Criterial Thinking Cases
13.1 Damon’s Dilemma: Common Stocks, Mutual Funds, or ETFs?
Damon Bellamy has worked in the management services division of Niche Consultants for
the past five years. He currently earns an annual salary of about $120,000. At 33, he’s still a
bachelor and has accumulated about $100,000 in savings over the past few years. He keeps
his savings in a money market account, where it earns about 3 percent interest. Damon
wants to get “a bigger bang for his buck,” so he has considered withdrawing $50,000 from
his money market account and investing it in the stock market. He feels that such an
investment can easily earn more than 3 percent. Naomi Ladd, a close friend, suggests that
he invest in mutual fund shares. Damon has approached you, his broker, for advice.
Critical Thinking Questions
1. Explain to Damon the key reasons for purchasing mutual fund or ETF shares.
Mutual funds offer professional management with substantial support from security analysts who
investigates companies, traders who execute the purchases and sales for the money manager,
custodians who keep the records of who owns the fund, and agents who takes the investor’s
2. What special fund features might help Damon achieve his investment objectives?
There are mutual funds for all types of risk. If Damon wants to go for appreciation, there are
3. What types of mutual funds or ETFs would you recommend to Damon?
Given his age and income, I would go for growth funds and small caps. Tech stocks and health
4. What recommendations would you make regarding Damon’s dilemma about whether to
go into stocks, mutual funds, or ETFs? Explain.
The new investor needs the support of a mutual fund. ETFs are OK, but he does not need the
5. Explain to Damon the rationale for choosing ETFs over mutual funds.
ETFs offer trading during the day and a variety of index funds to match whatever interest Damon
13.2 Nichole Ponders Mutual Funds
Nichole Whiting is the director of a major charitable organization in Charlotte, North
Carolina. A single mother of one young child, she earns what could best be described as a
modest income. Because charitable organizations aren’t known for their generous
retirement programs, Nichole has decided it would be best for her to do a little investing on
her own. She’d like to set up a program to supplement her employer’s retirement program
and, at the same time, provide some funds for her child’s college education (which is still 12
years away). Although her income is modest, Nichole believes that with careful planning,
she could probably invest about $250 a quarter, and she hopes to increase this amount over
time. Nichole now has about $15,000 in a bank savings account, which she’s willing to use
to kick off this program. In view of her investment objectives, she isn’t interested in taking
a lot of risk. Because her knowledge of investments extends no further than savings
accounts, series EE bonds, and a little bit about mutual funds, she approaches you for some
investment advice.
Critical Thinking Questions
1. In view of Nichole’s long-term investment goals, do you think mutual funds or ETFs are
the more appropriate investment vehicle for her?
2. Do you think that Nichole should use her $15,000 savings to start a mutual fund or an
ETF investment program?
Nichole needs to keep some funds for emergencies. The guide is to have 6 to 9 months of living
costs in emergencies funds. These funds could be invested in a money market account that will
provide more interest than a simple saving account. The $250 per month will give her $1,500 in
3. What type of mutual fund or ETF investment program would you set up for Nichole? In
your answer, discuss the types of funds you’d consider, the investment objectives you’d set,
and any investment services (such as withdrawal plans) you’d seek. Would taxes be an
important consideration in your investment advice? Explain.
As before, I would use a money market for her emergency fund; move the $250 per month
saving to a growth or small cap stock mutual fund; and make no withdrawals until kid goes to
4. Do you think some type of real estate investment would make sense for Nichole? If so,
what type would you suggest? Explain.
Terms Found in the Chapter
12b-1 fee
.
A annual fee that’s supposed to be used to offset promotion and selling
expenses
automatic
investment plan
An automatic savings program that enables an investor to channel a set
amount of money systematically into a given mutual fund.
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.
back-end load
.
A commission charged for redeeming fund shares
closed-end
investment
company
An investment company that issues a fixed number of shares, which
are themselves listed and traded like any other share of stock.
conversion
(exchange)
privileges
A feature that allows investors to switch from one mutual fund to
another within a family of funds.
exchange traded
fund (ETF)
An investment company whose shares trade on stock exchanges; unlike
mutual funds, ETF shares can be bought or sold (or sold short)
throughout the day. ETFs are usually structured as an index fund that’s
set up to match the performance of a certain market segment.
general-purpose
money fund
A money fund that invests in virtually any type of short-term
investment vehicle.
government
securities money
fund
A money fund that limits its investments to short-term securities of the
U.S. government and its agencies.
income (income-
producing)
property
Real estate purchased for leasing or renting to tenants in order to
generate ongoing monthly/annual income in the form of rent receipts.
international fund A mutual fund that does all or most of its investing in foreign
securities.
load fund
.
A fund that charges a fee at time of purchase.
low-load fund A fund that has a low purchase fee
management fee A fee paid to the professional money managers who administer a
mutual fund’s portfolio.
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.
net asset value The current market value of all the securities the fund owns, less any
(NAV) liabilities, on a per-share basis.
no-load fund A fund on which no transaction fees are charged.
open-end
investment
company
A firm that can issue an unlimited number of shares that it buys and
sells at a price based on the current market value of the securities it
owns; also called a mutual fund.
pooled
diversification
A process whereby investors buy into a diversified portfolio of
securities for the collective benefit of individual investors.
real estate
investment trust
(REIT)
An investment company that accumulates money by selling shares to
investors, in order to invest that money in various forms of real estate,
including mortgages; this type of fund is similar to a mutual fund, but a
REIT invests only in specific types of real estate or real estate–related
firms.
socially responsible
fund (SRF)
A fund that invests only in companies meeting certain moral, ethical,
and/or environmental criteria.
systematic
withdrawal plan
A plan offered by mutual funds that allows shareholders to be paid
specified amounts of money each period.
tax-exempt money
fund
A money fund that limits its investments to short-term, tax-exempt
municipal securities.
Investing in Mutual Funds, ETFs, and Real Estate
Chapter Outline
Learning Goals
I. Mutual Funds and Exchange Traded Funds: Some Basics
A. The Mutual Fund Concept
1. Pooled Diversication
B. Why Invest in Mutual Funds or ETFs?
1. Diversication
2. Professional Management
3. Financial Returns
4. Convenience
C. How Mutual Funds Are Organized and Run
D. Open-End versus Closed-End Funds
1. Open-End Investment Companies
2. Closed-End Investment Companies
E. ETFs
F. Choosing between ETFs and Mutual Funds
G. Some Important Cost Considerations
1. Load Funds
2. No-Load Funds
3. 12(b)-1 Fees
4. Management Fees
5. Keeping Track of Fund Fees and Loads
H. Buying and Selling Funds
*Test Yourself*
II. Types of Funds and Fund Services
A. Types of Funds
1. Growth Funds
2. Aggressive Growth Funds
3. Value Funds
4. Equity-Income Funds
5. Balanced Funds
6. Growth-and-Income Funds
7. Bond Funds
8. Money Market Mutual Funds
9. Index Funds
10. Sector Funds
11. Socially Responsible Funds
12. International Funds
13. Asset Allocation Funds
B. Services OAered by Mutual Funds
1. Automatic Investment Plans
2. Automatic Reinvestment Plans
3. Regular Income
4. Conversion Privileges
5. Retirement Plans
*Test Yourself*
III. Making Mutual Fund and ETF Investments
A. The Selection Process
1. Objectives and Motives for Using Funds
2. What Funds Have to OAer
3. Whittling Down the Alternatives
4. Stick with No-Loads or Low-Load Mutual Funds
5. Choosing between ETFs and Mutual Funds
B. Getting a Handle on Mutual Fund Performance
1. Measuring Fund Performance
a. Evaluating ETF Performance
2. What About Future Performance?
*Test Yourself*
IV. Investing in Real Estate
A. Some Basic Considerations
1. Cash Flow and Taxes
2. Appreciation in Value
3. Use of Leverage
B. Speculating in Raw Land
C. Investing in Income Property
1. Commercial Properties
2. Residential Properties
D. Other Ways to Invest in Real Estate
1. Real Estate Investment Trusts
2. Real Estate Limited Partnerships or Limited Liability Companies
*Test Yourself*
Summary
Financial Planning Exercises
Applying Personal Finance
The Feeling’s Mutual!
Critical Thinking Cases
13.1 Damon’s Dilemma: Common Stocks, Mutual Funds, or ETFs?
13.2 Nichole Ponders Mutual Funds