Have you ever wondered how a mutual fund works? How about why people buy them?

What makes them such a hot topic in todays modern finance world? This essay will show you in depth how to pick a mutual fund, analyze it, and then make a decision as to whether or not to buy it or not. I am going to be specifically looking at one mutual fund, Columbia Dividend Inc B. There are many things to analyze when we pull out an information sheet on a specific mutual fund. At first, all of the numbers and letters can seem frustrating. However, with a good analysis, it becomes clearer as to what they all mean. Mutual funds are an attractive way to invest now because the performance of one company has only minimal effect on the overall performance of the mutual fund. This mutual fund invests in large companies, and is concerned with dividends for the mutual fund investors. The B in the mutual fund name denotes that this fund, when bought, would be paid for in small commissions over a few years, rather than one lump sum at the purchasing of the mutual fund shares. The first part of the mutual fund that we will analyze is the risk and return portfolio. From this, we can see how well the fund has performed over the years, and how well it is expected to perform. Morningstar, the maker of this mutual fund data sheet, gave this fund a 5 star rating in 3 and 5-year ratings. It classified this fund as low risk, and said that the returns were high. Within the risk and return portfolio are very key terms that an investor must understand in order to be able to make a good selection. One of these key terms is beta. Beta is A quantitative measure of the volatility of a given stock, mutual fund, or portfolio, relative to the overall market, usually the S&P 500. (InvestorWords) This is simply a prediction of risk and return for a mutual fund. The S&P 500 has a beta of 1.0.

When looking into a beta, most stocks have between a .5 beta, and a 2.0 beta. If the beta of a mutual fund is lower than 1.0, then that is a conservative fund that is investing in conservative stocks. If it is more than 1.0, then it is a more risky investment. A conservative beta, one that is less than 1.0 is less responsive when there is volatility in the market, and thus is a much safer investment. These tend to be invested in large, well established blue-chip stocks. A more risky investment, one thats beta is over 1.0, will be more active in a volatile market. These tend to be smaller companies that are not well founded yet. Generally speaking, if the beta is over 1.0, it will be more active when the stock market is down, meaning you will lose money faster than with a lower beta. However, when the stock market is doing well, the return will be much higher with a beta over 1.0, as it has swung in alignment with the market up. The beta of our mutual fund is .86 when compared to the S&P 500. This means that we have a generally conservative mutual fund. For example, if the market were to increase by 10%, our mutual fund would only increase by 8.6%. However, if the market were to go down by 10%, our fund would be safer than the market in general, as our fund value would only decrease by 8.6%. When compared to the best fit index, the Russ 1000, our mutual fund was given a rating of .80. The best-fit index is a way of pairing a mutual fund up with an index or stocks that are more appropriate, or that fit better with the mutual fund, rather than just using the S&P 500. Meaning once again that if the Russ 1000 market were to increase or decrease by 10%, our mutual fund would only increase or decrease by 8%. The second part of the risk and return portfolio that we are interested in is the alpha of our mutual fund. Alpha is a risk-adjusted measure of the so-called "excess

return" on an investment. It is a common measure of assessing an active manager's performance as it is the return in excess of a benchmark index or "risk-free" investment. (Hedgefund-Index) In simpler terms, the alpha is the difference between the beta predicted risk/return and what actually happened to the mutual fund. If the mutual fund manager performed well, then the fund will have a positive alpha. If he did not, then the number will be negative. For example, our mutual funds alpha is 2.24 when compared to the S&P 500. This means that our mutual fund performed 2.24% better than how well it was supposed to have performed. Meaning our fund managers have performed well at their jobs. When compared to the best fit index, which for our mutual fund is the Russ 1000 Value, our mutual fund ourperformed this by 3.13%, its alpha being 3.13. Next, we must define r-squared. R-squared is A measurement of how closely a portfolio's performance correlates with the performance of a benchmark index, such as the S&P 500, and thus a measurement of what portion of its performance can be explained by the performance of the overall market or index. (InvestorWords) An rsquared number can be anywhere from 0 to 100. It is a way to see how well the mutual fund follows the index that it is being compared to, in our case the S&P 500 and the Russ 1000. The higher the number, the closer it follows the market and the better it is. The higher the number, the better the mutual fund manager is doing trying to match the market with their fund. Generally, we want an r-squared value of 80 or higher. Our r-squared value is 95. This means that our fund managers are doing a good job of following the market, almost exactly. When compared to our best fit index, the Russel 1000, our mutual fund has an r-squared rating of 96. Because both of these

numbers are above 80, and because both of these numbers are very high, this mutual fund is a good buy. This mutual fund invests in large companies, and is concerned with dividends for the mutual fund investors. The B in the mutual fund name signifies that this fund, when bought, one would pay a small amount of commission over a few years, instead of one lump sum, as with a type A mutual fund. Our mutual fund is in the Columbia family of mutual funds, its managers are Davis and Dahlberg, and they have been the fund manager for 6.3 years. Some mutual funds invest in bonds, however this fund invests in stocks. This is a large value mutual fund. It invests in large, safe companies that have good dividends. This mutual fund was given a 5 star out of 5 rating by the Morningstar Rating service. This means it is an overall good and genuinely safe mutual fund. Since this mutual find invests in relatively large companies, it would be wise for investors of short term to invest in it. Because larger companies are safer than small ones, it would be a safe way in which to store your money for a short period. However, if you are looking for long-term storage of extra assets, this mutual fund is most likely not for you. Small companies, and long-term mutual funds would be wiser. From the portfolio analysis we can see how diversified the stocks are. As we can see from the composition, our mutual fund is all long-term growth. 6.9% of the assets of the mutual fund are in cash, 82.6% U.S. stocks, 7.0% in non-U.S. stocks, no money in bonds (as this is an only stock fund) and an undefined 3.5% in other assets. We also see the top companies in which this mutual fund places assets. This can be an important tool for research. For example, if you dont like the ethical practices of one company on the

list, then you should not invest in that mutual fund. Or perhaps you think that one company on the list is not faring well, then it would also be advisable to not invest in this fund. However, because mutual funds place so little money into so many stocks and cash, the crash of one company would hardly affect the performance of the mutual fund. As we can see from our companies, the fund has diversified the shares evenly between large companies. For example, after reading up and researching on this mutual fund, I would then go to an investor and buy this mutual fund. Its a good idea to begin investing young, because in my personal life, I would like to buy a mutual fund, as I only have bonds, stocks, and gold as investments. Mutual funds are a good vanguard for your money, and for the future. In conclusion, investing in this mutual fund would in my opinion be a good choice. The concept of putting money away is a good idea for all, not only people who work on Wall Street. This mutual fund, Columbia Dividend B has a 5 star rating from Morningstar. It has money even distributed in different areas of the economy. It has a good beta, and an even better alpha. It r-squared is 15 above what is considered good for a mutual fund. The mutual fund directors have been on the job for 6.3 years, and it appears that their work is paying off for them. Overall, it is a good fund to buy. Hopefully now you know how a mutual fund works, and how to analyze one, and make the decision as to whether or not to buy one.

Works Cited Investorwords.com. 2009. Investor Words. 7 Oct. 2009 < http://www.investorwords.com/468/beta.html> < http://www.investorwords.com/4334/r_squared.html> Hedgefund-Index.com. 2009. Hedgefund Index. 7 Oct. 2009 < http://www.hedgefund-index.com/d_alpha.asp>