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A Guide to Understanding Mutual Funds*

What Mutual Funds Can do for You

By investing in mutual funds, you can put expert money managers to work to help you achieve your financial goals, whether you're saving for retirement, planning for your children's education or saving for any special need. Before investing, you'll want to understand the basics of mutual funds. The following document is designed to help you meet this purpose.

Mutual funds, annuities, and other investment products:

  • are not insured by the FDIC, or any other government agency;
  • are not deposits or other obligations of, or guaranteed by, any bank or any affiliate; and
  • are subject to investment risks, including possible loss of principal amount invested.

Understanding Mutual Funds

Simply put, a mutual fund is a company that makes investments on behalf of its shareholders.

The fund pools your money with money from many other people who have similar investment objectives. Professional money managers then take the pool of money and invest it in securities, such as stocks, bonds and money market instruments.

Mutual funds can make money for you in two ways. One, they can pay dividends earned from the funds' investments. And two, if a security held by a fund is sold at a profit, the fund can pay capital gains.

As a shareholder, you own a proportionate share of the fund. Each share represents ownership in all the fund's underlying securities. Funds pay dividends and capital gains in proportion to the number of fund shares owned. Thus, if you invest $1,000 you'll get the same rate of return as if you invest $10,000.

Mutual Funds Provide the Basics for Smart Investing
Diversification

Your best protection against risk is diversification--spreading your investment across dozens of securities instead of just one.

Mutual funds provide an assortment of investment options. They offer growth, income, or both, and the opportunity to invest in international markets, as well as the U.S. A fund's portfolio manager typically invests in as many as 50 to 200 or more different securities. In effect, they put your money in many baskets instead of just one. Only the most affluent investors can attain the diversification on their own that mutual funds can for their shareholders.

Personal Management

With mutual funds, you have built-in professional money managers who base their buying and selling decisions on extensive, ongoing economic research. After analyzing stock market conditions, interest rates, inflation and the financial performances of individual companies, these managers select investments that best match the fund's objectives.

Professional money management has long been available to large institutions and wealthy investors. Mutual funds make this type of financial expertise accessible to everyone.

Growth

Mutual funds create the possibility of higher long-term returns than conventional savings. Today, mutual funds manage more than 114.9 million shareholder accounts valued at about $2.16 trillion. They have become the nation's third largest financial intermediary--behind commercial banks and life insurance companies.

One reason for mutual fund growth is their performance record in relation to what individuals might expect by investing on their own.

Of course, performance varies from fund to fund, but on average and over the long run, the growth of stock funds has paralleled the growth in the U.S. economy. Additionally, bond and money market funds have reflected the long term movements in their respective markets.

Investing Can Be a Piece of Cake
Convenience

Mutual funds are easy to buy at a bank or trust company. For example, you can purchase mutual funds through a professional investment representative who can help you analyze your financial needs and objectives and recommend appropriate funds. You can get your investment program started for as little as $500. Subsequent investments can be made for as little as $50.

You also have easy access to your money, making your investment a liquid asset. You can generally redeem all or part of your shares any day the New York Stock Exchange is open and receive the current value of the investment, which may be more or less than the original cost. Payment for redeemed shares will generally be made within seven days.

Fund Facts:
  • Mutual funds began in the 1920s
  • Over $2.16 trillion in assets
  • 114.9 million individual shareholders
  • 31% of all U.S. Households own funds


Flexibility

Mutual funds offer various features that allow you to stay in control of your investments.

Automatic Reinvestment of Dividends and/or Capital Gains.

Most mutual funds allow you to automatically reinvest your dividends and capital gains in the purchase of additional fund shares at no extra cost. Over time, the power of compounding can significantly increase the value of your assets.

Exchange Privilege

Within a fund family, you can generally exchange portions of your investment into other funds with different objectives as your financial situation changes.

Rundown on Securities
Stocks

A stock is an equity security that represents part ownership in a corporation. Stocks are sold in shares and their prices will change. The Standard & Poor's Composite Index of 500 Stocks (S&P 500) measures the general price movement of a group of unmanaged securities. It is widely regarded by investors to be representative of the stock market in general.

Bonds

A bond is essentially a debt security or IOU, usually issued by a corporation, government or government agency. Most bonds pay interest, which is distributed to the bondholder at specific intervals. Bond prices will vary, and their price movements are strongly affected by changes in interest rates.

Money Market Instruments

In many ways, most money market securities are just short-term investments because the debt that they represent must be paid back within a relatively brief period of time, no more than one year. With such short maturity periods, the prices of money market instruments are generally more stable than prices of longer-term debt securities. However, money market securities usually pay less interest than longer-term bonds.

Treasury bills and certificates of deposit (CDs) are two examples of commonly-issued money market instruments. In addition, CDs are insured by the FDIC for up to $100,000, and Treasury bills offer a government guarantee as to the repayment of principal and interest if held to maturity.

A mutual fund invests in securities that fit its specific objective. For example, if a fund's investment objective is current income, it will want to invest in bonds or stocks which can produce current earnings or dividends. The fund turns around and pays its shareholders from those dividends. Now let's suppose there's a rally in the stock market. If prices of the securities held by a mutual fund increase, and the fund sells a portion of its holdings for a higher price than it originally paid for them, it realizes a capital gain. The fund may then pass that gain on to its shareholders as a capital gains distribution.

Types of Mutual Funds

There are funds that fit just about any investment need:

Aggressive Growth Funds seek maximum capital gains as their investment objective. These funds may invest in stocks that are somewhat out of the mainstream--such as smaller, lesser-known companies that managers believe possess dynamic potential. Current income isn't a significant factor for shareholders in these funds.

Growth Funds typically invest in stocks and seek capital growth through the price appreciation of the securities held in their portfolio. Their primary aim is to produce an increase in the value of their investments rather than a flow of dividends.

Growth and Income Funds invest primarily in the common stock of companies with longer track records. These funds have the expectation of a higher share value but also maintain a solid record of paying dividends.

Balanced Funds invest in both stocks and bonds. They emphasize the growth potential of stocks as well as the relative stability of income from bonds.

Income Funds seek a high level of current income, which is often achieved by investing in the common stock of companies with good dividend-paying records. They may invest in such fixed-income securities as corporate and government bonds. Some income funds maintain more aggressive objectives than others: High-yield corporate bonds have potential to produce greater income than government bonds. In turn, government bonds are considered less volatile than high-yield bonds.

Municipal Bond Funds invest in bonds issued by local governments--such as cities--which use the money to build such public buildings as schools. Income earned from these securities is usually federally tax-exempt for most shareholders.

Money Market Funds participate in short-term investment instruments that are considered the safest, most stable type of securities available. By investing in such funds, shareholders can earn current money market interest rates and maintain asset liquidity. In addition, these funds may specialize by investing in tax-exempt money market securities.

Mutual fund performance will vary. An investor's shares, when redeemed, may be worth more or less than original cost. Higher-yielding bonds have a greater risk of price fluctuation and loss of principal and income than U.S. Government Securities, which guarantee repayment of principal and interest if held to maturity. Always read the prospectus(es) carefully before you invest or send money.

* Courtesy of AIM Distributors, Inc.

 
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