Mutual funds vary by asset class, size, location

What is the best starting point when comparing mutual funds?

Market uncertainty has caused many physicians to

Joel M. Blau, CFPclosely re-examine their investment portfolios to determine whether changes are warranted. With mutual funds being so widely held, it is prudent to gain an understanding of fund specifics in order to build a valid basis for comparison. The universe of mutual fund options is overwhelming. If investors take a moment to learn the basics of how to compare mutual funds, they’ll be armed with the ability to choose wisely for themselves or to intelligently weigh the advice of their financial professional.

Asset class is often described in the title of the fund, and defines the underlying securities the fund purchases on the investors’ behalf. For example, a fund can be comprised of stocks, bonds, or real estate investments,

Ronald J. Paprocki, JD, CFP, CHBCto name the largest and most common fund holdings. Among these classes are dizzying arrays of distinctions. Stock funds can be further categorized according to the location, size, and sector of companies held. Roughly the same distinctions hold true for bond funds.

The main geographic categories for mutual funds are domestic, foreign/international, and global. Domestic funds purchase shares of companies headquartered in the U.S. Foreign funds purchase shares of companies operating anywhere outside of the U.S., while global funds tend to invest in a combination of companies throughout the world. Of course, these categories themselves have varying distinctions.

Company size and sector are other basic asset class differentiations. Company size refers to market capitalization, which is actually a simple calculation: Multiply the total number of outstanding shares of a given company by its stock price. Mutual fund market cap distinctions are commonly divided into three categories: large cap, mid cap, and small cap. Large cap typically refers to companies with a market capitalization exceeding $10 billion, mid cap to companies in the range of $4 billion to $10 billion, and small cap to those under $4 billion.

Sector-specific funds are yet another subcategory to consider. Sector funds purchase stocks of companies in a particular sector, such as retail or finance. An energy fund, for example, may buy shares of companies that run hydroelectric power plants, build natural gas lines, or operate oil refineries. Sector funds can be broad, as in “finance,” or very narrow, as in “South African precious metals.” Sector funds provide exposure to a limited segment of the overall market and should be well researched and fully understood prior to taking the plunge.

Investors should also be aware of the many differences and available choices in the mutual fund fixed-income arena, each of which offers varying degrees of potential risk and reward.

U.S. government bond funds invest primarily, or exclusively, in U.S. Treasury bonds, government agency obligations, and the mortgage-backed debt of Fannie Mae, Ginnie Mae, and Freddie Mac. The safety advantage of Treasury bonds and direct obligations of certain federal agencies is that they carry a government guarantee relative to interest and principal repayment. While government bond funds carry the lowest credit risk among the various fund choices, they are still subject to interest rate fluctuations, which can affect their principal value.

Corporate bond funds are available with a wide variety of choices. While some invest primarily in high-quality, investment-grade bonds, others incorporate a certain percentage of below-investment-grade bonds. This is done to provide a higher income payout for the investor but also increases risk within the fund. Another type of corporate bond fund is known as a high-yield bond fund and focuses the portfolio entirely on riskier, lower quality bond offerings. Along with the higher risk primarily associated with an increased possibility of default of the issuing corporation, there may also be potential for price appreciation if the issuing companies improve their financial situation in the eyes of the various credit rating agencies.

What is the new tax on investment income and how does it work?

The Net Investment Income Tax is an entirely new 3.8% federal tax on net investment income. The new tax will be assessed only on taxpayers who exceed the modified adjusted gross income (MAGI) thresholds of $200,000 for single filers or $250,000 for married couples filing jointly. If those MAGI threshold amounts are exceeded, then the lesser of the following will be assessed the new 3.8% tax:

• “Net Investment Income,” which includes taxable interest and dividends, long- and short-term capital gains, annuity income, and passive rental income and royalties, or

• the amount by which the MAGI exceeds the $200,000/$250,000 threshold.UT

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