Investing Unit 6: Marketplace - Financial Security for All

Mutual funds fall into three main categories:

Stock (investing primarily in stocks)
Bond (investing in debt issues)
Money market (investing in short-term cash assets).

All are established to achieve one of the following investment objectives:

Growth
Income
Growth and Income
Preservation of Capital

A mutual fund’s stated objective might read something like “this fund seeks capital appreciation,” meaning it is appropriate for investors who want to grow their money over the long term. Or it could state, “this fund seeks current income,” indicating that the fund should be considered by investors who need a regular stream of income from their investments. The way these objectives are to be accomplished is outlined in the fund’s prospectus and is the responsibility of the professional money manager hired by the mutual fund company.

To be a successful investor, you must match your objectives to that of the fund (e.g., long-term growth for retirement in 15 years). Equally important is matching the fund’s risk level to your own risk tolerance. Study the fund’s objective and understand the strategies it uses to achieve its goal in light of what you want to accomplish. Refer to Figure 1 to put various categories of mutual funds into perspective according to their level of risk and return:

Figure 1. Adapted from AAII Mutual Funds Video Course Workbook

The worksheets which follow break down mutual fund types by their basic investment objectives. Use them to help you match your goals with the appropriate funds. Examples for each category are provided. Any of the sample objectives could be met by any of the mutual fund types in each category. Write in your goals in the space provided on the left under Your Objective in each chart.

Worksheet 1

YOUR OBJECTIVE	MUTUAL FUNDS WITH A GROWTH OBJECTIVE
Examples: Retirement in 25 years College fund for a newborn Your Objectives: _______________ _______________ _______________	Growth funds invest for the long term, and share prices can fluctuate considerably. They buy profitable, well-established companies that expect above-average earnings growth. Income is secondary, paying very small dividends, if any.
	Aggressive growth (also called maximum capital appreciation) funds use riskier investment techniques (e.g., options, short selling) and/or invest in stocks of smaller, less-proven companies. They can be very volatile, but the trade-off is a high potential for capital appreciation.
	Small capitalization funds invest in stocks of small companies with assets under $1 billion and are riskier than larger capitalization stock funds (over $10 billion in assets). (Capitalization means number of shares outstanding multiplied by the price per share.)
	Specialty or Sector funds limit investments to a specific industry (e.g., health care, biotechnology, financial services).
	International funds invest in securities of countries outside the United States.
	Global funds invest in securities worldwide including the U.S.
	Index funds invest in stocks of one of the major broadly based market indexes such as the S&P 500 (large companies), Russell 2000 (small companies) or Europe, Australia, Far East or EAFE (international). Generally, these are passively managed funds with low expenses (meaning there is no manager deciding when to buy or sell securities).
	Emerging markets funds invest primarily in the stock of developing countries.
	Sector funds invest entirely or predominantly in a single economic sector (e.g., technology and health care).
	Socially conscious funds are managed for capital appreciation and screen out certain securities based on designated social priorities (e.g., eliminating companies with poor environmental records).

Worksheet 2

YOUR OBJECTIVE	MUTUAL FUNDS WITH AN INCOME OBJECTIVE
Examples: Lower risk in a stock-rich portfolio Additional income for high tax-bracket retiree. Supplement Social Security and pension for living expenses. *Your Objectives:* _______________ _______________ _______________	Income funds usually include a combination of bonds and utility stocks to produce steady income and lower investment risk.
	Corporate bond funds are available in short-term, intermediate, or long-term maturities. They invest in investment-grade bonds (debt) of seasoned companies. Investment grade bonds have ratings of AAA, AA, A, or BBB by Moody’s or Standard and Poor’s.
	Municipal bond funds (short-, intermediate-, and long-term) invest in tax-exempt municipal issues of state and local governments. They are generally sought by investors in the 28% and higher brackets.
	High-yield (junk) bond funds buy bonds with less than a BBB rating, thereby increasing risk to seek a higher return (not suitable for the risk-averse). See Unit 5.
	Government bond funds invest in safe government-backed securities (e.g., Treasury notes).
	Ginnie Mae (GNMA) funds hold securities backed by a pool of government-insured mortgages.
	Global bond funds invest in bonds of overseas companies.

Worksheet 3

YOUR OBJECTIVE	MUTUAL FUNDS WITH GROWTH AND INCOME OBJECTIVES
Examples: College Tuition in 7 Years Retirement in 10 Years *Your Objectives:* _______________ _______________ _______________	Equity-income funds aim for moderate income and some growth, investing primarily in blue chip companies and utilties that pay current income and higher dividends.
	Growth and income funds aim for more long-term growth and a little less income than equity-income funds. They invest in large well-known firms that pay dividends.
	Balanced funds combine stocks and bonds in one portfolio to earn a reasonable income with reasonable growth. They are usually found in a fixed ratio of 60% stocks to 40% bonds.

Worksheet 4

YOUR OBJECTIVE

MUTUAL FUNDS WITH A PRESERVATION OF CAPITAL OBJECTIVE

Examples: Down Payment on a House in 1 Year
Wedding in 18 Months – Upper Tax Bracket

Your Objectives: _______________ _______________

_______________

Taxable and tax-free money market funds invest in very short-term debt securities such as Treasury bills and corporate IOUs known as commercial paper.

Tax-free money market funds invest in very short-term securities issued by state and local governments.

Worksheet 5

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YOUR OBJECTIVE	MUTUAL FUNDS WITH ALL FOUR OBJECTIVES
Examples: Invest for Retirement in 5 Years in a One-Fund Portfolio New Graduate Starting from Scratch *Your Objectives:* _______________ _______________ _______________	Lifecycle (Lifestyle) funds typically offer three to four portfolios from which to select one with different mixes of stocks, bonds, and cash planned to fit people at different stages in the life cycle, different tolerances for risk, or those getting started with a limited amount of money (e.g., Vanguard LifeStrategy funds and T.Rowe Price Personal Strategy funds).
	Asset allocation funds aim for good returns and relatively low risk by combining changing amounts of the three asset classes–stocks, bonds, and cash. Managers of the fund shift the investment portfolio among the categories at their own discretion.
	Funds of funds are mutual funds that buy shares of other funds. In some instances they are run by a mutual fund family (e.g., Vanguard STAR, composed of nine Vanguard stock, bond, and money market funds; T. Rowe Price Spectrum-Income or Spectrum-Growth, composed of six bond and six stock funds, respectively).