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In the first few decades of the mutual fund industry, most companies would have one or two mutual funds that they managed. Competition pushed companies in the industry to offer more and more mutual fund choices and to support more and better customer services. This led to the growth of what are now referred to as mutual fund families.
Mutual Fund Families
A family of funds exists when one investment company manages a group of mutual funds. The funds in the family vary in their objectives. You can move your money from one fund to another within a fund family, almost always with no charge. This is especially important if you purchased a load fund. If you decided to move your money to another fund, you would not be charged the sales load again. However, there may be an exception to this rule. Some mutual fund companies will charge an “excessive transfer” fee to discourage trading of mutual funds. This fee only applies to open-end mutual funds. It does not apply to closed-end mutual funds or ETFs since they are bought and sold on the exchanges through a brokerage account. Mutual funds are meant to be long-term investments. Short-term trading of mutual funds is highly discouraged.
Although the fund family will not charge you to move your money into another fund, be aware that the IRS regulations say that you have generated a taxable transaction. You will need to declare either a loss or a gain on the sale of your previous mutual fund. Therefore, taxes should be considered when deciding to alter your investments. We will discuss taxes on mutual funds shortly. This consideration does not apply to mutual funds that are tax-qualified accounts such as retirement accounts, educational savings accounts, or health savings accounts. We will discuss a few of the more popular types of qualified and non-qualified accounts at the end of our journey together.
Many years ago, Forbes, the popular financial magazine, gave the following advice: Choose a Family, not a Fund. The authors were lamenting the tendency of investors to have many mutual funds from several different mutual fund companies. They believed that investors were better served concentrating on a single mutual fund family where most all funds have consistently done well over significant periods of time and experienced both favorable and unfavorable markets. Below is a list of the top ten mutual fund families.
|2||Blackrock / iShares|
|4||American Funds (The Capital Group)|
|5||State Street Global Advisors / SPDR|
|6||T. Rowe Price|
|8||Dimensional Fund Advisors|
|10||Franklin Templeton Investments|
It is surprisingly difficult to find precise data about the top ten mutual funds families. The source of the data above comes from ThinkAdvisor in September 2019. They reference Morningstar. However, this data is not available on Morningstar’s website. Note that other sources have the top 10 listed differently. Some mistakenly add non-mutual fund assets to the totals. For this reason, for example, you may see Blackrock as the #1 company. Although Blackrock holds more assets under management than any other company, not all of the assets are mutual funds. Vanguard has more mutual fund assets.
Mutual Fund Services, Transactions, and Sources of Information
The growth and competition in the mutual fund industry has led the industry to offer many convenient and powerful mutual fund services for investors. Three of these services are automatic contribution plans, automatic reinvestment plans, and automatic withdrawal plans. The most important of these is the automatic contribution plan, also known as an automatic investment plan or a systematic investment plan. These plans allow an investor to establish an automatic contribution from their checking or savings account at a bank or credit union. The investor can specify a day of the month that $50 or $100 or whatever is appropriate is taken from their checking account and sent to their mutual fund. Systematic investments plans are also available with employer-sponsored retirement plans. The employer automatically takes a sum from the employee’s paycheck and invests it into the employee’s account. Examples include 401k or 403b or Simple IRA accounts.
Automatic contribution plans make investing very simple. The investor no longer needs to concern themselves when it is the best time to invest. The investments happen automatically. Every month is a great time to invest. Indeed, these plans are practically the only way that many individuals will ever start or continue to invest. Well-intentioned people might say to themselves, “I will wait until I save up $5,000 and then start investing.” When and how is that going to happen in one’s life when there are always so many other costly responsibilities to attend to? This manner of investing is often called “paying yourself first” and is widely recommended by financial planning and investment experts.
According to the Investment Company Act of 1940, mutual funds must distribute their earnings to their investors at least once a year. Some distribute their earnings semi-annually, quarterly, or monthly. With an automatic reinvestment plan, the earnings an investor receives are automatically reinvested back into the mutual fund. The investor is credited with more shares of the investment. Today, this is the default. The mutual fund company will enroll the investor in their automatic reinvestment plan unless they specify otherwise. This allows the investor to earn fully compounded rates of return. Unless an investor needs the income, it is always a good idea to reinvest dividends and capital gains.
Now here is the best part! An automatic withdrawal plan, also known as a systematic withdrawal plan, is the exact opposite of the automatic contribution plan. This service enables shareholders to automatically receive a predetermined amount of money periodically. Typically, this would be monthly but others may decide upon quarter, semi-annual, or annual withdrawals. Ideally, the investor will establish a periodic electronic withdrawal transferred directly to their checking account. So, here you go, young adults! Start putting away $50, $100, or whatever you afford while you are young. Choose prudent, long-term oriented mutual funds with an eye toward growth and income. Don’t get caught up in the Next Big Thing and don’t panic when the markets tumble. Do this throughout your working career, ideally bumping up your contribution $5 or $10 per year, especially when you get a raise or some other debt is paid off. In your retirement, you will be happy to discover that ‒ providing the world did not end ‒ you will be able to withdraw $2,000 or $3,000 or $4,000 per month for the rest of your life! (Did we mention that there are no guarantees? Good! Just checking.)
These and other mutual fund services help to give mutual funds their very low PITA factor. (Recall that PITA stands for Pain-in-the-***.) One factor that is out of the control of the mutual fund companies, though, is taxes. We will reiterate throughout the course that we should not allow taxes to dissuade us from an investment. Taxes should not be the “tail that wags the dog.” However, we should be mindful of their presence. For regular, non-qualified accounts, there are two types of taxes, income dividends and capital gains. Each is taxed differently depending upon the investor’s income level and whether the distribution was a short-term distribution or a long-term distribution. In this context, a short-term distribution means a year or less and a long-term distribution means anything more than a year and day. We will leave the details for your accounting classes.
One item to keep in mind, reinvested dividends and capital gains are still taxable transactions. This can create an awkward situation for some investors. In a year when markets fall, the mutual fund is still required to distribute the earnings. The investor receives a Form 1099 that requires the investor to pay taxes on the earnings. The investor exclaims, “But I lost money this year! Why do I have to pay taxes?!” Our representatives in Congress get this complaint often from constituents. Every so often, there is discussion about allowing these unrealized gains to be taxed when the investor actually sells the mutual fund. Again, we will leave the details and a discussion of the pros and cons of such a change to the tax code to your accounting professor. Suffice to say that it is highly unlikely that this will ever happen. It would be an accounting nightmare! In any event, be sure to save your year-end statements.
What about tax-qualified accounts such as retirement accounts? These accounts are typically tax-deferred. You do not pay taxes until the money is withdrawn, typically in retirement when the investor is often in a lower tax bracket. All the proceeds are normally taxed as income. The exception to this rule applies to Roth IRA and similar accounts. Roth IRA accounts are normally tax-exempt in retirement. We will cover types of accounts in detail much later on.
Where does one go for information about mutual funds? What tools are available for research? The quick answer is, “There is too much information and too many resources!” However, there are two documents that are indispensable when investigating a potential mutual fund for your portfolio, the prospectus and the annual report. We discussed the prospectus when we covered the fees that mutual funds charge. The prospectus contains a tremendous amount of other information such as a statement describing the risk factors, descriptions of the fund’s past performance, the type of investments in the fund’s portfolio, information about dividends, distributions and taxes, and information about the fund’s management. It is quite unfortunate that practically no investor had bothered to read one. In fact, the Securities and Exchange Commission has authorized the use of much shorter versions of the prospectus, called the Summary Prospectus, in an effort to save paper since most prospectuses wind up in the landfill.
The other important document is the annual report. The mutual fund is a corporation and corporations must provide an annual report to their investors that describes their operations and financial conditions. The annual report is often divided into two distinct parts. The front part of the report is printed on glossy, high-quality paper and contains tasty graphs and failsafe superlative prose that describes how wonderful the mutual fund is performing. The back part of the report is typically printed on low-quality paper and contains the hard and fast numbers that often call into question the ornamental and flowery words found in the first part. There is an old saying in the investment industry that the most important information about an investment is printed on the least quality paper. This is also true of stocks and their annual reports.
Of course, in this day and age of digital publications, inventors typically don’t even receive a prospectus or annual report in the mail anymore. “Click here to confirm that you have read the prospectus and agree to the terms of this investment.” As part of one of your assignments for chapter 2, we are going to ask you to dig into the prospectus and annual report as well as other resources for researching mutual funds.
What are some of the other resources for researching mutual funds? There are two major mutual fund rating companies, Morningstar and Lipper, now owned by Thomson Reuters. Their information is available online and at most libraries. Be careful as Morningstar will do their best to get you to subscribe to the service for a monthly fee. Remember that most of the information from these two agencies is available at your local library for free.
Other resources include the vast number of financial publications such as Bloomberg BusinessWeek, Forbes, Kiplinger's Personal Finance, and Barron’s, and financial websites such as Yahoo Finance and MarketWatch. Most offer mutual fund surveys usually include the fund’s overall rating compared to other funds in the same category, fund size, sales charges and expense ratios, risk factors, and the rewards history for the past three, five, and ten years. The mutual fund companies themselves have invested heavily in their own websites and along with all the normal marketing materials now include excellent educational articles and commentaries on investing and the markets. The chapter 2 sections of the class website have numerous links to websites of some of the largest and most successful mutual fund companies. There are many, many others. Last, the mother lode of information can be found at ici.org, the website of the Investment Company Institute, the non-profit trade organization sponsored by the mutual fund companies.