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The Financial Freedom
Odyssey
By Lynda B. Claiborne
| In her columns, Lynda will
follow two women, Mary and Anna, as they gain control of their finances and build their
investment portfolios. Mary is fifty-five, recently widowed, and a homemaker. Anna is
thirty-three, divorced with children, and works outside the home. Neither has experience
with investing, and both were nervous about the stock market and fear losing their money. |
Diversify your Portfolio with Mutual Funds
After she was widowed, Mary received a lump
sum from her husband’s life insurance policy. Mary needed current income and also
wanted to invest for her retirement. Her financial planner, Harriet, suggested mutual
funds.
Harriet explained that a mutual fund is a
professionally managed pool of stocks and/or bonds that provide reduced portfolio risk
through diversification. Investors buy or sell shares of the pooled securities, which
provide liquidity and the convenience of automatic reinvestment of dividends and capital
gains. Because there are over 9,000 funds, there are plenty of funds that are right for
every investor.
Harriet explained to Mary about
"no-load" and "load" funds. No-load funds can be purchased directly
from the fund without incurring a sales charge. Load funds typically involve a
commissioned broker who markets the fund. "NAV" (net asset value) refers to the
share price.
Harriet stressed the importance of carefully
reading the fund’s prospectus, which describes the fund’s objectives,
manager’s style, other pertinent information regarding the fund, and fees.
All funds charge fees, referred to as the
"expense ratio", for professional management and operating expenses. For
example, 12b-1 fees cover advertising and promotion of the fund. Look for other fees such
as deferred sales charges, exchange fee, or redemption fees.
Harriet warned that fees reduce your return
dollar for dollar. A 20% return less a 2% fee nets 18%. Not bad. An 8% return less a 2%
fee nets 6%. Not so good. Harriet also warned that most of the returns are taxable each
year as income.
There are two kinds of mutual funds: open-end
and closed-end.
Open-end funds create more shares as more
money is received by the fund and are bought or sold by the fund or a broker. Closed-end
funds have a fixed number of shares and are bought or sold on stock exchanges using a
broker.
Given Mary’s goals of retirement and
income, safety and preservation of capital is important. Harriet described to Mary how
mutual funds are classified by risk.
- Aggressive growth: Greatest long-term growth
generally in small to medium cap stocks. Highly risky.
- Growth: Long term growth generally in large
cap growth companies with solid track records. Less risky than aggressive.
- Growth and Income: Long-term growth with
emphasis on stable companies that pay dividends. Moderate risk.
- Income: Generally consists of bonds or
high-paying dividend stock such as utilities. Moderate to low risk (no junk bonds).
Harriet also explained the often-used
terminology for naming funds.
- Stock funds: Consist of large/medium/small cap
stocks, value or growth companies.
- Global funds: The manger invests in U.S and
foreign stocks.
- Foreign funds: Fund invests in developed
foreign and emerging markets.
- Index funds: These funds track or mirror the
performance of particular indexes. These funds have low stock turnover, thus minimal
capital gains.
- Balanced funds: A combination of stocks and
bonds to reduce risk.
- Bond Funds: A fund consisting of bonds, such
as government, corporate or municipals.
- Money Market Funds: Consist of highly liquid
and safe short term investments and pay a higher interest rate than a savings account.
With Harriet’s guidance, Mary selected
an investment portfolio with; a balanced fund for safety and preservation of capital, a
growth stock fund her retirement, an index fund to minimize taxes, and an income fund to
satisfy her current need for living expenses.
At WIFE we welcome your comments and questions.
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