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Mutual Funds

The cost to the shareholder of investing in mutual that is selected to reflect the investment risk level of the
funds comes in various forms: front-end loads, manage- fund’s portfolio to see whether the mutual fund had a
ment fees, cost of maintaining and servicing shareholder superior performance.
accounts (administrative cost), redemption fees, and dis-
The rate of return of a mutual fund with a NAV of
tribution fees (also known as 12b-1 fees). As mentioned $15.00 at the beginning of a year and $15.50 at the end
before, a redemption fee is usually levied on shares held of that year, and distributed $0.75 and $0.50 per share as
for less than a specified period. A distribution fee is a income and capital gain respectively during the year
charge on current shareholders to cover the costs of adver-
would be:
tising, promotion, selling, and other activities. It is some-
times combined with load charges. All these expenses are [($15.50 – $15.00) + $0.75 + $0.50]/$15.00 =
aggregated to obtain a single measure of cost to the share- 11.67%
holder. An aggregate measure commonly found in the
published data is the expense ratio (expenses as a percent
ANALYSIS AND REPORTING
of assets). This measure does not include sales load, if
there is one. Rea and Reid (1998) discuss the calculation Key statistics pertaining to a fund—such as the NAV, offer
of an alternative measure of total ownership cost that price, sales charges, expense ratio, and performance meas-
includes the sales load. ure for various categories of funds—are regularly calcu-
lated, analyzed, and published. Two firms well known for
REGULATION AND TAXATION their analytical service are the Lipper Analytical Services
(Lipperweb.com) and the Morning Star Inc. (Morn-
All U.S. mutual funds are subject to strict regulation by
the Securities and Exchange Commission. They are also ingstar.com). The Wall Street Journal and Barron’s carry
subject to states’s notice filing requirements and anti-fraud the information supplied by Lipper Analytical Services on
statutes. They are required to provide investors a full dis- a regular basis. Investment Company Institute
closure of their activities in a written prospectus. They (www.ici.org) also provides a wealth of information on
also provide their investors a yearly statement of distribu- mutual funds, including historical data and Web site
tion with the details of the federal tax status of their dis- addresses of its member funds.
tribution. Mutual funds in the United States are not
SEE ALSO Investments
subject to corporate income tax, if they meet certain Inter-
nal Revenue Code requirements. Instead, mutual fund
shareholders are taxed on the distribution of fund’s BIBLIOGRAPHY
income. For tax purpose, mutual funds distribute their net Bogle, John (1994). Bogle on Mutual Funds. Burr Ridge, IL:
income to the shareholders in two ways: (1) dividend and Irwin.
interest payments and (2) realized capital gains. Crane, Peter G. (1997). Mutual Fund Investing on the Internet.
Burlington, MA: AP Professional.
PERFORMANCE AND COMPARISON Find the right mutual funds (2005). Hoboken, N.J.: Wiley.
The rate of return is widely used for comparing the per- Henriques, Diana B. (1995). Fidelity’s World: The Secret Life and
Public Power of the Mutual Fund Giant. New York: Scribner.
formance of mutual funds. The rate of return on a mutual
fund investment for a period of one year, for example, is Investment Company Institute website.
http://www.ici.org/index.html. Accessed December 1, 2005.
calculated by adding the change in the NAV
(NAV t –NAV t–1 ) to income and capital gains distributed Lavine, Alan, and Liberman, Gail (2001). The Complete Idiot’s
during the year and dividing the sum by the NAV at the Guide to Making Money with Mutual Funds. Indianapolis, IN:
beginning of the year. The following describes the calcula- Alpha.
tion of return for no-load funds: Levy, Haim (1999). Introduction to Investments. Cincinnati, OH:
South-Western College Publishing.
[(NAV t – NAV t-1 ) + i + c] Rea, John D., and Reid, Brian K. (1998, November). “Trends in
R t = the Ownership Cost of Equity Mutual Funds.” ICI Perspec-
NAV t-1
tive, 41(3), 2-15.
Sharpe, William F., Alexander, Gordon J., and Bailey, Jeffrey V.
where R, i, and c represent rate of return, income, and
(1999). Investments. 6th ed., Upper Saddle River, NJ: Pren-
capital gains, respectively. For load funds, the calculation tice Hall.
of return must account for load charges by adding them
to the NAV. The performance of a mutual fund is often
compared with the performance of a benchmark portfolio Anand G. Shetty

532 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION