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Understanding the different types of mutual funds

Like ice cream, mutual funds come in many different flavors. Together, you and your financial advisor can find the combinations, quantities and types of mutual fund shares that are right for you based on your circumstances and objectives.

 

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How to choose the right mutual fund.

Before you choose a mutual fund (or make investment decisions in general), make sure you understand how it fits into your overall investment strategy.

Know your goals Are you looking to fund your retirement? Or are you thinking about funding a child’s education or buying a new home? Or perhaps you want to leave money to heirs or a charity? Once you’ve established your goals, you can create a plan for how to reach them.

Consider your risk tolerance

Are you a conservative, moderate or aggressive investor? Your risk tolerance reflects how you choose to balance fund volatility with the potential for greater growth. A higher degree of risk can potentially achieve a higher rate of return. Less-risky investments may have less potential for growth. You have to find the right balance that helps you work toward your financial goals, but still allows you to sleep at night.

Evaluate your time horizon

How much time do you have between when you invest and when you need the money? Time is an important factor in your investment strategy. If you are able to hold your investments for a longer term, you may be able to tolerate more risk. That’s because your investment has more time to take advantage of potential market gains. Your investment also has more time to recover if the market goes down. With a longer time horizon, you can choose an investment that offers tax-deferred growth until you withdraw the money. Not only does your investment have a chance to grow, but so does the money you would have paid in taxes along the way. If your time horizon is short, you may have less risk tolerance because you have a shorter time to recover from any potential losses.

Investment strategy and funds costs

Some mutual funds invest in a particular market or follow a particular investment strategy. Some invest in large companies with a history of low but consistent returns. Others invest in small, fast-growing companies. Before you invest, carefully read a fund's summary prospectus and/or prospectus, along with other brochures and information from the fund company’s website. Be sure to find out what fees and expenses may be charged for a fund, such as sales charges and gross expenses. Then ask your FA investment professional to help you evaluate how a fund fits with your investment goals.

Understanding mutual fund dividends and capital gains

Mutual funds typically have a payout (distribution) of dividends and/or capital gains to shareholders, as specified in a fund’s prospectus. Until the payout date, dividends and capital gains awaiting distribution are included in a fund's daily net asset value (NAV). Here are a few facts about mutual fund payouts:

Record date

All shareholders who hold shares of a fund on this date are eligible to receive the distributions.

Ex-date

This is typically the business day after the record date. On the ex-date, a fund's share price drops by the amount of the distribution that will be paid for each share, not including adjustments for market fluctuations. Example: Say a fund has an ex-date of December 30 and is scheduled to make distributions of $1 per share on the payout date. On December 29, the fund’s NAV is $10 per share. On the ex-date (December 30), the NAV would drop to $9, barring any market fluctuations or reinvestment.

Payouts

No matter when you buy shares of a fund – many months before the record date or just days before – if you own the shares on the record date, you will receive the dividends and/or capital gains. If you buy a fund right before the record date, part of your investment will be returned to you when distributions are paid. This is known as “buying a dividend.” Depending on how your account is set up, you’ll either receive a check for the payout or the distributions will be reinvested.

Taxes

You’ll pay taxes on mutual fund distributions (unless the mutual funds are held in tax-advantaged accounts such as individual retirement, 401(k) and 403(b) accounts), whether you receive your distributions in cash or reinvest in additional fund shares. You can find current information about the tax rates applied to capital gains at the IRS website.

Questions?

Talk with your FA professional about how this may affect your investment strategy. Contact your tax advisor for information about how payouts could impact your personal taxes.

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