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.

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3 Considerations When Opening an IRA Account

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As we head toward April 15 it is now high IRA season for the major brokerage and financial services firms.   You will undoubtedly see many TV commercials and ads by these firms touting the benefits of opening an IRA with their firm.  Here are 3 things to consider as you evaluate your best IRA account options.

Understanding your retirement

How much will this cost me? 

Some firms may charge a fee just to have the account.  This might be on the order of $25 or $50 annually.  If your balance is relatively low this can be a significant bite.  Sometimes these fees are based on the size of your account balance.

Additionally you will want to understand any and all transaction fees.  This might include trading fees for buying and selling stocks, ETFs, or other exchange-traded investment vehicles.  Certain mutual funds might carry a transaction cost as well.

If you are working with a commission-based financial advisor understand how he or she is compensated.  Will the funds in the IRA account they are advocating carry sales charges or high internal fees to compensate them?

Is this custodian a good fit with my investing needs? 

This runs the gamut.  Certainly the fees mentioned above are part of this.  Beyond this look at how you invest and the vehicles in which you invest.

For example if you use ETFs extensively does this custodian offer any commission-free ETFs?  If so are these the ETFs that you would use?

As an example if you were planning on using Vanguard mutual funds exclusively it might make sense to house your IRA there.  On the other hand if you were looking to use funds from a variety of families perhaps a custodian that is more of a fund supermarket like Schwab or Fidelity is more appropriate for you.

Beyond an IRA account is this custodian a good fit for my needs in terms of other types of accounts such as a taxable brokerage account?  Do they offer the full array of services that I might need?  In my experience having an IRA at one custodian plus other accounts scattered around several other custodians is rarely a good idea.

Should I roll my 401(k) to an IRA or leave in my old employers plan? 

One of the primary reasons that investors open an IRA during the year is to roll their old 401(k) account over when leaving a job.

If you are leaving your employer whether to roll your 401(k) balance over to an IRA, leave it in your old employer’s plan, or roll it to your new employer’s plan (if applicable) is a critical decision.

There are good  reasons to move your account balance to an IRA which could include:

  • Your old employer’s 401(k) plan is lousy (as is your new employer’s if applicable).
  • A desire to consolidate all of your various retirement accounts into a single IRA to make management of your investments easier.
  • Access to a wider selection of quality investment options than might be available via your old employer’s plan.
  • Perhaps you are working with a trusted financial advisor and the rollover with allow them to better integrate this money with your overall investment strategy. 

On the other hand two reasons to consider either leaving your money in your old employer’s plan or rolling it into your new employer’s plan (if applicable):

  • The plan offers a menu of low cost institutional investments that might not be available to you via a rollover IRA.  This is often the case with very large employers with tremendous buying power, but also with smaller plans who use a competent outside investment advisor.
  • Similar to the last bullet, the plan offers specific investment options that you would be unable to match in an IRA. 

An IRA, either Traditional or Roth, is a great vehicle to help you win the retirement gamble.  Before opening an IRA account you need to do your homework just as with any investing decision.

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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Target Date Funds: Does the Glide Path Matter?

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Most Target Date Funds are funds of the mutual funds of the fund family offering the TDF.  The pitch is to invest in the fund with a target date closest to your projected retirement date and “… we’ll do the rest….”  A key element of Target Date Funds is their Glide Path into retirement.  Stated another way the Glide Path is the gradual decline in the allocation to equities into and during retirement.  Should the fund’s Glide Path matter to you as an investor?

Glide PathTarget Date Funds have become a big part of the 401(k) landscape with many plans offering TDFs as an option for participants who don’t want to make their own investment choices.  Target Date Funds have also grown in popularity since the Pension Protection Act of 2006 included TDFs as a safe harbor option for plan sponsors to use for participants who do not make an investment election for their salary deferrals and/or any company match.

These funds are big business for the likes of Vanguard, Fidelity, and T. Rowe Price who control somewhere around 70% of the assets in these funds.  Major fund families such as Blackrock, JP Morgan Funds, and the American Funds also offer a full menu of these funds.  Ideally for the fund company you will leave you money in a TDF with them when you retire or leave your employer, either in the plan or via a rollover to an IRA.

What is a Glide Path?

The allocation of the fund to equities will gradually decrease over time.  For example Vanguard’s 2060 Target Date Fund had an equity allocation of almost 88% at the end of 2013.  By contrast the 2015 fund had an equity allocation of approximately 52%.

This gradual decrease continues through retirement for many TDF families including the “Big 3” until the equity allocation levels out conceivably until the shareholder’s death.  T. Rowe Price has traditionally had one of the longest Glide Paths with equities not leveling out until the investor is past 80.  The Fidelity and Vanguard funds level out earlier, though past age 65.

There are some TDF families where the glide path levels out at retirement and there is some debate in the industry whether “To” or “Through” retirement is the better strategy for a fund’s Glide Path.

Should you care about the Glide Path? 

The fund families offering Target Date Funds put a lot of research into their Glide Paths and make it a selling point for the funds.  The slope of the Glide Path influences the asset allocation throughout the target date years of an investor’s retirement accumulation years.  The real issue is whether the post-retirement Glide Path is right for you as an investor.

On the one hand if you might be inclined to use your Target Date Fund as an investment vehicle into retirement, as the mutual fund companies hope, then this is a critical issue for you.

On the other hand if you would be inclined to roll your 401(k) account over to either an IRA or a new employer’s retirement plan upon leaving your company then the Glide Path really doesn’t make a whole lot of difference to you as an investor in my opinion.

In either case investing in a Target Date Fund whether you are a 401(k) participant saving for retirement or a retiree is the ultimate “one size fits all” investment.  In the case of the Glide Path this is completely true.  If you feel that the Glide Path of a given Target Date Fund is in synch with your investment needs and risk tolerance into retirement then it might be the way to go for you.

Conversely many people have a number of investment accounts and vehicles as they head into retirement.  Besides their 401(k) there might be a spouse’s 401(k), other retirement accounts including IRAs, taxable investments, annuities, an interest in a business, real estate, and others.

In short, Target Date Funds are a growing part of the 401(k) landscape and I’m guessing a profitable way for mutual fund companies to gather assets.  They also represent a potentially sound alternative for investors looking for a professionally managed investment vehicle.  The Glide Path is a key element in the efforts to keep these investors in the Target Date Fund potentially for life.  Before going this route make sure you understand how the TDF invests, the length and slope of the Glide Path, the fund’s underlying expenses, and overall how the fund’s investments fit with everything else you may doing to plan for and manage a comfortable retirement.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss your 401(k) plan and 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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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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7 Year-End 2013 Financial Planning Tips

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Thanksgiving is behind us and we are in the home stretch of 2013.  While your thoughts might be on shopping and getting ready for the holidays, there are a number of financial planning tasks that still need your attention.  Here are 7 financial planning tips for the end of the year.

Use appreciated investments for charitable donations

 If you would normally contribute to charity why not donate appreciated stocks, mutual funds, ETFs, closed-end funds, etc.?  The value of doing this is that you receive credit for the market value of the donated securities and avoid paying the capital gains on the appreciation.  A few things to keep in mind:

  • This only works with investments held in a taxable account.
  • This is not a good strategy for investments in which you have an unrealized loss.  Here it is better to sell the investment, realize the loss and donate the cash.

 

English: A bauble on a Christmas tree.

 

Harvest losses from your portfolio

The thought here is to review investments held in taxable accounts and sell all or some of them with unrealized losses.  These may be a bit harder to come by this year given the appreciation in the stock market.  Bond funds and other fixed income investments might be your best bet here.

The benefit of this strategy is that realized losses can be offset against capital gains to mitigate the tax due.  There are a number of nuances to be aware of here, including the Wash Sale Rules, so be sure you’ve done your research and/or consulted with your tax or financial advisor before proceeding.

Establish a Solo 401(k) 

If you are self-employed and haven’t done so already consider opening a Solo 401(k) account.  The Solo 401(k) can be an excellent retirement planning vehicle for the self-employed.  If you want to contribute for 2013 the account must be opened by December 31.  You then have until the date that you file your tax return, including extensions, to make your 2013 contributions. 

Rebalance your portfolio

With the tremendous gains in the stock market so far this year, your portfolio might be overly allocated to equities if you haven’t rebalanced lately.  The problem with letting your equity allocation just run with the market is that you may be taking more risk than you had intended or more than is appropriate for your situation.

Rebalance with a total portfolio view.  Use tax-deferred accounts such as IRAs and 401(k)s to your best advantage.  Donating appreciated investments to charity can help.  You can also use new money to shore up under allocated portions of your portfolio to reduce the need to sell winners.

Review your 401(k) options 

This is the time of the year when many companies update their 401(k) investment menus both by adding new investment options and replacing some funds with new choices.  This often coincides with the open enrollment process for employee benefits and is a good time for you to review any changes and update your investment choices if appropriate.

Be careful when buying into mutual funds 

Many mutual fund companies issue distributions from the funds for dividends and capital gains around the end of the year.  These distributions are based upon owning the fund on the date the distribution is declared.  If you are not careful you could be the recipient of a distribution even though you’ve only owned the fund for a short time.  You would be fully liable for any taxes due on this distribution.  This of course only pertains to mutual fund investments made in taxable accounts.

Required Minimum Distributions 

If you are 70 ½ or older you are required to take a minimum distribution from your IRAs and other retirement accounts.  The amount required is based upon your account balance as of the end of the prior year and is based on IRS tables.  Account custodians are required to calculate your RMD and report this amount to the IRS.

Note beneficiaries of inherited IRAs may also be required to take an RMD if the deceased individual was taking RMDs at the time of his/her death.

If you have multiple accounts with multiple custodians you need to take a total distribution based upon all of these accounts, though you can pick and choose from which accounts you’d like to take the distribution.  Make sure to take your distribution by the end of the year otherwise you will be faced with a stiff penalty of 50% of the amount you did not take on top of the income taxes normally due.

If you turned 70 ½ this year you can delay your first distribution to April 1 of next year, but that means that you will need to take two distributions next year with the corresponding tax liability.  Also if you are still working and are not a 5% or greater owner of your company you do not need to take a distribution from your 401(k) with that employer.  You do, however, need to take the distribution on all remaining retirement accounts.

For those who take required minimum distributions and who are otherwise charitably inclined, you have the option of diverting some or all of your distribution via a provision called the qualified charitable distribution (QCD).  The advantage is that this portion of your RMD is not treated as a taxable income and may have a favorable impact on the amount of Social Security that is subject to income taxes for 2014 and other potential benefits.  Note that you can’t double dip and also take this as a deductible charitable contribution.  Consult with the custodian of your IRA or retirement plan for the logistics of executing this transaction.

With all of the strategies mentioned above I recommend that you consult with a qualified tax or financial advisor to ensure  that the strategy is right for your unique situation and if so that you execute it properly. 

Certainly year-end is about the holidays, family, friends, food, and football.  It is also a great time to take execute some final year-end financial planning moves that can have a big payoff and in the case of RMDs save you from some hefty penalties.

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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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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Percent Symbols - Best Percentage Growth or In...

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.

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Mutual Funds and The Rolling Stones: Time is on Their Side

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One of the Rolling Stones’ greatest hits is called Time is on My Side.  Given the potential impact that the passage of time will have on the trailing five year returns of many mutual funds  by the end of 2013, the fund companies should be singing this song as well.

In a recent article on Market Watch Chuck Jaffe highlighted this quirk as cited by Morningstar.  According to Jaffe and Morningstar:

“For example, the average large-cap growth fund entered September with a five-year annualized return of 6.38%, according to Morningstar Inc. If the market simply stays flat and the average fund stands still to the end of the year, that five-year average will be 9.2% once September is wiped off the books, and will reach 15.16% by the end of the year.” 

As a case in point, the Vanguard Growth Index (VIGSX) fund’s five year annualized return as of June 30, 2013 was 7.15%.  At the end of the most recent quarter ending September 30, 2013, the fund’s five year annualized return stood at 11.73%.  This is a combination of fund’s 11.99% loss for the third quarter of 2008 dropping off of the five year record and the addition of the fund’s very solid gains of 8.48% for the most recent quarter.

If we carry this forward, at the end of the 2013 the loss of 23.81% for the fourth quarter of 2008 will fall off of the fund’s five year track record.  As Jaffe and Morningstar indicated even a flat return in the fourth quarter of 2013 will result in a significant jump in the fund’s trailing five year track record at the end of 2013, erasing a large portion of the financial crisis from the track record of this and many funds.

A marketing boon for mutual fund companies 

Just like the folks who market breakfast sausage, cars, or life insurance, mutual fund marketers are paid to accentuate the positive aspects of investing in their funds.  The mere passage of time will result in a marketing boon for these folks.

Be leery of the facts

If a mutual fund company touts the fund’s sheer numerical return, this is pretty meaningless.  Mutual fund returns should be viewed in the context of the fund’s peer group.  For example an average annual five year return of 10% might sound great, but not if 90% of the other funds in this same investment category (peer group) did better than that.

Further look at the fund’s risk-adjusted returns.  Did the fund take inordinate risks to achieve their returns, or did they do this with less risk than the average fund?

The past may not be a good indicator of the future

Past returns are not an indication of future results is a standard disclaimer in our industry.  The past is the past.  Many things can change.  Perhaps the fund manager who racked up this stellar track record has moved on.  In the case of small and mid cap funds, gathering too much money to effectively manage can be an issue and is often the result of outstanding performance.  Money has a habit of chasing returns.

Don’t be fooled by the hype that will surely surround these returns on steroids.  Always analyze any mutual fund’s results in terms of the potential implications of this performance and structure on future relative performance.

Please contact me at 847-506-9827 for a free 30-minute consultation to review your mutual fund holdings and 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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Investing Lessons from Vanguard’s Gus Sauter

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Graph With Stacks Of Coins

I had the pleasure of attending Vanguard’s Investment Symposium here in Chicago recently.  The entire session was excellent and very well done.  The highlight for me was the opportunity to hear Gus Sauter, Vanguard’s recently retired Chief Investment Officer, speak.  Gus closed his presentation with several investing lessons that I want to share with you.

Equity volatility is a fact of life 

We experienced two sharp, drastic stock market downturns in the first decade of this century:  2000-2002 and 2008-2009.  In addition we had the Flash Crash in 2010 and a sharp downturn in 2011 following the fiscal wrangling in Washington.  Whether event driven or driven by other factors; volatility in the stock market is a fact of investing life.  I suggest that you embrace this volatility or at least factor it into your financial planning assumptions.

Sauter’s suggestion:  Ignore emotional reactions to market volatility and stay the course. 

Despite lower expected returns, bonds still play a significant role 

Coming out of 2008 many very solid bond funds suffered large losses that were based almost entirely on investor’s fears of anything that wasn’t a Treasury.  I was able to earn some very solid returns for my clients post-2008 via the use of selected bond funds.  The poor performance of bond funds YTD in 2013 is likely a preview of the low upside many of see in bond funds going forward, especially when the predictions of higher interest rates actually comes to fruition.

According to Mr. Sauter bonds still have a role in most portfolios as a diversifying element.  Bonds have historically done well when stocks haven’t.  Going forward bonds will likely revert to their more traditional role of reducing investment volatility.

Sauter’s suggestion:  Maintain a balanced portfolio.

Manager selection is difficult, past performance is not a predictor of future returns 

Selecting an active mutual fund manager who is likely to outperform their benchmark on a consistent basis is difficult.  Sauter presented a slide that showed that mutual funds underperformed their benchmark by an average of 120 basis points in the 36 months following their receiving a 5 star rating from Morningstar.  This isn’t a knock on Morningstar as they would be the first to admit that their star system is not a predictive ranking but rather one that rewards funds based upon past performance.

Sauter’s suggestion:  Focus on low cost investing. 

Market timing is difficult 

Sauter cited a USA today graph that showed that over a six month period ending in June of this year buy and hold investors achieved returns that were almost 75% higher than a group of investors with a portfolio turnover rate ranging from 51% – 75% during the same period.  This during a period of strong stock market returns.

Sauter’s suggestion:  Establish a strategic asset allocation and think long-term.

Investing fads come and go.  A long-term investing strategy that is tied to a sound financial plan is timeless.

Please contact me at 847-506-9827 for a free 30-minute consultation and 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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