This online SIE study guide page covers packaged products such as mutual funds, exchange-traded funds (ETFs), unit investment trusts, and variable life insurance. Here, you’ll learn about the features of various packaged products in the securities market.
Packaged products are investment vehicles that pool funds from multiple investors to invest in a diversified portfolio of assets. These products offer investors exposure to a broad range of securities, professional management, and risk mitigation through diversification.
Packaged products include mutual funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). They provide an accessible way for individual investors to benefit from diversified investments without needing significant capital or in-depth market knowledge.
Mutual Funds
A mutual fund is an SEC-registered open-end investment company that pools money from many individual investors to invest in a diversified portfolio of stocks, bonds, or other securities. This investment portfolio is managed by experienced fund managers who decide to buy or sell securities.
Investment in mutual funds reduces the risk of market volatility because money is diversified across various securities. The price of each mutual fund unit is known as net asset value (NAV). The net asset value denotes the mutual fund’s past performance, calculated by the following:
- NAV= (Assets – Liabilities) / Total Shares
If an individual invests in a mutual fund, he/she buys the mutual fund units according to the NAV of that day. For example, if the NAV of an XYZ mutual fund is $10 and a person invests $10,000, then he’ll get 1000 units of XYZ mutual fund.
The mutual funds have a minimum investment threshold that can range between $500 to $5000. This means that if someone wants to invest in a mutual fund with a purchase minimum of $ 3,000, individual investors must invest at least $ 3,000.
- Expense Ratio: The fee charged by the assets management company (AMC) to manage the fund is called the expense ratio. It is generally expressed in the percentage of total assets under management. The expense ratio of actively managed funds is higher, and it varies between 0.5% to 1%.
The mutual fund’s prospectus mentions all expense details, such as sales loads, redemption fees, account fees, management fees, etc. A prospectus must be provided to individual investor before accepting their investment. The prospectus must include essential information such as the fund’s objectives, managers, securities held, minimum investment amounts, fees, etc.
Mutual fund orders are typically executed at the NAV calculated at the end of the trading day. Orders placed before the fund’s cutoff time, usually 4:00 PM Eastern Standard Time (EST), will be executed at that day’s closing NAV.
The timing of placing orders affects the price at which the mutual fund shares are bought or sold. Investors should know the fund’s cutoff time to ensure their orders are executed at the desired NAV.
The SEC regulates the advertisement of mutual funds. All mutual fund advertisements must be approved by FINRA members before their distribution. Funds must provide accurate and precise information, avoiding misleading statements about past performance and future returns.
- Open-End Funds: Open-end mutual funds allow investors to buy and sell shares directly from the fund at the net asset value (NAV), calculated daily. There is no limit to the number of shares the fund can issue. These funds are continuously offered and can expand or contract based on investor demand, providing liquidity and ease of access.
- Closed-End Funds: Closed-end mutual funds have a fixed number of shares issued through an initial public offering (IPO) and subsequently traded on stock exchanges. The market price of these shares can differ from the net asset value (NAV) due to supply and demand dynamics.
Types of Mutual Funds
- Money Market Funds: Money market funds invest in short-term, high-quality debt securities such as Treasury bills, certificates of deposit, and commercial paper. They aim to provide investors with liquidity, safety, and a stable net asset value (NAV), typically $1 per share. These funds are ideal for conservative investors seeking capital preservation and minimal risk.
- Bond Funds: Bond funds, also known as fixed-income funds, invest in bonds issued by governments, corporations, and other entities. These funds provide regular income through interest payments and can vary in risk based on the credit quality and duration of the bonds held. Bond funds are suitable for investors seeking income and moderate risk.
- Stock Funds: Stock funds, or equity funds, invest in shares of publicly traded companies. They aim for capital growth by appreciating the value of the underlying stocks. Stock funds can focus on different market segments, such as large-cap, mid-cap, or small-cap stocks, and may have varying levels of risk based on their investment strategy.
- Target Date Funds: Target date funds are designed to provide a diversified portfolio that gradually becomes more conservative as the target date (typically retirement) approaches. These funds automatically adjust their asset allocation from higher-risk investments to more conservative ones over time, making them suitable for long-term investors planning for a specific financial goal.
Index Funds
Index funds aim to replicate the performance of a specific market index, such as the S&P 500 or the Dow Jones Industrial Average. They offer broad market exposure, low operating expenses, and low portfolio turnover. Index funds are passively managed, meaning they do not try to outperform the market but instead mirror its performance.
Exchange-Traded Funds (ETFs)
ETFs are similar to mutual funds but trade on stock exchanges like individual stocks. They typically have lower fees, allow for intraday trading, and offer tax efficiency due to their structure. ETFs can track various indexes, sectors, or themes, providing investors with flexible and targeted investment options that can be bought and sold throughout the trading day.
Closed-End Funds (CEFs)
Closed-end funds issue a fixed number of shares through an initial public offering (IPO) and trade on stock exchanges. The market price of CEFs can fluctuate based on supply and demand and may trade at a premium or discount to their net asset value (NAV). CEFs offer diversified portfolios but come with liquidity and price volatility risks.
Unit Investment Trusts (UITs)
UITs are passively managed, have a fixed duration, and feature a predetermined portfolio. They provide a way for investors to receive a portion of the income generated by the underlying assets, with the trust terminating on a specified date. At this point, the assets are sold, and the proceeds are distributed.
Other Investment Companies
- Variable Life Insurance: Variable life insurance policies combine a death benefit with investment options in separate accounts. Policyholders can allocate premiums among various investment choices, such as stocks, bonds, and money market funds. The cash value and death benefit can fluctuate based on the performance of the chosen investments.
- Separate Accounts of Variable Annuities: Variable annuities allow investors to allocate funds into separate accounts, which operate like mutual funds. These separate accounts offer various investment options and the potential for tax-deferred growth. The value of the annuity and the income it provides depend on the performance of the chosen investments.
- Municipal Fund Securities — 529 College Savings Plans: 529 are tax-advantaged savings plans designed to encourage saving for future education costs. Contributions to a 529 plan grow tax-deferred, and withdrawals for qualified education expenses are tax-free. These plans offer various investment options, including age-based and static portfolios, and are sponsored by states or educational institutions.
Packaged Products Terminology
- Investment Objective: The investment objective is the fund’s primary goal, such as growth, income, or capital preservation. It guides the fund’s investment strategy and asset allocation, helping investors select funds that align with their financial goals and risk tolerance.
- Surrender Charge: A surrender charge is a fee imposed on investors for withdrawing funds from a variable annuity or certain mutual funds before a specified period. This charge discourages early withdrawals and helps cover the costs associated with managing the investment.
- Load Funds: Load funds are mutual funds that charge a sales fee or commission. This fee can be assessed at the time of purchase (front-end load) or when shares are sold (back-end load). Load funds compensate financial advisors or brokers for their services. FINRA caps these loads at 8.5% of the purchase or sale.
- Front-End Funds: Front-end funds charge a sales fee when investors purchase shares. The fee, typically a percentage of the investment amount, reduces the initial investment. These funds are often sold through financial advisors who provide investment advice.
- No-Load Funds: No-load funds do not charge any sales fees or commissions. Investors can purchase and redeem shares directly from the fund company without incurring additional costs, making them an attractive option for cost-conscious investors.
- Breakpoint: A breakpoint is a dollar amount at which the sales charge on mutual fund purchases is reduced. Investors can qualify for lower fees by investing larger sums or by combining investments within a family of funds.
- Lumpsum: A lump sum is a single, large investment made into a mutual fund or other investment product. Investors may choose to invest a lump sum to take advantage of market opportunities or to meet investment minimums.
- Letter of Intent (LOI): A Letter of Intent (LOI) allows investors to qualify for reduced sales charges by committing to invest a specified amount in a mutual fund within a certain period, typically 13 months. The LOI helps investors reach breakpoints and lower their investment costs.
- Rights of Accumulation: Rights of Accumulation (ROA) allow investors to combine the value of their existing mutual fund holdings with new purchases to qualify for breakpoint discounts on sales charges. This benefit encourages continued investment in the same fund family.