Mutual Funds – Test Your Knowledge
Mutual Funds are a cornerstone of retirement and investment planning. But they are widely misunderstood, and these misunderstandings can cost you. So how much do you really know about mutual funds? In commemoration of Financial Literacy Month, the Associated Press has created this short quiz to test your knowledge of mutual funds.
QUESTIONS:
1. What percentage of American households own mutual funds?
a) 10 percent
b) 27 percent
c) 45 percent
2. When was the key law governing mutual fund operations adopted?
a) 1924
b) 1933
c) 1934
d) 1940
3. How many mutual funds are there in the U.S.?
a) About 1,000
b) About 4,000
c) About 8,000
4. What is a mutual fund’s expense ratio?
a)The sales fee paid when you buy into a fund, expressed as a percentage of how much you invest.
b)The fee charged to manage the fund and cover other ongoing expenses, expressed as a percentage of the fund’s assets.
c)The fee you pay to a broker who sells you the fund.
5. What is a mutual fund’s turnover ratio?
a) A measure of how often a fund’s managers are replaced.
b) How frequently the fund trades stocks or other investments in and out of its portfolio.
c) How often the fund gets new investors and loses existing clients.
6. True or False: An open-end mutual fund can issue as many or as few shares as investors demand, with potentially no limits on the number of investors in the fund, or the amount of money it can hold.
7. True or False: Mutual funds are prohibited from using the investing strategies that unregulated hedge funds can employ.
8. True or False: You can lose money in a mutual fund that’s called an “absolute return” fund.
9. Mutual fund managers’ interests should be aligned with their investors’ interests. But what percentage of managers don’t invest in their own funds?
a) 10 percent
b) 35 percent
c) More than 40 percent
10. After losing money on stocks, Bob played it safe by investing in a money-market mutual fund last October. The government is temporarily guaranteeing most money funds through September 18, 2009, so Bob is protected if something bad happens, right?
a) Yes
b) No
ANSWERS & EXPLANATIONS:
1. c – A survey by the Investment Company Institute, a mutual fund industry organization, found 45% of U.S. households owned mutual funds at the end of 2008, representing more than 92 million individual fund shareholders.
2. d – The main law governing mutual fund operations is the Investment Company Act of 1940, although funds are also subject to the Securities Act of 1933 and the Securities & Exchange Act of 1934.
3. c – The Investment Company Institute counted 8,039 funds in February 2009, holding about $9 trillion. The two most common types of funds are stock funds, numbering more than 4,800, and taxable bond funds, with nearly 1,300.
4. b – A mutual fund’s expense ratio is the percentage of assets used to cover the fund company’s costs before distributing earnings to investors. This amount can have a much bigger impact than any upfront sales costs – also known as loads or commission – since expenses can eat into returns for years to come.
5. b – The turnover ratio measures the percentage of a mutual fund’s holdings that have been replaced over the past year. If the manager makes smart trades, a higher ratio can boost short-term returns. But a fund with high turnover increases fund trading costs, and can boost an investor’s tax bill.
6. True – Open-end funds are structured so that they can add investors and assets. Far less common are closed-end funds, where the company decides up front how many shares will be issued, limited the number of investors. The initial investors can later trade shares to others.
7. False - Regulations limit how much mutual funds can borrow to invest in derivatives, such as futures and options. But, depending on the guidelines in its prospectus, a fund can adopt some of the same strategies that hedge funds use, including short-selling.
8. True – These funds generally employ the same strategies as many hedge funds to smooth out returns in good times and bad. But you can still lose money, even if you’ll fare better than most investors in a downturn. The same goes for “stable-value” funds.
9. c - A Morningstar, Inc. study found 46 percent of U.S. stock funds reported no manager ownership last year. For other types of funds, the percentages were even higher.
10. b – The guarantees apply only to assets in money funds as of September 19, 2008, just after one such fund exposed investors to losses. So any money invested after that isn’t covered. However, risks are very low because money funds generally invest in the safest forms of bonds, such as Treasury bills.
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