Mutual Funds and Bonds
A mutual fund is a type of investment where the money manager takes your cash and invests it as he sees fit, usually following some rough guidelines. For example, the Fidelity Group has a fund that specializes in finding high dividend paying stocks, one that specializes in bank stocks, one that specializes in European stocks, etc. You simply find a fund that matches your objective, you review its past performance and its management team, and then you write a check to that mutual fund. Most mutual funds are called “open-ended” funds because they will continue to take your cash, manage it for you, and issue shares to show your ownership. Each night the mutual funds calculate the value of all of their holdings and divided that value by the number of shares they have issued, and that number is called the Net Asset Value or NA V. So if the Fidelity Bank Fund had a value of $10.00 and your write them a check for $5,000 you would now own 500 shares of this fund. Gains, losses, and earnings are mutually shared with investors in proportion to the size of their investment. Since one of the primary rules of investment is to diversify portfolios, a mutual fund can be a simple and successful way to accomplish this goal. With one investment, you might own shares of stock in many corporations.
Mutual funds are a great way to start investing, but because they are so easy they also carry a cost. Mutual fund companies have to make money, of course, and they do that by taking some of the funds’ assets to cover their salaries and other expenses. These are called management fees. As noted in the Introduction, mutual fund companies have to pay salaries and marketing expenses and they always get paid FIRST before the investors/owners get paid! The other negative about mutual funds is that if you $10,000 in 5 different funds, then you probably own as many as 1,000 different stocks! It becomes harder to outperform the market when you own so many different stocks
As an investor, management fees are one of the key metrics you need to watch out for, because they can quickly and devilishly eat into your profits over time. Do higher management fees correlate to higher returns and better performance? As it turns out, the answer is no; in fact, many studies show that higher fees actually correlate to lower performance. Mutual funds are not traded on an open market like stocks, and their prices are calculated just once, at the end of every trading day. The price for a mutual fund is called the Net Asset Value (NA V) because it is a calculation of the entire value of stocks and other assets held by the fund divided by the total number of shares outstanding: Mutual fund NAV = Value of stocks and other assets/ Shares outstanding
Since Mutual fund NA Vs are calculated just once a day, mutual funds can’t be traded several times during the day like a stock. In fact, active trading is generally discouraged, as most mutual funds impose penalties and redemption fees upon withdrawal.
Exchange-Traded Funds (ETF s)
At first glance, ETF s appear very similar to mutual funds, in that one investment allows ownership in a group of stocks; however, there are differences of which you should be aware. Unlike mutual funds, ETF shares can be traded whenever the host stock market is open for transactions. This ability to react quickly comes at a price, as making these trades usually incurs a broker fee; therefore, larger trades are more cost-efficient. ETF s are also often tied to an index, which make them exchange traded index funds. These ETF s are a bit less diversified, as they concentrate their stocks on a particular asset type, region, or other recognizable index. For example, many ETF s try to mirror the composition of the Standard & Poor (S&P) 500, using their performance as an index (see the S&P 500 ETF , ticker symbol SPY). At WallStreetSurvivor.com, ETF s are very popular; often, the top Weekly prize winners have an ETF as their “hot stock” which rocketed them to the top of the rankings page. ETF s are great for winning the Weekly and Monthly prizes at WSS because you can trade specific sectors of the market like Agriculture, Energy or even foreign countries.
Bonds
Unlike stocks, which are equity instruments, bonds are debt instruments. In effect, you’re loaning the bond issuer money, which they repay with interest. When bonds are first issued, the investor/lender typically gives the company $1,000, upon which the company promises to pay a certain interest rate every year, called the coupon rate, and then repay the $1,000 loan when the bond matures, at the maturity date. For example, General Electric (GE ) could issue a 30-year bond with a 5% coupon. The investor/lender gives GE $1,000; every year the lender receives $50 from GE , and at the end of 30 years the investor/lender gets their $1,000 back. Bonds differ from stocks in that they have a stated earnings rate and will provide a regular cash flow, in the form of the coupon payments to the bondholders. This cash flow contributes to the value and price of the bond, and affects the true yield (or earnings rate) bondholders receive; there are no such promises associated with common stock ownership. After a bond has been issued directly by the company, the bond then trades on the exchanges. As supply and demand forces take effect, the price of the bond changes from its initial $1,000 face value. On the date the GE bond was issued, a 5% return was acceptable given the risk of GE , but if interest rates go up and that 5% return becomes unacceptable, the price of the GE bond will drop below $1,000, so that the effective yield will be higher than the 5% coupon rate. Conversely, if interest rates in general go down, then that 5% GE coupon rate starts looking attractive, and investors will bid the price of the bond back up above $1,000. When a bond trades above its face value, it is said to be trading at a premium; when a bond trades below its face value it is said to be trading at a discount. If you ever trade bonds, understanding the difference between your coupon payments and the true yield is critical.
There are three common types of bonds available for general sale, each of which offer different levels of security and projected earnings: Treasuries: U.S. Treasury bonds carry the full faith and credit of the U.S. federal government, eliminating much of the risk associated with investments. As you can imagine, in return for this minimized risk, your earnings rate will be less than more “exotic” investment choices. Treasuries, particularly the 3-month Treasury bill, are sometimes quoted as the“risk-free rate of return,” the minimum rate of return an informed investor will accept for enjoying the minimum risk. In the real world there is no true risk-free investment, although Treasuries do come close.
You should also understand the meaning of a yield curve, as displayed on the Bloomberg.com screenshot opposite. A yield curve is the relationship between the interest rate offered and the time to maturity of an investment. While all investments have a yield curve, many traders and economists closely follow the yield curve of Treasuries of different maturities to help make other financial decisions and projections. Corporate Bonds : These bonds can be quite secure or sometimes risky; their inherent value is greatly determined by the creditworthiness of the corporation offering them, and corporate stability can change over time. For example, until 2009, most bonds offered by U.S. automakers implied good levels of security. The bankruptcies of GM and Chrysler, combined with serious financial problems at Ford Motor Company, generated much higher risk factors for their corporate bonds. Typically, however, corporate bonds are more secure than corporate stocks.
Mutual funds are a great way to start investing, but because they are so easy they also carry a cost. Mutual fund companies have to make money, of course, and they do that by taking some of the funds’ assets to cover their salaries and other expenses. These are called management fees. As noted in the Introduction, mutual fund companies have to pay salaries and marketing expenses and they always get paid FIRST before the investors/owners get paid! The other negative about mutual funds is that if you $10,000 in 5 different funds, then you probably own as many as 1,000 different stocks! It becomes harder to outperform the market when you own so many different stocks
As an investor, management fees are one of the key metrics you need to watch out for, because they can quickly and devilishly eat into your profits over time. Do higher management fees correlate to higher returns and better performance? As it turns out, the answer is no; in fact, many studies show that higher fees actually correlate to lower performance. Mutual funds are not traded on an open market like stocks, and their prices are calculated just once, at the end of every trading day. The price for a mutual fund is called the Net Asset Value (NA V) because it is a calculation of the entire value of stocks and other assets held by the fund divided by the total number of shares outstanding: Mutual fund NAV = Value of stocks and other assets/ Shares outstanding
Since Mutual fund NA Vs are calculated just once a day, mutual funds can’t be traded several times during the day like a stock. In fact, active trading is generally discouraged, as most mutual funds impose penalties and redemption fees upon withdrawal.
Exchange-Traded Funds (ETF s)
At first glance, ETF s appear very similar to mutual funds, in that one investment allows ownership in a group of stocks; however, there are differences of which you should be aware. Unlike mutual funds, ETF shares can be traded whenever the host stock market is open for transactions. This ability to react quickly comes at a price, as making these trades usually incurs a broker fee; therefore, larger trades are more cost-efficient. ETF s are also often tied to an index, which make them exchange traded index funds. These ETF s are a bit less diversified, as they concentrate their stocks on a particular asset type, region, or other recognizable index. For example, many ETF s try to mirror the composition of the Standard & Poor (S&P) 500, using their performance as an index (see the S&P 500 ETF , ticker symbol SPY). At WallStreetSurvivor.com, ETF s are very popular; often, the top Weekly prize winners have an ETF as their “hot stock” which rocketed them to the top of the rankings page. ETF s are great for winning the Weekly and Monthly prizes at WSS because you can trade specific sectors of the market like Agriculture, Energy or even foreign countries.
Bonds
Unlike stocks, which are equity instruments, bonds are debt instruments. In effect, you’re loaning the bond issuer money, which they repay with interest. When bonds are first issued, the investor/lender typically gives the company $1,000, upon which the company promises to pay a certain interest rate every year, called the coupon rate, and then repay the $1,000 loan when the bond matures, at the maturity date. For example, General Electric (GE ) could issue a 30-year bond with a 5% coupon. The investor/lender gives GE $1,000; every year the lender receives $50 from GE , and at the end of 30 years the investor/lender gets their $1,000 back. Bonds differ from stocks in that they have a stated earnings rate and will provide a regular cash flow, in the form of the coupon payments to the bondholders. This cash flow contributes to the value and price of the bond, and affects the true yield (or earnings rate) bondholders receive; there are no such promises associated with common stock ownership. After a bond has been issued directly by the company, the bond then trades on the exchanges. As supply and demand forces take effect, the price of the bond changes from its initial $1,000 face value. On the date the GE bond was issued, a 5% return was acceptable given the risk of GE , but if interest rates go up and that 5% return becomes unacceptable, the price of the GE bond will drop below $1,000, so that the effective yield will be higher than the 5% coupon rate. Conversely, if interest rates in general go down, then that 5% GE coupon rate starts looking attractive, and investors will bid the price of the bond back up above $1,000. When a bond trades above its face value, it is said to be trading at a premium; when a bond trades below its face value it is said to be trading at a discount. If you ever trade bonds, understanding the difference between your coupon payments and the true yield is critical.
There are three common types of bonds available for general sale, each of which offer different levels of security and projected earnings: Treasuries: U.S. Treasury bonds carry the full faith and credit of the U.S. federal government, eliminating much of the risk associated with investments. As you can imagine, in return for this minimized risk, your earnings rate will be less than more “exotic” investment choices. Treasuries, particularly the 3-month Treasury bill, are sometimes quoted as the“risk-free rate of return,” the minimum rate of return an informed investor will accept for enjoying the minimum risk. In the real world there is no true risk-free investment, although Treasuries do come close.
You should also understand the meaning of a yield curve, as displayed on the Bloomberg.com screenshot opposite. A yield curve is the relationship between the interest rate offered and the time to maturity of an investment. While all investments have a yield curve, many traders and economists closely follow the yield curve of Treasuries of different maturities to help make other financial decisions and projections. Corporate Bonds : These bonds can be quite secure or sometimes risky; their inherent value is greatly determined by the creditworthiness of the corporation offering them, and corporate stability can change over time. For example, until 2009, most bonds offered by U.S. automakers implied good levels of security. The bankruptcies of GM and Chrysler, combined with serious financial problems at Ford Motor Company, generated much higher risk factors for their corporate bonds. Typically, however, corporate bonds are more secure than corporate stocks.
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