Danger Ahead, Ignore It

In this week’s column, Zweig states that some investors are starting to invest in their brokers company. The important thing is not what they are doing, but why they are doing it. Their motivation comes from the fact that the market is at record highs, gold is tumbling and bonds pay nothing. He doesn’t come right out and say it, but the implication is that it’s time for investors to start making adjustments in their portfolio.  This is the way it always happens. At first there’s whisper about the need to do something. Then as time goes by and the market continues to climb, the whispers turn into a shout. At this point it is critical that 401(k) index investors remember that “there are some things you can know and some things you need to know.” What you need to know is that index investing will outperform your ability to time the market.  So, ignore the media and devote your time and energy to something you enjoy.

 

An Inexpensive Lunch

A lot of ink has been used examining the impact that fees and turnover costs have on mutual fund performance and minuscule amount of ink has been used to explain that not every investor’s goal is performance. During my career as an investment professional I ran across many people who were willing to accept a reduced rate of return in exchange for a reduction of risk. Many advisors respond to this situation using a portfolio of mutual funds that are periodically rebalanced. In return for their advice on the selection and rebalancing of the portfolio the broker charges a fee in addition to that of the mutual fund. Some may criticize this approach, but if the investor fully understands what they are paying and what they are getting, this is a reasonable solution. The important disclosure is that the investor understands the ramifications of this approach on performance.   

 

 

No Free Lunch

Most investors, particularly those with 401(k) accounts, could improve their investment returns by spending less time focused on the market and more time monitoring their investment expenses. Wall Street is very good at charging fees and making them less than transparent.  Every mutual fund, whether it is a load or a no-load fund, charges a maintenance fee. The fee results from the trading activity within the account that is supposed to increase the investment performance. However, the data show that the performance of the mainstream equity mutual funds is equal to the performance of the market minus the maintenance fee. Or to put it another way you are paying for something that you are not getting. A major reason index funds outperform actively managed funds is that their low trading volume results in extremely low maintenance fees. 

 

A Fee By Any Other Name

The first mutual funds were owned by the shareholders and paid the fund manager a small portion of the assets to manage the portfolio. The early years of the fund industry witnessed slow growth as the market recovered from the Crash of 1929, but it matured in 1940 Congress when passed the Investment Company Act. The next decade saw the US fully engaged with World War II. By the late 1950s, the economy had recovered as technology companies such as Polaroid, Xerox and Sperry Rand came into being. Wall Street has never backed away from an opportunity to make a buck. A Boston broker by the name of Jerry Tsai created a group of mutual funds that focused on the dynamic growth of the technology sector. Soon the investing public would refer to them as GO GO funds. Demand for these funds skyrocketed and as they did the fund industry discovered new and creative ways to charge investors to participate.

 

Changes Blowing In The Wind

For the past few years we have had three constants; low inflation, low interest rates and Ben Bernanke as Chairman of the Federal Reserve. Indications are that sometime in the not too distant future one of these constants will change and the others will follow like dominos. The Fed has announced that they will maintain a low interest rate policy through this year and through a portion of next year. There is a small vocal minority who opposes the Bernanke plan and favors an immediate terminate of QEII. There are hints that Mr. Bernanke will not return after his appointment expires at the end of this year. The biggest hint was a Wall Street Journal article that explored who might succeed him. His departure will most likely be accompanied with a return to moderate inflation and rising interest rates.

The Origin Of "Mutual" Fund

The mutual fund industry was born in 1924 when a Boston stockbroker started the Massachusetts Investment Trust. MIT truly was a mutual fund because it was a nonprofit entity run by a board of directors that answered to the fund’s investors. Fund managers were paid a small percentage of the assets under management, not a fee based on performance. Since the trust was owned by its investors any money over and above the small for cost of running the business was returned to them. Today’s mutual funds are operated by a for- profit investment company. Investment companies hire the managers, do the bookkeeping, take care of advertising and keep any money that exceeds their costs. Some investment companies deliver their product using for- profit brokers as their point of sale. Other investment companies deliver their product online and thus eliminate the extra cost of broker delivery. The for-profit operations are called load funds while those who deliver online are called no-load funds.

They Have More Money

This week’s “The Intelligent Investor” reports on a study by three Ivy League professors on the investing habits of the super-rich. In order to be included in the study you had to have an investment portfolio in excess of $90 million. The study notes, what to me was obvious, that the super-rich have access to investment vehicles that the rest of us straphangers don’t. What was somewhat of a surprise to me was that the percentage that the super-rich have in hedge funds is a relatively minor percentage of their total portfolio value. The conclusion of the study is that the super-rich are not all that different than the general investing public. In their words; “They (the super-rich) chase investment fads’ like dogs chasing cars. They freeze with fear just when bravery is most likely to be rewarded. They are not all that different from the dumb money that Wall Street likes to mock.” The study concludes that the super-rich would be better off if they put money in index funds and left it alone.