PFIN 4 Investing in Mutual Funds, ETFs and Real Estate 13 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,

PFIN 4

Investing in Mutual Funds, ETFs and Real Estate

13

Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

GITMAN/ JOEHNK/ BILLINGSLEY

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1 Describe basic features and operating characteristics of a mutual funds and exchange traded funds

2 Differentiate between open- and closed-end mutual funds as well as exchange traded funds, and discuss the various types of fund loads and charges

3 Discuss types of funds available to investors and the different kinds of investors services offered by mutual funds and exchange traded funds

LEARNING OUTCOMES

PFIN4 | CH13

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4 Gain an understanding of the variables that should be considered when selecting funds for investment purposes

5 Identify the sources of return and calculate rate of return earned on an investment in a mutual fund as well as evaluate the performance of an exchange traded fund

6 Understand the role that real estate plays in a diversified investment portfolio along with basics of investing in real estate, either directly or indirectly

LEARNING OUTCOMES (continued)

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Mutual Funds and Traded Funds

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• Mutual fund• Financial services organization that receives

money from its shareholders• Invests funds in a diversified portfolio of

securities• Exchange traded fund (ETF)

• Investment company whose shares trade on stock exchanges• Shares can be bought and sold throughout the

day

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Exhibit 13.1

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Basic Mutual Fund Structure

Reasons for Investing in Mutual Funds or ETFs

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• Achieve diversification in the investment holdings

• Obtain services of professional money managers • Pooled diversification: Investors buy into a

diversified portfolio of securities for the collective benefit of individual investors

• Generate rate of return on the investment capital

• Offer convenience

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How Mutual Funds are Organized and Run

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• Management company - Runs daily operations

• Investment advisor - Oversees portfolio• Distributor - Sells the fund shares • Custodian - Safeguards the securities and

other fund assets• Transfer agent - Executes transactions and

maintains other records

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Open-End versus Closed-End Funds

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• Open-end investment company• Issues unlimited number of shares that it buys

and sells at a price based on the current market value of the securities

• Net asset value (NAV): Current market value of all the securities the fund owns, less liabilities, on a per-share basis

• Closed-end investment company• Issues a fixed number of shares which are

themselves listed and traded share of stock

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ETFs

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• Structured as index funds• Offer professional money management of

mutual funds• Provide liquidity of an exchange traded

stock• Distributors can create new shares or

redeem old shares• Contain higher costs, portfolio turnover and

taxes when managed actively

Important Cost Considerations

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• Load fund: Charges a fee at purchase• Low: Consists a low purchase fee• Back-end: Commission charged for

redeeming fund shares• No-load fund: Involves no transaction

fees charged

Important Cost Considerations

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• 12(b)-1 Fee: Annual fee used to offset the promotion and selling expenses

• Management fee: Paid to the professional money managers who administer a mutual fund’s portfolio

Types of Funds

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• Growth• Aims for capital appreciation• Involves risk exposure• Viewed as long-term investment vehicles

• Aggressive growth• Highly speculative investment vehicles• Seek large profits from capital gains• Volatile in nature

Types of Funds

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• Value• Invest in stocks that are considered to be

undervalued by the market• Equity-Income

• Emphasize current income• Aim to preserve the capital• Viewed as low-risk way of investing in stocks

Types of Funds

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• Balanced• Hold a balanced portfolio of stocks and bonds• Generate well-balanced return of current

income and long-term capital gains• Confine investing to high-grade securities

• Growth-and-Income• Confine investing to high-quality issues• Involve risk due to their emphasis on stocks

and capital gains

Types of Funds

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• Bond• Invest in various kinds of fixed-income

securities• Advantages

• More liquid• Offer a cost-effective way of achieving a

high degree of diversification • Automatically reinvest interest and other

income

Types of Funds

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• Index• Buys and holds a portfolio of stocks

equivalent to those in a market index• Sector

• Restricts investments to particular sector of the market

Types of Funds

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• Money market• General purpose: Invests in virtually any

type of short-term investment vehicle• Tax-exempt: Limits its investments to short-

term, tax-exempt municipal securities• Government securities: Limits its

investments to short-term securities of the U.S. government and its agencies

Types of Funds

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• Socially responsible: Invest only in companies meeting social, ethical, and/or environmental criteria

• International fund: Invest in foreign securities

• Asset allocation• Spread investors’ money across all different

types of markets

Services Offered by Mutual Funds

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Services Offered by Mutual Funds

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Selection Process for Making Mutual Fund and ETF Investments

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• Identify objectives and motives for using funds

• Recognize what funds have to offer• Eliminate the alternatives

• Evaluate funds investment performance• Stick with no-load or low-load mutual

funds

Measuring Fund Performance

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• Sources of return• Dividend income • Capital gains distributions • Change in fund's share price

• Evaluating ETF performance• Reason for investing in an index based ETF is

to replicate the performance of the index• Determined by R-Squared statistical

measure

Basic Considerations of Investing in Real Estate

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• Factors affecting the value of real estate investments• Cash flow and taxes• Appreciation in value• Use of leverage

Speculating in Raw Land

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• Investors seek to generate high rates of return by investing in a property hoping it will increase in value

• Involves high risk

Investing in Income Property

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• Income-producing property• Purchased for renting to generate periodic

income in the form of rent receipts • Commercial properties

• Office buildings, industrial space, and warehouses to retail space and hotels

• Risk and returns are tied to business conditions and location

Investing in Income Property

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• Residential properties• Homes, apartments, and smaller multifamily

buildings• Profitability is influenced by the occupancy

rates• Other factors to be considered

• Location• Local regulations • Supply and demand trends

Other Ways to Invest in Real Estate

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• Real estate investment trust (REIT)• Accumulates money, by selling shares to

investors to invest in various forms of real estate

• Types• Equity• Mortgage• Hybrid

Other Ways to Invest in Real Estate

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• Limited partnerships (LPs)• Managers assume the role of general

partner with unlimited liability • Other investors are limited partners legally

liable only for the amount of their initial investment

• Limited liability companies (LLCs)• Includes a managing member and other

members without any liability

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• Mutual fund• Exchange traded fund

(ETF)• Pooled diversification• Open-end investment

company• Net asset value (NAV)• Closed-end

investment company• Load fund• Low-load fund• Back-end load fund

KEY TERMS

• No-load fund • 12(b)-1 fee• Management fee• General-purpose

money fund• Tax-exempt money

fund• Government

securities money fund • Socially responsible

fund (SRF)• International fund

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• Automatic investment plan• Automatic reinvestment plan• Systematic withdrawal plan• Conversion (or exchange) privilege• Income-producing property• Real estate investment trust (REIT)

KEY TERMS

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SUMMARY

• Mutual funds are invested in a diversified portfolio of securities• ETF shares are traded on stock exchanges

• Open-end investment companies issue unlimited number of shares at a price based on the current market value of the securities • Closed-end investment companies issue a

fixed number of shares which are listed and traded

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SUMMARY

• Types of funds• Growth, aggressive growth, value, equity-

income, balanced, growth-and-income, bond, money market mutual funds, index, sector, socially responsible, international, and asset allocation

• Variables to be considered while making mutual funds and ETF investments• Identify objectives and motives for using

funds, recognize what the funds have to offer, eliminate the alternatives, and stick with no-load or low-load mutual funds

PFIN4 | CH13

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SUMMARY

• Sources of return• Dividend income, capital gains distributions,

and change in fund's share price• Factors that affect the value of real estate

investments• Cash flow and taxes• Appreciation in value• Use of leverage

PFIN4 | CH13