Objective information about financial planning, investments, and retirement plans

What I’m Reading – Triple Crown Edition

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The Belmont Stakes offers the chance for California Chrome to become horse racing’s first Triple Crown winner since 1978.  Win or lose he is destined for nice life after racing as he will surely command enormous stud fees that will enrich his owner’s.  We will certainly be watching and rooting for him.

Kentucky Derby 2014-0186

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

Stan Haithcock offers some great insights for annuity holders in How to evaluate your annuity contract at Market Watch.

There is a new king in terms of 401(k) assets as reported in Vanguard Passes Fidelity to Become Number One in 401(k) Assets at Bloomberg.

Jim Blankenship shares Mechanics of 401(k) Plans – Loans  shedding light on this often misunderstood aspect of 401(k) plans at Getting Your Financial Ducks in a Row.

Scott Holsopple explains What to Do With ‘Orphaned’ 401(k)s at US News.

Russ Thornton discusses The Lifestyle Cost Of High Investment Expenses at Wealthcare for Women.

Michael Zhuang declares Variable Annuity: Bad Investment! at Investment Scientist.

Mike Piper of Oblivious Investor always does an excellent job of explaining complex topics in easy to understand terms, so consider checking out his latest book.

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

Financial Advisors to Follow on Social Media

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

Peyton Manning and Investment Success

I hope you enjoy some of these articles and hope you have a great weekend.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  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.

  

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.

Photo credit:  Flickr

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What I’m Reading – Memorial Day Edition

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The Memorial Day weekend is looking like a good one in terms of the weather here in the Chicago area.  It should be a great weekend for family fun and for any activities that you may have planned.  Let’s not forget what Memorial Day is all about though and give thanks to our current and former members of the military for all they have sacrificed for us.

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

Josh Brown offers his unique insights into the thought process behind brokers who sell non-traded REITS to clients as only he can in Scenes from an Independent Brokerage Firm at The Reformed Broker.

Wade Slome discusses the Rise of the Robo-Advisors: Paying to Do-It-Yourself at Investing Caffine.

Jim Blankenship shares Mechanics of 401(k) Plan – Vesting shedding light on this often misunderstood aspect of 401(k) plans at Getting Your Financial Ducks in a Row.

Ryan Guina offers the AAFES Coupon Guide – How to Save Big at the Exchanges a guide to savings for eligible shoppers at the Army Air Force Exchange service at The Military Wallet.

Emily Guy Birken discusses What You Need to Know About Disability Insurance for the Self-Employed at PT Money.

Mitch Tuchman tells us that Advice seekers retire with 79% more money at Market Watch.  Food for thought for retirement investors.

Russ Kinnel tells us to Lower Your Fees, Boost Your Returns at Morningstar.  Always good advice for mutual fund investors. 

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

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

Financial Advisors to Follow on Social Media

Peyton Manning and Investment Success

I hope you enjoy some of these articles and have a great holiday weekend.

Looking for a good read this weekend, check out Still Standing by Major (ret) Steve Hirst. Steve was a year behind me in high school and was severely injured in an auto accident while serving in Alaska in the mid 1990s. The book is well written and provides an inspriational account of his long road back and some of the obstacles Steve faced along the way.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  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.

 

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.

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Are Alternative Investments the Right Alternative for You?

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Alternative investments are all the rage these days.  Mutual fund companies are falling all over themselves to sell financial advisors and their clients on “liquid alts” or hedge fund-like strategies with the daily liquidity offered in a mutual fund wrapper.  Hedge funds were allowed to advertise due to a change in the rules last year.  The financial press is filled with articles about alternatives and the fund companies are offering numerous webinars and conferences covering them.

Are alternative investment strategies right for your portfolio?  I have no idea but here are some questions to ask as well as some information for you to consider.

What is an alternative investment strategy?

Alternatives are basically investment vehicles that aren’t purely stocks, bonds, or cash. The purpose of alternatives is generally to diversify an investment portfolio.  Ideally these strategies will have a low correlation to other investment vehicles in your portfolio.  Examples of alternative strategies include:

  • Hedge funds
  • Unconstrained fixed income
  • Macro strategy funds
  • Commodities and managed futures
  • Real estate
  • Precious metals
  • Long/short equity
  • Convertible arbitrage
  • Private equity
  • Vulture funds
  • Venture funds
  • Merger arbitrage 

As mentioned above, these strategies are available in the more traditional hedge fund format, as mutual funds, ETFs, and as fund of funds in each of these formats.

Consider this before investing in alternatives 

Before buying an alternative fund or product here are a few questions to consider:

  • Do you understand the underlying investment strategy?
  • What benefit will this investment provide to your overall portfolio?  Reduced volatility?  Low correlation to other holdings?
  • What are the expenses? Are they justified given the expected benefit of investing in this alterative fund?
  • Are there any restrictions on redeeming your investment? Typically (but not always) with a mutual fund or ETF the answer is no, hedge funds may have a lockup period or other restrictions.
  • Have this fund’s performance been tested in real market conditions or just back-tested on a computer?
  • Who’s managing the fund?  What is their background and track record? 

I am actually a fan of alternatives and have used several mutual funds of this type for a number of years.

Remember though, large endowments like those of the Ivy League schools use alternative investments extensively and successfully.  Unlike you they have access to the expertise needed to perform proper due diligence. Does the financial advisor recommending these funds to you really understand them? Be sure that you do before investing in any alternative investment product.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  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. 

 

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

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Peyton Manning and Investing Success

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I attended the Envestnet Advisor Summit at the Chicago Hilton this past week.  Excellent conference, Envestnet offers a robust platform for financial advisors.  A colleague urged me to attend and I’m glad I did.

The highlight of the conference was Peyton Manning’s keynote address on Friday morning.  Regular readers here know that I am diehard fan of the Green Bay Packers, but I think all football fans have to respect Manning’s skill and his character.  His address was about leadership and being a game changer.  I felt that several of his remarks and comments have a direct correlation to being a successful investor.

Peyton Manning

Thrive on discomfort 

Manning made this reference in terms of it being a key trait of game changers.  I think this is a key trait of successful investors as well.

The investing landscape has certainly undergone change and disruption since the beginning of this century.  We’ve experienced the bursting of the Dot Com Bubble, the financial crisis of 2008-09, the Flash Crash and many other disruptions.

Successful investors adapt to change and embrace it to their advantage.  In some cases this means knowing when to change their investing style, in others it means knowing when to stay the course.  It also means knowing how and when to use new investing tools like ETFs and others.

Ask questions 

Manning mentioned this as a key trait of leaders in business and something that he does constantly in an effort to guide his team to even greater levels of success.

Investors should always ask questions.  Some key questions include:

  • Would I buy this particular investment today?
  • Is there a better place for my money?
  • What are your conflicts of interest in terms of advising me to make this investment?
  • How does this investment fit into my overall portfolio?  

It’s over move on after a bad play

Manning cited the uncanny ability of 49ers great Joe Montana to lead his team to a touchdown on the series immediately following his having thrown an interception.

This is a key trait for successful investors to adopt.  I can’t tell you how many investors I’ve spoken to who want to hold a losing position until it breaks even.  The ability to accept an investment loss is critical.  Sometimes it is better to realize a loss and reinvest the proceeds elsewhere.  Even the best investors make bad investing bets.  The successful ones are capable of admitting this and moving on.

Invest in a coach to keep you growing

Manning hired the current Duke Head Football Coach as his offseason coach to help him improve his quarterback skills.  This individual was his offensive coordinator in college at Tennessee.  This is Peyton Manning, 5 time MVP and Super Bowl champion hiring a coach to help him improve his game!

Many investors do a great job of accumulating wealth and managing their investments.  At some point even the most successful ones realize that they might need some outside expertise to take things to the next level.

Perhaps this realization comes as their career and family obligations limit the time they can spend on their investments.  Often this realization comes as retirement approaches.

Hiring a financial advisor is not a sign of weakness; rather it is a sign that you realize the limits of your expertise and the best uses of your time.  If you are at this point here is a guide to choosing a financial advisor that might help you.

Peyton Manning spoke about leadership and did a great job of tying in his experiences as a leader in sports to what financial advisors need to do to lead clients to the successful outcomes they are seeking.  As I listened to him speak I couldn’t help but see the relevance of his message to what I believe it takes to be a successful investor in today’s dynamic investing world.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  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. 

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.

Photo credit:  Flickr

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Financial Advisors to Follow on Social Media

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For those of you who are regular readers here you know that I publish list posts very infrequently, so two in a row is a real rarity.  However both the nature of the list below and the fact that I am in and out of the office about equally this week convinced me to go this route.

BrightScope, a leading provider of independent financial information and research, just released their first Social Influence Rankings for Financial Advisors.

While I was astonished to be number three on this list, I am flattered to be included on a list that includes a number of people whom I admire and learn from.  This list includes Jim Blankenship, George Papadopoulos, and Russ Thornton who I’ve followed from the onset of my involvement in social media.

Josh Brown, Carolyn McClanahan, Neal Frankle, Jeff Rose, Jason Hull, Jude Boudreaux, Alan Moore, Sheri Cupo, and Tom Brakke are others who I follow on a regular basis.   I plan to become familiar with the rest of this list and learn from them as well.

If you are looking for good information about investing, financial planning, retirement, and related financial topics this list is for you.

BrightScope’s 2013 Top Social Influencers in the United States:

Advisor Pages Profile – Blog – Twitter Handle

1. Josh Brown - The Reformed Broker - @ReformedBroker
2. Barry Ritholtz The Big Picture - @ritholtz
3. Roger Wohlner - The Chicago Financial Planner - @rwohlner
4. Jason Hull - Hull Financial Planning - @hull_j
5. Michael Kitces - Nerd’s Eye View - @MichaelKitces
6. Russ Thornton - Wealthcare for Women - @RussThornton
7. Charles Sizemore - Sizemore Insights - @CharlesSizemore
8. George Papadopoulos - George Papadopoulos on WSJ - @feeonlyplanner
9. Cullen Roche - Pragmatic Capitalism - @cullenroche
10. Jeff Rose - Good Financial Cents - @jjeffrose
11. Jim Blankenship - Getting Your Financial Ducks In A Row - @BlankenshipFP
12. David Merkel - The Aleph Blog - @AlephBlog
13. David Fabian - Investor Insights Blog - @fabiancapital
14. Ted Jenkin - Your Smart Money Moves - @oXYGenFinancial
15. Meb Faber - Meb Faber Research - @MebFaber
16. Alan Moore - Serenity Financial Consulting Blog - @R_Alan_Moore
17. Kimberly L. Curtis - Wealth Legacy Institute Blog - @KimCurtisLegacy
18. Ric Edelman - Edelman Financial Services Education Center - @ricedelman
19. Tom Brakke - The Research Puzzle - @researchpuzzler
20. Carolyn McClanahan - Carolyn Sue McClanahan on Forbes - @CarolynMcC
21. Tim Maurer - Tim Maurer Blog - @TimMaurer
22. Neal Frankle - Wealth Pilgrim - @NealFrankle
23. Wade Slome - Investing Caffeine - @WadeSlome
24. Sheri Cupo - SageBroadview Blog - @sage_cupo
25. Jude Boudreaux - Upperline Financial Blog - @HJudeBoudreaux

To view the complete list of the Top 100 Social Influencers in the United States, visit the BrightScope Blog.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  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.

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.

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What I’m Reading – Mother’s Day Edition

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Started out as a beautiful Sunday here in the Chicago area for Mother’s Day, though it’s starting to look like rain.  To all of the Mom’s out there I wish you a Happy Mother’s Day.

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

Jason Hull explains Why Soldiers Need Financial Help at Financial Planning online. A real eye-opener for me.

Glen Craig discusses Lifestyle Inflation: The Silent Killer of Your Finances? at Free From Broke.  This is a real issue for many at all stages of their lives.

Robert Powell writes Retirement investing: Don’t go it alone at Market Watch.  You may well need a financial advisor to help accumulate enough for retirement and to give yourself some financial peace of mind.

Christine Benz shares Concerned About Longevity: 4 Mistakes to Avoid at Morningstar.com.

Trading rules for the newly enthuasiastic retail trader provides a great discussion of renewed interest in the stock market at its current high levels and  some rules new retail stock traders should keep in mind at Abnormal Returns.

3 generations face USA’s retirement crisis is discussed at USA Today.

Jason Zweig asks Just How Dumb Are Investors? in the context of variations in the returns of many individual investors compared to popular benchmarks like the S&P 500 at The Wall Street Journal.

Here is my latest for the US News Smarter Investor blog 3 Things to Know About Bond Funds.  The environment for bond investors going forward will be challenging to say the least.

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

A Pre-Retirement Financial Checklist

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

4 Signs of a Lousy 401(k) Plan

I hope you enjoy some of these articles and have a great rest of your weekend.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  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.

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

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Retirement Investors: Poor Timing and Short Memories?

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A recent Wall Street Journal article Retirement Investors Flock Back to Stocks (not behind their paywall as I write this) discussed how retirement savers are putting more money into stocks.  Nothing like waiting for the stock market rally to pass its fifth anniversary, with many of the major market averages in record territory, to get retail investors interested in the stock market.  Two excerpts from this article:

“Stocks accounted for 67% of employees’ new contributions into retirement portfolios in March, according to the most-recent data from Aon Hewitt, which tracks 401(k) data for 1.3 million people at large corporations.” 

What cash I have, I’m going to use to buy more if the market dips,” said Roy Chastain, a 68-year-old retiree in Sacramento, Calif., who put an extra 10% of his retirement account into stocks in September, bringing his total stock allocation to 80%.  Mr. Chastain, who had put all his retirement assets into cash in May 2008, has gradually rebuilt his stockholdings.” 

If I understand Mr. Chastain’s situation, he sold out about half way through the market decline, he likely missed a good part of the ensuing market run-up, and now he’s bulking up on stocks 5+ years into the market rally.  I sincerely hope this all works out for him.

 What’s wrong with this picture? 

Part of the rational cited in this article and elsewhere is that stocks appear to be the only game in town.  At one level it’s hard to argue.  Bonds appear to have run their course and with interest rates at record low levels there is seemingly nowhere for bond prices to go but down.

Alternatives, the new darling of the mutual fund industry have merit, but it is hard for most individual investors (and for many advisors) to separate the wheat from the chafe here.

But a 68 year old retiree with 80% of his retirement investments in stocks is this really a good idea?

I’m not advocating that anyone sell everything and go to cash or even that stocks aren’t a good place for a portion of your money.  What I am saying is that with the markets where they are investors need to be conscious of risk and at the very least invest in a fashion that is appropriate for their situation.

Can you say risk? 

With the stock market flirting with all-time highs and in year six of a torrid Bull Market I’m guessing things are a bit riskier than they were on March 9, 2009 when the S&P 500 bottomed out.

Let’s say an investor had a $500,000 portfolio with 80% in stocks and the rest in cash.  If stocks were to drop 57% as the S&P 500 did from October 9, 2007 through March 9, 2009 this would reduce the size of his portfolio to 272,000.

Not devastating if this investor is 45 years old with 15-20 years until retirement.  However if this investor is 68 and counting on this money to fund his retirement this could be a total game changer.  Let’s further assume this occurred just as this investor was starting retirement.

Using the classic 4% annual rule of thumb for retirement withdrawals (for discussion only retirees should not rely on this or any rule of thumb), this investor could have reasonably withdrawn $20,000 annually from his nest egg prior to this market decline.  After the 57% loss on the equity portion this amount would have declined to $10,880 a drop of 45.6%.

Assuming this retiree had other sources of income such as Social Security and perhaps a pension the damage is somewhat mitigated.  Still this type of loss in a retiree’s portfolio would be a disaster that could have been partially avoided.

Am I saying that the stock market will suffer another 57% decline?  While my crystal ball hasn’t been working well of late I’m guessing (hoping) this isn’t in the cards, but then again after the S&P 500 suffered a 49% drop from May 24, 2000 through October 9, 2002 many folks (myself included) felt like another market decline of this magnitude wasn’t going to happen anytime soon.

Diversification still matters 

I agree with those who say investing in bonds will likely not result in gains over the next few years.  But given their low correlation to stocks and relatively lower volatility than stocks, bonds (or bond mutual funds) can still be a key diversifying tool in building a portfolio.

When I read an article like the Wall Street Journal piece referenced above or hear “experts” advocating the same thing on the cable financial news shows I just have to wonder if investor’s memories are really this short.

Individual investors are historically notorious for their bad market timing.  Is this another case of bad timing fueled by greed and a short memory?  Are you willing to bet your retirement that the markets will keep going up?  Or perhaps you think that you might be able to get out before the big market correction.

Perhaps you should consider doing some financial planning to include an appropriate investment allocation for your stage of life and your real risk tolerance.

Please check out our Book Store for books on financial planning, retirement, and related topics as well as any Amazon shopping needs you may have (or just click on the link below).  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.

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.

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Is Your Mutual Fund Bloated and Should You Care?

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Asset bloat in a mutual fund is akin to the situation we’ve all found ourselves in while dining out.  Our meal is fantastic and we can’t stop eating it even though we know we’ll feel lousy and bloated if we don’t stop.  Mutual fund asset bloat can also be a big problem for investors.

What is asset bloat? 

Asset bloat is simply a large increase in the assets managed by a given mutual fund.  Asset bloat is typically not an issue for index funds or money market funds, but it certainly can be for actively managed stock and bond mutual funds.

Asset bloat can be caused by an influx of new money into a mutual fund, often the result of a period of superior performance by the fund.  It has been my experience over the years that investor money chases good performance.  Asset bloat can also be organic in nature via the fund’s investment gains.

Morningstar’s Russ Kinnel wrote an excellent piece on mutual fund bloat that you should check out.

Why is asset bloat a problem? 

At some point an actively managed mutual fund can become too large for the manager(s) to effectively manage.  As an example, Peter Lynch was the legendary manager of the Fidelity Magellan Fund (FMAGX).  Lynch managed the fund from 1977 until 1990 during which time the fund’s assets grew from about $18 million to about $13 billion.  During this time period the fund’s average annual return was 29%.

At the end of the decade of the 1990s the fund’s assets had hit $100 billion, ultimately dropping to today’s level of about $16 billion.  Subsequent to Lunch’s departure the fund’s performance never hit the levels seen during Lynch’s tenure.  I have to believe that this was in part due to the massive growth in the fund’s assets.

This phenomenon is especially problematic in mutual funds that invest in small and mid-cap stocks.  Due to the smaller market capitalization of the underlying holdings in these funds at some point it becomes difficult for the manager to find enough good stock ideas within the fund’s mandate to continue to deliver the top performance that was responsible for the asset growth in the first place.

There have been many instances of small and mid-cap funds that have grown to be so large they have started to invest in larger stocks and ultimately have migrated to another investment style, for example from mid to large cap.

How can funds curb asset bloat? 

Close the fund to new money.  I always respect mutual funds that shut off purchases by new investors in the interest of benefiting existing shareholders.  More assets under management means more money for the fund company.  A shining example of a fund that does this is Sequoia (SEQUX) which has been closed for most of the past 25 years.  The fund’s long-term track record is exemplary.

Start losing money or underperforming.  I say this only partially tongue and cheek.  Nothing will reduce mutual fund assets like a period of underperformance.  Just ask the folks at Fidelity Magellan.  Just as investor money often chases superior mutual fund performance it also has a tendency to flee poor performance.

As Russ Kinnel points out in the Morningstar piece referenced earlier, asset bloat is a symptom of the solid stock market performance we have seen over the past five years.  This is not to say that a large fund cannot be effectively managed.  Case in point is Fidelity Contra (FCNTX).  Manager Will Danoff has done a credible job given the sheer volume of money under his management.  On the other hand American Funds Growth Fund of America (AGTHX) has been called a “closet index fund” meaning that its investments are extremely closely correlated to its benchmark Russell 1000 Growth Index.

For investors in actively managed mutual funds it is important to monitor the fund’s size as one of the indicators that you look at in your periodic review of your mutual fund holdings.  No single indicator is a reason onto itself in determining whether to hold onto a fund or consider selling it, but several key indicators viewed together can help you understand what is happening with your fund holdings.

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 financial planning related selections in our Book Store.

 

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Investing: Time and Diversification are your Friends

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Each quarter Dr. David Kelly and his staff at JP Morgan Asset Management publish their Guide to the Markets.  This is a comprehensive chart book of investment and economic data that I find invaluable.

For the past several quarters the Guide has included this chart which as a long-term investor should be quite important to you.
 


The chart depicts the range of average annual returns for stocks, bonds, and a combination of the two over rolling 1, 5, 10, and 20 year periods from 1950 through 2013.  In my opinion every investor should understand the impact of diversification and time on their investments as depicted on the chart.

Understanding the chart 

The green bar depicts stocks, the light blue bar depicts bonds, and the grey bar depicts a 50-50 mix of the two.

As you can see the greatest volatility of return occurs over rolling 12 month periods.  The range of a 51% gain to a 37% loss in a 12 month period is huge.  The range for bonds is more compact and the range for a 50-50 mx of stock and bonds is slightly more compact.

As you move out to the 5, 10, and 20 year ranges you will note that the ranges from the largest gains to smallest (or a loss) become smaller with the passage of time.

Also of note is that in no 5, 10, or 20 year rolling time frame depicted does a 50-50 mix of stocks and bonds result in a negative return over the holding period.

What does this mean to you as an investor?

Diversification dampens the variability of your returns. As you can see from the chart stocks have a wider range of returns over all of the periods depicted than do bonds.  Combining the two tends to dampen the volatility of your portfolio.  Further enhancing the benefits of diversification is the fact that stocks and bonds are not highly correlated.

Taking this a step further, while an investment in an index mutual fund like the Vanguard 500 Index (VFINX) would have lost money if held over that 10 year period 2000-2009, a portfolio that was diversified to include fixed income, small and mid-cap funds, international equities, and other asset classes would have recorded gains during that same time period.

Time reduces the volatility of returns. I will leave any scientific explanation to those more attuned to this than myself, but certainly part of the reason are the ebbs and flows of market and business cycle factors that have an impact on stocks and bonds.  These might be recessions, interest rate movements, or other factors.

Implications for the future

The performance and characteristics of stocks and bonds might well differ in the future.  Diversification for most investors will likely mean holding more than just Large Cap domestic stocks and Intermediate Bonds as the graph depicts.  A few thoughts for the future, especially in this market environment of record highs for many stock market indexes:

  • Diversification reduces risk.
  • Diversification among assets with low correlations to one another further reduces risk.
  • Diversification is important because we have no way of knowing which investments or asset classes will perform well or poorly or when.
  • A longer holding period will generally serve you well as an investor in terms of smoothing out portfolio volatility. 

While every investor is different as is every investment environment, diversification and patience can be two of your greatest allies.

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.

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