. Similarly, the performances of other types of funds reflect the long-term movements of more specialized markets. For instance, money-market funds reflect activity in the short-term money-market; bond funds, the bond market; tax-exempt funds, the municipal bond market, etc.

Regulation & Disclosure Mutual funds are regulated under four federal laws, as well as the Wisconsin Uniform Securities Law, all of which are designed to protect investors who, nevertheless, assume the risks inherent in investing in securities. The Investment Company Act of 1940 requires all funds to register with the U.S. Securities and Exchange Commission and to meet certain operating standards; the Securities Act of 1933 mandates specific disclosures; the Securities and Exchange Act of 1934 sets out anti-fraud rules covering the purchase and sale of fund shares; and the Investment Advisors Act of 1940 regulates advisors to the funds. The Wisconsin law regulates the offer and sale of mutual fund shares to persons in Wisconsin.

These laws require all funds to provide closed-end" investment companies because it is now commonly used to include both. "Open-end" and "closed-end" funds are defined elsewhere in this brochure. a "prospectus" to every potential investor. This document, which should be read before making such an investment, describes in detail the fund, its shares, and its investment objectives. It also outlines all fees.

Investors may also request from a mutual fund a copy of its Statement of Additional Information, which discusses in even more detail the investment policy and the securities that make up the fund’s portfolio.

All mutual funds are also required to provide their shareholders with periodic reports on what the fund is doing and what is happening to its investments. In addition, investors must be sent a yearly statement detailing the federal tax status of their earnings from the fund.

Accessibility Mutual-fund shares are easy to buy. For those who prefer to make investment decisions themselves, mutual funds are as close as the telephone. Those who would like help in choosing a fund can draw upon a wide variety of sources. For instance, many funds sell their shares through stock brokerage firms and their registered representatives, and through those financial planners or insurance agents who are also licensed as securities agents. These representatives can help investors to analyze their financial needs and objectives, and they can recommend appropriate funds. Other funds maintain their own sales forces. They can be reached through toll-free telephone numbers. Investors can write or call these funds and a sales agent will contact them.

Sales Charges & Fees Investors may encounter three kinds of charges and fees when investing in mutual funds.

Many funds charge a sales commission, or "load," usually expressed as a percent of the total purchase price of the fund shares. Sometimes the load charged by open-end funds is deferred until the investor redeems (or "cashes in") his or her shares; this is referred to as a "back-end" or "rear-end" load or a "deferred sales charge."

Some funds, known as "no-loads," sell their shares directly to the public. No-loads advertise in magazines and newspapers, and potential investors can write or call for additional information. Because no sales agents are involved, these funds do not charge sales commissions.

Investors will also pay fees for the operation of the fund. For example, most funds contract with an investment adviser for investment advice and other management services. The company providing these services receives a fee based upon, and paid from, the fund’s total assets.

In addition, some funds charge what are known as 12b-1 fees, named after a section of the rules under the Investment Company Act of 1940. These fees, which range from ¾ of a percent to 1% or more of the total of net assets of the fund, cover promotional and distribution expenses. Such fees, as well as administrative expenses, brokerage commissions, and taxes, add to the expenses deducted from fund income before dividends are distributed to shareholders. Prospective investors should read all fee and expense information in a prospectus and compare it to that of similar funds.

Whether investing in load or no-load funds, it is up to individuals to do the "homework" necessary to determine what fees are being charged, as well as to select the best mutual fund for their needs.

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