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Understanding Mutual Funds

Investors have increasingly turned to mutual funds to meet their retirement and other financial goals. An understanding of how mutual funds work, the different kinds of funds, and how they might fit into your financial plan is an important step in preparing to work with your financial advisor.

What is a Mutual Fund?

Mutual funds offer the opportunity for a number of investors, who share a similar investment objective, to pool their money and have it invested and managed by professional investment managers. The managers invest in stocks, bonds, or other securities for a fund’s portfolio. When you buy shares in a mutual fund you get a stake in its portfolio of investments.

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Characteristics of a Mutual Fund

A mutual fund offers a number of characteristics that differ from investing in individual securities; they include:

Professional management. Mutual funds offer investors access to full time, professional money managers who have the expertise, experience and resources to actively buy, sell, and monitor investments.

Affordability. Initial investments in most funds are reasonable, and the requirement for additional investments is usually even lower. Many funds require as little as $1,000 for initial investments and only a $50 minimum for subsequent investments.

Diversification. An investment in a mutual fund generally includes a number of different securities. For example, diversified equity fund portfolios usually hold stocks representing different companies, different industries and sometimes even different nations. Diversification can help reduce the financial risk inherent in investing. If one investment decreases in value, another investment in the portfolio may increase.

Flexibility. Many mutual funds are part of a “family of funds,” which means that as your investment objectives change, you can exchange shares from one fund to another in the same family at little or no cost. For example, Franklin Templeton Investments offers more than 110 Franklin, Templeton and Franklin Mutual Series funds to help meet an investor’s financial goals.

Liquidity. It’s easy to withdraw some or all of the money you’ve invested. Typically, you can get your money within one week. Of course, the value of shares, when redeemed, may be worth more or less than their original cost.

Front-end and, in some cases, back-end sales loads, management fees, Rule 12b-1 fees and other expenses are associated with Franklin Templeton mutual fund investments. Investors’ returns are reduced by these fees and expenses. Funds are offered through prospectuses, which contain detailed information about a fund’s goals, charges, expenses and risks. They should be read carefully before investing.

You can read more about fees and expenses in Getting Started With Mutual Funds.

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Three Ways Mutual Funds Can Earn You Money

  • Increased Net Asset Value (NAV) — If the market value of a fund's portfolio increases after deduction of expenses and liabilities, then the value (NAV) of the fund and its shares increases. A higher NAV reflects the higher value of your investment. Of course, the value of shares you redeem may be more or less than you originally paid for them.
  • Dividend Distributions — A mutual fund may earn income through dividends and interest on the securities in its portfolio. It then pays shareholders nearly all of the income (minus expenses) it has earned in the form of dividends.
  • Capital Gain Distributions — When a mutual fund sells a security in its portfolio that has increased in price, it has a capital gain. At the end of the year, the fund distributes these capital gains (minus any capital losses) to investors.

Mutual funds will usually give you a choice regarding dividend and capital gain distributions: They can send you a check, or you can have your distributions reinvested to buy more shares (often without paying an additional sales load).

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Kinds of Mutual Funds

Many kinds of mutual funds are available, but they generally fall into four basic types defined by the class of assets they hold: equity funds, fixed-income funds, hybrid funds/asset allocation funds, and money market funds.

Equity funds. These funds invest in common stocks of public companies, generally with capital appreciation as the primary objective.

Bond funds. These funds invest in corporate, government and municipal bonds, generally with current income as the primary objective.

Hybrid funds/asset allocation funds. Hybrid funds allocate assets with direct investments in stocks, bonds and money market instruments, with current income and capital growth as an objective. Similarly, asset allocation funds diversify their investments across asset classes by investing in a portfolio of other mutual funds with long-term capital growth or total return as an objective. Target funds are generally used for retirement planning and manage asset allocation and risk levels toward a target retirement date.

Money market funds. These funds invest in certificates of deposit (CDs), commercial paper and highly liquid securities, with preservation of principal, liquidity and current income as their objective.

An investment in a money fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although these funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in them.

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Mutual Fund Investing Styles

Mutual funds come in a variety of investing styles. Some funds focus on companies with large or small market capitalization, others specialize in industry sectors or particular geographic boundaries.

Investment styles. Equity fund styles may include growth, value and blend. Bond fund styles may focus on specific ranges of credit quality and maturity.

  • Growth Fund Managers invest in stocks of companies they believe well positioned to capitalize on long-term growth trends that may drive earnings higher.
  • Value Fund Managers invest in stocks they think have been overlooked or are out-of-favor in the market.
  • Blend Fund Managers invest in a mix of growth and value stocks.
  • Hybrid Fund Managers invest in a mixture of equities and fixed-income securities.

Market capitalization (cap). Equity funds may limit their investment universe to a portion of the market cap spectrum. Typically small cap funds will focus on companies whose market capitalization is less than $2 billion, while large cap funds will focus on companies with market capitalization greater than $10 billion. Mid cap funds usually focus on companies in between.

Specialization. Specialty fixed-income funds and sector equity funds have this distinction:

  • Specialty fixed-income funds invest in specific debt securities such as GNMAs, municipal bonds or corporate bonds.
  • Sector funds invest only in stocks of companies of one specific sector or industry, such as utilities, real estate or technology.

Geographic boundaries. Funds can also invest globally, internationally and in specific countries or regions.

  • Global. Global funds invest anywhere in the world (including the United States). Generally, global funds have a broad investment mandate and have the greatest number of stocks from which to choose.
  • International or foreign. International funds, also referred to as foreign funds, invest only in companies based outside the United States. They may invest in developed markets such as Asia or Europe, or in emerging markets around the world.
  • Country or regional. Country- or region-specific funds invest within one specific country or region such as India or BRIC (Brazil, Russia, India, China).

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Important Legal Information

All investments involve risks, including possible loss of principal. Generally, those offering potential for higher returns are accompanied by a higher degree of risk. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices are affected by interest rate changes. Bond prices, and thus a bond fund’s share price, generally move in the opposite direction of interest rates. As the price of bonds in a fund adjusts to a rise in interest rates, the fund’s share price may decline. Foreign investing, especially in developing markets, has additional risks such as currency and market volatility and political or social instability. For tax-free income funds, the alternative minimum tax may apply.

For more information on any of our funds, contact your financial advisor or download a free prospectus. Investors should carefully consider a fund’s investment goals, risks, sales charges and expenses before investing. The prospectus contains this and other information. Please read the prospectus carefully before investing or sending money.

Dividends will vary, depending on the fund’s income, and past distributions are not indicative of future trends.

Diversification does not guarantee a profit or protect against a loss.

Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect.

This material is provided for educational purposes only and is not intended as investment advice or an offer or solicitation to buy or sell securities.

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