Category: Mutual funds

Can You Answer These Basic Money Questions?

The NY Post published an article Most Americans can’t answer these 4 basic money questions.   They questioned “Millennials” and “Boomers” to see who were most knowledgeable about investing.
Here are the questions – see how well you do.

  1. Which of the following statements describes the main function of the stock market?
    A) The stock market brings people who want to buy stocks together with people who want to sell stocks.
    B) The stock market helps predict stock earnings
    C) The stock market results in an increase in the price of stocks
    D) None of the above
    E) Not sure
  2. If you had $100 in a savings account and the interest rate was 2 percent per year, after 5 years, how much do you think you would have in the account if you left the money to grow?
    A) Exactly $102
    B) Less than $102
    C) More than $102
    D) Not sure
  3. If the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year, after 1 year, how much would you be able to buy with the money in this account?
    A) More than today
    B) Exactly the same as today
    C) Less than today
    D) Not sure
  4. Which provides a safer return, buying a single company’s stock or a mutual fund?
    A) Single company’s stock
    B) Mutual fund
    C) Not sure
    D) Not sure

 
 
The correct answers are

  1. A
  2. C
  3. C
  4. B

If you had trouble getting the right answers you could benefit from the guidance of a good RIA (Registered Investment Advisor).

Mutual Fund Shares and Why They’re Important

Mutual fund share classes are little understood by the investing public, but they are important because they determine how much the investor pays in fees.

Fund classes are identified by an alphabetical letter that follows a mutual fund’s name in most newspapers.

Mutual fund “A” share classes typically have a “front-end load,” a sales charge payable when you buy the fund. This fee is used to pay the brokerage firm and part of it goes to the broker who sells the fund.

The amount of the load depends on the kind of fund – bond funds generally have lower loads than stock funds – and the amount of money invested. The more money that’s invested, the lower the fee. Known as “break points,” they refer to points at which front-end charges go down. For example, the front-end load for the Growth Fund of America class A shares is 5.75% on investments up to $25,000. But if you invest $1 million dollars or more the front-end load is 0%.

Mutual fund “B” shares typically have a “back end load” payable when you redeem the shares. These decline over a period of years (usually 6 to 8 years) until they finally disappear.

Both “A” and “B” shares usually have an “12b-1” marketing fee, generally 0.25%, charged annually.

Class “C” shares have no front-end load, a small back end load, usually 1%, that goes away after 1 year. However, they have higher 12b-1 fees, typically 1%.

There are other share classes such as I, Y, F-1, F-1, F-2. In fact, some funds have as many as 18 share classes. They are all the same fund; the only difference is the fee charged to the investor.

Many fund families offer “institutional” share classes that are only available to certain investors. Institutional shares are purchased by businesses who are in the investing business such as banks, pension funds, insurance companies and registered investment advisors (RIAs) who buy them as agents for their clients. This is one of the benefits of working with an independent RIA who has access to lower cost funds, load waived funds and no-load funds that are often not offered by the major Wall Street firms.

Contact us for more information.

What does “diversification” mean?

To many retail investors “diversification” means owning a collection of stocks, bonds, mutual funds or Exchange Traded Funds (ETFs).  But that’s really not what diversification is all about.

What’s the big deal about diversification anyhow?

Diversification means that you are spreading the risk of loss by putting your investment assets in several different categories of investments.  Examples include stocks, bonds, money market instruments, commodities, and real estate.  Within each of these categories you can slice even finer.  For example, stocks can be classified as large cap (big companies), mid cap (medium sized companies), small cap (smaller companies), domestic (U.S. companies), and foreign (non-U.S. companies).

And within each of these categories you can look for industry diversification.  Many people lost their savings in 2000 when the “Tech Bubble” burst because they owned too many technology-oriented stocks.  Others lost big when the real estate market crashed in late 2007 because they focused too much of their portfolio in bank stocks.

The idea behind owning a variety of asset classes is that different asset classes will go in different directions independent of each other.  Theoretically, if one goes down, another may go up or hold it’s value.  There is a term for this: “correlation.”  Investment assets that have a high correlation tend to move in the same direction, those with a low correlation do not.  These assumptions do not always hold true, but they are true often enough that proper diversification is a valuable tool to control risk.

Many investors believe that if they own a number of different mutual funds they are diversified.  They are, of course, more diversified than someone who owns only a single stock.  But many funds own the same stocks.  We have to look within the fund, to the things they own, and their investment styles, to find out if your funds are merely duplicates of each other or if you are properly diversified.

You need to look at a “portfolio x-ray” which will show you how much overlap there is between two or more mutual funds.

Only by looking at your portfolio with this view of diversification can you determine if you are diversified or if you have accidentally concentrated your portfolio without realizing it.

The Trouble with 401(k) Plans

assets.sourcemedia.com

The 401(k) plan is now the primary retirement plan for employees in the private sector and Ted Benna isn’t happy.  Benna is regarded as the “father” of the 401(k) plan but now he calls his child a “monster.”

There are several problems modern with 401(k) type plans.

  1. They are too complicated. The typical 401(k) plan has dozens of investment options. These are often included to satisfy government regulatory demands for broad diversification.  For the plan sponsor, who has a fiduciary responsibility, more is better.  However, for the typical worker, this just creates confusion.  He or she is not an expert in portfolio construction.  Investment choices are often made when an employee gets a new job and there are other things that are more pressing than creating the perfect portfolio.  Which leads to the second problem.
  1. Employees are given too little information. Along with a list of funds available to the employee, the primary information provided is the past performance of the funds in the plan.  However, we are constantly reminded that past performance is no guarantee of future results.  But if past performance is the main thing that the employee goes by, he or she will often invest in high-flying funds that are likely to expose them to the highest risk, setting them up for losses when the market turns.
  1. There are no in-house financial experts available to employees. Employee benefits departments are not equipped to provide guidance to their employees; that’s not their function.  In fact, they are discouraged from providing any information beyond the list of investment options and on-line links to mutual fund prospectuses.  Doing more exposes the company to liability if the employee becomes unhappy.

What’s the answer?  Until there are major revisions to 401(k) plans, it’s up to the employee to get help.  One answer is to meet with a financial advisor – an RIA – who is able and willing to accept the responsibility of providing advice and creating an appropriate portfolio using the options available in the plan.  There will probably be a fee associated with this advice, but the result should be a portfolio that reflects the employee’s financial goals and risk tolerance.

Three benefits of a Separately Managed Account

A Separately Managed Account (SMA) is an investment account managed by a professional investment manager that can be used as an alternative to a mutual fund.  They provide diversification and professional management.  But they differ from mutual funds in that an SMA investor owns individual stocks instead shares in a fund.

Here are some of the benefits of SMAs.

  • Customization: Investors in SMAs can usually exclude certain stocks from their portfolio.  They may have an aversion to certain stocks, such as tobacco or alcohol.  Or they may have legal restrictions on owning certain stocks.  SMAs allow some customization that’s not available in mutual funds.
  • Taxes: Investors in SMAs can take advantage of tax loss harvesting at the end of the year by instructing a manager to sell certain stocks to reduce capital gains taxes. In addition, an SMA has another advantage over mutual funds in that each stock in an SMA is purchased separately.  Mutual fund investors are liable for “embedded capital gains” even if the shares were purchased before the investor bought the fund shares.
  • Transparency: You know exactly what you own and can see whenever a change is made in your account.  Mutual fund investors don’t see the individual securities they own or what changes are being made by the portfolio manager.

These are features that are attractive to certain investors.  However, they are not for everyone.  Most SMAs require minimum investments of $100,000.  That means that they are only appropriate for high net worth investors who will typically use several SMA managers for purposes of diversification.  In addition, the fees associated with SMAs are often higher than fees for mutual funds.

For more information, please contact us.

Is your money going in the right direction?

An acquaintance recently asked me how his money should be invested.  With banks paying virtually zero on savings, it’s a question on everyone’s mind.  Should he invest in stocks or bonds? If it’s stocks, what kind: Growth, Value, Small Cap or Large Cap, U.S. or Foreign?  The same can be asked of bonds: government or corporate, high yield or AAA, taxable of tax free?  That’s a question that faces many people who have money to invest but are not sure of where.

It’s a dilemma because we can’t be sure what the future holds. Is this the time to put money into stocks or will the market go down? If we invest in bonds will interest rates go up … or down? How about investing in some of those Asian “Tigers” where economic growth has been higher than in more developed countries?

There is no perfect answer. We are not gifted with the ability to read the future. And what is this “future” anyway? Next week? Next year? Or 20 years from now when we will need the money for retirement?

We know that generally, people who own companies usually make more money that people put their money in the bank. Another word for “people who own companies” is “stockholders.” That’s why, over the long term, stockholders do better than bondholders. On the other hand, bonds produce income and are generally lower risk than stocks. So my first answer to the question I was asked is: invest in both stocks and bonds.

Choosing the right stocks and bonds is a job that is best left to professionals. That’s the benefit of mutual funds. Mutual funds pool the money of many investors to create professionally managed portfolios of stocks and bonds. They are an easy way of creating the kind of diversification that is important for reducing risk.

To circle back to the original question our friend asked: the answer is to create a well diversified portfolio. We know that some of the time stocks will do better than bonds, and vice versa. We know that some of the time foreign markets outperform the U.S. market. We know that some the time Growth stocks will do better than Value stocks. We just don’t know when. So we select the best funds in each category and measure the over-all result. With so many funds to choose from, the smart investor will get help from a Registered Investment Advisor like the folks at Korving & Company.

Call us for more details.

Types of mutual funds: Traditional Funds vs. ETFs

When people think about traditional mutual funds they typically think about funds known as “open ended funds.” They are the most commons funds. Shares of the fund are bought or sold though the fund company. There are no limits to the number of shares that can be issued and shares prices are determined once a day, after the market closes. At that point the total value of the assets in the mutual fund are determined and divided by the number of shares. This is the “net asset value” (NAV) and everyone who buys a share on that day pays the same price and everyone who sells also gets the same price, not matter what time of the day the order to buy or sell has actually been entered.

“Exchange Traded Funds” (ETFs) are newer but have become popular because they are bought and sold like a stock and are traded on major exchanges. The price of the shares can fluctuate during the day and the price that an investor pays for the shares can be different from minute to minute, just like the price of a stock will fluctuate during the day. That means that an ETF can be bought in the morning and sold in the afternoon for a profit or a loss depending on the change in value. The market price of an ETF is kept near the NAV by large institutional investors who will detect any difference between the NAV and the actual share price and use “arbitrage” to make that difference go away.

Because ETFs are more flexible in terms of trading strategy, they have become very popular with many active investors and speculators. In addition, because many ETFs are “passive” funds they often have lower expense ratios than many traditional mutual funds.

There are a number of other issues that an investor should be aware of with ETFs such as liquidity, commissions to trade, the bid-asked spread, and the viability of any specific ETF.

As always, consult your investment advisor.

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Types of mutual funds: popular types

There are more mutual funds that there are stocks on the NY stock exchange. To make sense of the variety here are some of the most common fund types.

• Money market funds. These are funds that invest in very short term, liquid securities that offer a safe place to put cash. They offer a very low rate of return but try to maintain a net asset value of $1 per share.

• Bond funds invest primarily in fixed income securities. These could be government bonds, corporate bonds, municipal bonds, convertible bonds or mortgage backed securities.

• Stock funds (equity funds) invest primarily in stocks. They are subdivided into many categories according the size of the companies they invest in (large cap, small cap), the investment style (growth, value) and geography (US, Foreign).

• Balanced funds combine the features of stock and bond funds.

• Specialty funds may invest in certain industries (technology, drugs), countries (Britain, Korea) or real estate (REITs).

Well balanced portfolios frequently include funds from many of these categories in proportions appropriate to the risk tolerance of the investor.

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Types of mutual funds: cost structure

Sales Charges
Some funds (load funds) sold by brokers, insurance agents or investment advisors have a front-end sales charge which is paid by the investor and passed along to the seller for his services. The charge is deducted from the amount being invested.

Other mutual funds (no load funds) are offered directly to the investing public by fund companies, or they are offered to investors by financial intermediaries who have a compensation arrangement (hourly, flat fee or a percentage of assets) with the purchaser. In this case, a sales charge is not involved, and the investor fully invests his or her available money into funds sponsored by a no-load fund company.

There are several other arrangement by which load mutual fund companies compensate sales people that are less obvious than front end sales charges in a variety of fund share classes – A, B and C. Many fund families offer special no-load share classes (F-1, F-2) for fee-based advisors who want to use their funds but do not want their clients to pay a sales charge. Before anyone invests in a mutual fund it is important that the investor understands how the broker, salesperson or investment advisor is compensated.

Expense Ratio
A mutual fund’s expense ratio is the amount of money that the fund charges for running the fund. It is usually shown as a percentage of the fund assets. All mutual funds charge investors a fee for their services. In general, passively managed index funds have a lower expense ratio than actively managed funds and bond funds have a lower expense ratio than stock funds.

Redemption Fee
Many mutual funds are charging a fee if the investor withdraws his money from a fund within a certain specified time of making an investment. This is designed to discourage market timing which can complicate the process of managing a fund.

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Types of mutual funds: passive vs. active

A passive mutual fund invests in a portfolio that mirrors the component of a market index. For example, an S&P 500 index fund is invested in the 500 stocks of Standard & Poor’s 500 Index. There is no attempt made to try to determine which stocks are expected to do well and which are not.

Actively managed funds are managed by an individual manager, co-managers, or a team of managers. The mangers try to buy stocks that they think will outperform the market.

The costs associated with passive investing are lower than the costs of active management. Active managers attempt to justify their higher costs by doing better in either up or down markets.

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