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Investing: Even Indexing Takes Work

May 16, 2013 By 6 Comments
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The benefits of low-cost index mutual funds and ETFs are all over the news.  They were front and center in the recent PBS Frontline Special The Retirement Gamble.  Index funds are a great tool for investors of all ages; in many cases these passively managed funds beat the majority of their actively managed peers within the same investment style.  However, investing in index funds takes work, especially with the proliferation of new index products that continue to hit the marketplace.

Expenses matter 

Costs matter when investing.  One of the biggest lures of index fund investing is that many of these products provide a low cost way to investment in a given segment of the market.  If you are looking for an index fund that mimics the S&P 500 there are many great low cost alternatives such as the Vanguard 500 Index Fund (Ticker VFINX) with an expense ratio of 0.17% or the SPDR S&P 500 Index ETF (Ticker SPY) with an expense ratio of 0.09%.  On the other hand, there is also the Rydex S&P 500 A (Ticker RYSOX) with its expense ratio of 1.51%.  How big of a deal is this difference?

A $10,000 investment in the Vanguard 500 fund made on May 31, 2006 and held until May 15, 2013 would now be worth $15,064.  That same investment in the Rydex S&P 500 fund would be worth $13,798 or 9.2% less for an investment in a mutual fund tracking the same index as the Vanguard fund. 

Understand the underlying index 

In the wake of the 2008-2009 market downturn new index products, especially in the ETF space, have proliferated.  ETF providers are falling all over themselves to bring new index products to the market hoping to attract assets.  Like any investment, investing in an index fund or ETF requires that you understand what it is that you are buying.

When I think of indexing I think of the traditional, basic index products that track benchmarks such as the S&P 500, the total U.S. stock market, the total non-U.S. market, the domestic bond market, etc.  Additionally I typically use index funds to benchmark the U.S. small and mid cap equity spaces, real estate, and emerging markets equity among others.

Several months ago Market Watch’s Chuck Jaffe cited a Vanguard report that found “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.”  

As an investor this should be a huge red flag.  What this study says is that many of these new index products were developed much like the monster in the Mel Brook’s classic Young Frankenstein.  Look back-testing is not inherently bad and many of these new index products are appropriate for professional traders.  However if you are looking to index in the fashion that Vanguard founder John Bogle and others espouse then you should consider sticking with index products that track known, battle-tested market benchmarks.

Asset allocation is still vital 

Whether you use index products as a portion of your overall portfolio in conjunction with other investment vehicles such as actively managed mutual funds or individual stocks, or if you invest in index funds exclusively you still need to develop and asset allocation for your portfolio.  As I say frequently on this blog, this should be done as an outgrowth of your financial plan.

Even a seemingly simple strategy of investing in a total U.S. stock market fund, a total international stock market fund, and a total bond market fund still requires that you determine how much to invest in each fund, that you monitor your allocation and rebalance when needed, and that you review and adjust your target allocation as you age or if your situation changes.

Index funds and ETFs are a great investment tool.  Like any tool it is important that you select the right index product and that you manage your portfolio properly.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your index mutual fund and ETF options and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

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Winning The Retirement Gamble: Step 1 Adjust Your Mindset

May 6, 2013 By 9 Comments
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Tri-Athletes Mental Tool Box -- F.A.S.T.

The PBS Frontline documentary The Retirement Gamble has sparked a lot of discussion, both pro and con.  One thing that is clear, the show contributed to the discussion about the lack of retirement readiness among many in the United States.  I’m hardly an expert in behavioral finance, but I do know that in order for investors to be able to focus on planning for their retirement they need to adopt  the right mindset.

Lose the victim mentality

I saw a lot of this on the PBS special and see this written about frequently in the press.  The last few years especially have been rough on many of us saving for retirement.  Job losses; the financial crises; the Flash Crash; the realization that not all financial advisors have their client’s best interests at heart; the mutual fund scandals of the middle part of the last decade might all be good excuses to feel like a victim.

As my wife used to say to our kids on the soccer field (when they had a minor injury) “…suck it up and get back in the game…”  If you feel like a victim you likely will end up as one.  Right or wrong saving for retirement is on you, deal with it.

Drink your own flavor of Kool Aid 

I love index funds and ETFs and use them extensively throughout my practice.  They comprise the majority of the assets for which I provide advice.  I don’t, however, use passive index products exclusively.  There are solid actively managed funds that in my opinion warrant inclusion in some client portfolios.

There are some folks out there who have an almost cult-like devotion to indexing and John Bogle.  Mr. Bogle deserves all of the respect and admiration that he gets and then some.  My point is that no single way of doing things is always right in all cases.  It’s OK to mix and match funds, ETFs, active, and passive strategies, as well as other vehicles as long as they fit your financial plan and your needs.  Don’t let anyone put you down because you disagree with their way of doing things.

Focus on the future, don’t dwell on the past 

The past is in the books.  Maybe you didn’t save enough perhaps you invested in all of the wrong places.  Perhaps you had a greedy “financial guy” whose focus was on selling you products that enriched their bottom line at your expense.  Don’t forget your past mistakes, learn from them, but don’t dwell on them.

All you can do in the financial planning and investing world is move forward from wherever you are now.

  • Find a fee-only financial advisor who puts your interests first.
  • Get a financial plan in place with appropriate goals and strategies.
  • Review your investing strategy.
  • Beef up your retirement savings.
  • Manage your career.
  • Take charge

Our retirement savings system puts the responsibility for accumulating enough for retirement on us.  Get in the game make sure you have the right mindset and attitude to be successful.

Please feel free to contact me with your financial planning and investing questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your investment holdings and your portfolio. Please click on the link to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you. 

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My Thoughts on PBS Frontline The Retirement Gamble

April 29, 2013 By 24 Comments
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Gamble

The PBS show Frontline recently aired an investigative documentary on the state of retirement savings and the problems with 401(k) and similar retirement plans.  The show did a great job of highlighting a number of issues and was pretty scathing in its treatment of the financial services industry and workplace retirement savings plans.

As a professional who serves as a financial advisor to a number of 401(k) plan sponsors as well as to individual clients (most of whom are either close to retirement or in retirement) I watched this broadcast with great interest.  Here are my reactions to what I saw.

Key issues highlighted by The Retirement Gamble

  • The high fees imbedded in some retirement plans, often these fees are next to impossible for the average participant to uncover.
  • Poor investment choices offered in some plans.
  • There are a lot of lousy 401(k) plans out there.
  • The confusion and frustration that many retirement savers in 401(k) and other defined contribution plans feel due to the fact that they are responsible for accumulating enough for retirement.  This is in contrast to the era when many folks were covered by a defined benefit pension plan where the investment risks and responsibilities for funding the plan were on the employer’s shoulders.
  • While the issues highlighted were not new to me nor to many of us in the industry, I think this documentary was a bit of an eye-opener to many in the general public.  I say this as there have been several surveys taken over the years where a shocking number of investors responded that they had no idea that there were fees charged by their 401(k) plan.

Where the documentary fell a bit short in my opinion 

As regular readers of this blog and those who follow me on Twitter and other social media outlets know, I am highly in favor of lower retirement plan fees and anything that increases transparency for investors.  That said I thought the show had a very decided bias against the financial services industry and almost felt as though they had come to their conclusions before they started on the project.

  • The show did not highlight a single good 401(k) plan and there are many out there.
  • The show did not highlight a single person who had used the 401(k) to accumulate a significant nest egg. I have the privilege to serve as advisor to a number of folks who have done just that.
  • While I am an admirer of Vanguard founder John Bogle and use index funds extensively in the 401(k) plans that I advise and in the portfolios of all clients, I disagree that there are no actively managed funds worthy of investor’s dollars.  That’s not to say that these are the majority of active funds, but they do exist.  Finding them and determining if they are an appropriate investment choice for a plan sponsor to offer is what plan investment consultants are paid to do.
  • While the program did mention advisors who act as Fiduciaries in passing, the focus was on those advisors, reps, and brokers who sell plans and/or suggest investment options that serve to line their pockets sometimes at the expense of the plan’s participants.  Why not interview some advisors who do the right thing for their plan sponsor clients and the participants of those plans?
  • The worst part of the show is that while many problems and issues were brought to light, there was little in the way of advice or suggestions for plan participants on what to do to improve their situation.

I do have to say that the most amazing part of the show was the interview with the head of Prudential Retirement Christine Marcks.  She insisted that she was unaware of any of the research showing the advantages of low cost index investing over high cost active management.  While she may or may agree with the findings, the fact that she insisted that she was unaware of this research was jaw-dropping in my opinion.  I think Ms. Marcks should have been coached prior to her appearance by someone at Prudential.

The documentary is very worthwhile and if you haven’t seen it there is a link to the video on our Resources page.  Please weigh in below as to your thoughts on The Retirement Gamble.

Please feel free to contact me with your retirement planning and investing questions.   Check out our Financial Planning and Investment Advice for Individuals page for more information about our services.    

Retirement plan sponsors, do you need an independent review of your company’s plan?  Do you need help selecting a new plan provider?  Are you looking for ongoing financial advice to help you meet your fiduciary obligations and to provide a superior retirement savings vehicle for your employees?  Please feel free to contact me to learn about our investment consulting services for retirement plan sponsors.

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ETFs or Mutual Funds? – Why Not Both?

April 8, 2013 By 8 Comments
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Diversification - Investing

Over the past several months I’ve read a number of articles along the lines of “ETFs vs. Mutual Funds.”  In most cases these articles take an either or position which is generally in favor of ETFs.  While I am a fan of ETFs and use them extensively in client portfolios, my question is why do we need to choose between ETFs and mutual funds?  Why not use both?

Looking over the portfolios of my individual clients I could not find one that did not include both ETFs and mutual funds.  In addition some include closed-end mutual funds as well as individual stocks.

Advantages of ETFs  

Originally ETFs were introduced as a way to trade various stock market indexes.  The S&P 500 SPDR (ticker SPY) just turned 20 and is generally at or near the top of the list in terms of ETF trading volume.  The availability of low cost ETFs across a variety of equity and fixed income indexes has mushroomed over the years.  As a financial advisor I use them extensively for their style consistency, low cost, and in many cases their consistently above average performance within their style peer groups.

Especially after the 2008-09 financial crisis the number of ETFs offered has mushroomed and so has the variety of offerings.  Actively managed ETFs are growing and the success of PIMco’s ETF version (ticker BOND) of its popular PIMco Total Return (ticker PTTRX) mutual fund will undoubtedly spur further growth here.

Why bother with Mutual Funds?

In looking at mutual funds you have to divide them into actively managed funds and passive (index) funds.

If you are indexing all or part of your portfolio you want to look at various factors in making your decision as to whether to go with a mutual fund or an ETF.  These include:

  • The size of your account/portfolio.  Even in the world of index mutual funds there are some lower cost versions available to investors who can meet higher minimum investment thresholds.  Vanguard is a good example here.
  • Cost to own.  The expense ratio should be the main factor, but transaction costs can come into play.  While the availability of no-transaction fee ETFs is growing, the ETF you want to buy may not be on this menu at a given custodian.  Likewise some mutual fund families might incur a transaction fee at certain custodians.
  • How will you invest?  If you are dollar cost averaging into a fund/ETF at say $250 per month you’ll want to look for options with no transaction costs.

While actively managed mutual funds get a bad rap in the press, there are still a number of well-managed reasonably priced funds across equity and fixed income styles.  A Schwab study a number of years ago touted a “core and explore” approach to investing.  This meant that the core of the portfolio would be index funds, with the use of actively managed funds in certain asset classes where good index products were not available.

Given the expansion of indexing to a wide range of assets classes in both the ETF and mutual fund format this approach in its original form may be passé.  However I still use a number of actively managed funds across both individual and institutional portfolios.

In choosing an active fund I’m looking for some or all of the following:

  • Long-term outperformance.
  • Superior risk-adjusted performance.
  • Consistency of management.
  • Something that I can’t find in an index product that adds to the overall quality of the portfolio.

Certainly there are a lot of mutual funds that don’t belong in your portfolio.  Loaded funds, proprietary funds from various brokerage houses and other high fee alternatives put a lot of money into your broker/registered rep’s pockets.  Go with no load funds and always shop for the most competitive share class available to you in terms of expense ratio.

Why exclude either ETFs or Mutual Funds?

My point here is not to argue the merits of either mutual funds or ETFs, or for that matter active management vs. passive.  Certainly I’ve seen some excellent examples of portfolios that are all ETF and/or all index products.

However why limit yourself and feel that you need to avoid funds or ETFs?  There are so many choices out there, I feel that I owe to my clients to look at the whole universe of ETFS, mutual funds, and other products that might enhance their portfolio and help them to achieve their investment goals.  In building a portfolio I suggest that you take the approach of picking the best investing vehicles for the various allocation “buckets” in your portfolio whether they be ETFs, mutual funds, actively managed, or passive index products.

Please feel free to contact me with your financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page for more information about our services.   

For you do-it-yourselfers, check out Morningstar.com to analyze your mutual funds, ETFs, and all of your investments and to get a free trial for their premium services.

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Do Index Funds Reduce Investment Risk?

February 27, 2013 By 8 Comments
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Index mutual funds and ETFs (we will refer to them as index funds unless otherwise indicated going forward in this article) have received a lot of favorable press of late.  This is justifiable as index funds offer a low cost way to invest and are generally quite specific to a given investment style.  Over the years I have been asked if index funds reduce investment risk.  Let’s examine this question.

Illustration of Standard deviation

What is investment risk? 

One definition of  investment risk as the variability of the investment’s returns also known as standard deviation.   Note variability means returns that are both higher and lower than the fund’s average returns over a given period, say the trailing three or five years.

I contend that most investors would define investment risk as the risk of losing money on an investment.  This is especially true in the wake of the recent financial crises.

An index fund takes on the risk of the underlying index it tries to replicate. For instance, in 2008 the S&P 500 Index lost 37 percent. There are many funds and ETFs that track that index. They all lost around 37 percent plus the fund’s expenses. For example, the Vanguard 500 Index Fund (symbol VFINX) posted a loss of 37.02 percent for the year.

Active management vs. index funds 

Let’s take a look at several of Morningstar’s analyst favorites in the Large Growth style compared with an index fund in this style and with the S&P 500 index.

10 yr. Standard Deviation

10 yr. mean return
Vanguard Growth Index (VIGRX)

+/-15.14%

8.10%
Jensen Quality Growth (JENSX)

+/-13.19%

6.62%
Vanguard Primecap (VPMCX)

+/-15.50%

10.83%
Harbor Capital Apprec. (HACAX)

+/-15.57%

8.65%
S&P 500 Index

+/-14.80%

7.93%

Data from Morningstar.com

In plain English, the Vanguard Primecap fund posted an average annual return of 10.83% over the trailing ten years depicted.  Based on fund’s standard deviation of +/- 15.50% one would expect the fund’s returns to range between -4.67% and +26.33%.

The bigger take away from this chart is that the Vanguard Index fund’s volatility was lower than a couple of the funds and higher than Jensen.   As with any index fund the Vanguard fund experienced approximately the level of risk and return of its underlying index, other actively managed funds in this category experienced more or less risk and return based upon the stock selections of the managers.

Manager Risk 

Index funds can eliminate manager risk, or the risk of investing in an actively managed fund only to see the manager underperform the benchmark index.  As an example for the trailing periods ending January 31, 2013 the Vanguard Growth Index outperformed 83% of the other Large Growth funds for the trailing three years; 84% of the other fund for the trailing five years; and 61% of the other fund for the trailing ten years.

This is not to say this will be the case with all index funds over all periods of time. However, a well-run index fund should track its underlying index closely and deliver index-like performance.

Several years ago an instructor at a continuing education session indicated that many of the actively managed mutual funds atop the 10-year rankings in their respective categories most likely spent three of those calendar years in the bottom quartile of their category rankings. For an investor who held one of these funds over that entire 10-year period this isn’t a problem. But investors who bought into such a fund at a different time or over various periods of time may have had quite a different experience.  As we know, money tends to chase performance, hot funds attract investor dollars, funds that are struggling tend to see more client redemptions.  This is so prevalent that Morningstar measures investor performance along with the actual performance of the mutual fund.  Investor performance provides a measure of how actual investors fared by investing in this fund, including the timing of investments and redemptions.  In many cases investor performance varies significantly from the actual fund returns.

A few other points to consider: 

Expenses matter

You should generally buy the cheapest index fund that tracks the index you are interested in. There is a huge disparity in the fees for funds that track the S&P 500 for example.

Understand the underlying index.

There has been a proliferation of new index ETFs tracking a variety of indexes. In many cases I have never heard of many of these indexes. Make sure the index tracked by the fund or ETF you are considering makes sense for your overall portfolio and that the index has a real history not just some back-tested data behind it.

Using index funds is no guarantee of investment success

Just like with any mutual fund or ETF, how you use these products is the key to your success. Index funds are nothing more than a building block to construct your portfolio.

Don’t dismiss active managers  

Evaluate actively managed funds and understand why they have been successful in the past and in what types of environments they might lag their peers. Moreover, carefully think through the role the fund might play in your portfolio, and be aware of who is managing the fund. Is the same person or team that actually compiled the impressive track record still in charge? Or has this manager moved on, placing the fund in the hands of some new, unproven manager?

Index funds do not necessarily reduce investment risk or guarantee a higher investment return than using actively managed funds.  Like anything in the investment world, investing with a strategy (ideally tied to your financial plan), monitoring your results, rebalancing your allocation, and making adjustments to your portfolio when warranted are still key elements in successful investing.  Index funds are simply a tool you can use in this process.

Feel free to contact me with your investment and financial planning questions.

For you do-it-yourselfers, check out Morningstar.com to analyze your mutual funds and all of your investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

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4 Signs of a Lousy 401(k) Plan

February 6, 2013 By 20 Comments
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Much has been written about the sorry state of retirement readiness in the United States.  In fact the most frequently asked question that I get is Can I Retire? 

For better or worse, the primary responsibility for accumulating sufficient assets for retirement has been placed upon our shoulders in the form of defined contribution retirement plans such as the 401(k), 403(b), etc.  The defined benefit pension plans of our parent’s generation are rapidly fading away.

It is important that you make the most of any workplace retirement plan available to you.  New required disclosures about the costs of the plan and the underlying investments were introduced in 2012 and are a good start.  However, 401(k) plans are still a mystery to many of the workers who participate in them and sadly to many of the employers sponsoring these plans.  Here are 4 signs that your 401(k) plan might be lousy.

Proprietary Funds 

By this I mean your 401(k) plan provider or a brokerage firm affiliated with the plan offering their own mutual funds.  The most extreme recent example of this is Ameriprise Financial who is being sued by a group of current and former employees for allegedly stuffing the plan offered to company employees with poor performing, high cost funds offered by Ameriprise.  To boot they are also accused of taking revenue sharing payments from these funds.

While most examples are not this egregious, it should be a red flag if your plan is stuffed with funds or annuity sub-accounts from the likes of John Hancock or Principal and they also happen to be the provider of your retirement plan.  There are often many incentives to be had by servicing brokers and other service providers to offer this type of line-up.  While they are making money off of this type of plan, such an arrangement might be costing you big-time.

Single Fund Family Line-ups 

For years the broker/registered rep community would offer a line-up filled with funds from the American Funds.  These were often the best funds that they could sell and they rightly had a good name.

Just as bad is a line-up dominated by Vanguard or T. Rowe Price funds, or any other single fund family for that matter.  Even though I highly respect both companies, no single fund family offers the best option in every asset class.

Expensive share classes 

In many cases mutual fund companies offer a variety of share classes for use by various financial advisor channels ranging from fee-only RIAs to brokers and reps seeking compensation from selling the funds.  In many cases the fund families offer several retirement plan share classes as well, again with some offering compensation to the advisor directly or to the retirement plan.

Check out the funds offered in your plan via Morningstar or elsewhere to see if there are less expensive share classes of your fund that are available.  This even extends to low cost index fund providers like Vanguard who offer share classes which carry a lower expense ratio that the basic Investor share class.

A group annuity plan

This was the traditional fare for plans offered by insurance company providers.  They are still around but if your employer’s plan is still in this format it is likely small in size or it has been in a group annuity for awhile.

A group annuity plan generally offers either mutual funds or annuity sub-accounts that are “wrapped” into a group annuity.  These are complicated and generally expensive insurance contracts that often don’t bestow any particular benefit on the plan participants.  In fact some plans carry surrender charges that make it difficult for employers to change providers.

What do I do if my 401(k) plan is lousy? 

  • If there is a company match it often makes sense to contribute enough to receive the full match.  This is free money you shouldn’t leave it on the table.
  • Do your homework and say something to those in charge of administering the company’s plan.  This may or may not result in things changing, but many employers are more sensitive to this type of input in light of the current trends toward more disclosure and transparency.
  • If your plan offers a self-directed brokerage window check this option out.  Understand the costs and any limitations involved.  Also make sure that you are comfortable choosing your own investments or that you have an advisor to assist you.
  • Focus on retirement savings vehicles available outside of your plan including an IRA, maxing out a spouse’s retirement plan (if it’s better than yours), investing in a taxable account, or a low-cost annuity (ideally one with no surrender fees).
  • Make sure not to leave your money in this plan when you leave the company, roll it over to an IRA or to a new employer’s plan.

We are increasingly responsible for our own retirement savings.  It is important that you understand how to best utilize the retirement plan offered by your employer.  A good plan can be an invaluable tool in reaching your retirement savings goals.  A lousy, expensive plan can cost you $1,000s in lost retirement savings and might be the difference between retiring in style or settling for less in your Golden Years.

Please feel free to contact me with your retirement planning and investing questions. 

Retirement plan sponsors, do you need an independent review of your company’s plan?  Do you need help selecting a new plan provider?  Are you looking for ongoing financial advice to help you meet your fiduciary obligations and to provide a superior retirement savings vehicle for your employees?  Please feel free to contact me to learn about our investment consulting services for retirement plan sponsors.

For you do-it-yourselfers, check out Morningstar.com to analyze your 401(k) plan options and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

Update 2/27/13:  It has come to my attention that a Tom Gonnella from Lincoln Trust Company has seen fit to use this post in an email to 401(k) advisors promoting their 401(k) platform.  While I am flattered on the one hand, please know this was done without my knowledge or consent.  I in no way, shape, or form endorse Lincoln Trust Company or its products.  I will leave it to you the reader to judge the ethics of Mr. Gonnella and/or his employer in this matter.  -  Roger Wohlner

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ETFs – 4 Considerations Before Buying

January 30, 2013 By 4 Comments
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English: You may have heard enough of bad news...

ETFs (Exchange Traded Funds) are the  “hot” investing product. Fund companies are tripping over themselves to bring new ETFs to the market place.  This reminds me a lot of the mid to late 90s and the proliferation of new mutual funds.  While the number of ETFs is lower, the growth in new products is still high.

Traditionally most ETFs have been index products.  The new frontier is actively managed ETFs.  Several providers have filed for approval to offer active ETFs, no doubt buoyed by the success of the ETF version of PIMco’s popular Total Return bond fund (tickers BOND for the ETF and PTTRX for the fund).

I have been a big user of ETFs in the portfolios of my individual clients.  To date I’ve used index ETFs exclusively.  The low cost and style purity are the big selling points in my opinion.

Just as with mutual funds or any other investment vehicle, investors need to do their homework before buying an ETF.  Here are 4 factors to consider:

Understand the ETF’s underlying index

Beware of ETFs with somewhat suspect underlying indexes. According to Chuck Jaffe in a MarketWatch article several months ago, a Vanguard report found that “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.” 

Many of these new ETFs rely on the hypothetical back-testing of these new indexes. While history is not always a good predictor of future performance, I like to see an ETF with an underlying index that has been “battle tested” in the real world.

Even among ETFs tracking more traditional indexes there can be differences.  For example in the Large Cap Growth style:

  • iShares Russell 1000 Growth ETF (IWF) tracks the Russell 1000 Growth Index, the growth slice of the Russell 1000 Index.
  • Vanguard’s Growth ETF (VUG) is in the process of switching index benchmarks as part of an overall switch of benchmark providers by Vanguard across many of its index mutual funds and ETFs.  The new provider’s index will remain a bit different from the Russell index used by the Barclay’s ishares product.
  • The Schwab U.S. Large Growth Index (SCHG) tracks Dow Jones U.S. Large-Cap Growth Total Stock Market Index, with a smaller market cap than the benchmark index of the other two ETFs. Additionally the Schwab ETF has higher weighting in financial stocks than most other Large Growth indexes.

To most investors these are fairly subtle differences, but none the less each of these Large Growth ETFs will exhibit slightly different performance during different market conditions.

Leverage and inverse indexing

Not all ETFs make sense for all investors.  There are a number of ETFs that move inversely with a given benchmark.  For example there are ETFs that move in the opposite direction of the S&P 500 index.  What many investors fail to understand is that these movements are tied to the markets on a daily basis, over longer periods of time the performance may not be as closely tied to the inverse performance of the index due to the use of derivatives in these products.

Leveraged index ETFs are available both long and inverse.  These ETFs multiply the movement of the index both up and down.  This is great if you’ve “bet” in the right direction.  However if for example you hold a leveraged ETF that goes 3 times inverse of the S&P 500 Index during a  market rally the ETF will drop in value roughly 3 times as much as the gains on the S&P 500.

There is nothing wrong with either inverse or leveraged ETFs as long as you understand how they work, when and when not to use them, and are comfortable with the risks.  In my opinion these products are not appropriate for most individual investors.

Know what you are buying 

With the advent of “funky” index products as mentioned above and with the growth of actively managed ETFs, investors really need to understand where they are investing their money more than ever.

ETF providers are just like mutual fund providers (in fact many firms offer both) in that they are about gathering assets and making a profit.  There is nothing wrong with this, but make sure that you invest based upon your needs and unique situation and that you ignore their hype, especially about “new and better” ETFs. 

Cheap is good 

One of the great features about ETFs has generally been their low expense ratios.  Just as with mutual funds and any other investment vehicle the cost of ownership is critical, cheaper is better.

Along these same lines there is an ETF price war going on.  The major players are Vanguard, Barclay’s (via their ishares), and Schwab who is trying to make inroads into the ETF business. It is key to make sure that the ETF product fits your needs and your portfolio, don’t just opt for the lowest expense product.

It is also important to note the transaction fees involved in buying ETFs.  Remember ETFs trade like stocks during the trading day as opposed to mutual funds which trade daily after the market close.  A number of custodians offer no transaction fee trades for certain ETFs.  Look at how you will be investing. Will you make larger lump-sum purchases? If so, paying a transaction fee for an ETF really won’t make much of an impact. However, if you will be making smaller purchases, say via dollar-cost averaging, it pays to look around.

Do you use ETFs?  Please leave a comment about your experiences with ETFs both good or bad.

Please feel free to contact me with your financial planning and investing questions. 

For you do-it-yourselfers, check out Morningstar.com to analyze your ETFs and all of your investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

Photo credit:  Wikipedia

 

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Investing in 2013 – Is it Different This Time?

January 2, 2013 By 6 Comments
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The Year the Dot-Com Bubble Burst

The New Year has started out with a nice opening day rally in the markets, following a strong rally on the last day of 2012.  In all the Dow Jones Industrial Average is up 3.7% over the past two trading days.

Longer –term, the S&P 500 index was up 111% from the lows on March 9, 2009 through December 31, 2012.  With the solid rise in the markets on the first trading day of 2013, the index closed at 1,462 just 6.6% below its all time high of 1,565 reached in October of 2007.

The phrase “It’s different this time…” remains etched in my mind as this was a common theme among many investment managers with regard to many technology companies in the period leading to the bursting of the Dot Com Bubble in early 2000.  They contended that it made sense to invest in start-ups with high multiples and no balance sheet, “It’s different this time…”

As we now know it wasn’t different, the stocks of most of these companies fell hard and the NASDAQ has never come close to its peak.

I thought of this time period today as I was listening to Professor Jeremy Siegel on CNBC while working out.  He felt the market would rise 20% this year, he is generally bullish.

It is different this time 

While there have been a number of investment managers and analysts on CNBC and elsewhere indicating that they felt markets would rise in 2013, the mindless euphoria of the late 1990′s doesn’t seem to be present in general, and certainly not among my clients and the prospective clients I talk with.

In fact the mood seems a bit more pessimistic than I would expect given the solid rally in the markets that is close to entering its fourth year.  This pessimism is exemplified by the outflows we’ve seen over the past several years from equity mutual funds.  Much of this money has flowed into fixed income, despite historically low interest rates.

Filter out the noise and invest sensibly 

For regular readers of this blog, my investing suggestions for the current year will look very much like my suggestions for past years:

  • Start with a financial plan.  Your investment strategy should be tied to your goals and risk tolerance.
  • Focus on asset allocation.
  • Rebalance your portfolio as needed, generally twice per year is appropriate.
  • Don’t think you can consistently beat the market, you likely can’t.  This is why asset allocation and a healthy dose of low cost index funds generally make sense for most investors.
  • Use actively managed mutual funds sparingly, but don’t discount active management either.
  • Review your portfolio and your financial plan periodically, but don’t obsess over short-term market moves.
  • Manage all of your investment accounts as a total portfolio, not a collection of separate account.
  • Read up on the markets and the economy but don’t let yourself become driven by what you hear on CNBC or in the financial media.
  • Don’t get your advice from around the water cooler at work.  Your co-workers may be nice folks but they may not be financial experts and their situation may not resemble yours at all.
  • If you need professional advice, hire a competent fee-only advisor.

Here’s wishing you a successful 2013.

Please feel free to contact me with your financial planning and investing questions at any time. 

Check out our Resources page for links to some services and tools that might be beneficial to you.

Photo credit:  Flickr

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Are Mutual Fund Closures a Bad Thing?

December 19, 2012 By 2 Comments
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Road closed, farm road in Champaign County, Il...

You’ve been following a mutual fund for awhile and you’ve decided that this fund is a good fit for your portfolio.  You go online to make an initial purchase and you learn the fund has closed to new investments.  While you might be frustrated, overall I tend to view fund closures as a positive move in most cases.

Factors that might lead to a fund closing 

Typically the main reason that mutual funds close to new investments is that more money is coming in than the managers feel they can effectively invest.  Closely related to this is the rule that funds are only allowed to buy into the stock of a single company if that holding is 5% or less of the total value of the fund.  (Note a holding may constitute more than 5% of a fund’s value due to price appreciation).  Generally fund closures occur in actively managed mutual funds versus passively managed index products.

Fund closures benefit existing shareholders 

In my opinion, a fund closure is generally a sign of a fund company that values its shareholders.  A case in point is Artisan, a fund company based in Milwaukee.  Over the years I have used Artisan Mid Cap Value (ARTQX) extensively in several of the retirement plans for whom I serve as advisor as well in the portfolios of many of my individual clients.  The management team of this fund was named Domestic Manager of the Year for 2011 by Morningstar.

Artisan runs 12 funds, of which 5 are currently closed to new investors, including Mid Cap Value.  Even with the closure, fund assets have topped $8 billion a high for the fund.  The fund’s performance has lagged in 2011, though I don’t think that it is related to the increased size.  The fund ranks in the top 1% of all Mid Cap Value funds over the past 10 years.

The fact that Artisan is willing to close a popular fund like Mid Cap Value speaks volumes about the firm.  Shutting off the spigot of new money means that the firm will lose the fees it would collect on these assets.  Artisan is also in the process of going public.

Examples of large funds that didn’t close 

This can work both ways.  An example of a fund that in my opinion should have closed to new investment is Ariel (ARGFX).  This was an outstanding Small Cap Value fund run by John Rogers, a well-known Chicago-based value investor.  Fund assets ballooned from about $600 million in 2001 to over $4.7 billion in 2005.  The fund never closed its doors to new money and was forced to increase the market cap of the stocks held in the fund.

As a Mid Cap Blend fund, performance has largely been below average, the fund ranks in the middle of the pack for the trailing 5 years and in the bottom 25% of its category for the tailing 10 years.  Performance has picked up in recent years with the fund ranking in the top quarter of its category in 2009, 2010, and year to date in 2012.  In-between the fund ranked in the bottom 7% of its category in 2011.  This improved performance follows a significant decline in fund assets in recent years.

I haven’t followed this fund for several years and have no client money invested here.  Would shareholders have been better served had the fund closed its doors a number of years ago and stuck to the type of investing it was known for?  In my opinion yes, but I’ll leave that to others to decide.

On the flip side of this is Fidelity Contra (FCNTX).  Will Danoff manages about $85 billion in this fund and over $100 billion in this style (Large Growth) when you add in some other portfolios under his management.  The fund has placed in the category’s top 39% or better in every annual period since 2002 with the exception of 2009 (when the fund earned over 29%).  For the trailing 10 years the fund ranks in the category’s top 7%.  To be able to manage this much money as well as Danoff has year in and year out is a commendable and rare feat.

Asset bloat

While asset bloat can be a problem in any fund, it is generally a more serious issue in a fund that invests in small or mid cap stocks.  At some point there are only so many good places to invest new cash coming in.

While fund companies are in the business to make money, my experience has been that the fund companies that tend to close funds when they get too big also tend to run funds that are better performers over time.  At some point if a fund gets too big it might also become a “closet indexer.”  In those situations, why pay the fees associated with an actively managed fund?  Why not just buy an index fund or ETF?

What if my fund closes? 

Typically if you already own a fund and it closes, you be able to buy more shares if you wish.  This is not always the case, however.

If a fund that you were considering closes before you own it, look for an alternative fund.  This might be a good opportunity to consider a low cost index fund or ETF in the same asset class.

Feel free to contact me with questions about your investments.

For you do-it-yourselfers, check out Morningstar.com to analyze your investments and to get a free trial for their premium services.

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Mutual Fund Expenses – Where Real Holiday Savings Can be Found

November 26, 2012 By 4 Comments
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Blue Piggy Bank With Coins - Retirement

As I write this its Cyber Monday, the biggest online shopping day of the year.  Where to save a few dollars on this item or that has been the focus of many news stories and discussion.  While we all like to save money on the things we buy, these savings are “chump change” compared with the savings opportunities available by reducing your expenses on the mutual fund and ETFs in which you invest.  Here are 5 tips for reducing your investing costs for mutual funds and ETFs to help grow your investments for retirement, college savings, and other goals.

Index Funds are Not Created Equal

As an example the Dreyfus Mid Cap Index Fund (ticker PESPX) has an expense ratio of 0.50% which is pricey for a core index fund of this type.  The Investor Share Class of the Vanguard Mid Cap Index Fund (VIMSX) carries an expense ratio of 0.24% and the SPDR S&P Midcap 400 ETF (MDY) has an expense ratio of 0.25%.  An investment of $10,000 in each of these funds made on May 31, 1998 and held until October 31, 2012 would have grown to:

Dreyfus Mid Cap Index

$30,743

SPDR Midcap

$31,643

Vanguard Mid Cap Index

$31,770

The above information is via Morningstar and is based upon the earliest common inception date of the three funds and also assumes reinvestment of dividends and distributions.  Note that an investment in one of the lower cost share classes of the Vanguard fund would yield even better results.

ETF Price Wars are a Good Thing

There is a price war happening among several providers initiated by Schwab to offer the lowest cost ETF.  Vanguard has jumped on the bandwagon by changing the index provider on many of its funds and ETFs; Blackrock’s ishares unit has also joined in.  While I likely would not suggest switching from an already low cost index ETF product because it is not the absolute lowest in cost, I would suggest taking a look at the offerings of the “warring” factions.  You should also take any transaction fees into account as well.  Schwab and Vanguard allow transaction free trading of their own ETFs, TD and Fidelity offer a menu of transaction free ETFs as well.

Your Financial Advisor May be able to Save You Money

In many cases I am able to invest my client’s money in less expensive share classes of a given mutual fund than they might be able to purchase on their own.  As an example PIMco Commodity Real Return as a number of share classes as do most of the PIMco Funds.  I am able to invest client dollars in the Institutional Share Class (PCRIX) with its 0.74% expense ratio and typical $1 million minimum.  This compares to the no-load D shares (PCRDX) with an expense ratio of 1.19% and a $1,000 minimum initial investment.  Often the savings in expense ratios that I can provide to my clients can go a long way in covering a portion of my professional fees.

Ensure that Your Stock Broker or Registered Rep isn’t costing you Money

The flip side of the last point is to make sure that you are not paying more in mutual fund fees just so that your broker or registered rep can make additional fees and commissions.  Case in point is if your money is invested in a proprietary mutual fund offered by the rep’s employer.  While some of these proprietary funds can be decent, all too often they are under performers that are laden with fees and charges to generate revenue for the broker and their firm.

Read your 401(k) Plan Fee Disclosures

Some plans sold by commissioned reps and producing TPAs (Third-Party Administrators) may contain funds that are not very low cost.  Case in point might be a plan with an American Funds fund in the R1, R2, or R3 share classes.  This might also be the case with some Fidelity shares classes (typically the Advisor share class), as well as with some T. Rowe Price funds (the Advisor or the R share classes).  These shares exist typically to compensate a producer.  If you see these or similar share classes for other fund families in your plan it would behoove you to ask the person who administers your plan if it might be possible to move the plan into lower cost funds or fund share classes.

We all like to find a bargain when doing our holiday shopping.  If a fraction of the time and effort that people spend on this activity went into analyzing their investment portfolios, the potential cost savings alone would dwarf anything that you might realize from finding a couple of deals this holiday season.  These savings are not just one-time in nature, but they “keep on giving.”

Check out Morningstar to review the expenses for all of  your mutual funds and ETFs and to get a free trial for their premium services.

Please feel free to contact me with questions about your investments.

Photo credit: Flickr

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