Recs

0

How Funds Differ From Stocks

Welcome back to another edition of Foolish mutual fund basics. This time, we're leaving behind the friendly confines of fund redemption fees for the native land of the NAV. Ready to get started? Good.

What it is
For investors, buying shares of a fund can feel a lot like buying shares of a stock. Either way, you're buying shares.

But that's where the similarities end. Funds, you see, are a collection of assets. So, when you buy shares at the NAV, or net asset value, you're staking a claim on a portion of the fund's total assets. Motley Fool Green Light co-advisor Shannon Zimmerman, who also leads our Champion Funds service, explains:

"Unlike stock price, a fund's NAV simply represents the total of its assets minus liabilities divided by the number of shares outstanding -- and so long as a fund is open, additional shares are always available. A good way of demonstrating the difference between stock price and NAV is with distributions. When a fund pays out capital gains or dividends, its NAV is adjusted downward to account for the per-share amount of the distribution, but investors are no poorer for the slide."

Let's use an example. If Fidelity Magellan (FUND: FMAGX  ) manager Harry Lange was wildly successful in his stock picks during 2007, he might realize $1 per share in capital gains. That money would have to be paid back to shareholders. But the payments would also reduce total assets, and thereby NAV, by $1 per stub.

How it works
So how do you make money as a fund investor? When the underlying assets of the fund you own increase in value.

For example, if the per-share prices of Corning (NYSE: GLW  ) , Genentech (NYSE: DNA  ) , and Seagate (NYSE: STX  ) rise, the total assets of funds that hold shares of these stocks, such as Lange's Magellan, rise in lockstep. That, in turn, juices the NAV.

Or, in simpler terms: Fund owners make money when those who pull the levers make smart stock picks. That's why Shannon spends so much time studying the talent, track record, and tenure of managers when making his own picks for Champion Funds.

Go under the hood
Which brings me to the bad news. Unlike stock prices, from which you can learn much using classic valuation metrics, there's little to be gained from the NAV.

But that doesn't mean you should ignore the numbers altogether. Thanks to Morningstar, it's pretty simple to determine, on a relative basis, whether a fund's portfolio is cheap or expensive. Just enter the ticker at Morningstar.com and click on "portfolio." That will get you a host of worthwhile statistics.

For example, Morningstar says that Magellan trades for 10.7 times projected cash flow, or roughly equal to the multiple of the broader market. Meanwhile, average cash flow is on pace to grow more than five times faster than the S&P. That could indicate Lange has scored some serious bargains.

Follow the money
Stocks and funds, like per-share prices and NAV, are kissing cousins. Sure, they're related, but you don't want them getting too close. Confuse the two as an investor and your portfolio could suffer the sort of indignity that's usually reserved for those awkward, what's-your-name-again, twice-a-decade family reunions. No Fool deserves that.

Interested in more moneymaking advice? Consider Green Light. Therein, Shannon and co-advisor Dayana Yochim show you how to unlock the hidden fortune inside your paycheck. The February issue alone contains $1,717 worth of tips. Click here to get your copy and 30 days of free access to the service. There's no obligation to subscribe.

Interested in more mutual fund basics? Your digital chariot awaits:

Fool contributor Tim Beyers, ranked 998 out of more than 22,500 in the Motley Fool CAPS investor intelligence database, writes weekly about personal finance and investing basics. Have a Foolish money tip? Tell him. Tim owns shares of Seagate. All of his portfolio holdings can be found at Tim's Fool profile. His thoughts on personal finance, Foolishness, and investing in general may be found in his blog. The Motley Fool's disclosure policy just sent your portfolio flowers. Happy Valentine's Day.


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 535496, ~/Articles/ArticleHandler.aspx, 10/23/2014 1:11:46 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Tim Beyers
TMFMileHigh

Tim Beyers first began writing for the Fool in 2003. Today, he's an analyst for Motley Fool Rule Breakers and Motley Fool Supernova. At Fool.com, he covers disruptive ideas in technology and entertainment, though you'll most often find him writing and talking about the business of comics. Find him online at timbeyers.me or send email to tbeyers@fool.com. For more insights, follow Tim on Google+ and Twitter.

Today's Market

updated 3 hours ago Sponsored by:
DOW 16,461.32 -153.49 -0.92%
S&P 500 1,927.11 -14.17 -0.73%
NASD 4,382.85 -36.63 -0.83%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

3/26/2009 4:00 PM
DNA $94.97 Down +0.00 +0.00%
Genentech, Inc. CAPS Rating: ****
GLW $18.41 Down -0.12 -0.65%
Corning CAPS Rating: *****
STX $54.28 Down -0.94 -1.69%
Seagate Technology CAPS Rating: ****

Advertisement