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Buy Value Mutual Fund

Who Should Run It

Rookies and up

When to Run It

  • Slightly to moderately bullish
  • Degree of sentiment: +1 to +2

Broader Market Outlook

It’s usually wise to have a bright long-term outlook for the components held in your value fund as well as the market at large. If your outlook is incorrect and the value of your value mutual fund declines, you will incur a loss.

Potential Risks

An investment in a value mutual fund could lose money over short or long periods of time. A value mutual fund’s performance could be hurt by:

  • Stock market risk, which is the chance that stock prices overall will decline or the risk that the fund may underperform the overall stock market.
  • Investment style risk, which is the chance that returns from large-cap stocks will trail returns from the overall stock market.
  • Manager risk, which is the chance that poor security selection or focus on securities in a particular sector, category, or group of companies will cause the value fund to underperform relevant benchmarks.
  • Other risks specific to your mutual fund, so be sure to read the prospectus carefully before investing.

About the Security

A mutual fund pools many investors’ funds together and invests the money in diversified assets under the direction of one or more professional fund managers. Investors in a mutual fund hold shares in the fund itself and do not hold shares in the individual securities held by the fund.

Before investing in any mutual fund, carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. Free prospectuses may be ordered from the fund company or send an email to service@tradeking.com. Many but not all prospectuses are available online. Not all mutual funds are available through TradeKing. Read the prospectus carefully before investing. Investment returns will fluctuate and are subject to market volatility so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost.

When you buy shares in a mutual fund, you pay the public offering price (POP). It’s based on the net asset value (NAV) plus the fund’s maximum sales charge, known as the sales load. If it is a no-load fund, the POP and the NAV are the same. The investors who pooled their money participate in the returns generated by the fund, proportionate to the amount of money invested by each. This occurs through changes in the NAV and gains or dividends distributed to investors. As with any security, you should be informed about the possible tax consequences when investing in mutual funds. Consult a tax advisor.

Some mutual funds are open-end, meaning the collective pool of money to be managed in the fund is constantly changing with demand for the fund. Closed-end mutual funds, by contrast, consist of a finite number of shares.

There are several key features of mutual funds, including diversification and professional money management. Besides a sales charge (front-end load or back-end load) investors in mutual funds may incur other costs, such as management fees, 12b-1 fees, and other administrative fees. Your broker’s commission may also negatively affect your returns. At TradeKing a purchase and a sale of no-load mutual funds cost $14.95 each. Investors should also consider the past performance of the fund, past performance of its manager, and the fund’s turnover ratio. However, past performance is no guarantee of future results. To learn more, check out Mutual Funds: An Investor's Guide.

A handy tool that may help you when reviewing mutual fund investments is the FINRA Expense Analyzer. This tool is created by the Financial Industry Regulatory Authority, and it’s free for all investors.

Value mutual funds seek out stocks that the fund management considers undervalued by the marketplace – good bargains at current prices. Typically, this involves using fundamental analysis to examine the firm’s sales, its earnings, and the value of the

The Strategy

Value mutual funds seek out stocks that the fund management considers undervalued by the marketplace – good bargains at current prices. Typically, this involves using fundamental analysis to examine the firm’s sales, its earnings, and the value of the company’s assets, for example, and then comparing these figures to the current stock price. In general, value mutual funds tend to be comprised of large-cap stocks.

Here are just a few of the characteristics of value stocks that fund managers seek out:

  • Low price-to-earnings ratio (P/E ratio). This ratio compares the price of the stock to the company’s earnings per share.
  • Low price-to-book ratio. This figure compares the current stock price to the book value, or how much the company would be worth per share if all assets were sold in their entirety.
  • Low price-to-sales ratio. This is the comparison between stock price and revenue per share and is measured against other firms in the same industry.
  • High dividend yield. This is the annual dividend divided by the stock price and is measured against the company’s peers.
  • Future earnings potential that other investors have (thus far) failed to recognize. Fund managers will quantify this opportunity in various ways.

Value-minded investing is based on the assumption that the stock market is not 100% rational at any given moment, so stocks may be overvalued or undervalued at any time. Value investors believe that the market will tend toward rational behavior over the long term and stock prices will tend to approach what they are really (hopefully) worth.

This means managers of value mutual funds are essentially bargain hunters, who try to take advantage of undervalued stocks that may trend higher toward their true worth as any irrationality is shaken out of the marketplace. Regardless of your sentiment, the market has the ability to move in an adverse direction. Owning a value fund can result in losses if the mutual fund declines in value. The steeper the decline, the greater the loss will be.

Instant diversification

Because value mutual funds are usually made up of many different stocks, your investment, in essence, is instantly diversified. In general, price movement for a value mutual fund may be less volatile than an individual stock or the average growth fund. But be careful—diversification doesn’t mean safety. Don’t buy a value mutual fund during uncertain times and naively expect safe haven from the next financial storm. Diversification doesn’t guarantee a profit or ensure against a loss.

Active management

Value mutual funds usually take a longer-term view than the average growth fund. As a result, this strategy may have the upshot of lower ongoing fund expenses because the holdings are less actively managed. Across the spectrum for mutual funds, value funds will tend to fall in between index funds and growth funds for both the frequency of trades, known as “turnover”, and for the resulting costs.

Lower maintenance over the long-term

Some investors choose mutual funds as a long-term, lower-maintenance trade than choosing individual stocks. If you don’t have the time or inclination for researching value stocks, then buying a value mutual fund may be a strategy to consider. In that case it may be worth paying the higher fees associated with actively managed mutual funds in exchange for the fund manager’s expertise. Keep in mind however, higher fees are not an indicator of better performance. Don’t expect the stocks in your value fund to make a dramatic turnaround once you become a proud shareholder. It’s possible these companies will remain out of favor with investors for some time.

Bottom line: Don’t put your money in a mutual fund, go to a faraway island and forget about it. You need to be as vigilant as you can and keep an eye on your investments.

Dollar-cost averaging or lump-sum investing?

There are two common methods for investing in mutual funds. Lump-sum investing is when you plunk down a boat-load of cash all at once, or over a short period of time, such as a few weeks. At the other end of the spectrum, some investors choose to employ dollar-cost averaging. This approach entails investing a fixed amount of money according to a pre-set schedule over many years, such as monthly or quarterly, irrespective of how the mutual fund is performing. You can think of it as tiptoeing into the fund, as opposed to shooting off all your bullets at once.

In general, lump-sum investing is well suited for investors who feel they can time their investments well, buying in when the mutual fund is low in price. If correct, the lump-sum investment is likely to outperform similar investments made with a dollar-cost averaging strategy. If instead the lump-sum investment is ill-timed and coincides with a peak followed by a decline, the investment will likely underperform. Ideally speaking, lump-sum investors like their investments to increase at the beginning of the time horizon, and remain at least relatively stable towards the end of the investing period.

Dollar-cost averaging is preferred among investors who choose to invest periodically with smaller amounts. That way, you avoid buying in all at once when the mutual fund is at an anomalous peak, but you’ll also miss investing a lump-sum at the lows. If it declines, you continue buying in. Because you buy more shares as the market declines and fewer shares as the market rises, you lower your average cost per share. Dollar-cost averaging fares better than lump-sum investing if the investment increases in value more towards the end of the investor’s time horizon.

Although we all want the value of our investments to increase over time, lump-sum investors have more of an edge if their timing is well-chosen. However, many investors may not have adequate capital resources for lump-sum investing and prefer to invest over time using dollar-cost averaging.

Please note: If you use a value mutual fund in a market timing strategy, this may involve frequent trading, higher transaction costs, and the possibility of increased capital gains that will generally be taxable to you as ordinary income. Market timing is an inexact science and a complex investment strategy.

Time Horizon

Investing in value mutual funds tends to be a longer-term play (one year or preferably more). The goal here is relatively consistent growth over time rather than spectacular short-term gains. Remember to check which fees for different share classes will apply given your time horizon.

When to Get In

Having time on your side is advantageous when investing, so in general, getting in sooner than later is preferable. However, there are some timing considerations for your initial investment. If you are using dollar-cost averaging, you would adhere to your periodic investment schedule.

A turnaround may be on the horizon

The challenge of value investing is deciphering between companies that are truly undervalued from stock prices that are low for good reason. It’s best to have some sense that the stocks in the value fund are poised for a recovery, not just beaten up by the markets. If instead the fund owns stocks that are going nowhere fast, or worse, it may be wise to examine other value funds with holdings in different areas of the economy.

When to Get Out

When you buy a value mutual fund, it’s usually a long-term investment. Typically, if you’ve reached your goals, if your investing strategy has fundamentally changed, or if you need the money for some long-term objective, you start to exit your position, either in phases, or all at once.

Ideally, you would like to get out when the value fund is doing well, before you really need the cash for its intended purpose. That way you can pick your spot and try to sell during high times. Take into account this may be contrary to the overall market if your value fund is invested in defensive stocks. If you wait until the last second and you have mounting expenses you need to meet (such as when a child goes to college, you want to buy a home, or you’re about to retire) you could find yourself stuck in the midst of a recession, be forced to sell anyway, and be left with much less than estimated when you first initiated the investment.

Since timing the market is an inexact science and is easier said than done, it may be wise to lighten up your holdings in value mutual funds over time as you get closer to the end of your time horizon. Dollar-cost averaging to exit is one method you could employ to do this. In other words, withdrawing a predetermined amount on a pre-set schedule as the date for completion of a financial goal approaches. Another method is based on asset allocation and is discussed in our series on bonds.

Bear in mind that you need to have realistic objectives. You shouldn’t expect your money to double over the course of a few months. You are also very unlikely to hit the high point of a rally. By trying to milk a trade for every last percentage point, time and again investors have given back too much of their gains. Don’t be one of them.

If your investment is a loser from the start, you have two options: hold tight and weather the storm, or stick to a predefined rule of acceptable losses and head for the exits. Although transaction costs are often minimal when compared to the total investment amount, they are not negligible. So be sure you understand how fees are incurred if you exit after a relatively short holding period. But don’t let them sway you to stay with a non-performing investment that is no longer in your comfort zone.

Investment Management

Because you have a professional fund manager managing your trades, this is a relatively low-maintenance play. You buy in through either a lump-sum or periodic investments, after reading the fund’s prospectus.

Since this is an actively managed fund, there are likely to be modifications in how the fund is managed over time. So review a current prospectus periodically to be aware of any noteworthy changes.

Any time you make an investment, you are obviously expecting the results to be outstanding. But as you know, that will not always be the case. Even the most carefully chosen mutual fund can go south in a hurry, resulting in losses.

It’s also a good idea to keep an eye on your fund’s performance relative to its peers. Of course past performance is not an indication of future results, but if your fund is underperforming, you may want to consider switching to one that’s been better managed on a historical basis.

If you are scaling in or scaling out of this strategy with dollar-cost averaging, you need to be sure to stick to your investment schedule over the life of the investment. Deviate from your schedule only if there is a significant shift in your personal investment plan or financial picture.

Volatility Factor

Since some stocks can go up while others go down, a value mutual fund’s price movement will tend to be less volatile than the average stock. Because many of the holdings held by value mutual funds have depressed prices, these stocks tend to lose less when the average bear market roars through. These investments also tend to be more stable than your average growth fund during a market downturn. On the flip side, you shouldn’t view value funds as a safe haven. Be sure you are comfortable with the level of risk associated with this investment when running this strategy. Don’t assume that a value mutual fund is low risk just because it may have lesser volatility than another type of investment.

TradeKing Margin Requirements

After the trade is paid for, no additional margin is required. You cannot trade mutual funds on margin.

Tax Ramifications

There are several ways your mutual fund investment can impact your tax liability. Read How Taxes Affect Mutual Funds and consult your tax advisor for the low-down on this important topic.

TradeKing Tips

Be wary of earnings season and news events

  • Just prior to and during quarterly “earnings seasons,” when corporate earnings are announced—January, April, July and October—major indices tend to be more volatile than usual. Furthermore, other types of announcements can cause increasing volatility as well.
  • If earnings are coming up, the Fed is about to hold a greatly anticipated meeting regarding interest rates, or you're generally unsettled by increased volatility, you may want to hold off with making that initial investment and see what happens. On the other hand, if you have good reason to think positive news will boost your upcoming investment, by all means get in before the next big rally gets underway. Either way, be sure you are making an active decision to stay in or out during a time of increased news releases because prices are likely to experience greater volatility during these times.


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