Recently, my oldest daughter faced a pop quiz in English. The idea was to see "if we knew stuff the teacher thinks we should know by now...
Recently, my oldest daughter faced a pop quiz in English.
The idea was to see “if we knew stuff the teacher thinks we should know by now.” She hated that idea, because “sometimes you forget the stuff you should know or you just don’t know the stuff the teacher thinks you should.”
She’s right, which is why class is in session and you’re getting a pop quiz on basic things all fund shareholders should know.
The questions are not designed to stump you, just test your level of knowledge and awareness. Good luck.
1. True or false: A fund that invests only in insured bonds or U.S. government bonds cannot lose money.
2. Which of the following characteristics is least important when evaluating a bond fund?
(b) total return
3. You’re in the 28 percent tax bracket. Which bond fund generates a greater after-tax return?
(a) a national municipal-bond fund yielding 4 percent
(b) a corporate-bond fund yielding 5.5 percent?
4. True or false: You can lose money in a fund during a calendar year but still owe capital-gains taxes on the investment profits realized by the fund during the year.
5. True or false: Every time a fund pays shareholders a capital gain or dividend distribution, its share price falls by the amount of that payout.
6. True or false: A diversified mutual fund cannot invest more than 5 percent of its assets in any one stock.
Now the answers:
1. False. Every fund has investment risk. If interest rates keep rising, the market value of a bond fund’s holdings decline. That drops the value of the fund’s shares and can result in a loss, even if the fund holds only guaranteed bonds.
2. (a) Yield is just a flat percentage of principal, which is why total return is a better measure of what you can expect a bond fund to deliver. Expenses, critical to all investment decisions, are particularly important in bonds, since funds with higher costs are virtually guaranteed to produce lesser returns than lower-cost competitors.
3. (a) This is about “tax-equivalent yield” and requires some math. The corporate fund’s after-tax yield is 3.96 percent (5.5 percent multiplied by 0.72, or the percentage you keep after taxes); in the muni fund, the after-tax yield is the entire 4 percent.
4. True. A fund is a pass-through vehicle, meaning whatever capital gains it realizes get passed on to you; as a result, if the manager sells past winners and the fund also suffers through a down period, investors can get a tax bill and a loss in the same year.
5. True. Accumulated capital gains and dividends are part of the share price until they are paid out. If a fund trades at $10 a share and pays a $1 distribution, its net asset value will fall to $9 when the payout is made.
6. False. Diversified funds aren’t supposed to put more than 5 percent of assets into one stock, but the rule applies to just 75 percent of the portfolio; the remaining 25 percent of assets all can go into one stock.
Next week: Study up, the questions will get trickier.
Chuck Jaffe is senior columnist at CBS Marketwatch. He can be reached at firstname.lastname@example.org or Box 70, Cohasset, MA 02025-0070.