Investing in Mutual Funds,
ETFs, and Real Estate
Chapter 13
How Will This Affect Me?
Having a financial plan, and being aware that diversification is crucial is a great start to the task
of investment planning. The next step is figuring out how to implement your plan by deciding
what to invest in. For most people, diversification is best achieved using mutual funds and
exchange traded funds (ETFs). This chapter describes the key characteristics of each type of
fund, sorts through the various options you have, shows how to calculate rates of return and
evaluate performance, and explains how to choose among funds. The essential elements of
investing in real estate and its role in diversifying your overall investment portfolio are also
covered. After reading this chapter, you should be in a good position to invest in mutual funds,
ETFs, and real estate in a way that will help you achieve your financial objectives.
This is the last of the investment chapters of 11, 12, and 13. The chapter explains how Mutual
Funds, Exchange Traded Funds, and Real Estate investment operate and the advantages of each.
There are some problems that ask the student to find mutual funds, ETFs, and REITs and
recommend one. It would be good to assign one of those problems; Financial Planning Exercises
number 5 or 6 for example.
Learning Objectives
13-1 Describe the basic features and operating characteristics of mutual funds and exchange
traded funds.
13-2 Differentiate between open- and closed-end mutual funds as well as exchange traded funds
and discuss the various types of fund loads and charges.
13-3 Discuss the types of funds available to investors and the different kinds of investor services
offered by mutual funds and exchange traded funds.
13-4 Gain an understanding of the variables that should be considered when selecting funds for
investment purposes.
13-5 Identify the sources of return and calculate the rate of return earned on an investment in a
mutual fund, as well as evaluate the performance of an exchange traded fund.
13-6 Understand the role that real estate plays in a diversified investment portfolio, along with
the basics of investing in real estate, either directly or indirectly.
Financial Facts or Fantasies?
These may be used as “teasers” to get the students on the right page with you. Also, they may be
used as quizzes after you covered the material or as “pre–test questions” to get their attention.
• While exchange traded funds (ETFs) offer many of the benefits of mutual funds, they
have tax-timing disadvantages not present with otherwise comparable mutual funds.
Fantasy: While ETFs offer many of the benefits of mutual funds, they also have tax-
timing
advantages
over mutual funds. Most mutual funds regularly distribute taxable
capital gains to investors. In contrast, ETFs rarely distribute them. Thus, ETF investors
defer most all capital gains taxes until they choose to take them by selling shares.
• In many types of real estate investments, appreciation in the value of the property
affects return more than annual rental income.
Financial Facts or Fantasies?
These may be used as a quiz or as a pre-test to get the students interested.
1. True False When a mutual fund is open-ended, it means there’s no limit on the
returns an investor can realize.
2. True False Online and phone switching are services that enable you to move
money from one fund to another, so long as you stay within the
same family of funds.
3. True False While exchange traded funds (ETFs) offer many of the benefits of
mutual funds, they have tax-timing disadvantages not present with
otherwise comparable mutual funds.
4. True False In many types of real estate investments, appreciation in the value
of the property affects return more than annual rental income.
5. True False A real estate investment trust (REIT) is a popular form of limited
partnership that enables individuals to invest directly in income-
producing property.
Answers:
YOU CAN DO IT NOW
The “You Can Do It Now” cases may be assigned to the students as short cases or problems.
They will help make the topic more real or relevant to the students. In most cases, it will only
take about ten minutes to do, that is, until the student starts looking around at the web site. But
they will learn by doing so.
YOU CAN DO IT NOW
Objective Mutual Fund Resources
YOU CAN DO IT NOW
How to Choose the Best ETF for You
Financial Impact of Personal Choices
Read and think about the choices being made. Do you agree or not? Ask the students to discuss
the choices being made.
Eliza Finds a Simple Retirement Investment Plan
Eliza Myers, 27 years old, wants to get her retirement investing portfolio up and
running. But she has a demanding job and little time to manage a portfolio closely. In
doing some research, she read a short (16-page) booklet by William J. Bernstein, “If
You Can” (www.etf.com/docs/IfYouCan.pdf). Bernstein argues that by age 25 it’s
important to invest at least 15 percent of your income annually in a 401(k), an IRA, or a
taxable account (or all three) in just three mutual funds or ETFs:
• U.S. total stock market index fund
• International total stock market fund
• U.S. total bond market index fund
These funds will earn different rates of return over time, so once a year it makes sense
to rebalance the amount in each account so they’re equal. Bernstein convincingly
argues that following this simple investment plan will beat most professional investors
and would likely provide enough savings for Virginia to retire comfortably.
Eliza was indeed convinced and estimated that keeping the plan in place would take
about 30 minutes a year. So she invested equal amounts in the following ETFs:
• Vanguard Total International Stock ETF (VXUS)
• Vanguard Total Stock Market ETF (VXUS)
• Vanguard Total Bond Market ETF (BND)
Eliza will invest 15 percent of her income each year in these ETFs and rebalance them
annually. Her research and simple, systematic approach will no doubt serve her well.
Financial Planning Exercises
1. Choosing between a mutual fund and an ETF. Lily Hughes is considering whether she
should invest some extra money in a mutual fund or an ETF. Explain the key factors that
should influence her decision.
An exchange traded fund (ETF) is an investment company whose shares trade on stock
exchanges. Unlike mutual funds, ETF shares can be bought or sold (or sold short) throughout the
2. Estimating cost of mutual fund investments. Using the mutual fund quotes in Exhibit 13.3,
and assuming that you can buy these funds at their quoted NAVs, how much would you
have to pay to buy each of the following funds?
a. AEMMX
b. ADCVX
c. FCPAX
d. FSTAX
According to the quotes, which of these four funds have 12b-1 fees? Which have
redemption fees? Are any of them no-loads? Which fund has the highest year-to-date
return? Which has the lowest?
From Exhibit
13.3
Emerging
Markets
AEMMX
ADCVX
FCPAX
FSTAX
Net Asset Value
1
25.27
19.56
11.99
12b-1 fees ?
Yes
No
Yes
No
Redemption
fees?
Yes
No
No
No
No-load?
No [front-end]
Yes
No [front-end load]
Yes
Yield to date
-13.5%
11.6%
-1.0%
-0.5%
Rank by yield
4
1
3
2
3. Building a mutual fund portfolio. Imagine that you’ve just inherited $40,000 from a rich
uncle. Now you’re faced with the problem of deciding how to spend it. You could make a
down payment on a condo—or better yet, on that BMW that you’ve always wanted; or you
could spend your windfall more profitably by building a mutual fund portfolio. Let’s say
that, after a lot of soul-searching, you decide to build a mutual fund portfolio. Your task is
to develop a $40,000 mutual fund portfolio. Use actual funds and actual quoted prices,
invest as much of the $40,000 as you possibly can, and be specific! Briefly describe the
portfolio that you end up with, including the investment objectives that you’re trying to
achieve.
4. Comparing ETF with SPRD. Describe an ETF and explain how these funds combine the
characteristics of open- and closed-end funds. In the Vanguard family of funds, which
would most closely resemble a “Spider” (SPDR)? In what respects are the Vanguard fund
(that you selected) and SPDRs the same, and how are they different? If you could invest in
only one of them, which would it be? Explain.
5. Comparing risks of different mutual fund types. For each pair of funds listed below, select
the fund that would be less risky and briefly explain your answer.
a. Growth versus growth-and-income
The income fund would be less risky. The funds look for stable companies that pay consistent
6. Evaluating ETF performance. Do an online search for information on the PowerShares
QQQ ETF. Discuss what information you need to evaluate the performance of the ETF
and use what you find to evaluate the QQQ ETF. What kind of investor should invest in
this ETF?
7. Calculating approximate yield on mutual fund. About a year ago, Elliot Cox bought some
shares in the Axix Fund. He bought the fund at $24.50 a share, and it now trades at $26.
Last year, the fund paid dividends of 40 cents a share and had capital gains distributions of
$1.83 a share. Using the approximate yield formula, what rate of return did Elliot earn on
his investment? Repeat the calculation using a handheld financial calculator. Would he
have made a 20 percent rate of return if the stock had risen to $30 a share?
8. Calculating mutual fund approximate rate of return
.
A year ago, the Constellation Fund was
being quoted at an NAV of $21.50 and an offer price of $23.35; today, it’s being quoted at
$23.04 (NAV) and $25.04 (offer). Use the approximate yield formula or a handheld
financial calculator to find the rate of return on this load fund; it was purchased a year
ago, and its dividends and capital gains distributions over the year totaled $1.05 a share.
(Hint: As an investor, you buy fund shares at the offer price and sell at the NAV.)
9. Investing in residential income-producing property. Leah Reyes is thinking about investing
in some residential income-producing property that she can purchase for $200,000. Leah
can either pay cash for the full amount of the property or put up $50,000 of her own money
and borrow the remaining $150,000 at 8 percent interest. The property is expected to
generate $30,000 per year after all expenses but before interest and income taxes. Assume
that Leah is in the 25 percent tax bracket. Calculate her annual profit and return on
investment, assuming that she (a) pays the full $200,000 from her own funds or (b) borrows
$150,000 at 8 percent. Then discuss the effect, if any, of leverage on her rate of return.
No Leverage Leveraged
10. Different ways to invest in real estate. Assume that you’ve just inherited $100,000 and
wish to use all or part of it to make a real estate investment.
a. Would you invest directly in real estate, or indirectly through something like a REIT?
Explain.
b. Assuming that you decided to invest directly, would you invest in income-producing
property or speculative property? Why? Describe the key characteristics of the types of
income producing or speculative property you would seek.
One of the most popular forms of real estate investing is income (or income- producing)
c. What financial and nonfinancial goals would you establish before beginning the search
for suitable property?
d. If you decide to invest in real estate indirectly, which type(s) of securities would you buy,
and why?
Test Yourself
13-1 What is a mutual fund? Why are diversification and professional management so
important to mutual funds?
13-2 Who are the key players in a typical mutual fund organization?
13-3 What’s the difference between an open-end mutual fund and an ETF?
An exchange traded fund (ETF) is an investment company whose shares trade on stock
13-4 What types of ETFs are available to investors?