Category Archives: Stocks, ETF’s, and Mutual Funds

Advisors: A Conversation to Have with your Clients

There was another great article in Financial Advisor magazine this month which highlights the sort of fears and concerns that plague many generations of today’s investors, specifically those nearing retirement who are trying to better preserve capital. It’s no longer just about the magic number one needs to retire comfortably or which financial product you can buy to protect your future income against long life spans. Today’s concerns are often about the potential of current events to cause another market retreat along the lines of the tech bubble or housing crash, the sort of thing which can further jeopardize a comfortable retirement. The article suggests that some of the top concerns that clients/investors have at the moment include: 1) the debt issue and whether that may ultimately cause the US to lose its status as the world’s reserve currency; 2) the likelihood that we’ll experience severe inflation in the coming years which could dramatically impact purchasing power; 3) what are the potential ramifications of Obama’s large and complex health care plan? So let’s briefly touch on each of those and then see if we can back those concerns into some sort of investment opportunity.

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A Mutual Fund Share Class Discussion

There is a tremendous amount of money invested in mutual funds in the United States. In some cases people own mutual funds for their personal investments. In other cases people own mutual funds in their employer retirement plan, whether it be a 401k, 403b, Simple or Sep IRA, etc. I’ve found that the majority of people whom I meet, whether clients or otherwise, don’t know the difference between A, B, C, and other less common share classes. I find that odd considering the investor is often the person who must choose which share class they own and therefore should have at least a basic knowledge of each. However, many people leave that decision to their advisor and don’t learn the differences until after their account has been open a while or worse, when they need money and find out they are subject to some sort of deferred sales charge. Let me elaborate below so that, in the future, you know exactly what you are buying and why:

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Are Exchange-Traded Funds Really Ruining the Market?

In my opinion, no, that’s ridiculous. As I wrote in my book back in 2007, I believe ETFs are one of the best financial innovations to hit the market in decades, perhaps since the mutual fund made its debut. ETFs allow investors to own broad, diversified portfolios at low annual costs. That’s what mutual funds offered back in the day but people ultimately realized that some fund expenses weren’t so low and the performance wasn’t so hot. I believe ETFs offer a solid way to own a passive portfolio which covers a broad cross-section of the market. Couple that with the fact that they are transparent, trade on exchanges like stocks, and are tax-efficient. Now to clarify, when I refer to ETFs, I am referring to large, popular indexes such as the S&P 500* which do not employ leverage. Please read on to hear some professional opinions about how ETFs may have contributed to market volatility:

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Advice for Trading ETFs in Volatile Markets

It would be hard not to notice the recent surge in market volatility. As a firm believer in the low-cost, transparent nature of exchange-traded funds (ETFs), I wanted to provide some tips to my clients and readers about how to handle trading ETFs in this environment. I should note that large, popular ETF issues, particularly equity ETFs, can often be traded like blue-chip stocks without too much worry about volume, pricing, and liquidity. However, when it comes to new issues, obscure issues, or any ETF with low daily trading volume, it can save you money to do a little research and avoid throwing in blind market orders.

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Confused about ‘Floating Rate’ Bank Loans?

With interest rates at rock bottom and a growing expectation that rates will move upwards over the next year, many investment managers are jumping back into the floating rate bank loan space—an asset class which historically performs very well in low and rising interest rate environments. However, I’ve noticed with my own clients that while the conventional bond space is fairly well understood among experienced investors, the bank loan space is not. Most people don’t know what differentiates these loans from traditional bonds and as a result abandon an asset class which may be a useful, low-correlation diversifier at the moment. So below is my attempt to demystify this asset class.

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My Issue with Mutual Funds

There has been much debate over the past decade about the value proposition of actively-managed mutual funds to the average investor. The potential advantage which you’re really paying for with mutual funds is the possibility of choosing a brilliant portfolio manager who can beat their benchmark year after year. I’ll only break out one statistic here among the many which convey the same unfortunate message about the mutual fund industry: six out of ten actively managed stock funds underperformed their indices in 2008, primarily due to fees, according to the Center for Institutional Investment Management at the University of Albany. Besides the fact that actively managed mutual funds, on average, cost investors more to own than index and exchange-traded funds, they are also generally less transparent than index and exchange-traded funds. This isn’t necessarily a criticism of mutual funds, but an inherent operational difference between two very different investment products: mutual funds and exchange-traded funds.

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Interesting Mutual Fund Alternatives

When people refer to mutual funds they are most often referring to ‘open-end’ mutual funds in which investors buy and sell shares on a regular basis. Most mutual funds have active managers who, with their teams, make decisions as to the fund holdings which correspond to the fund’s stated objectives. These objectives are often growth, income, international exposure, etc. What many people don’t realize is that similar products exist which may be able to achieve a similar objective but at a lower cost. For example, closed-end funds are out there along with unit investment trusts.* Let me explain each:

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On Leveraged ETFs: Investors & Advisors

The craze of exchange-traded funds (ETFs) which employ leverage (the use of borrowed capital to increase the potential return of an investment) has been on a tear over the past year.* It makes sense that speculative investors would toy around with such vehicles given the extreme market volatility we’ve been experiencing of late. Combine that with the high level of conviction certain day traders have about which direction the markets will move in and when, and you can fully appreciate why the trading volume on these ETFs is so high. Leveraged ‘inverse’ ETFs are part of this craze as well, allowing investors to take bets against sectors of the market which they expect to decline. Just to be clear, these leveraged ETFs are designed principally for experienced investors who engage in market timing. They wouldn’t generally be suitable for an inexperienced investor or somebody who didn’t fully understand the characteristics, including the risks of the product. The financial advisor channel uses leveraged ETFs as well. In my practice their primary use is as a hedging tool to lock in gains or limit losses on certain positions at certain times. The function which they do not serve, and most advisors will agree on this, is as core portfolio holdings. More on that below:

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State of the Exchange-Traded Fund (ETF) Market

Many of my clients and readers understand my general preference for exchange-traded funds (ETFs) over mutual funds.* It isn’t that I doubt the ability of any active mutual fund managers to outperform their benchmarks—plenty of them do. It’s just that if I have to pick an overall methodology to follow in my practice, I’d rather stick to the low-cost, transparent nature of ETF investing over buying actively-managed mutual funds. Back when I wrote my book in mid-2007, ETFs were graduating quickly from speculative tools to core holdings, a trend that really started in 2005. Nowadays, we can see in the constant release of fund flow data by companies like TrimTabs and Barclays that ETF investing is growing at a rapid pace while mutual fund outflows have been consistently heavy. Part of that is obviously due to investors sidelined by the recession, but the other part is the financial advisor channel quickly catching onto the benefits of ETF investing.

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How Do I Pick Mutual Funds?

A good financial advisor will try to explain concepts in such a way that their clients can really grasp the knowledge. As obvious as that may sound, many people who work with financial advisors do not learn much about how to make financial decisions, they merely pay to have those decisions made for them. Mutual fund investing is one such financial concept that all investors should know about. If you haven’t already, you’ll likely encounter mutual funds at some point during your financial life, through either your individual savings, or a company retirement plan. According to the Investment Company Institute, which compiles statistics on various investment classes, currently over $9.5 trillion is invested through more than 10,000 mutual funds in the United States.* In fact, many retirement plans require their participants to use mutual funds rather than individual stocks to prevent them from taking on too much risk. Imagine if inexperienced investors decided to put the full balances of their 401(k) plans into the stock of a single company? What if the company became distressed or went bankrupt? They could say good-bye to their retirement nest eggs, possibly forever.

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