• Ting Zheng

Mutual Funds 101

Come with me on a new unknown where I dive into the world of investing. I'm by no means an expert, but while we are in these low market times I thought it would be something to take a look into and actively start learning about. Here are all my notes I've pulled together as I jump into this crazy information.

What is a Mutual Fund?

It's an investment strategy with a "portfolio" of stocks, bonds, and other securities. Think of it as buying little crumbs from a pie that a company owns, but you're buying crumbs from lots of different pies and it all sits in one basket. The benefit of this strategy is that because it consists of a group of assets when one company goes bankrupt or is not performing well and the stock goes down, there's a way to offset this loss with the overall group of assets. This type of "diversification" gives the investment more flexibility and basically makes it less risky than other strategies like directly investing into stocks with one company.

Mutual funds are managed by a team of investment managers and research analysts. They decide what to change within the fund and optimize performance based on the objective in place. Due to this 3rd party management, mutual funds incur fees. This is typically known as an expense ratio and it's a small percentage of your shares.

How is a Mutual Fund priced?

You need to look at 2 values that are computed daily:

  • Net asset value (NAV): This tells you how much it costs for one share of the mutual fund. This is the price you receive if you were to sell. To calculate this amount, you need to add up all the assets, subtract the liabilities, and finally divide by all the number of shares owned by the public.

  • Public offering price (POP): It takes money for someone to run a mutual fund. POP is the cost a person would have to spend to purchase the mutual fund which contains a sales charge, aka a "sales load". A sales load typically ranges from 0% to 8.5% of the POP.

Therefore, POP = NAV + sales load!

How to Choose the Right Mutual Fund?

1. Determine your objective: Are you in this for the long haul or the short term, or maybe somewhere in between? Think of this like a 5 year, 15-20 year, or 30+ year investment and when you're willing to pull out the funds. The longer time you plan to invest, the more likely you can tolerate risk. For myself, I'm in this for the long haul so I can take on more risk.

2. Match your goal to the investment objective: Essentially there are 4 objectives that a mutual fund can take.

  • "Growth and Income" which consists of large companies (large cap) like Apple. These are consistent and low risk.

  • "Growth" which has stocks made up of growing companies (mid to large cap) and add a bit more risk.

  • "Aggressive Growth" has the highest possible return, but also the riskiest with small cap companies.

  • "International" which provides a way to spread your risk beyond the US and invest in big foreign companies.

3. Research, Research, Research: This is honestly the hardest part, with thousands of mutual funds, it's hard to trim down your options. I have a Morningstar subscription which is an online screening tool and provides a compilation of data and insights to inform you. I may have to do another blog post on just navigating this tool, it's super comprehensive, but for now, I'll give you a quick gist of what to look at and the definitions.

  • Expense Ratio: This is the percentage amount you'll need to pay for a fund's annual operating expense. These typically range from 0% to 1%. Obviously the lower this fee percentage is, the better!

  • Sales Load: As mentioned in the pricing, there is often a sales load added in when buying (front-end load) and selling (back-end load). These are commissions paid to third parties.

  • Category/Investment Style: Basically, now you can match your objective and investment objective to this parameter. It will tell you what types of companies the fund consists of and where it intends to invest.

  • Trailing 12 Month Yield (TTM Yield): This is where the money is at! It refers to the percentage of income a fund returned over the past 12 months. The higher the percentage, the better return you're getting back.

  • Turnover: Refers to the fund's trading activity within a year. A low turnover percentage (20% - 30%) tells you the fund has a buy-and-hold strategy, while a high turnover percentage (more than 100%) means the fund has a very fluid strategy of buying and selling assets. Typically really aggressive mutual funds have a higher turnover.

4. Check Past Performance: This is an obvious one that most people tend to look at as you want a fund that has a history of strong returns aka the track record, but it's not all about the fund's historical performance. You also need to look at who manages it. Review the manager's experience extensively and check if they have also had their net worth invested in the same fund.

Next up, I'll be putting these 4 steps into practice! Wish me luck and happy investing!

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