MUTUAL FUND · a pooled portfolio managed by a professional advisorNAV · net asset value, the price of one shareOPEN-END · sells as many shares as investors wantCLOSED-END · fixed shares traded like a stockDIVERSIFICATION · combining investments that don't move in stepMUTUAL FUND · a pooled portfolio managed by a professional advisorNAV · net asset value, the price of one shareOPEN-END · sells as many shares as investors wantCLOSED-END · fixed shares traded like a stockDIVERSIFICATION · combining investments that don't move in step
You don't have to pick every stock yourself. This session covers how mutual funds pool many investors' money into one professionally managed portfolio, and how to read what's actually inside one.
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Background
What Is a Mutual Fund?
A mutual fund is a collection of stocks, bonds, and other securities owned by a group of investors and managed by a professional investment advisory firm. The firm collects money from investors, pools it, and invests it. The fund manager, working with a team of analysts, decides which stocks and securities to include, often investing in 100 or more securities. Some mutual funds are index funds, which closely follow a particular index of stocks, such as the S&P 500 or the Dow.
Mutual funds fit the needs of people with a variety of risk tolerances, from the very conservative to the more speculative. Every day, the fund's managers evaluate the performance of each security and how current economic, social, and political events might affect their holdings, then decide which securities to keep or sell.
All mutual funds have investment objectives. Value funds, for example, only invest in stocks the fund's managers believe are undervalued. Some funds take this further by only investing in companies the managers believe are "socially responsible," which can mean different things to different people, from environmental standards to religious ones.
Investing in mutual funds helps individual investors diversify their portfolios. Investors cannot buy a mutual fund's shares on margin (using money borrowed from a broker to buy stock), or sell them short (selling a borrowed stock, betting its price will drop).
Key Terms
Vocabulary
Tap a card to flip it and reveal the definition.
Bonds
An IOU that a company or government sells when it borrows money. Bonds are called fixed-income investments because they pay a fixed amount of interest to the bondholder for the use of their money.
Closed-End Funds
Like open-end mutual funds, collections of securities managed by a professional investment advisor. Unlike open-end funds, their shares are traded on a stock exchange like ordinary stock.
Diversification
Reducing risk by combining different investments whose prices aren't likely to move in step with one another.
Exchange-Traded Funds
Funds whose shares, like closed-end funds, are traded on a stock exchange. These invest in stocks or bonds that closely follow an index.
Index
A statistical measure of change in an economy or securities market, essentially an imaginary portfolio representing a particular market or a portion of it. The S&P 500 is one of the world's best known indexes.
Mutual Funds
An investment instrument developed and managed by a company that pools members' money, often millions of dollars, to invest in a variety of stocks and bonds, actively managed by investment professionals.
Open-End Funds
Funds that usually sell as many shares as investors want to buy. Sometimes they stop selling shares to new investors once they grow too large to manage effectively. Investors sell their shares back to the fund.
Goals
Performance Objectives
By the end of this session, you should be able to:
Define and identify the characteristics of a mutual fund.
Use the newspaper and internet to research mutual funds.
Use your research on mutual funds to help determine your investments for the Stock Market Game.
Create and deliver a presentation on mutual funds, their risk, and their performance.
Materials for this session:
Activity Sheet 1 · What Are Mutual Funds? (Parts I & II)
Activity Sheet 2 · Reading and Interpreting Information on Mutual Funds
Activity Sheet 3 · Evaluating a Mutual Fund
Chart paper & markers, computers / internet access
Springboard Activity
Information, Services, Manufacturing
Working in teams, brainstorm different products and services people buy and use. Name a range of products in these three categories:
Explain why, when you are making investments, you want to diversify your portfolio.
As an investor, why might you want to invest in companies under all three categories?
Would you invest in products in more than one category? What if you could only buy in one category? Would that put your money at greater risk?
A mutual fund company does exactly what you just discussed. It takes investors' money, pools it with other investors' money, and invests it across various stocks, bonds, and other securities. Some mutual funds are riskier than others depending on the types of investments they make.
Activity Sheet 1
What Are Mutual Funds?
Part 1
Look at the stocks your team has purchased or plans to purchase. Do the stocks represent a broad range of industries? If yes, what industries are represented? If no, create a brief list of industries you would consider investing in to diversify your portfolio.
Types of Mutual Funds
There are more than 17,000 mutual funds for investors to choose from, including balanced funds, stock funds, bond funds, sector funds, money market funds, and more.
Most are open-end funds, meaning they sell as many shares as investors want to buy. (Sometimes open-end funds stop selling new shares once they grow too large to manage effectively.) If you want to sell shares of your open-end fund, you sell them back to the fund.
Closed-end funds are collections of securities managed by a professional investment advisor, but unlike open-end funds, they offer a fixed number of shares traded on a stock exchange like ordinary stock.
Exchange-Traded Funds are funds whose shares, like closed-end funds, are traded on a stock exchange. These invest in stocks or bonds that closely follow an index.
List and describe three different mutual funds you would consider investing in. Use Morningstar.com, Yahoo! Finance, or a similar research site to help you.
Mutual Fund Name
Description
A number of funds have been created to support particular ideas or causes, such as support for women's issues, encouraging socially responsible business practices, or supporting family-friendly companies. Locate two funds that fall into this category and describe the causes they support.
Mutual Fund Name
Description
A mutual fund investor can make money in several ways:
The fund earns income from interest or dividends on its investments, and distributes it to fund holders in an income distribution, the frequency depends on the fund.
The fund produces capital gains by selling securities at a profit and distributes them to fund holders, usually at year end.
You sell your shares of the mutual fund at a higher price than you paid for them.
Part 2: Mutual Fund Families
A family of mutual funds is a group of funds offered by the same investment company. A fund family can use different distributors for different funds, and will often include many different types: stock funds, bond funds, international funds, and more. For example, Vanguard's 500 Index Admiral Shares stock fund (VFIAX), Short Term Tax Exempt Bond Fund (VWSTX), and its Emerging Markets Stock Index Admiral Shares international fund (VEMAX).
Mutual fund ticker symbols are five letters long and end in an "X" (VFIAX, VWSTX, VEMAX). Many commercial websites provide a fund index and list mutual funds by family.
Identify three mutual fund families you would like to research. Describe what they are invested in and why they appeal to you.
Fund Family Name
Description
Activity Sheet 2
Reading and Interpreting Information on Mutual Funds
Most daily newspapers include mutual fund quotes in the financial section, but not all mutual funds are listed every day. Listings for open-end funds are usually organized by fund family name. Listings for closed-end funds sit in the stock quotation section, since they're valued like stocks.
Here is an example of information for two Fidelity family funds:
Name
NAV
Net Chg
YTD % Ret
Fidelity
EmrgMkt
16.59
+0.07
+16.0
LgGrowth
24.66
-0.14
+4.92
NAV (Net Asset Value): the value of one share in the fund. Calculated by taking the total value of the fund's investments, subtracting its expenses, and dividing by the number of shares outstanding. Here, one share of the Fidelity Emerging Markets Fund is valued at $16.59.
Net Chg (Net Change): the change in the value of one share from the previous day's market close. Here, the value increased seven cents from the previous day, so a share closed the previous day at $16.52.
YTD % Ret (Year-to-Date Percent Return): the percentage increase or decrease in value for one share since the beginning of the calendar year, assuming reinvestment of any dividends. Here, a share of the Fidelity Emerging Markets Fund increased 16% in value this year.
Based upon what you have read so far, what is the main reason why you would choose to invest in a mutual fund?
Find the NAV, Net Chg, and YTD % Ret for the three mutual funds you named on Activity Sheet 1.
Ticker Symbol
NAV
Net Chg
YTD % Ret
To be filled in with a live lookup on the day of the activity.
Activity Sheet 3
Evaluating a Mutual Fund
Select three mutual funds to help you answer the questions below. If you need help, Morningstar.com and Yahoo! Finance are reliable mutual fund lookup resources.
Mutual Fund Selection 1, 2, and 3
Fund Name
Ticker
NAV
Date
YTD Return
Morningstar Risk Rating
Top Three Holdings
1. 2. 3.
Repeat this table for each of your three selected funds.
How has the fund performed over the past five years?
What is the percent breakdown among Information, Service, and Manufacturing holdings, if the fund invests in stocks?
From which industry or industries are the fund's top three holdings?
What is the fund's Morningstar Risk Rating? Why do you think it was rated that way?
Would you invest in this fund? Why, or why not?
Bonus Question: the Morningstar Box is a mutual fund rating tool unique to Morningstar. Visit morningstar.com to answer: what is the Morningstar style box, and what information does it provide to help investors make decisions? Explain what blend, value, and growth mean.
Assessment
Would You Invest in a Mutual Fund?
Based on what you now know about mutual funds, will you consider investing in mutual funds? Why or why not?
Based on your research, if you wish to invest in a mutual fund, which fund would be your primary investment? Why did you choose this fund?
Application
Researching Your Selected Funds
Go to morningstar.com to research the three funds you selected in Activity Sheet 1. Use Activity Sheet 3 to guide the research.
How will the information you found through internet research help you decide where to put your mutual fund investments?
Based on your new understanding of mutual funds, what will your investment strategy be, mutual funds, individual stocks, or perhaps both? Write a paragraph describing your investment approach.
What information does Morningstar provide to help investors make their decisions? Could you use the same system for individual stocks? Why or why not?
Enrichment Activities
Researching Funds Under Consideration
Select several mutual funds for possible investment. Research each fund under consideration.
Math Strands
What Is a Mutual Fund? Companion Worksheet
This companion worksheet works the math behind mutual fund holdings: calculating percentages, reading pie charts and ownership zone graphs, building a histogram, and matching funds to investors.
Thinking Algebraically: Practicing With Percentages
Percentages are a key part of analyzing financial information. In this exercise, find the percentage of the total mutual fund's worth invested in each stock type.
% of fund = (part of investment ÷ total investment) × 100%
Worked example: $13.4 million ÷ $51.7 million = 0.25918 × 100 = 25.92%.
1
Mutual Fund A: $13.4 million in growth stocks, $20.1 million in value stocks, $18.2 million in blend stocks.
Communicating Quantitative Information: Fund Pie Charts
Below are pie charts representing the assets of six different mutual funds. For each, the percentage invested in each category is calculated from the dollar values shown.
Mutual Fund A
Small Cap · $43M · 43%
Mid Cap · $11M · 11%
Large Cap · $46M · 46%
Mutual Fund B
Small Cap · $2.1M · 21%
Mid Cap · $3.6M · 36%
Large Cap · $4.3M · 43%
Mutual Fund C
Bonds · 7.14%
Cash · 4.17%
Intl Stocks · 17.26%
American Stocks · 71.43%
Mutual Fund D
Services · 25.64%
Basic Materials · 22.05%
Financial · 6.15%
Utilities · 46.15%
Mutual Fund E
Cash · 4.35%
Basic Materials · 13.04%
Industrial Goods · 34.78%
Healthcare · 21.74%
Technology · 26.09%
Mutual Fund F
Cash · 1.16%
Bonds · 1.63%
Industrial Goods · 28.84%
Technology · 17.67%
Services · 13.49%
Utilities · 37.21%
Interpreting Ownership Zone Graphs
Mutual funds can be thought of as someone else's stock portfolio. Since fund managers won't reveal their exact combination of stocks, they instead publish "Ownership Zone" graphs. The red dot shows the average type of company the fund holds; the shaded zone shows where roughly three-quarters of its holdings fall, across the value-to-growth axis and the small-to-large cap axis.
FUND 1
LargeMidSmall
ValueBlendGrowth
Mostly large and mid cap stocks, with a small percentage of small cap. On average, a moderate fund.
FUND 2
LargeMidSmall
ValueBlendGrowth
Almost entirely mid cap stocks. No large cap stocks, and only a small amount of small cap.
FUND 3
LargeMidSmall
ValueBlendGrowth
A diversified fund. Contains large, mid, and small cap stocks.
FUND 4
LargeMidSmall
ValueBlendGrowth
Mostly large cap value stocks. Very few mid cap, no small cap. A conservative fund.
FUND 5
LargeMidSmall
ValueBlendGrowth
A large cap growth fund. Roughly twice as many large cap stocks as mid cap. No small cap stocks.
FUND 6
LargeMidSmall
ValueBlendGrowth
For the risk taker. No large or mid cap stocks. Made up exclusively of small cap stocks.
Q7
Which of the above funds is the most diversified, in terms of risk and cap size? Which is the least diversified by the same criteria? How do you know?
MOST: FUND 3 · LEAST: FUND 6Fund 3 is the most diversified, its zone spans the full grid, touching every cap size and every style. Fund 6 is the least diversified, its zone is confined entirely to the small cap row, with no mid or large cap exposure at all.
Displaying Mutual Fund Holdings: A Histogram
One way to show how a mutual fund is invested is with a histogram: add one unit to the appropriate column for each company in the fund, categorized by cap size (small < $1 billion, $1 billion ≤ mid ≤ $5 billion, large > $5 billion) and by growth rating (value, blend, or growth).
Show the full 29-company data table
Company
Growth Rating
Cap
Cap-Size Category
1
Value
13.22 B
Large
2
Blend
1.30 B
Mid
3
Growth
18.17 B
Large
4
Value
1.20 B
Mid
5
Blend
27.04 B
Large
6
Growth
22.96 B
Large
7
Value
746.12 M
Small
8
Value
26.06 B
Large
9
Value
13.42 B
Large
10
Growth
17.95 B
Large
11
Blend
1.23 B
Mid
12
Blend
1.27 B
Mid
13
Growth
34.42 B
Large
14
Growth
34.31 B
Large
15
Blend
35.45 B
Large
16
Growth
960.57 M
Small
17
Blend
38.38 B
Large
18
Growth
211.80 M
Small
19
Growth
390.61 M
Small
20
Blend
404.86 M
Small
21
Growth
419.14 M
Small
22
Blend
421.20 M
Small
23
Blend
589.42 M
Small
24
Blend
37.27 B
Large
25
Blend
44.04 B
Large
26
Growth
4.34 B
Mid
27
Growth
1.04 B
Mid
28
Blend
433.55 M
Small
29
Value
1.06 B
Mid
Small · Value
1
Small · Growth
4
Small · Blend
4
Mid · Value
2
Mid · Growth
2
Mid · Blend
3
Large · Value
3
Large · Growth
5
Large · Blend
5
A discrepancy worth flagging: sorting the 29 companies above by the stated cap-size rule gives 13 large cap, 7 mid cap, and 9 small cap companies. The source worksheet's own written answer claims "14 large cap stocks, about half the portfolio," which does not match a literal reading of its data table (13 of 29 is about 45%, not half). The gap is exactly one company, shifted between the Mid-Value and Large-Value bars above. I cannot tell from the source which figure has the error, the data table or the "14" in the prose, so both counts are reported here rather than silently picking one.
On average, what type of stocks does this mutual fund invest in?
Large cap stocks dominate this fund, 13 of 29 companies (about 45%) by the data table above. The mode is tied between Large-Growth and Large-Blend, five companies each. Taken together, roughly two-thirds of the portfolio sits in the "large" row across all three styles.
Tackling Complex Problems: Choosing Mutual Funds for Investors
Different investors have different priorities, and need different investment strategies. Some can chase volatile stocks; others should stay in stable, conservative holdings. For each investor profile below, a fund type is proposed, along with a possible asset allocation across the same nine cap-size and style categories used above.
1. Susan is interested in a diversified portfolio, but can tolerate some risk. She is not a financial whiz, but her advisor has given her a basic education in how the market works. She is most concerned about being broadly invested.
MODEL ANSWER
A broad, balanced blend fund spread fairly evenly across all nine boxes, favoring blend and mid/large cap slightly, since Susan wants breadth over any one bet.
Small · Value
8%
Small · Growth
10%
Small · Blend
12%
Mid · Value
10%
Mid · Growth
12%
Mid · Blend
14%
Large · Value
10%
Large · Growth
12%
Large · Blend
12%
2. Rajib is a young, well-paid consultant who knows the market well through his job. He's comfortable taking risks and unconcerned with short-term volatility, since he plans to invest for a long time.
MODEL ANSWER
A growth-tilted fund weighted toward small and mid cap, where the long growth runway matches his long time horizon and high risk tolerance.
Small · Value
5%
Small · Growth
20%
Small · Blend
15%
Mid · Value
8%
Mid · Growth
15%
Mid · Blend
7%
Large · Value
8%
Large · Growth
15%
Large · Blend
7%
3. Omar wants small but consistent growth. He's very cautious, will only be invested for a short time, and only wants in if he can be persuaded the investment won't be volatile.
MODEL ANSWER
A conservative, large cap value-heavy fund, the lowest-volatility corner of the grid, with a little large cap blend for modest additional growth.