Mutual Funds

Professional Money Management

Mutual funds provide the benefit of full-time investment management expertise and recordkeeping services. Fund investors own shares in a diversified, professionally managed portfolio that most investors could not afford to create.

Diversification

A mutual fund is required to be diversified. Its assets are invested in many different securities. This reduces the exposure to individual security risk by spreading risk across many different securities. In addition to the diversification inside a mutual fund, mutual fund investors manage risk by purchasing mutual funds with different objectives. A balanced portfolio of different asset classes (stocks, bonds, real estate and commodities) and categories within an asset classes (value vs. growth stocks, or government vs. corporate bonds) is a risk management strategy.

Affordability

inimum investment requirements and subsequent investment minimums are low enough on some mutual funds that most anyone can invest.  Plus, you have access to types of investments not always available for small investment amounts.

Additionally, with mutual funds, fees pay for professional management, account recordkeeping/investment advice and other basic services needed to run the mutual fund. Some fees are paid from the fund’s assets, some are paid directly by the investor, and some are deducted only for certain services or circumstances. There are three types of operating expenses:

• Management Fees: Cover the costs to manage the investment portfolio and administrative expenses, and all funds have these charges. Fees usually range from 0.5% to 1% of the fund's total asset value and are often higher for specialized funds. They are reflected in the fund’s share price and are not directly charged to the investor.
• Other Expenses: Include legal, accounting, custodial and recordkeeping expenses.
• Distribution Fees: Called 12b-1 fees, are marketing expenses needed to distribute the fund. Not all mutual funds have 12b-1 fees. For a fund to be called "no-load" its 12b-1 fee must not exceed 0.25% of assets.

Convenience and Accessibility

Mutual funds may be purchased directly from a fund company, through a financial advisor, through an employer-sponsored retirement plan or from a fund supermarket. Each share purchased represents a widely diversified portfolio of investments, professionally managed for you.

Liquidity

Mutual fund shares may be redeemed at the closing price any day the financial markets are open. Some funds, especially international funds, charge redemption fees to discourage short-term trading. Proceeds may be sent by wire, electronic transfer or check.

Types of Funds and Features

While the core features of mutual funds are the same, their investment objectives can be very different. Because each mutual fund has a specific investment objective, such as growth, capital preservation or income, it is important to understand which funds are designed to meet your investment objectives. Mutual funds generally fall into these main categories:

• Stock or Equity Funds invest in the ownership of companies through stocks.
• Bond or Fixed-Income Funds invest in government or corporate debt to generate income.
• Money Market Funds invest in short-term debt, pay interest and target a stable share price.
• Asset Allocation Funds invest in a mix of stocks, bonds, alternatives and money market securities.
• Alternative Funds do not invest in conventional securities such as stocks, bonds and cash. Rather, they invest in private equity, hedge funds, managed futures, real estate, commodities and derivatives contracts.
• Alternative strategies on traditional asset classes include long and short equities as investment strategies. This involves buying long equities expecting to increase in value and selling short equities expected to decrease.

Mutual funds are the most common way people invest for the future with more than $20 trillion in investment assets. They are so popular because they are a simple, convenient way to invest in stocks, bonds, money markets, commodities and other securities. Through mutual funds, almost anyone can invest in the financial markets as a means to meet financial goals. Nearly half of all U.S. households invest in mutual funds.

These professionally managed investment products use money from investors to create a diversified pool of securities to achieve a specific investment objective. Investors purchase shares, which represent ownership in the mutual fund. The price of the fund fluctuates based on the gain or loss of the securities that make up the fund. Investors in a mutual fund are entitled to a pro-rata share of the proceeds or the losses.

Fund Taxes

• The decision to buy or sell mutual fund shares can impact how much you pay in taxes. Understanding mutual fund tax issues can help you keep an eye on taxes, while still working toward your long-term financial goals.
• When you sell shares in a mutual fund, whether by redeeming, exchanging or writing a check, you have triggered a taxable event, unless the transaction occurred in a tax-deferred retirement plan or a money market fund. At tax time, you'll need to report any gain or loss on your taxes.
• When it comes to taxes and your investments, there is a lot to think about. You may want to consult a tax professional for information tailored to your personal situation.

How Capital Gains Work

Investors in mutual funds can be taxed on both the income a fund makes while you own its shares -- known as capital gains -- and on the profits you make when you exchange or sell shares.

Capital gains can be defined as the difference between an asset's purchase price and selling price, when the difference is positive. (A capital loss would be when the difference between an asset's purchase price and selling price is negative.) Gains come in two forms, unrealized and realized:

• Unrealized gains are gains on paper only and aren't taxed until the gains are realized and distributed to shareholders. A fund can post a large return and not trigger taxes for its shareholders if the securities appreciate and are not sold.
• Realized gains occur when an asset that has appreciated in value is sold. At that point, the profit is taxable as a capital gain.

There are two categories of capital gains:

• Short-term gains and losses occur when the assets are held one year or less. Short-term gains are taxed at your ordinary income tax rate. Short-term capital losses can be used offset short-term capital gains.
• Long-term gains and losses occur when the assets are held longer than 12 months. Long-term capital gains are generally lower than your ordinary income tax rate. Long-term capital losses can be used offset long-term capital gains.
• IRS capital gains tax rates and information

Distributions

Mutual funds are required to distribute income and net realized gains to its shareholders. Owning a mutual fund in a taxable account when it pays a distribution can affect your tax bill. Types of distributions include:

• Income dividends — Interest, dividends or short-term capital gains earned from the securities in the portfolio, after fund expenses are deducted.
• Capital gains distributions — Profits on the sale of securities after deducting any losses, typically paid annually.

Distributions lower a fund’s share price by the amount of the distribution. Shareholders who reinvest their distributions will receive additional shares. Shareholders who receive distributions in cash must include the distribution as part of their investment's total return.

The below chart shows distribution’s effect on a fund's price and on the change in the account's shares and balance. Distributions of capital gains typically occur in November and December and may be significant. Investors may consider deferring large purchases near a distribution to avoid a tax liability.

Mutual FundsDistributions

*The $125 distribution reinvested at $8.75 will purchase an additional 14.286 shares.

Taxes and Account Types

• To encourage savings, legislators have created tax-advantaged accounts like 401ks and IRAs (Individual Retirement Accounts. To encourage investment in government projects, legislators have created tax-advantaged investments like municipal bonds. Understanding these concepts will help you determine if tax-advantaged investments are right for you.
• Employer retirement plans and traditional IRAs allow most individuals to invest earnings before taxed. Many employers will match a portion of your contributions to their retirement plan. Most financial planners suggest that you invest in these plans first to increase retirement contributions.
• Tax-deferred accounts allow investment gains to grow tax-free until the money is withdrawn. There are two types of tax-deferred accounts. First, are accounts funded with pre-tax income. These include employer retirement plans like 401Ks and IRAs. Second, are accounts funded with after-tax income. These include Roth IRAs and annuities.
• Roth IRA accounts — Roth IRA accounts are funded with after-tax earnings, but investment returns are never taxed, not even when withdrawn.
• Tax-free investments — Interest on municipal bonds is exempt from federal taxes and may be exempt from state and local taxes. Capital gains are not exempt from taxes. These investments are not appropriate for tax-advantaged accounts.

Index Funds

Structure

With reduced taxes/fees, index funds are a passive type of mutual fund designed with diversification in mind.

Diversification

Index funds track popular, well diversified market indexes. As a result, index funds typically provide investors with broad exposure to an asset class.

Affordability

By replicating the benchmarks of popular market indexes, index funds do not require the research and resources that accompany a traditional mutual fund, thus allowing for passive management. Consequently, index funds have lower management fees, which keep these products more affordable.

Access & Convenience

Because these investments abide by set guidelines, index funds offer a simple structure for gaining broad market exposure.