Investing in Mutual Funds, Real Estate, and Other Choices

Transcription

1 Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 14.1 Ivestig i Mutual Fuds 14.2 Ivestig i Real Estate ad Other Choices Cosider THIS Patrick works 20 hours a week, lives at home, ad ca save $100 a moth. He does t have a large lump sum to ivest, but he s sure that he ca set aside this amout permaetly. Patrick told his fiacial adviser, I ve thought about several kids of ivestmets. I researched several mutual fuds olie, ad I thik I m ready to buy shares i a fud that specializes i growth stocks. The oe I m most iterested i has averaged a 12 percet aual retur over the last 15 years. That s good, cosiderig the ups ad dows of the stock market. A importat beefit I ll have is the ability to check my accout daily, if I wat, by loggig oto the fud s web site. I ca trasfer my moey from oe fud to aother electroically if I see that this would be a wise thig to do. Ad, oce I buy i, I m guarateed to be able to keep buyig shares of the fud, eve if the fud is closed to ew ivestors later o. 300 Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

2 14.1 Ivestig i Mutual Fuds GOALS Discuss mutual fuds as a ivestmet strategy. Explai how to buy ad sell mutual fuds. TERMS growth fud, p. 302 icome fud, p. 303 growth ad icome fud, p. 303 balaced fud, p. 303 moey market fud, p. 303 global fud, p. 304 idex fud, p. 304 et asset value, p. 304 prospectus, p. 305 load, p. 305 EVALUATING MUTUAL FUNDS A mutual fud is a professioally maaged group of ivestmets bought usig a pool of moey from may ivestors. Idividuals buy shares i the mutual fud. The fud maagers use this pooled moey to buy stocks, bods, ad other securities. The kids of securities they buy deped o the fud s stated ivestmet objectives. For example, some mutual fuds specialize i aggressive growth stocks. Others specialize i more coservative ivestmets, such as bods or moey market securities. Most mutual fud compaies offer a family of fuds, which is a variety of fuds coverig a whole rage of ivestmet objectives. You ca choose the family member or members that best match your ow goals. You are allowed to move back ad forth amog the compay s fuds. You ca purchase oe type of fud (such as a stock fud) ad later switch to aother (such as a bod fud), all withi the same family of fuds. Professioal mutual fud maagers perform the followig duties: Research idividual stocks ad bods Iterpret market coditios, fiacial statemets, idustry treds, ad other market data Buy ad sell idividual stocks, bods, ad other fiacial istrumets Match good ivestmets to meet their ivestors objectives Fud ivestors share i ay profits made by the mutual fud. They receive profits as divideds ad as capital gais, both of which may be reivested i the fud or distributed to Photodisc/Getty Images Is a family of fuds a good ivestmet? Why or why ot? Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 301 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

3 ivestors as cash paymets. Capital gais come from the profits made whe the maagers sell some of the fud s securities for more tha they paid for them. For most mutual fud ivestig, you will have to make a iitial purchase of $500 to $3,000 or more. Oce you buy ito a fud, you ca make additioal purchases as ofte as you like. May people make regular purchases of $50 to $100 a moth. To take moey out of your fud, you simply call the compay ad place a order to sell your shares or make your request olie at the compay web site. ADVANTAGES OF MUTUAL FUNDS Ivestors ofte choose mutual fuds for several good reasos. Professioal Maagemet. Whe you hire someoe who kows how to ivest, you do t have to worry about followig stock ad bod markets or lookig for hot ew ivestmets. Professioals are doig the work for you. Liquidity. You ca get your moey quickly if you eed it, though there is some risk of loss if the fud s price is low whe you choose to sell. Diversificatio. Whe you ivest i mutual fuds, you are diversifyig because mutual fuds purchase a variety of stocks ad bods. Whe you have eough moey to ivest i more tha oe fud, you ca further diversify by buyig shares i fuds with differet ivestmet objectives. I the same way that you would diversify idividual stock purchases, you ca buy some shares i riskier, aggressive mutual fuds ad limit the risk by also purchasig shares i more coservative fuds. Small Iitial ad Ogoig Purchases. Aother advatage of mutual fuds is that you eed ot have a lot of moey to ivest. May fuds require oly a small miimum ivestmet. Also, through poolig your moey with other ivestors i the fud, you ca ow, for example, part of a $10,000 govermet bod without havig $10,000 to buy the whole bod yourself. MUTUAL FUND RISK Idividual fuds withi a family have differet ivestmet goals ad risk levels. I their publicatios ad o their web sites, ivestmet compaies describe the ivestmet goals ad level of risk for each fud. You ca choose fuds that match your goals ad risk tolerace. As with ay ivestmet, the greater the potetial retur, the higher the risk. Figure 14.1 shows the geeral risk/retur profiles for geeral categories of mutual fuds. Growth Fuds A growth fud is a mutual fud whose ivestmet goal is to buy stocks that will icrease i value over time. To do this, the fud s maagers select stocks i compaies that reivest their profit i the compay rather tha distribute it to ivestors as divideds. Ivestors i growth fuds ear their retur through capital gais rather tha through divideds. A aggressive growth fud ivests i stock of ew or out-of-favor compaies ad idustries that the fud maagers thik will achieve above-average icreases i value. The philosophy behid aggressive growth fuds is to accept high risk of loss i exchage for a chace to ear high returs. Other growth fuds follow a less risky philosophy. They 302 Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

4 FIGURE 14.1 RiskadReturPyramid Higher risk/higher retur potetial Growth Fuds Growth ad Icome Fuds Icome Fuds Lower risk/lower retur potetial Moey Market Fuds ivest i more stable compaies that the fud maagers expect to icrease i value but at a slower, steadier rate tha the stocks of aggressive growth fuds. Icome Fuds A icome fud is a mutual fud whose ivestmet goal is to produce curret icome i the form of iterest or divideds. At times, these ivestmets will also share moey with ivestors i the form of capital gais distributios. I this case, the ivestor receives a check or deposit to his or her accout. Ivestors i icome fuds are lookig for icome from their ivestmets ow rather tha capital gais later. Icome fuds are cosidered to be of low-to-moderate risk ad less risky tha growth fuds. Some icome fuds specialize i tax-exempt bods. Their goal is to provide tax-free icome for ivestors. Tax-exempt bod fuds appeal to ivestors i high-icome tax brackets. Growth ad Icome Fuds A growth ad icome fud is a mutual fud whose ivestmet goal is to ear returs from both divideds ad capital gais. Maagers of these fuds try to select stocks that pay divideds as well as stocks that icrease i market value over time. The risk level of this type of fud is moderate betwee the riskier growth fuds ad less risky icome fuds, as you ca see i Figure A balaced fud is a mutual fud that seeks both growth ad icome but attempts to miimize risk by ivestig i a mixture of stocks ad bods rather tha stocks aloe. Like growth ad icome fuds, the goal of a balaced fud is to ear returs from curret icome ad capital gais. Balaced fuds have moderate risk. They are a little less risky tha growth ad icome fuds that ivest oly i stocks. Moey Market Fuds A moey market fud is a mutual fud that ivests i safe, liquid securities, such as Treasury Bills ad bods that mature i less tha a year. These short Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 303 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

5 maturities provide modest curret icome with little risk. The goal of ay moey market fud is the preservatio of pricipal ad very high liquidity. May ivestors choose to put their moey ito moey market fuds while they are waitig out ufavorable market coditios. For example, returs from icome fuds may be droppig. A ivestor might the trasfer his or her balace to a moey market fud util the icome fuds are risig oce agai. Global Fuds A global fud is a mutual fud that purchases iteratioal stocks ad bods as well as U.S. securities. Global fuds fall ito a variety of risk categories, depedig o the ivestmet objective of the idividual fud. For example, a global fud ca be very risky if its goal is to ivest i aggressive growth iteratioal stocks. A global fud that ivests i a coservative mix of iteratioal stocks ad bods would be less risky. However, most global fuds have risks that U.S. stock fuds do ot have. Fluctuatios i currecy exchage rates ad political istability i other coutries ca affect the value of global stocks. These ucertaities make global fuds geerally more risky tha U.S. stock fuds. Idex Fuds A idex is a average of the price movemets of certai selected securities. Ivestors use idexes as bechmarks for compariso to judge how well their ivestmets are doig. A idex fud is a mutual fud that tries to match the performace of a particular idex by ivestig i the compaies icluded i that idex. For example, a idex fud might ivest i compaies icluded i the Stadard & Poor s 500 idex or the Dow Joes Idustrial Average idex. The risk level of a idex fud depeds o the idex to which it is tied. Sice the Dow icludes oly blue chip stocks, fuds tied to this idex would be relatively low risk. The NASDAQ Composite Idex, o the other had, averages stocks of some volatile high-tech compaies. Fuds tied to this idex could be relatively risky. BUYING AND SELLING MUTUAL FUNDS There are thousads of mutual fuds coverig the whole rage of ivestmet objectives ad risk levels. To choose the mutual fud that is right for you, you must kow your ow ivestmet objectives ad risk tolerace. Do you wat icome from your ivestmets ow, or ca you wait for capital gais i the future? Do you eed a tax-free or tax-deferred ivestmet to reduce your curret icome taxes? Are you comfortable with riskig your ivestmet for a chace at big returs, or do you prefer a safe but lower retur? Oce you kow your ow requiremets, you ca read about the objectives ad risk profiles of differet fuds ad fid oe that matches your requiremets. NET ASSET VALUE Ulike stocks, mutual fud prices are ot determied by what people are willig to pay for them. They are determied by et asset value (NAV). The et asset value tells you the market price for a share of a mutual fud. The NAV is 304 Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

6 the total value of a fud s ivestmet portfolio mius its liabilities, divided by the umber of outstadig shares of the fud. NAV ¼ Value of Portfolio Liabilities Number of Shares For example, suppose the value of all stocks i a fud s portfolio is curretly $100,000. The fud has $90,000 i liabilities ad has sold 500 shares of its fud to ivestors. The price for oe of its shares, or its et asset value, would be $20 at this time. $100; 000 $90; 000 ¼ $ Because the value of the portfolio chages as the stocks ad other securities are traded throughout the day, the NAV is calculated at the ed of each busiess day. Thus, the value of your ivestmet depeds o that fud s performace i the securities market. Although a mutual fud provides professioal maagemet, you should moitor your fud s performace. Some fuds cosistetly outperform the average amog those with the same objective ad risk. For example, if you ow a icome fud, you ca compare its performace to that of other icome fuds. THE PROSPECTUS By law, ivestmet compaies must provide detailed iformatio about their fuds. A mutual fud compay must provide a prospectus for each fud offered. The prospectus is a legal documet that offers securities or mutual fud shares for sale. It must cotai the terms, a summary of the fud s portfolio of ivestmets, its objectives, ad fiacial statemets showig past performace. You ca usually fid this iformatio o the ivestmet compay s web site as well. Before choosig a mutual fud, read the prospectus carefully. Compare the fud s objectives with your ow, ad compare its past performace with that of other fuds you are cosiderig. COSTS AND FEES If you buy a mutual fud through a broker, you will likely have to pay a sales fee, called a load. The broker s commissio comes from this fee. A frot-ed load is a sales charge paid whe you buy a ivestmet. Sometimes you pay VIEW Poits Some ivestors believe that oce you have selected a mutual fud or other type of log-term ivestmet, you should check o it oly periodically ad resist makig chages. Others believe that it is importat to check your accout balaces almost daily. These ivestors frequetly move their balaces from oe fud to aother as they costatly look for choices that pay higher returs. THINK CRITICALLY Which view do you agree with? The Iteret provides a very coveiet way to check balaces. How ofte should you check your balaces? Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 305 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

7 306 Uit 3 Fiacial Security this fee o reivested divideds as well. A back-ed load is a sales charge paid whe you sell a ivestmet. Either way, loads ca rage from 2 to 8 percet of the value of the shares purchased. I some cases, you ca buy mutual fuds directly from the ivestmet compaies. This kid of fud, called a o-load fud, does ot charge a sales fee whe you buy or sell because o salespeople are ivolved. You buy directly from the compay by telephoe, mail, or through the compay s web site. Mutual fuds make moey by chargig fees to their customers for the professioal services provided. Fuds ofte charge a aual maagemet fee, which averages about 1 to 1½ percet of a fud s total assets. This charge is for the services of professioal fud maagers ad for maitaiig your accout. The fud may also charge a 12b-1 fee to cover the costs of marketig ad distributig a mutual fud. These fees are part of the fud s expese ratio, which is expressed as a percetage of assets deducted each year for fud expeses. Mutual fuds publish their expese ratios with their fud descriptios. Whe you cosider ivestig i mutual fuds, compare expese ratios as part of your evaluatio. THE MUTUAL FUND COMPANY The most importat decisio you will make with mutual fud ivestig is selectig the right mutual fud compay or compaies. You ca read about a fud i its prited material. You ca compare its costs ad fees. You ca research published comparisos about fuds of the same type. But, you still have o guaratees that a mutual fud will make moey or that the mutual fud compay itself will ot fail. To reduce these risks, choose a mutual fud compay that has the followig characteristics: It has bee i busiess for 20 or more years It has a solid track record of returig good solid returs to its ivestors It is a large compay that maages ivestmets for millios of ivestors It is a well-kow compay that is highly respected amog ivestmet advisers ad experts It exists both i brick-ad-mortar ad i cyberspace It is customer friedly ad resposive to customer questios ad eeds It provides customers with easy-to-read statemets ad reports ad offers daily olie access SOURCES OF MUTUAL FUND INFORMATION Fiacial publicatios, such as Forbes, Fortue, ad Moey, regularly review ad rak mutual fuds. They compare oe-year, five-year, ad te-year performaces of various fuds with similar objectives. They also show the expese ratios of each oe, so that you ca make comparisos. Occasioally, etire sectios of busiess magazies are devoted to listig, describig, ad rakig mutual fuds. You ca also fid a great deal of iformatio olie. For example, the Morig Star web site issues reports that compare mutual fuds. You ca also search for the sites of fud families by ame, such as Vaguard, Fidelity, ad Dreyfus. At their sites, you ca fid detailed descriptios, icludig risk/retur profiles for all fuds i their fud families. At the Yahoo! Fiace web site, you ca search for fud iformatio by its ticker symbol. Aother good web site for educatioal iformatio o mutual fuds is the Mutual Fud Ivestors Ceter. Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

8 ISSUES IN YOUR WORLD HOW TO READ THE MUTUAL FUNDS LISTINGS Mutual Fud Quotatios Iv. Offer NAV Retur Obj. NAV Price Chg. YTD 26 Wks. 4 Yrs. Ables Fud: AciBt1A GRO NA BiClo BND 1.51 NL þ8.9 CoxDli SML 8.61 NL þ.01 þ1.6 þ1.5 þ18.6 DrixLt G&I NL.07 þ6.1 þ4.0 þ18.0 BB&B Fud: Globl B WOR þ2.7 MtgLtd MTG þ Colum 1. The sposorig mutual fud compay s ame is listed first. Its fuds appear below i alphabetical order. Colum 2. The ivestmet objective of the fud family is idetified here. These compaies offer ivestors a choice of growth (GRO), bod (BND), small compay growth (SML), growth ad icome (G&I), global (WOR, for world ), ad mortgage (MTG) fuds. Colum 3. NAV stads for et asset value. It is the dollar value of oe share of the fud, based o closig quotes. Colum 4. The offer price reflects the et asset value plus sales commissio, if ay. A NL idicates a o-load fud. Colum 5. NAV chage idicates the gai or loss i the price for a share of the fud, based o the previous NAV quotatio. Colum 6. YTD stads for year to date. It tells you how much this fud has goe up or dow sice Jauary 1 of the curret year. Colum 7. Total retur, 26 weeks, shows the average earigs the fud has retured to ivestors i the last six moths, stated as a percetage retur o ivestmet. Colum 8. Total retur, 4 years, shows the average earigs the fud has retured to ivestors for the last four years, stated as a percetage retur o ivestmet. THINK CRITICALLY 1. Which of the mutual fuds i the listig seems to be the best ivestmet as compared to the other choices give? Why? 2. Why is it importat to kow the ivestmet objective? Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 307 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

9 14.1 Assessmet KEY TERMS REVIEW Match the terms with the defiitios. Some terms may ot be used. 1. A mutual fud whose ivestmet goal is to produce curret icome i the form of iterest or divideds 2. A mutual fud that ivests i safe, liquid securities 3. A mutual fud that tries to match the performace of a particular idex 4. A mutual fud that purchases iteratioal stocks ad bods as well as U.S. securities 5. The sales fee charged for buyig mutual fuds 6. A mutual fud whose goal is to buy stocks that icrease i value over time 7. A mutual fud that miimizes risk by ivestig i a mixture of stocks ad bods 8. The legal documet that offers securities or mutual fud shares for sale 9. The market price for a share of a mutual fud a. balaced fud b. global fud c. growth ad icome fud d. growth fud e. icome fud f. idex fud g. load h. moey market fud i. et asset value j. prospectus CHECK YOUR UNDERSTANDING 10. Why might you choose a mutual fud over ivestig directly i stocks? 11. What is NAV, ad how is it computed? APPLY YOUR KNOWLEDGE 12. Describe the type of ivestor (i terms of goals ad risk tolerace) who would be iterested i each of the followig types of mutual fuds: (a) growth fuds, (b) icome fuds, (c) growth ad icome fuds, ad (d) moey market fuds. THINK CRITICALLY 308 Uit 3 Fiacial Security 13. Where is a good place for youg ad iexperieced ivestors to start buyig mutual fuds? 14. How ca you lower risks while choosig mutual fuds? 15. Why is it importat to choose a mutual fud compay that has bee i busiess for a log time? Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

10 14.2 Ivestig i Real Estate ad Other Choices GOALS Explai real estate ivestig, both direct ad idirect. Describe other ivestmets, icludig metals, gems, collectibles, ad fiacial istrumets. TERMS real estate, p. 309 duplex, p. 310 codomiium, p. 310 mortgage, p. 312 depreciatio, p. 313 precious metals, p. 314 gems, p. 314 REAL ESTATE INVESTING Whe you ivest i real estate, you are buyig lad ad ay buildigs o it. Ivestig i real estate is cosidered a good way to combat iflatio, because it usually icreases i value over the years at rates equal to or higher tha iflatio. However, real estate is oe of the least liquid ivestmets you ca make, sice a property ca take moths or eve years to sell. Also, some real estate ivestmets are speculative ad ca result i a substatial loss. Commercial property is lad ad buildigs that produce lease or retal icome. Such property icludes office buildigs, stores, hotels, duplexes, ad multi-uit apartmets. You ca ivest i real estate directly or idirectly. BUYING REAL ESTATE There are may types of real estate properties you ca buy directly, such as vacat lad, sigle-family houses, duplexes, apartmets, codomiiums, ad recreatio or retiremet property. With direct ivestmets, the ivestor holds legal title to the property. Photodisc/Getty Images Why would you ivest i a vacat lot? Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 309 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

11 Vacat Lad Vacat lad, or uimproved property, is usually cosidered a speculative ivestmet. Ivestors hold the property expectig it to go up substatially i value over time. Other people purchase a vacat lot with plas for buildig a house o it later, either whe they ca afford it or at retiremet. I either case, you will likely have to pay cash for vacat lad. Because it is cosidered speculative, baks are ofte uwillig to make loas o vacat lad. Sigle-Family Houses I additio to owig your ow home, you might wish to purchase a siglefamily house ad ret it to others. Because the property is ot ower-occupied, you may fid baks reluctat to grat you a mortgage loa to buy a house as retal property. As a coditio for a loa, you may have to make a larger dow paymet or pay a higher iterest rate. Whe a reter takes possessio of your house, you still have resposibilities. For example, as the ower, you must maitai the premises i a livable coditio. You must provide ruig water, electricity, sewer or septic hookups, ad ormal repairs ad maiteace. If the roof leaks or a pipe breaks, it is your resposibility to fix it. Retal Properties There are several other types of retal properties, or real estate desiged for owers to ret to teats. A duplex is a buildig with two separate livig quarters. A duplex may be side-by-side livig quarters with separate etraces, or it may be upper ad lower floors of the buildig. A triplex (three uits) ad a quad (four uits) are buildigs with three or four idividual housig uits. They ofte have commo walls ad surroudig areas. A apartmet complex is a group of may apartmets with commo facilities such as recreatio areas, clubhouses, ad parkig lots. A codomiium, orcodo, is a idividually owed uit i a apartmetstyle complex with shared owership of commo areas. The ower of a codo ows the idividual apartmet as well as a proportioal share of commo areas, such as the lobby, yard, ad hallways. Codo owers usually pay a mothly fee for the upkeep of the commo areas, such as for mowig the law ad maitaiig a shared swimmig pool. Codos are geerally less expesive tha sigle-family houses because they have less lad ad private areas ad share roofs, walls, plumbig, ad so o. By poolig your cash with that of other ivestors, you ca afford to buy larger ad more expesive pieces of property. For example, if you ad three others formed a partership to buy a eight-uit apartmet buildig, each of you would have to pay oly oe-fourth of the total costs of buyig ad maitaiig the property. Recreatio ad Retiremet Property May people buy secod homes for vacatios or for their retiremet years. Ofte, the owers ret these properties out to others to geerate icome durig the times whe they are ot usig them. Of course, reted property will ot be i brad-ew coditio whe the ower retires to live there full time. 310 Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

12 Recreatio property icludes beach ad moutai cabis ad eve vacat lad ear vacatio sites such as rivers, lakes, or a ocea. The ower ca use ad ejoy the property o weekeds ad durig vacatios, ad at other times ret out the property. However, abset owers may eed to arrage for someoe to take care of the property ad maage the retal process. Real estate compaies i popular vacatio areas ofte provide these services for abset owers for a fee. INVESTING INDIRECTLY With idirect ivestig, ivestors have a third perso do the actual buyig ad sellig of property. A trustee is a idividual or istitutio that maages assets for someoe else. The trustee holds the title to the property. Real estate sydicates, real estate ivestmet trusts, ad mortgage pools (i the form of participatio certificates) are examples of idirect ivestmets usig a thirdparty trustee. Real Estate Sydicates A real estate sydicate (ofte called a limited partership) is a group of ivestors who pool their moey to buy high-priced real estate. This is a temporary associatio of idividuals orgaized for the purpose of raisig a large amout of capital. The orgaizer of the sydicate is called the geeral parter or sydicator. The people who cotribute the capital are called limited parters. I a real estate sydicate, the geeral parter forms a partership ad assumes ulimited liability for all the obligatios (debts) of the partership. By assumig ulimited liability, the geeral parter s resposibility exteds beyod the iitial ivestmet to his or her persoal assets if the ivestmet icurs debt. The geeral parter the sells participatio uits to limited parters whose liability is limited to the amout of their ivestmet. This meas that the limited parters ca lose o more tha they ivested if the ivestmet fails. Limited liability is especially importat i real estate parterships because the mortgage acquired to purchase real estate ofte exceeds the et worth of the idividual parters. A real estate sydicate ofte ows several properties for diversificatio. The commercial properties acquired are usually professioally maaged. Real Estate Ivestmet Trusts (REITs) A real estate ivestmet trust (REIT) is similar to a mutual fud. It is a corporatio that pools the moey of may idividuals to ivest i real estate. Like a mutual fud, the REIT makes all buy-ad-sell decisios Digital Visio/Getty Images Why might a ivestor choose a idirect real estate ivestmet? Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 311 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

13 for properties. You ca buy ad sell REIT shares at will. REITs are traded o stock exchages or over the couter. Like stocks, REIT shares fluctuate with market coditios, ad divideds are paid whe the real estate ivestmets do well. There are may types of REITs, ivestig i everythig from retal properties for mothly icome to mortgages for log-term icome. REITs are foud i the fiacial sectio of the ewspaper alog with stock, bod, ad mutual fud price quotatios. Participatio Certificates A participatio certificate is a ivestmet i a pool of mortgages that have bee purchased by a govermet agecy. Participatio certificates are sold by federal agecies such as the Govermet Natioal Mortgage Associatio (Giie Mae), the Federal Home Loa Mortgage Corporatio (Freddie Mac), ad the Federal Natioal Mortgage Associatio (Faie Mae). At oe time, you eeded $25,000 to ivest i these certificates. However, may mutual fuds ivest etirely i them, makig it possible to buy shares for as little as $1,000. BUYING AND OWNING RENTAL PROPERTY Whe buyig real estate, most people make a dow paymet ad get a mortgage to pay the balace. A mortgage (also called a trust deed) is a loa to purchase real estate. Most people borrow moey to buy property because large sums of cash are eeded. Borrowig moey to buy a ivestmet is called leverage, which meas oly a small amout of the purchase price is your ow moey. For example, if you buy a duplex for $300,000 ad make a dow paymet of $60,000 (a 20 percet dow paymet is usually required for retal property), you are borrowig $240,000 from the bak. As the property gais i value, the mortgage remais fixed. Whe you evetually sell the property, you keep the differece betwee the sales price ad the mortgage. This differece is the equity, or owership iterest. Mothly Paymets As your teat makes ret paymets, you make the mortgage paymets to the bak. You would use the differece betwee the amout of ret collected ad the mortgage paymet to pay property taxes ad the cost of upkeep o the property. If you have moey left over after payig these expeses, you have a positive cash flow. If, however, you caot collect eough ret to pay the mortgage, property taxes, repairs, ad maiteace, the you have a egative cash flow ad must make up the shortfall from your ow pocket. Mothly Maagemet To maage your property, you ca be a residet ladlord or hire a residet ladlord or property maager. A residet ladlord lives at the retal site, takes care of all repairs ad maiteace, collects the ret, ad assures suitable livig coditios. A property maager collects ret, hires ad pays people to make repairs ad maitai the property, charges a fee for his or her services, ad remits the differece to the ower of the property. Property maagers do ot live o site, but usually maage a large umber of retal properties at the same time. 312 Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

14 Tax Advatages Depreciatio is the declie i the value of property due to ormal wear ad tear. Eve though your property may be icreasig i overall value, you ca deduct depreciatio expese o your retal property usig Schedule C of the Form 1040 tax retur. I additio, property taxes ad other expeses of maitaiig retal property ca be deducted to help reduce the taxes you have to pay o your retal icome. Sellig Retal Property Whe you sell your property, you will have to pay taxes o the capital gai. Real estate ca be difficult to sell. Durig slow ecoomic times whe people have difficulty obtaiig low-iterest loas, you may have to lower the price of your property substatially i order to sell it. Risks of Owig Retals You should cosider the risks of owig ad retig property. Reters ca damage or destroy your property to a degree far exceedig what a security deposit ca cover. Whe your uits have vacacies, your retal icome will declie, yet you still have to pay the mortgage ad other expeses, thus cuttig ito your profits. Real estate is also subject to zoig laws ad other local use restrictios. Cities have laws that regulate what type of structure (for example, sigle-family residece, apartmet complex, office buildig) ca be built i each area of the city. Before buyig property, you should check the applicable zoig laws to make sure you will be allowed to use the property as you ited. OTHER INVESTING CHOICES You may be willig to ivest your moey i just about aythig you thik will brig you a retur i value over time or some other form of icome. Ofte these choices deped o persoal values ad tastes. METALS, GEMS, AND COLLECTIBLES Ivestmets i this category are ofte speculative. They ca retur large profitsorlosseswhesold.isomecases, the ejoymet of havig the ivestmet will far exceed ay resale value. Although ot iexpesive, precious metals, gems, ad collectibles are easy to purchase. However, they ca be very difficult to sell i a hurry ad do ot provide ay curret icome i the Photodisc/Getty Images Why are gems cosidered risky ivestmets? Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 313 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

15 form of iterest or divideds. So be cautious whe makig this type of ivestmet. Precious Metals Gold, silver, ad platium are examples of precious metals. Precious metals are tagible metals that have kow ad uiversal value aroud the world. They are usually atural substaces that people value. However, prices of precious metals ca swig widely over time. These swigs are what make ivestmets i precious metals very risky. You ca buy gold ad silver as cois, medallios, jewelry, ad bullio. Storig precious metals safely may be a problem because of bulk ad weight. Istead of storig your ivestmet yourself, you ca buy gold ad silver i the form of a certificate statig how much you ow of the metal beig stored for you. You also ca ow gold idirectly by ivestig i gold-miig stocks or i mutual fuds specializig i these stocks. Other metals i which you ca ivest iclude alumium, ti, copper, lead, ickel, ad zic. Prices for metals ca be foud i the fiacial sectio of ewspapers ad olie. Gems ad Jewelry Gems are atural, precious stoes, such as diamods, rubies, sapphires, ad emeralds. Their prices are high ad subject to drastic chage. Precious metals ad gems have their greatest value as jewelry. However, whe you purchase jewelry at retail prices, you are payig markups of 50 to 500 percet or more. Prices must icrease substatially i the world market before you ca recover the cost ad make a profit from resellig your jewelry. The biggest disadvatage of ivestig i gems is the risk that you wo t be able to resell them. The gems market ca be very small ad upredictable. No ready market may exist whe you decide to sell. Ofte you have to go out o your ow to fid a buyer, such as sellig o the Iteret or advertisig i the paper. The process of buyig ad sellig ca also be hazardous, as most such trasactios require the use of cash. Collectibles Collectios of valuable or rare items, such as atiques, art, baseball cards, stamps, ad comic books, are called collectibles. They are valuable because they are old, o loger produced, uusual, irreplaceable, or of historic importace. Cois are the most commoly collected items. Silver cois (rather tha today s alloy cois) ofte are worth more tha 20 times their face value. COMMUNICATION Coectio Review the collectibles sectio(s) i your local ewspaper s classified ads. You will fid all types of thigs offered to buy, sell, ad exchage. These ofte represet items people ad families have collected for years. Sometimes you fid these items at swap meets or other types of collectible shows. They attract a certai type of ivestor. What types of items are offered for sale? I cotrast, what items are people lookig to buy? Prepare a summary of your fidigs to share i a class discussio. 314 Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

16 People like to collect favorite items, from porcelai figures to hubcaps, ad hope that someday their collectio will be valuable. Collectig ca be a satisfyig hobby. Ufortuately, collectibles ca be hard to sell ad may ot icrease i value. You may fid it difficult to locate a buyer who is willig to pay you the value of your collectio, eve whe the value is well kow. If you wat to be a collector, buy what you ca persoally appreciate ad ejoy through the years, kowig that your collectio may or may ot result i a profit whe you decide to sell it. FINANCIAL INSTRUMENTS Futures are cotracts to buy ad sell commodities or stocks for a specified price o a specified date i the future. Commodities iclude farm products (such as wheat, cor, ad cattle) ad metals (such as gold ad silver). Commodity prices are volatile because supply ad demad for commodities are disrupted by all kids of mostly upredictable situatios, from political upheaval to the weather. Commodities may be sold for cash (the local farmer s market) or traded i the futures market. For example, a farmer could sell a futures cotract to deliver 5,000 bushels of wheat oe year from today. The futures market was created for those who wat to kow i advace what they will be paid. Farmers eter the futures market oly for protectio agaist volatile prices. Futures cotracts are like a isurace policy agaist chages i prices. I this case, the farmers like kowig i advace what they will be paid for their wheat. A optio is the right, but ot the obligatio, to buy or sell a commodity or stock for a specified price withi a specified time period. A call optio is the right to buy shares of stock at a set price by a certai expiratio date. You ca exercise the right at ay time before the optio expires. A put optio is the right to sell stock at a fixed price util the expiratio date. A ivestor who thiks a stock s price will icrease durig a short period of time may decide to purchase a call optio. O the other had, a ivestor who feels a stock s price will decrease durig a short period of time may purchase a put optio to safeguard the ivestmet. Optios are risky busiess ad ot for the iexperieced ivestor. Optios also apply to the purchase ad sale of futures cotracts. Ivestors who choose to buy ad sell fiacial istrumets are takig very high risk. While large gais are possible, the ivestor must be prepared to take losses as well as gais. It is feasible that you could lose your etire ivestmet. Over time, those who specialize i fiacial istrumets make profits, because their gais exceed their losses. Buyig comic books as a ivestmet is relatively ew. Most people buy comics for the ejoymet of readig them. As they have grow more ad more popular, some comics have become quite valuable. A sigle, mitcoditio issue of Actio Comics #1, which itroduced the world to Superma, is worth over $1 millio. Access ad click o the lik for Chapter 14. Read the article about comics collectig. List the three factors that determie a comic s value. Accordig to the author, where are good places to fid ivestmet-grade comics? What does the author seem to thik is the best way to sell comics? Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 315 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

17 Plaig a Career i... Stock Brokerage The most commo type of securities sales aget is the stockbroker. These are the people who sell securities to everyday people, called ivestors. Stockbrokers provide ivestig advice ad help their cliets buy ad sell at the right times to maximize their profits. Begiig stockbrokers sped much of their time fidig cliets ad buildig a customer base. They rely o etworkig ad social cotacts to build their busiess. They joi civic orgaizatios ad social groups to expad those etworks. After stockbrokers are established, they do most of their busiess through referrals. A referral is a recommedatio from a existig customer. Stockbrokers work for commissio icome. They ear commissios each time they buy or sell a security. Employmet Outlook l A much faster tha average rate of employmet growth is expected. Job Titles l l l l Securities broker Floor broker Idepedet stockbroker Ivestmet baker Needed Skills l A bachelor s degree i busiess, fiace, accoutig, or ecoomics is required; a MBA is preferred ad required for higher-level positios. l l l Itesive o-the-job traiig is required for etry-level employees. Brokers must be licesed ad pass a licesure exam. Maturity ad ability to work idepedetly are critical. What's it like to work i... Stock Brokerage Alysha is a stockbroker who works for a top ivestmet compay that has a seat o the New York Stock Exchage. She works i a regioal office, has more tha two doze cliets, ad is resposible for brokerage accouts worth more tha $5 millio. Alysha works hard to help her cliets meet their ivestmet objectives. She advises cliets about mutual fuds ad other ivestmet optios to help them attai the risk level ad the returs they desire. Whe cliets have selected stock i which to ivest or sell, Alysha makes the trasactios. Alysha is at the office daily before the stock market opes. She talks with her cliets mostly by phoe but sometimes meets with them for cosultatios. What About You? Would you like workig idepedetly ad o commissio? Do you ejoy social groups, civic orgaizatios, ad other etworkig evets? Would you cosider a career as a stockbroker? Why or why ot? 316 Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

18 14.2 Assessmet KEY TERMS REVIEW Match the terms with the defiitios. 1. A loa to purchase real estate 2. Tagible metals that have kow ad uiversal value worldwide 3. Lad ad the buildigs o it 4. The declie i the value of property due to ormal wear ad tear 5. Natural, precious stoes, such as diamods, rubies, sapphires, ad emeralds 6. A idividually owed uit i a apartmet-style complex with shared owership of commo areas 7. A buildig with two separate livig quarters a. codomiium b. depreciatio c. duplex d. gems e. mortgage f. precious metals g. real estate CHECK YOUR UNDERSTANDING 8. What are some advatages of owig real estate as a ivestmet? 9. Why are collectibles risky ivestmets? 10. Explai how futures cotracts work. APPLY YOUR KNOWLEDGE 11. Describe what it would be like to be a ladlord (your resposibilities ad duties) if you owed: (a) a sigle-family house reted to a family, (b) a secod home o the beach that you reted to vacatioers, ad (c) a eight-uit apartmet buildig where you were the residet ladlord. THINK CRITICALLY 12. Owig retal property ivolves receivig eough moey to pay expeses as you go alog. Explai the cocept of leverage ad the eed for a positive cash flow. 13. Price chages for precious metals ca be very upredictable. Why would ayoe wat to ivest i these items? 14. Name some collectible items you have see, collected, or read about that have icreased substatially i value over the years. What do/would you like to collect? Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 317 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

19 14 Chapter Assessmet SUMMARY 14.1 Mutual fuds use moey pooled from may ivestors to buy securities that fit the fud s stated objectives. Ivestors choose mutual fuds for the professioal maagemet, liquidity, diversificatio, ad relatively small miimum ivestmet required. Growth fuds focus o stocks expected to ear future capital gais, while icome fuds ivest to provide curret icome i the form of iterest ad divideds. Growth ad icome fuds ad balaced fuds seek curret icome ad capital gais. Moey market fuds ivest i safe, liquid securities, while global fuds ivest i more risky iteratioal as well as U.S. securities. Idex fuds try to match the performace of a particular idex. NAV is calculated as the total value of the fud s ivestmets mius its liabilities, divided by the umber of outstadig shares. To evaluate a fud, examie the prospectus, fees, ad published comparisos amog fuds of the same type If you ivest i real estate directly, you ow legal title to it. If you ivest idirectly, a trustee holds legal title o behalf of the ivestor group. You ca ivest i real estate idirectly through real estate sydicates, REITs, or federal agecy participatio certificates. If your retal icome from retal property exceeds your mortgage paymet, property taxes, ad upkeep expeses, the you have a positive cash flow. As the ower of retal property, you beefit from tax advatages for depreciatio ad other expeses. However, it may be difficult to resell, ad whe sold, you will have to pay taxes o the capital gai. Ivestmets i precious metals, gems, collectibles, futures cotracts, ad optios are very risky ad ot for the ovice ivestor. Gems have their greatest value as jewelry. The retail price has a huge markup, ad the resale market is small ad upredictable. Collectibles ca be very profitable or worthless, depedig o the chagig tastes of cosumers. 318 Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

20 APPLY WHAT YOU KNOW 1. Why should a ew ivestor read the prospectus of a mutual fud carefully before ivestig i the fud? 2. Why would a perso choose a frot- or back-ed load fud over a o-load mutual fud? 3. Why would you wish to buy a piece of vacat lad? Describe what your plas might be for the property i 10 or 20 years, icludig where you would buy such a lot ad its potetial uses. 4. Describe ivestors who might buy a secod home, such as a cabi i the woods. Why should they purchase the property ow rather tha i the future, whe they pla to use it full time for retiremet? 5. Explai how leverage applies to buyig real estate. Why is it desirable to have a positive cash flow from retal property you ow? 6. What is the meaig of the statemet Real estate is a illiquid ivestmet? 7. The Iteret has provided a ew way for buyers ad sellers of collectibles to fid each other. Search the Iteret for sites dealig with a collectible that iterests you. How is this item bought ad sold olie? Is there a associatio or club for your collectible? If so, how does the site help collectors? MAKE ACADEMIC CONNECTIONS 8. Commuicatio Mutual fuds are ofte the best choice for youg ivestors ad those wishig to get started ivestig for the first time. Suppose a perso had $500 to ivest iitially ad plaed to ivest $50 a moth thereafter. Write a oe-page paper explaiig why mutual fuds might be a better way to ivest this moey tha collectibles (such as buyig Barbie dolls or baseball cards). Explai the advatages of ivestig i mutual fuds. 9. Research Visit the web site of a ivestmet compay that offers a family of mutual fuds (such as Vaguard or Fidelity). Select five of the compay s fuds that are very differet from each other. Describe the ivestmet objective(s) ad risk level for each of the five fuds. Draw a graphic that visually displays risk level, goig from least risky to most risky. O the graph, idetify the most risky fud you selected ad the least risky fud. The place the three other fuds at their appropriate risk levels i betwee the two extremes. I a paragraph, summarize what you leared about mutual fuds ad risk. 10. Ecoomics Gold is a commodity. Most of the U.S. gold supply is stored at Fort Kox. Also stored at Fort Kox is the gold supply of may foreig coutries. What is meat by the gold stadard? Do we have a gold stadard today? How much gold does the Uited States have? Prepare a brief history of the importace of gold to the Uited States ecoomy. Chapter 14 Ivestig i Mutual Fuds, Real Estate, ad Other Choices 319 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

21 SOLVE PROBLEMS AND EXPLORE ISSUES 11. Toy ad Barbara have bee married for three years ad have maaged to save some moey to ivest. They have decided o mutual fuds but do t wat to take too much risk. Still, they would like to have some additioal icome ow ad also be able sell the shares for a good profit i five to te years. Suggest to them some types of mutual fuds that might fit their ivestmet goals ad risk tolerace. 12. Obtai a prospectus for a specific mutual fud. You ca write to a address provided i a ad i the fiacial pages of your local ewspaper or The Wall Street Joural, obtai oe from a brokerage firm or fiacial adviser, or locate the iformatio at a ivestmet compay s web site. Read the prospectus ad report o your fidigs regardig the objectives (goals) of the fud, risk profile, tax or tax-exempt status, ad performace of the fud over the last year ad last five years. 13. Alea has decided to ivest i real estate. She ca t decide whether to buy a vacat lot for $25,000 or a oe-fourth iterest i a four-uit apartmet buildig sellig for $400,000. Explai to her the pros ad cos of both of these alteratives. 14. Your gradmother has a woderful collectio of crystal, gold cois, diamod jewelry, ad silver datig back to the early ieteeth cetury. Whe purchased, it cost very little, but today it could be worth a great deal of moey. Explai to your gradmother, usig a curret issue of the ewspaper or Iteret resources, what today s prices are for silver, gold, gems, ad other valuables. 15. Your fried Georgia wats to buy a ruby rig at a local jewelry store. She believes that it will be a excellet ivestmet for the future because she iteds to sell the rig ad make a profit. Explai to her the pros ad cos of this type of ivestmet. 16. Rick is worried that the moey i his savigs accout is ot earig eough iterest to keep up with iflatio. He has bee readig about commodities ad thiks that tradig i commodities might be a great way to make some quick moey. Explai to him the risks ivolved i tradig commodities. EXTEND YOUR LEARNING 17. Legal Issues Every state has requiremets for becomig a licesed real estate broker. What are the requiremets to become a licesed real estate broker i your state? Why do you thik those requiremets are ecessary? What other laws or regulatios exist that aim to protect cosumers i real estate trasactios? If these laws did t exist, what legal issues might arise? For related activities ad liks, go to Uit 3 Fiacial Security Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.