Personal Finance Concept Checks (Chapter 13)

13-18 Which would you rather have: (a) $100 in dividend income or $100 in capital gains distribution? (b) $100 in realized capital gains or $100 in unrealized capital gains?

(a) I would rather have $100 in dividend income. (b) I would rather have $100 in unrealized capital gains.

13-6 What is a 12(b)-1 fund? Can such a fund operate as a no-load fund?

12(b)-1 fund: an annual fee that's supposed to be used to offset promotion and selling expenses. Legally, a mutual fund can't be considered as a no-load fund if it charges more than 0.25% in annual 12(b)-1 fees.

13-16 Why does it pay to invest in no-load funds rather than load funds? Under what conditions might it make sense to invest in a load fund?

A person would want to invest in a load fund if they preferred a certain type of fund manager/specialized type of fund.

13-20 How important is general market behavior in affecting the price performance of mutual funds?

As mutual funds include a wide range of securities, they generally reflect the current mood of the market as a whole. Essentially, if the market is good, most mutual funds are good.

13-10 What's an asset allocation fund? How do these funds differ from other types of mutual funds?

Asset allocation fund: a type of fund that allocates a specific amount to a fixed income and equities depending on that particular fund's goal.

13-13 What are automatic reinvestment plans, and how do they differ from automatic investment plans?

Automatic reinvestment plan: a plan that gives share owners the option of electing to have dividends and capital gains distributions reinvested in additional fund shares. Automatic investment plan: an automatic savings program that enables an investor to channel a set amount of money systematically into a given mutual fund.

13-7 Briefly describe a back-end load, a low load, and a hidden load. How can you tell what kind of fees and charges a mutual fund has?

Back-end load: a commission charged for redeeming fund shares. Low-load fund: a fund that has a low purchase fee. Hidden load: (also known as the 12(b)-1 fee) an undisclosed fee/sales charge (often hidden in the fine print of a fund's prospectus/in an insurance contract).

13-23 Describe the major categories of income property, and explain the advantages and disadvantages of investing in income property. How can a single-family home be used to generate income?

Commercial properties: (office buildings, industrial space, warehouses, retail space, hotels, etc.) the risks and returns on commercial real estate investments are tied to the business's conditions and location. Since these types of investments need professional management and involve significant expenses, they are often best suited for experienced/professional real estate investors. Residential properties: (homes, apartments, smaller multifamily buildings, etc.) because these types of investments vary in size, price, and range, they are often the ones chosen by new/first-time investors. Income can be made off of these investments from occupancy rates, maintenance and management costs, etc.

13-12 What are fund families? What advantages do these families offer investors?

Fund families refer to the range of fund products that are offered by a financial company. Some advantages that these families offer include: fair pricing, advanced portfolio management, dividend reinvestment, risk reduction, and convenience.

13-8 What's the difference between a growth fund and a balanced fund?

Growth fund: a fund that works towards generating long-term growth and capital gains (capital appreciation). Balanced fund: a fund that holds a balanced portfolio of stocks and bonds. These types of funds aim for well-balanced returns on an investor's current income and long-term capital gains.

13-9 What's an international fund, and how does it differ from a global fund?

International fund: a mutual fund that does all/most of its investing in foreign securities. Unlike global funds, international funds don't invest in U.S. companies.

13-5 What's the difference between a load fund and a no-load fund?

Load fund: a fund that charges a fee at the time of purchase. No-load fund: a fund where no transaction fees are charged.

13-1 What is a mutual fund? Why are diversification and professional management so important to mutual funds?

Mutual fund: a financial services organization that receives money from its shareholders and invests those funds on their behalf in a diversified portfolio of securities. Diversification reduces the overall risk made by the investor (without lowering the average return), and professional management liberates individual investors from managing their own portfolios.

13-11 If growth, income, and capital preservation are the primary objectives of mutual funds, why do we bother to categorize them by type?

Mutual funds are categorized by type because each fund has its own specific set of goals.

13-25 Briefly describe the basic structure and investment considerations associated with a REIT. What are the three basic types of REITs?

REIT: an investment company that accumulates money by selling shares to investors (so that they may invest it into various types of real estate (ex. mortgages)). This type of fund is similar to mutual funds, but a REIT invests only in specific types of real estate/real estate-related firms. Because REITs have relatively low correlations with other market sectors (ex. stocks and bonds), they have become popular with investors seeking portfolio diversification. Along with providing attractive dividend yields, they have also produced competitive returns. Equity REITs: they own and operate income-producing real estate (ex. apartments, office buildings, shopping centers, hotels, etc.) Mortgage REITs: these make both construction and mortgage loans to real estate investors. Hybrid REITs: they invest in both income-producing properties and mortgage loans.

13-14 What are the most common reasons for buying mutual funds?

Some common reasons investors buy mutual funds include: lower costs, diversification, and convenience.

13-17 Identify three potential sources of return to mutual fund investors, and briefly discuss how each could affect total return to shareholders.

Some potential sources of return to mutual funds include: capital appreciation, dividends paid, and gains from buying/selling stock. While all of these activities are incorporate into a mutual fund's NAV, the dividends and gains pass through to the mutual fund's owners (the ones responsible for paying income taxes due on these transactions).

13-4 What types of ETFs are available to investors?

Some types of ETFs include: S&P 500, NASDAQ-100, Nikkei, and MSCI.

13-22 Why is speculating in raw land considered a high-risk venture?

Speculating on raw land is a high-risk venture because it may not generate any income/capital gain when it is sold.

13-3 What's the difference between an open-end mutual fund and an ETF?

While open-ended mutual funds allow investors to buy their shares from and sell them back to the mutual fund, ETFs are open-ended investment company that trades on exchanges (and usually track a specific index).

13-19 Describe how to evaluate the attractiveness of investing in an index-based ETF.

1. Focus: since ETFs have been developed to accommodate investors pursuing narrow market segments, you'll want to find a singular market sector, industry, or geographic region that appeals to you as an investor. 2. Tax management: because ETFs are set up to protect investors from capital gains taxes (usually better than most mutual funds), you'll want to look for ETFs that generate the least taxable gains. 3. Costs: since ETFs have lower overhead expenses than most mutual funds, they don't have to manage customer accounts/staff call centers. In turn, you'll want to look for ETFs that are cost-effective (they are also good for people investing a large sum of money).

13-15 Briefly describe the steps in the mutual fund selection process.

1. Refer to sources of published mutual fund performance data. 2. Identify funds with appropriate investment objectives. 3. Look for funds with good long-term performance. 4. Search for the best performance per year (from the best long-term performers). 5. Find the lowest volatility (from the funds with the best performance per year). 6. Look for mutual funds that have performed well due to the current investment manager (from the funds with low volatility). 7. Compare fund facts, documents, and prospectuses. 8. Examine fees and charges. 9. Analyze the mutual fund size. 10. Make the decision.

13-2 Who are the key players in a typical mutual fund organization?

1. The management company runs the fund's daily operations. 2. The investment advisor buys and sells stocks/bonds and oversees the portfolio. 3. The distributor sells the fund shares. 4. The custodian physically safeguards the securities and other assets of the fund. 5. The transfer agent executes transactions, keeps track of purchase and redemption requests from shareholders, and maintains other shareholder records.

13-21 Define and briefly discuss the role of each of these factors in evaluating a proposed real estate investment: a. Cash flow and taxes b. Appreciation in value c. Use of leverage

a. Cash flow and taxes: in addition to the fact that after-tax cash flow on any given real estate investment depends on the revenues generated by a certain piece of property, any operating expenses, and depreciation, real estate is considered to be a passive investment (any write-offs are generally limited to the income amount made on the current property and others by the investor). b. Appreciation in value: this has a larger impact than the net annual cash flow from the property does in terms of the return rate. If the market price of the real estate property was expected to increase, the price appreciation should be treated as capital gains. c. Use of leverage: involves the use of borrowed money to magnify returns (real estate is a tangible asset so investors can borrow around 75-90% of its costs). So, in turn, the profit rate on the investment would be greater than the cost of borrowing.

13-24 Describe how the following securities allow investors to participate in the real estate market. a. Stock in real estate-related companies b. Real estate limited partnerships (LPs) or limited liability companies (LLCs)

a. using REITs (similar to a mutual fund), investors are able to participate in the real estate market by owning part of the real estate portfolio held by the REIT (REITs provide the benefits of capital appreciation and current income). b. LPs: managers assume the role of general partner (meaning that their liability is unlimited and other investors are limited partners who are legally liable only for the amount of their initial investment). LLCs: has a managing member and other members who all have no liability. Within both, investors buy units representing an ownership position (similar to stocks). With the fact that these are risker investments than a REIT, they often appeal to more affluent investors who can afford the typical unit cost of $100,000 (or more).