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Objectives
A. Understand the advantages and disadvantages of mutual funds B. Understand the major types of mutual funds C. Understand the major classes of mutual fund shares D. Understand how to calculate mutual fund returns E. Understand the process of how to buy a mutual fund F. Understand the costs of investing in mutual funds
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11 11 Source: S&P SPIVA Scorecard 2011, 84% of Actively Managed U.S. Equity Fund Underperformed Their Benchmark in 2011, S&P Research, 2011.
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Size
How much has the fund grown or shrunk? If a fund is losing assets, it generally sells its liquid assets first Often those left in a fund after liquidation are stuck with illiquid stocks that are harder to sell
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Fees
Watch the fee structures Sometimes funds will add additional fees, i.e. 12-b1 fees, or impose rear-end loads to help reduce costs to themselves 12-b1 fees are paid by the shareholders and are just marketing fees. Avoid them
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Questions
Any questions on purchasing a mutual fund?
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Review of Objectives
A. Do you understand the advantages and disadvantages of mutual funds? B. Do you understand the major types of mutual funds? C. Do you understand how to calculate mutual fund returns? D. Do you understand the process of how to buy a mutual fund? E. Do you understand the costs of investing in mutual funds?
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Case Study #1
Data Bill and Sally invested in the following mutual funds in 2011. They are in the 25% federal and 7% state marginal tax brackets. (Remember in 2011 that qualified stock dividends and long-term capital gains are taxed Federally at 15% if your marginal tax rate is 25% or greater, and 0% if your marginal tax rate is 15% or less.) They are really scared to calculate their returns. Calculations a. Calculate the before tax and after-tax return on each of the funds in their portfolio for 2011 (actual numbers from Morningstar) b. Calculate their overall portfolio before-tax and after-tax return. Note that the first three funds are all taxable, the municipal bond fund is federal tax-free for interest only, and the Treasury bond fund is state tax-free for interest only.
Funds End Begin NAV NAV Fid. Magellan (FMAGX) 62.98 71.67 Sch. Small Cap (SWSSX) 19.01 21.11 Van. ST Bond (VBISX) 10.61 10.55 WF Muni Bond (SXFIX) 9.80 9.29 Van. ST Treasury (VFISX) 10.79 10.68 Short-Term Distrib. .41 .35 .19 .40 .07 LTCG Qual. Stock . % of Total Distrib. Dividends. Portfolio 0.02 0.00 50% 1.16 0.00 10% 0.06 0.00 20% 0.00 0.00 10% 0.06 0.00 10%
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Remember that the tax benefits on municipal and treasury bonds are only on the interest distributions. You still must pay all taxes on the capital gains distributions
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Federal LT Capital Gains Rate: Federal Marginal Tax Rate Overall Portfolio Before Tax
Federal Tax on Qualified Dividends State marginal Tax Rate Overall Portfolio After Tax Weight:
Stock Funds (all taxable): Fidelity Magellan - FMAGX Tax Rate (all taxable) AT Return Schwab Small Cap - SWSSX Tax Rate (all taxable) AT Return
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71.67 (8.69)
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21.11 (2.10)
Bond Funds: Corporate Bond Funds (all taxable): Vanguard ST Bond - VBISX 10.61 10.55 Tax Rate (all taxable) AT Return 0.06 Muni Bond Funds (Federal Tax Free for Interest only): Wells Fargo Muni Bond - SXFIX 9.80 9.29 Tax Rate (Fed tax free) AT Return 0.51 Treasury Bond Funds (State Tax Free for Interest Only): Van. ST Treasury - VFISX 10.79 10.68 Tax Rate (state tax free) AT Return 0.11 Notes:
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2.94% 2.24%
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9.80% 9.49%
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2.25% 1.96%
1. Short-term dis tributions include all s hort-term dis tributions of interes t, s hort-term capital gains and s tock dividends which are not qualified. 2. Long-term Capital Gains dis tributions are dis tributions of any long-term capital gains which have been held for more than one year. 3. Qualified s tock dis tributions are dis tributions of qualified dividends , which aredividends from U.S. companies where you or the Fund held the s tock for morethan 60 days during the 121-day period that begins 60 days before the ex-dividend date (See Teaching Tool 32: Taxes on Security Earnings - Qualified Dividends ). 4. Tax benefits for Muni's and Treas uries are for interes t only--not capital gains .
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Case Study #2
Background
Bill is concerned about turnover. He knows that for financial assets, the turnover rate is a measure of the amount of trading activity completed during a year; the turnover rate is expressed as a percentage of the average amount of total assets in the fund. A turnover rate of 10 percent means that 10 percent of the average amount of total assets in the fund were bought and sold during the year. He also knows that as a mutual fund investor must pay taxes on any distributions received during the year, including distributions the investor reinvests in additional shares. While high turnover may lead to higher returns, high turnover always leads to higher transactions costs as well as increased taxes if assets are held in taxable accounts Bills marginal tax rate is 35 percent, and he lives in a state that does not have a state income taxes, so his short-term distributions will be taxed at 35 percent
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Case Study #2
A. Bills before-tax and after-tax returns are: Fund A Fund B YTD nominal returns 10% (note 1) 10%
Estimated Turnover 10% 90% Taxes on short-term distributions 35% 35% Taxes paid (on short-tern distributions) $.035 $0.315 After-tax return 9.65%(note 2) 6.85% Loss from nominal return due to taxes 0.35% 3.15%
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