Mutual Funds

Start Saving with Low Minimum Investment Mutual Funds

December 2nd, 2008  |  Published in Mutual Funds  |  1 Comment

I’m a big fan of Vanguard’s low cost mutual funds but they aren’t particularly friendly to the young and new investor because they often have decently sized minimum investments. Most require $3,000 to start, though their STAR Fund requires a mere $1,000, which is a lot when you consider most people are looking to save a few hundred dollars a month. At $100 a month, it would take two and a half years to accrue the $3,000 needed (or 10 months for the STAR Fund), to open a Vanguard fund. While you could always put it in an online bank and earn a few percentage points while you waited, most people want to jump right in – fortunately there are many companies offering mutual funds with a low minimum investment.

To find one, I recommend using Morningstar’s Mutual Fund Screener. You can set the minimum initial purchase to less than $500, no load only, and expense ratios less than or equal to 1% – that will give you a result set of at least 200 (that’s the limit). For even more granularity, you can set the star rating to 5 and narrow it down to a mere 125 to choose from.

That will give you a head start on your mutual fund investing!

Strata of Mutual Fund Expense Ratios

May 19th, 2008  |  Published in Mutual Funds  |  3 Comments

One of the most important characteristics about a mutual fund is its expense ratio. The expense ratio is the cost of running the fund and is charged to cover the expenses of running that fund, usually represented by a percentage of assets. Some of the things the expense ratio covers include, but are not limited to, the investment advisory fee, administrative costs, 12b-1 distribution fees, operating expenses, and paying for the fund manager’s Mercedes-Benz car allowance (just kidding on the last one).

The expense ratio is also one of the easiest things for you to control when you select a fund. You can’t predict the future with respect to returns, but you sure can predict how much of your investment is consumed by the operational expenses of a fund.

So, what are the three strata of mutual fund expense ratios? Passively managed funds, actively managed funds, and hedge funds (though hedge funds really don’t count, I had to throw them in there).

Passively Managed Funds

Passive funds are index funds, funds that don’t have a manager and management board actively making decisions on what investments to pursue. They don’t spend time researching companies or interviewing CEOs, they simply track an index such as the S&P 500 as closely as they can. Vanguard’s S&P 500 fund, the Vanguard 500 Index (VFINX), has an expense ratio of 0.18%. Fidelity’s S&P 500 fund, the Fidelity Spartan 500 Index, has an expense ratio of 0.10%.

Actively Managed Funds

Active funds are those mutual funds that have a manager and management team leading the way on deciding which investments to pursue. These funds generally have higher expense ratios, starting in the 1-1.5% range, simply because you need to pay people to conduct the research, make the decisions, and because you need to pay for the trading activity of the fund as well. If you take a look at some of the funds on Money’s Best Mutual Fund List of 2008, you’ll see them run the gamut. The Matrix Advisors Value fund costs 1.11%, Vanguard Windsor II costs only 0.33%, the T. Rowe Price Blue Chip Growth costs 0.81%, and the T. Rowe Price Emerging Markets Stock costs a pricier 1.21%. As you can see, the larger cap funds often charger lower expense ratios because there is less trading involved while the smaller cap and emerging markets funds have slightly higher ratios. Either way, they’re still far higher than the extremely low passively managed funds.

Hedge Funds

Hedge funds are a totally different animal, often charging high fees on both the asset amount and the profits earned. I wanted to throw these funds in there only because they represent the most expensive of the funds you’ll see and their name, hedge funds, don’t really indicate what they do anymore. Hedge funds are now essentially funds for the extremely wealth, thus they have less oversight by the SEC, and their fees are structured in a way that rewards performance. Hedge funds often will have an “expense ratio,” as a percentage of the managed assets, plus a fee based on the profitability of the fund. Something like 2% of assets and then 20% of profits is not unheard of.

There you have it, the three strata of expense ratios in the mutual fund world. It’s important to know where each of those lies so you don’t end up purchasing an actively managed fund that charges you an arm and a leg. When selecting funds, it’s valuable to check out resources like Morningstar to get a good idea of the landscape before selecting an investment.

Cut Those Fund Expenses

November 26th, 2007  |  Published in Mutual Funds  |  Comments Off on Cut Those Fund Expenses

When it comes to investing, cutting expenses is just as good as, if not better than, increasing your rates of return. When you cut expenses, it’s a guaranteed 100% increase to your bottom line. The only way to potentially increase your rate of return is to increase your risk and even then the rate of return is hardly guaranteed.

How do you cut expenses in retirement investing? Easy, the first part applies only to those who have mutual funds. If you’re the index fund type, which I am, the key to finding the best return is simply comparing the expense ratios of each mutual fund. Fidelity’s Fidelity Spartan 500 Index Investor is Fidelity’s S&P 500 index fund (I think this is their S&P 500 Index fund), FSMKX, and it has an expense ratio of 0.10%. Vanguard’s is called the Vanguard 500 Index Fund, VFINX, and it has an expense ratio of 0.18%. That means, all things being equal, your return from Fidelity will be 0.08% higher than with the Vanguard fund because there are fewer expenses.

Now, why do the returns for the two funds differ? The YTD on the Fidelity fund is 10.81% whereas the YTD on the Vanguard is 10.77%, the difference there may lie in part with how quickly the fund reacts to changes in the index (and the fund fees). Ultimately, when you’re comparing index funds, you’re mostly comparing apples to apples so the returns should be very very close.

Another thing to remember is whether the brokerage has fees outside of the fund. In our example, I know that Vanguard has no annual account maintenance fees if you’re willing to accept electronic delivery of statements and prospectuses (prospecti?). I don’t know for certain but I believe Fidelity doesn’t have any account fees either but I’m not 100% sure.

If you’re investing in mutual funds with a little more excitement, say picking a particular industry or theme, then you have to compare returns in addition to expenses. In those cases the answer isn’t as cut and dry, but if you’re looking just at easy index funds, pick the cheapest one.

Tax Inefficient Mutual Funds are Good in IRAs

September 14th, 2007  |  Published in IRA, Mutual Funds  |  2 Comments

Some mutual funds are very tax efficient. They realize very little in the way of realized capital gains, they pay out very little in dividends, and they have protocols in place to reduce how much buying and selling occurs so those events don’t happen. Some mutual funds, on the other hand, are not very tax efficient and throw off lots, relatively, in realized capital gains, dividends, etc. For those mutual funds that are not efficient but perform well, you can make a home for them in an IRA because the earnings are tax free (temporarily).

Whenever a fund realizes capital gains, dividends, interest, etc; it has to pay out that amount to shareholders if it exceeds the fund’s expense ratio. If the mutual fund has to pay this out, then you’re going to be taxed for it, which is not ideal. Ideally you want the fund to increase in value but not throw off these payments because you want the fund to just keep getting bigger. Kiplingers has a list of four mutual funds that are tax inefficient but otherwise great performers:

  • T. Rowe Price Global Stock (PRGSX)
  • Pimco StocksPlus D (PSPDX)
  • Merger (MERFX)
  • Calamos Market Neutral Income A (CVSIX)

So, if you know of a solid fund with weak tax efficiency, don’t dismiss it… consider putting it into your IRA.

Source: Kiplingers

Flaws of Target Retirement and Lifecycle Mutual Funds

August 13th, 2007  |  Published in Mutual Funds  |  Comments Off on Flaws of Target Retirement and Lifecycle Mutual Funds

I’m a huge fan of target retirement and lifecycle funds, those mutual funds that rebalance based on your age, but a recent article put out by MarketWatch identifies a few critical flaws with these types of mutual funds – flaws that I agree exist but nonetheless do not affect my admiration for these types of funds.

The primary flaw they identify, with which I agree with, is the fact that the target retirement and lifecycle funds are only concerned with one of many factors in your investment profile – your risk profile as a proxy for your age. That is, based on what your age is, they determine a risk profile and invest based on that. So a Target Retirement 2050 is riskier than a Target Retirement 2020 (that is, investors intend to retire in either 2050 or 2020 when they select those funds), but there are a lot of other characteristics involved that they don’t consider.

The second flaw is that there could be the fund overlapping with either other funds or other investments, thus throwing your diversification slightly or quite a bit out of whack. They claim this could be more work, which may or may not be true depending on your diligence, but it certain would be imprudent. At the very least, it would throw your intentions out of line with your actuals, which is bad anyway.

Their third point of every investor being different isn’t something new and it’s not something I consider that big of a deal.

The fourth point of how target retirement funds are not created equal is certainly true. In analyzing the rule of thumb that you should have 120 minus your age as a percentage of stocks in your portfolio, I compared the asset allocations of many popular target retirement and lifecycle funds to see how they differed and how closely they followed the “120 minus age” rule. As you can see, no two allocations for the same date were the same and that’s just looking at it from a stock vs. bond perspective, it’s likely messier even inside those two buckets.

The last point that “set it and forget it” is not a solid strategy anyway is very very true. You should always, at least semi-annually or even monthly, be taking a peek at your investments to see if you’re on track with your plans. You never want to just put it there and ignore it for years… that would be a mistake.

Source: MarketWatch

Ten Things Your 401K Provider Won’t Tell You, Part 1

March 22nd, 2007  |  Published in 401K, Fees, General, Investing, Mutual Funds  |  5 Comments

I love Smart Money’s series, Ten Things Your [Insert Someone Here] Won’t Tell You, because it really opens your eyes to some of the shady practices of some operations you may otherwise think are being honest and above board. In the latest installment, Smart Money takes a look at 401K’s and the little things that go on that they just won’t tell you about.

1. “We’re making a mint on your 401(k) — even if you’re not.”
I think this is the most egregious of the ten things and it revolves around the fact that the provider is being paid on a percentage of the money its managing and not for their performance. A lot of their fixed costs are instead charged on a percentage basis, such as administrative costs, and while the assets may increase, the administrative (and other fixed costs) aren’t likely to increase on a one to one basis. Luckily these sort of things are coming under the scrutiny of state attorney generals, such as Eliot Spitzer of New York.

2. “You’re buying wholesale, but we’re charging you retail.”
If you buy a fund all by yourself, it’s understandable that you’ll be paying retail because you’re not talking about millions of dollars (or perhaps you are, in which case could you send some my way?). If you buy a fund through your 401k, it’s conceivable, based on how large your company is; that the administrator is moving around millions and you should get some sort of discount on the retail fees – and many times they do. The disconnect is when they pass the charges off to you, they don’t merely divide what they pay and pass it through, they charge retail fees for something they paid wholesale for. That should be illegal.

3. “No one in his right mind would buy these funds — given a choice.”
When you sign up to the 401k, you’ll likely be limited to which funds you’ll be allowed to buy. Unfortunately, sometimes this means that you get to pick from lackluster or under-performing funds because your plan administrator, someone in HR perhaps, doesn’t know what he or she is doing. Also, Smart Money warns that sometimes the funds can’t handle a huge influx of money (the reason why some funds close) because it’s harder to make the same rates when you have so much more to invest.

4. “Our ‘target-date funds’ may miss the target.”
This isn’t a 401k specific issue but one about the target-date funds themselves, some may be incorrectly allocated based on expert opinion, especially if your administrator (and not a large brokerage) sets it up. That’s not to say the big brokerages have perfect target retirement funds, it’s just that they have more minds on the problem which hopefully reduces the problem. There isn’t event agreement on allocation, I did a review of target retirement funds and found the allocations were all over the board.

5. “We offer tons of investment options. Too many, in fact…”
Just as #3 (too few funds) can be brutal, too many options muddy the waters. A survey showed that the average number of funds in a 401k was 19, but that 10-12 was the ideal number, anymore and the investor was “paralyzed.”

Things six through twelve will be forthcoming.

Source: Yahoo Finance

Target Retirement Is Meant As Solo Offering

February 13th, 2007  |  Published in Mutual Funds  |  4 Comments

The purpose of a target retirement is that you can put your investments on autopilot and have the fund manager handle it all for you – you can go do something else while someone is analyzing your investment mix and rebalancing. The latest question to Walter Updegrave’s column on whether a near retiree has the right approach drives home the point that target retirement funds are meant to operate alone – not as a supplement to something else.

In the question, the reader, Vivian, has two Target Retirement funds and a Roth IRA consisting primarily of bonds. The problem, as Walter notes, is that Vivian is just making things way too complicated with two retirement funds and a Roth full of bonds.

First off, having two target retirement funds is redundant and unnecessary – if you are picking two target retirement funds because you want a percentage mix between the two, you’re probably analyzing the funds way too closely and you probably don’t want those types of funds in the first place. While I don’t personally thinks it’s a huge deal, if you don’t have a lot in those accounts, you might be hit with low balance fees. For example, if you have a Vanguard Target Retirement fund and your balance is under $5,000, you’re probably going to be paying a fee of $10 a year for each fund.

Second, the target retirement funds may be redundant with your other offerings as well. If you want a mix of 80% stocks and 20% bonds, you might hit that mix with your target retirement fund choice but your other funds will mess up that mix. If you have a fund that matches the S&P 500 Index, then your retirement portfolio will have a stock allocation percentage higher than your intended 80% – though you might not care.

Ultimately, while target retirement funds are designed to be used alone, I don’t see how anyone could just pick one fund and go with it for every single retirement dollar they have saved away. Personally, I have most of my Rollover IRA in a Target Retirement fund at Vanguard but my Roth IRA consists of stock investments and I’m okay with that, knowing full well the point of target retirement funds.

Watch Your Mutual Fund Fees

February 12th, 2007  |  Published in Mutual Funds  |  1 Comment

Next time you have a few spare minutes, check out how much your mutual funds are charging you for investing your money. It’s not uncommon for an actively managed mutual fund to be pushing over 1.5% in terms of fees and if that fund isn’t beating the market average each year by at least 1%, you’re paying more money for less performance which is a lose-lose!

Consider the Vanguard 500 Index Fund Investor Shares (VFINX), which returned exactly the same as the S&P Index (minus it’s expense ratio of 0.18%) every single year since its inception, not surprising since it’s an index fund that mirrors the S&P, but compare that with your own mutual funds.

Fees aren’t everything, if part of your strategy is to diversify your holdings and put 50% in domestic stocks and 50% in international holdings, you shouldn’t compare your international holdings to an S&P index fund. You also shouldn’t compare your domestic stocks to an S&P index fund, unless you’re holding the same types of investments that are in the S&P Index… in that case, you should be in an index and not in some actively managed fund (unless they’ve consistently given you above market returns and you have faith they’ll continue to do so).

I’m not advising of anything other than you should be aware how much your funds are costing you and that you should investigate cheaper more effective alternatives if they exist. 1% may seem like a pittance, but the difference between 11% and 10% on $1,000 over 30 years is $5,442.89, now multiply that by your holdings and it makes a big difference (a nice vacation? a car? a house?).

10 Rules: Watch the Watcher’s Prices

December 26th, 2006  |  Published in Mutual Funds  |  Comments Off on 10 Rules: Watch the Watcher’s Prices

A mutual fund usually has an expense ratio, that is, a percentage of its assets that it collects for administrative fees and “expertise.” The actively managed funds generally have higher fees because you’re paying the manager to be good at his job. Passively managed funds generally have lower fees because you’re basically paying for the administrative fees. Just as you should know how much that sweater or that cup of coffee costs, you should know how much you’re paying your brokerage for your funds because it adds up in the long run. Forbes’ eighth tip in their ten rules series is that you should keep an eye on the fund fees.

When you review the fees, it will be broken up into administrative and management fees. Forbes recommends not getting a fund with a management fee greater than 1%. Here is where the ten rules start to confuse me… if Forbes recommends that you should not try to beat the market and that you should avoid high fees, why don’t they just come out and say that you should invest in index funds? Those funds match the market perfectly and they usually have incredibly low fees.

Source: Fortune