Objective information about financial planning, investments, and retirement plans

4 Considerations When Evaluating Active Mutual Funds

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It’s spring here in Chicago (fingers crossed), the baseball season opened yesterday, and the first quarter of the year is in the books.  This means that you will be receiving statements from your 401(k) and your various investment accounts.  For many investors mutual funds comprise a significant percentage of their portfolio.  Here are 4 things to consider when evaluating actively managed mutual fund holdings.

Who’s running the show? 

Even with index mutual funds the manager(s) of the fund are a consideration.  However the management of the fund is a vital consideration when evaluating an actively managed fund.

Davis New York Venture (DNVYX) is an actively managed large cap blend fund with a long track record of success under two long-tenured co-managers.  When one of these co-managers unexpectedly left at the end of 2013 this was a cause of concern in evaluating the fund.  The fact that Davis moved quickly to replace this manager with an experienced member of the team at Davis was reassuring.  The fund continued its solid relative performance in the first quarter of 2014 after a solid 2013, which was preceded by three very sub-par years.  It is too early to tell what impact the management change with have on the long-term performance of the fund and this will bear close scrutiny.

Another example is the veritable soap-opera unfolding at PIMco over the departure of former Co-CEO Mohamed El-Erian.  While El-Erian didn’t manage many of PIMco’s funds, I’m guessing the whole situation was a distraction to CEO and founder Bill Gross who is also the manager of the firm’s flagship fund PIMco Total Return (PTTRX).  While this situation may not have been the cause, the fund finished in the bottom 15% of its peers in the first quarter.  This is on the heels of sub-par performances in calendar 2011 and 2013, though the fund ranks the top 5% of its peers over the trailing ten years all under Bill Gross’ leadership.

It is not uncommon for a fund that has achieved a solid track record over time to see the manager who was responsible for achieving that track record move on.  It is important when looking a mutual fund with a stellar track record to understand if the manager(s) responsible for this track record are still on board.

Size matters 

One of the truisms that I’ve noticed over the years is that good performance attracts new money.  Even if a top fund is responsible enough to its shareholders to close the doors to new investors before asset bloat sets in, the assets inside the fund might still balloon due to investment gains.  Two closed funds that I applaud for putting their shareholders first are Artisan Mid Cap Value (ARTQX) and Sequoia (SEQUX).

I’ve seen several formerly excellent actively managed mutual funds continue to take on new money to detriment of their shareholders.  Asset bloat can be a huge issue especially for equity mutual funds that invest in small and mid cap stocks.  At some point the managers have trouble putting all of this extra money to work and can be faced with investing in stock with larger market capitalizations.  At this point the fund might have the same name, but it is likely a far different fund than it was at its inception.

Closet index funds

According to a 2011 article in Reuters: 

Since the height of the U.S. financial crisis, more funds are playing it safe, hugging their benchmarks and sometimes earning the unwanted reputation as “closet indexers.” 

About one-third of U.S. mutual fund assets, amounting to several trillion dollars, are with closet indexers, according to research published last year by Antti Petajisto, a former Yale University professor who now works for BlackRock Inc. 

In general, Petajisto defines a closet indexer as a fund with less than 60 percent of its investments differing from its benchmark.” 

I was quoted in this 2012 piece in Investment News discussing closet indexers.  As the article mentions a fund is considered a closet indexer when its R2 ratio (a measure of correlation) reaches 95 in comparison to its benchmark.  In the example of American Funds Growth Fund of America this benchmark index would be the Russell 1000 Growth Index.

The point here is that if you are going to pay up in terms of an actively managed fund’s higher expense ratio, you should receive something in the way of better performance and/or perhaps better downside risk management over and above that which would be delivered by an index mutual fund or ETF.

An example of a an actively managed fund that you might consider being worth its expense ratio is the above-mentioned Sequoia Fund.  A hypothetical $10,000 investment in the fund at its inception on 7/15/1970 held through 12/31/13 would be worth $3,891,872.  The $10,000 invested in the S&P 500 Index (if this was possible) would have grown to $901,620 over the same period.  This fund suffered a much milder loss than did the S&P 500 in 2008 (-27.03% vs. 37.00%) and outgained the index considerably in challenging 2011 (13.19% vs. 2.11%).  Sequoia’s R2 ratio is 80.

R2 can be found on a fund’s Morningstar page under the Ratings and Risk section of the page.

Performance is relative 

Superior performance is an obvious motivation, but you should always make sure to compare the performance of a given mutual fund to other funds in the same peer group.  A good comparison would be to compare a Small Cap Value mutual fund to other funds in this peer group.  A comparison to Foreign Large Value fund would be far less useful and in my opinion irrelevant.

Unfortunately superior active mutual funds are often the exception rather than the rule, one reason I make extensive use of index mutual funds and ETFs.  However solid, well-run actively managed funds can add to a portfolio.  Finding them and monitoring their performance does take work.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. Click on the Amazon banner below to go directly to the main site or check out the selections on financial planning and related topics in our Book Store.

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What I’m Reading – March Madness Edition

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It’s a bit of a lazy Sunday here and I am half surfing the web and half watching the NCAA Men’s basketball tournament.  I’m not the college basketball fan that I once was, but I still love March Madness and watch every game that I can.

In 1939, H.V. Porter of the IHSA coined the te...

Here are some financial articles that I’ve read lately that you might find interesting and useful:

The Ultimate Guide to Understanding Your 401(k) A great piece loaded with information for those who might be new to 401(k) investing or who just want to learn a bit more by Harry Campbell on his blog Your Personal Finance Pro.

Five strategies to get the most Social Security another excellent and informative piece by Robert Powell at Market Watch.

And You Thought Just Tuition Was Expensive a nice piece on the Morningstar site that discusses how college expenses other than tuition can really put a strain on parents and students trying to pay for college.

Are You Paying Too Much For Mutual Funds?  Dana Anspach does a good job of addressing this important question at U.S. News.

The IRS Releases Their “Dirty Dozen” Tax Scams for 2014 was featured on Jim Blankenship’s excellent blog Getting Your Financial Ducks in a Row.

Americans and Retirement: 3 Worrying New Findings discusses EBRI’s most recent Retirement Confidence survey on Wall Street Cheat Sheet.

If you are new to The Chicago Financial Planner here are the three most popular posts over the past 30 days:

Your 401(k) is not Free

Life Insurance as a Retirement Savings Vehicle – A Good Idea?

7 Retirement Investing Tips

Well that’s it I hope you enjoy some of these articles and the rest of your Sunday.  I’ve watched a couple of good tournament games so far with hopefully more to follow.  Cool and sunny here today, but none the less good grilling weather, chicken is on the menu for tonight.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. Click on the Amazon banner below to go directly to the main site or check out the selections in our Book Store.

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Investing: The Bull Market Turns 5 What Now?

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The S&P 500 Index hit a low of 677 on March 9, 2009 at the bottom of the market drop connected to the financial crisis.  Since then the market has been on a tear, closing at 1,878 on March 7, 2014 for a gain of 178%.  Many market averages are at or near record highs.  As the rally celebrates its 5th anniversary what should investors expect going forward?

Birthday Party BashAccording to CNBC:

  • This Bull Market is the 2nd strongest since World War II
  • This is the 6th longest Bull Market of all-time
  • This is 4th strongest Bull Market of all-time 

How long do Bull Markets typically last? 

According to Zacks Investment Research the average length of a Bull Market since 1921 is 62 months and the average gain is 180%.  The median gain is 115% and the median length is 50  months.

At 60 months and counting with a gain of about 178% the current Bull Market is about average.

What’s next?

Over this past week I’ve heard varying opinions on CNBC.  Perpetual stock market Bear Harry Dent is predicting the Dow Jones Industrial Average will drop to 6,000 by 2016 from its current level of 16,453.

Another guest thought we were in the middle of a 15 year secular Bull Market.  Basically anyone’s guess is as valid as anyone else’s.

What should you do now? 

Perhaps more than ever a financial plan will put you on the right path.  If you stayed in the markets through the financial crisis and through these past five years your portfolio has likely done pretty well.  Perhaps you are even ahead of your retirement goals.  Your financial plan will help you determine where you stand relative to your goals.  This process will also help you determine if your asset allocation is still appropriate or if perhaps you should dial down your level of risk.

Investing when it feels good can be dangerous.  I wrote Investing: John Hancock’s TV Ad – Brilliant and Disturbing last year criticizing the company’s ads suggesting now was a good time to get back into the market.  Clearly anyone who did invest at the time of these ads did pretty well in 2013, but time will tell on longer term basis.  Moreover investors who feel the need to jump back into the markets because they feel like they missed out may live to regret that decision.

I have no idea what the future holds and I’m not saying that investing in equities is a bad idea.  What I am saying is that investors should not get caught up in the current market euphoria, but rather they should invest based upon their goals, risk tolerance, and the time horizon in which the money will be needed.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. Click on the Amazon banner below to go directly to the main site or check out the selections in our Book Store.

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The Super Bowl and Your Investments

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Lombardi Trophy - Super Bowl XXXI

It’s Super Bowl time and once again my beloved Packers are not playing.  At least they beat the hated Bears to make the playoffs.  Every year the Super Bowl Indicator is resurrected as a forecasting tool for the stock market.

This indicator says that a win by a team from the old pre-merger NFL is bullish for the stock market, while a win by a team from the old AFL is a bad sign for the markets.  Looking at this year’s game, Denver is an original AFL team while Seattle is neither.  The Seahawks came into existence in the 1970s (post-merger) first as an NFC team, then moved to the AFC, and are now back in the NFC.  To me this disqualifies them from this “scientific” prognostication tool but what do I know?

According to a recent Wall Street Journal article the indicator seems to work around 70% of the  time mostly because old NFL teams (which include the Steelers, Colts, and Ravens) have won a majority of the time (there is a 70% probability of this according to the WSJ article).  A notable exception occurred when the Broncos won in 1998 and 1999 and the stock market went up both years.

What should you do?

My suggestion is to enjoy the game, the halftime show, the commercials, and eat plenty of unhealthy food.

As far as your investments, I think you’ll agree that the outcome of the game should not dictate your strategy.  Rather I suggest an investment strategy that incorporates some basic blocking and tackling:

  • A financial plan should be the basis of your strategy.  Any investment strategy that does not incorporate your goals, time horizon, and risk tolerance is a bit flawed.
  • Take stock of where you are.  Have the strong stock market of 2013 and the almost five year rally since March of 2009 caused your portfolio to be over weight in equities?   If so perhaps it’s time to rebalance.
  • Costs matter.  Low cost index mutual funds and ETFs can be great core holdings.  Solid, well-managed active funds can also contribute to a well-diversified portfolio.  In all cases make sure you are in the lowest cost share classes available to you.
  • View all accounts as part of a total portfolio.  This means IRAs, your 401(k), taxable accounts, mutual funds, individual stocks and bonds, etc.  Each individual holding should serve a purpose in terms of your overall strategy.  

As far as the game, it should be a good one.  I suspect we will root for Seattle only because of Pete Carroll (we are USC fans and the proud parents of a 2010 USC grad).  On the other hand how can you not like Peyton Manning?

How has the Super Bowl Indicator done?

Going back to the game played in 2000 (following the 1999 season) the Super Bowl Indicator has been right 8 times, wrong 5 times, with one that I would call not applicable.  The 2003 game saw Tampa Bay an NFC team that came into existence post-merger won and the market (defined as the S&P 500 for this analysis) did go up so I will leave it to you be the judge on this one.

Notable misses during this time period:

  • St. Louis (an old NFL team) won in 2000 and the market dropped.
  • Baltimore (an old NFL team that was formerly the original Cleveland Browns) won in 2001 and the market dropped.
  • The New York Giants (an old NFL team) won in 2008 and the market tanked in what was the start of the recent financial crisis.

The Super Bowl Indicator is another fun piece of Super Bowl hype.  Your investment strategy should be guided by a financial plan, not the outcome of a football game.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your financial planning and investing questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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Shake-Up at PIMco – Should Investors Care?

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The big news in the mutual fund world this past week was the announcement that PIMco Co-Chairman Mohamed El-Erian will be resigning from the firm effective in March.  El-Erian is a frequent guest on CNBC and a really smart guy.  This has been a huge story in the financial press.  As an investor should you care?

Mohamed el Erian - World Economic Forum Summit...

Some background 

PIMco was founded by the soon to be sole Chairman and Chief Investment Officer Bill Gross.  PIMco is perhaps the preeminent bond mutual fund shop.  Many financial advisors, including yours truly, have client assets invested with them.  Their flagship bond fund PIMco Total Return (PTTRX) has had middling results the past couple of years and experienced significant fund outflows in 2013.

El-Erian is the second key executive to leave the firm recently preceded by the retirement of Paul McCulley in 2010.  Some say El-Erian’s departure is an outgrowth of PIMco’s rough year in 2013.

What others are saying 

Jeff Benjamin of Investment News wrote:

“Even as speculation ranges from whether the highly regarded and high-profile economic strategist was forced out or simply burned out, the general consensus is that Mr. El-Erian’s departure will not hurt Pimco‘s reputation or asset management prowess. 

“The news was an incredible surprise, and we have a number of clients with investments in Pimco funds,” said Richard Konrad, managing partner at Value Architects Asset Management. 

 “But at the same time, the issue of talent within the Pimco organization is unquestionable,” he added. “Even without [Mr. El-Erian], the essence of the firm remains, along with a track record that has been established over many years.”” 

The New York Times Dealbook said:

“The move was surprising because Mr. El-Erian, 55, has been the public face of Pimco since he rejoined the company in 2007, taking some of the spotlight from the company’s famous founder and co-chief investment officer, William H. Gross. 

In 2012, Mr. Gross said, “Mohamed is my heir apparent.” On Tuesday, by contrast, Mr. Gross took to Twitter to announce: “I’m ready to go for another 40 years.” That would take Mr. Gross to his 109th birthday. 

Mr. El-Erian’s resignation underscores the upheaval in the investment world as rising interest rates put an end to a bond bull market that lasted for decades and helped build industry giants like Pimco and BlackRock.” 

My take on the PIMco announcement 

PIMco is a very solid fund company with a deep bench of talented managers and researchers that offers a number of very solid mutual funds, closed-end funds, and ETFs.  They are best known as fixed income managers, which going forward will be a tough place to be for any firm.

On the other hand company literature has often mentioned the use of a consensus model called their Secular Outlook developed as the result of an annual meeting of PIMco personnel.  One has to wonder with El-Erian and McCully gone will Bill Gross dominate the discussion here or will others within the organization be able to step up and balance Mr. Goss’ views?  More importantly does PIMco have or are they in the process of developing a succession plan? As youthful as Mr. Gross looks at 69 I’m not counting on him being around PIMco for another 40 years as he indicated he is “… ready to go…”

This situation brings to mind Janus Funds, one of the preeminent go-go growth mutual fund houses of the 1980s and 1990s.  Beginning with the departure of star manager Jim Craig in 1999 and followed by the market drop of 2000-2002, several corporate restructurings, involvement in the mutual fund scandal of the early 2000s, and an awful lot of fund manager and executive turnover this company has never been the same.  I’m not saying PIMco will follow suit, but the potential parallels are there.

My strategy is simple.  I plan to watch the overall situation with the firm and to continue to evaluate my client’s PIMco holdings in the same fashion as before this announcement.  In my opinion this management shake-up is not a cause for any immediate or drastic action, but time will tell.

Personnel issues with a mutual fund and or its parent company are a valid reason to place a fund or a family of funds on your watch list.  This is generally a component of an Investment Policy Statement.  Do you have an orderly due diligence process in place to react to changes in your mutual funds and those in charge of managing them?

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your financial planning and investing questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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My Fearless 2014 Investing Forecast

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With the start of a new year, there is no shortage of forecasts about almost everything under the sun.  Forecasts about the economy and the financial markets abound throughout the financial news media and on the various cable financial news shows.  Here is my fearless and guaranteed to be accurate 2014 stock market forecast.

English: Dartboard with darts. Suomi: Tikkataulu.

As the top financial officer of one of my retirement plan sponsor clients predicts at the start of each year, I can say with 100% confidence that the stock market as a whole and the various market benchmarks will finish 2014 either higher, lower, or unchanged when compared with the levels at the end of 2013.

Further I will make the same prediction for your overall portfolio and for each of the individual investments you hold including mutual funds, ETFs, individual stocks, bonds, closed-end funds, and all other investment vehicles.

Forecasts are fun, but at the end of the day the performance of the financial markets and your individual holdings is beyond your control.  While the details underlying some of these forecasts are worth reading, as investors we need to focus on the factors that we can control versus worrying about what the market will or won’t do.

Investment expenses 

Morningstar, the PBS Frontline program The Retirement Gamble, and many other sources have highlighted the negative impact that high cost investments can have on your returns and the amount you accumulate for retirement and other goals.

Investment expenses can include:

  • Expense ratios on mutual funds, ETFs, closed-end funds, and variable annuities.
  • Transaction costs to buy or sell investment vehicles, this also includes front and back-end sales charges on mutual funds and annuities.
  • Expenses for investment advice.

Like anything else you want to keep these expenses as reasonable as possible and be sure that you are receiving appropriate value for any expenses incurred.

Portfolio risk 

While many of the pundits are saying stocks are undervalued, with the Dow, the S&P 500, and other market benchmarks at or near record highs the markets are inherently more risky.

For example the S&P 500 had its best year since 1997.  Even after big gains in 1997 the index had solid years in 1998 and 1998 before the Dot Com bubble and subsequent decline from mid 2000 thru most of 2002.  The markets may well continue on this pace in 2014 and beyond, but at some point we will see a correction.  Don’t become overconfident or complacent.

A good way to keep portfolio risk in check is to periodically rebalance your portfolio.  This is very important in a rising market like this one where your equity allocation can quickly exceed your desired allocation.

Along these same lines make sure that your portfolio is diversified.  This does not mean owning a large number of individual holdings but rather having some portfolio holdings whose performance is not closely correlated to the rest of portfolio.

Invest with a plan in mind 

Perhaps the most important investing element under your control is having a financial plan in place.  My biggest beef with “financial advisors” who focus on selling financial products is that they seem to lead with a sales pitch rather than with a financial plan.

Regular readers of this blog know that I am an advocate of an investing strategy that is an outgrowth of your financial plan.  I view investing as a vehicle to achieve your financial and life goals such as funding college for your kids and retirement.  How can you invest in a fashion that supports your goals and is appropriate for your time frame to achieve these goals and your risk tolerance without a financial plan in place?

A look at some famous market forecasters 

As long as I can remember there have been people forecasting what will happen in the financial markets.  Here are a few of the more colorful and noteworthy of this group:

Joe Granville was a well-known market forecaster of the 1970s, 1980s, and 1990s.  He published a popular newsletter, The Granville Market Letter, which had a notoriously poor track record.  He was also quite entertaining.  I had the occasion to see his “show” circa 1980 or ’81 as a graduate student at Milwaukee’s Marquette University.  All I recall is Granville playing the piano in his suit and boxer shorts on stage at a local movie theater.  Mr. Granville died in 2013, rest in peace Joe.  Check out this excellent piece about Granville by Mark Hulbert on Market Watch Four lessons Joe Granville taught us.

Elaine Garzarelli was an analyst with Shearson Lehman when she successfully called the 1987 market crash.  She was subsequently fired from the firm in the mid 90s after the firm cited the high cost of her research operation.  Ms. Garzerelli was a top-notch research analyst who became a bit of celebrity, even serving as a pitchwoman for pantyhose in a TV commercial.  Her call on the markets in 1987 is what launched her career and she is a true “one hit wonder.”

Meredith Whitney made a famous call about impending doom and gloom in the municipal bond market in an interview with 60 Minutes in late 2010.  Guess what, outside of the Detroit bankruptcy her prediction was pretty much a bust.  This hasn’t stopped the likes of CNBC from featuring here as a frequent guest expert. Barry Ritholz summed it up very nicely in this post Meredith Whitney, 2011 Winner, Elaine Garzarelli One-Hit Wonder Award on his excellent blog The Big Picture.

I’m not dismissing market forecasts out of hand; much of the research and analysis behind these forecasts is interesting and valuable to investors.  However at the end of the day investing is about you, your goals, and your tolerance for risk.  Control the factors that you can control and don’t lose a lot of sleep worrying about the factors you can’t control.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your financial planning and investing questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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New Stock Market Highs: It’s Different This Time Right?

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Dow Jones (19-Jul-1987 through 19-Jan-1988).

It seems like every time we hit new highs in the stock market, the pundits tell us that somehow it’s different this time.  In 1999 we didn’t need to worry that many of the high-flying tech stocks had no balance sheet or even a viable business plan behind the company.  We all remember how that turned out.

In 2007 Wall Street couldn’t securitize questionable mortgages fast enough.  Mortgages and real estate were very secure investments.  Again we recall how that turned out.

This year the markets are again reaching record highs.  Both the Dow Jones Industrial Average and the S&P 500 stand at record levels as I write this.  No worries say the experts.  Valuations are reasonable and this isn’t a bubble (translation, it’s different this time).  We don’t know how this will turn out, but hopefully those of you with any degree of common sense will recall and apply the lessons of the past 15 years.

Who’s paying the pundits? 

Day after day there are guests on CNBC and similar programs touting stocks.  The chief investment strategist of a major financial services firm recently dismissed any talk of a bubble in stocks at least in the near term.

These folks may be right; perhaps this almost five year old bull market still has a way to go.  But somewhere in the back of my mind I also have to wonder if they aren’t touting stocks because it is in the financial interests of their firms (and perhaps their annual bonuses) for investors to keep investing in stocks.

So what should investors do in this stock market environment? 

What should you do now? 

If you are a regular reader of this blog nothing that I’m going to say below will surprise you nor will it differ from what I’ve been saying for the 4+ years that I’ve been writing this blog or the almost 15 years that I’ve been providing advice to my clients.  For starters:

  • Step back and review your financial plan.  Where do the recent gains in the stock market put you relative to your goals?
  • Does your portfolio need to be rebalanced back to your intended allocations to stocks, bonds, cash, etc.?
  • Review your asset allocation.  Is it still appropriate for your situation?
  • Review the holdings in your portfolio.  In the case of mutual funds and ETFs, how do they compare to their peer groups (for example if you hold a large cap growth fund compare it against other large cap growth funds)?  Would you buy these holdings today for your portfolio?
  • Ignore the market hype from the media and from financial services ads.

If you don’t have a financial plan in place this is a great time to get this done. 

Remember the lessons learned from the market downturns of 2000-2002 and 2008-2009.  While your portfolio will likely sustain losses in a major market downturn or even a more moderate and normal sell-off, diversification helps.  Diversified portfolios fared far better than those that were overweight in equities during the decade 2000-2009.  Portfolios with a diversified equity allocation generally fared better than those heavily weighted to just large cap domestic stocks that use the S&P 500 as a benchmark.

Of note, bonds have been a great diversifier in the past, especially over the past 30 years with the steady decline in interest rates.  With rates at historically low levels at the very least investors may need to rethink how they use bonds and what types of fixed income products to use in their portfolios.

My point is not to imply that a market correction is imminent or that investors should abandon stocks.  Rather the higher the markets go, the greater the risk of a stock market correction.  Make sure your portfolio is properly allocated in line with your financial goals and your tolerance for risk.  Many of the investors who suffered devastating losses in 2008-2009 were over allocated to stocks.  Tragically many couldn’t stomach the losses and sold out near the bottom, booking losses and in many cases missing out on the current market gains.

Revisit your financial plan and rebalance your portfolio as needed.  Most of all use your good common sense.  It’s not different this time regardless of what the experts may say.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

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7 Reasons to Consider Selling a Mutual Fund

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Investing in mutual funds takes work, even index funds. Whether you own actively managed funds or index funds you still need to monitor your holdings. Here are 7 reasons you might consider selling a mutual fund holding.

Sale

A significant outflow of dollars

In my view, mutual fund managers should try to stay fully invested within their investment mandate. If I am investing in mutual fund in the large growth style, I want those dollars invested in large cap growth stocks.  I don’t want an equity fund manager deciding to be in cash, if I want to be in cash I’ll put that portion of the portfolio in a money market fund.   When a mutual fund experiences a high level of redemptions the managers may need to keep more cash on hand to meet these redemptions. This cash is not being invested in the stocks, bonds or other vehicles that the fund should be focused on.  In an up market like this one excess cash can be a drag on returns.

A significant inflow of dollars

Money follows success. Last year’s hot fund will attract more investors hoping to latch on to the fund’s success. Too much new cash in a short time frame can pose a real problem for a fund manager in terms of finding good investment ideas within the fund’s investment style.

This is not as significant for an index fund or a fund that invests in larger cap stocks.  However, for a fund investing in small- or mid-cap stocks this can be a death knell in terms of future success. I really admire mutual fund companies who close popular funds when they become too large.  Two that come to mind are Sequoia Fund (SEQUX) which was closed for over 20 years at one point and recently closed again after reopening for a couple of years (purchases can only be made directly from the fund company last time I checked).  Another is Artisan Funds and their Artisan Mid Cap Value Fund (ARTQX).  The mention of these funds should not be construed as investment advice in any way, shape, form. 

The flip-side is funds that simply allow new money to come in droves.  All too often these once stellar performers become tomorrow’s laggards.  I don’t know if this behavior is born out of stupidity, greed, hubris, or all three.  At the very least a fund taking in a vast amounts of new money should be raise a red flag as you monitor your portfolio. 

 A change in personnel

For an actively managed fund, a manager change is a significant event. Who will be in charge going forward? Will the fund’s investment style stay the same? This can also be an issue for an index product in terms of a change in its indexing methodology.

Personnel issues in the management of the fund company can also be an issue. As an example once high-flying Janus Funds has experienced heavy turnover in the executive suite over the past decade.  There has also been a fair amount of management turnover in many of the company’s mutual funds.  I find it hard to believe that this doesn’t have an impact on day to day operations and the management of the funds.

A change in the fund’s investment style  

I alluded to shifting investment styles above, but it’s worth repeating.  For example I recently suggested to the Committee of 401(k) plan for whom I serve as investment advisor that we remove a mutual fund whose investment style had shifted along with their investment methodology and some of the fund’s personnel.  While there’s nothing wrong with a go-anywhere fund that is style agnostic, if your intent is to invest in a mutual fund that invests in small cap growth stocks you should consider replacing that fund if its investment style changes to say small cap blend or value.

Fund mergers

Mutual fund companies sometimes merge laggard funds into other mutual funds within their families.  There are rules about restating past results for the surviving fund, but nonetheless if this happens to a fund you own, or recently took place in one you are thinking of buying, be sure to dig into the details, holdings and performance of the surviving fund to be sure it still makes sense for you as a part of your portfolio.

The reasons listed above generally warrant selling out of mutual fund entirely.  Here are two additional reasons to consider a total or partial sale that have nothing to do with negative developments with the fund. 

Donating appreciated fund shares 

As year-end approaches many of us look to make contributions to our favorite charities.  If you own shares of a mutual fund that has appreciated in value donating some or all of the shares to the charity is an excellent and tax-efficient way to make this contribution.  By donating appreciated shares owned in a taxable account (as opposed to a tax-deferred account like an IRA) you avoid paying capital gains taxes that would be due if the shares were simply sold.  You also receive a charitable deduction for the full market value of the shares donated.  Many charities have the capacity to receive donations in this fashion. 

Rebalancing your portfolio 

I generally suggest that most people look to rebalance their portfolio back to its intended asset allocation at least once or twice annually.  For example with the solid gains in most equity asset classes this year and the relatively flat to down performance of many fixed income asset classes, it is likely that your portfolio is over allocated to equities.  This potentially exposes you to more risk than your financial plan and your asset allocation calls for.  It is very appropriate in this case to sell off some of your mutual fund (or other investments) holdings where you are over allocated and adding to fund positions in areas of the portfolio that have become under allocated. 

I am not an advocate of the frequent buying and selling of mutual funds or any other investment vehicle for that matter.   However, mutual fund investing is not about sending in your money and forgetting about it. Successful mutual fund investors monitor their holdings and make changes when and if needed based upon a number of factors.  

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your financial planning and investing questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

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1% a Small Number with Big Implications

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The inspiration for this post comes from fellow finance blogger and financial advisor Jim Blankenship and his November is “Add 1% to Your Savings Month” movement.

It’s amazing how a small number like 1% can have such a big impact on your investments and the amount you’ll be able to accumulate for goals like retirement.  Here is a look at the impact of saving 1% on your investment expenses.

Mutual fund expenses matter

Using two share classes of the American Funds EuroPacific Growth fund as an example, the chart below illustrates the impact of 1% in expenses on the growth of your investment.  I was able to find two share classes of this fund whose expense ratios were exactly 1% different.  The B shares (ticker AEGBX) carry an expense ratio of 1.59% and the F-2 shares (ticker AEPFX) which carry and expense ratio of 0.59%.  Using Morningstar’s Advisor Workstation I compared the growth of a hypothetical $10,000 investment in each fund held over three time periods.

5 years ending 10/31/13 

Value of $10,000 investment
B Shares $17,710
F-2 Shares $18,606

 

As you can see varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $896 a 5.1% increase over an investment in the B share class.

10 years ending 10/31/13

Value of $10,000 investment
B Shares $22,677
F-2 Shares $24,734

 

Again varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $2,057 a 9.1% increase over an investment in the B share class.

From 4/30/84 through 10/31/13 

Value of $10,000 investment
B Shares $205,652
F-2 Shares $260,042

 

Once again varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $54,390 a 26.4% increase over an investment in the B share class.

A couple of things about the above comparison:  The assumption is that an investor put $10,000 into each of the funds and held them for the full time period, including the reinvestment of all fund distributions.  Any potential taxes or the expenses of engaging an investment advisor were not considered.  Further B shares are no longer available to new investors and even when they were they would generally convert to the less expensive A shares after a period of time.  None the less this comparison illustrates the impact saving 1% on your investment expenses can have on your returns and the amount you can potentially accumulate over time. 

How to reduce investing expenses 

While you may not always be able to save a full 1%, reducing your investment expenses by even a fraction of 1% can have a significant positive impact.  Here are some ideas that may help:

  • Utilize low cost index mutual funds and ETFs where possible and where they fit your investment strategy.  In many asset classes index funds outperform the majority of actively managed products.  Combine this with low expenses and index funds have a major leg up on most of their competitors.
  • In all cases make sure that you invest in the lowest cost share class of a given mutual fund that is available to you.
  • Avoid sales loads whenever possible.
  • Understand the expenses associated with the investment choices in your company’s 401(k) plan and the plan’s overall expenses.  If they are excessive consider asking your company’s plan administrator to look at some lower cost alternatives.  You might also  consider limiting your contributions to the amount needed to receive the maximum company match (if one is offered) and invest the remainder of your retirement savings elsewhere.
  • If you work with a financial advisor you must fully understand all of the ways in which your advisor makes money from your relationship.  This might include fees (hourly, flat-fee, or a percentage of assets).  In some cases the advisor makes money from the investment and insurance products they sell to you.  This can include up-front sales commissions (loads), deferred loads (B shares which are mostly obsolete), and level loads (C shares).  Additionally the advisor may make money from trialing commissions (12b-1 fees) or surrender charges incurred if your sell out of some mutual funds or annuity products too early.  If you are a regular reader of this blog you know that I am horribly biased in favor of using fee-only advisors (of which and I am one), avoiding the inherent conflict of interest that can arise when an advisor earns money from the sale of financial products. 

Saving 1% might seem like a trivial endeavor, but as you can see it can have big ramifications for investors.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your financial planning and investing questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

Photo credit:  Flickr

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