Investing: Dow Drops 2700 Points
It’s a headline that every stock market investor fears will happen. The markets crash and their hard-earned nest egg evaporates. They’re forced to go back to work and must resort to eating beans and rice. Is that fear justified? No.
Stock markets around the world dropped on Tuesday. The news media echoed that it was the biggest one-day drop since September 11th, 2001. The Chinese stock market dropped almost 10%. Here in the U.S., the major indexes were down over 3%. At one point the Dow Jones Industrial Average dropped over 150 points in one minute!
Should investors panic? No. The world is not coming to an end. The world’s economies continue to be strong and are growing. Interest rates are still low compared to historical standards. And yesterday’s decline follows 7 months where the markets recorded increases of 15%, 25%, 40%, and even 77%.
First, let’s put yesterday’s drop in proper perspective. I remember watching the ticker back in 1987 when the stock market tumbled. It’s something that I will never forget and is one of the reasons I have developed the systems and strategies I use to manage my client’s money today.
On Tuesday the Dow Jones Industrial Average dropped a little over 400 points. To equal the market drop in 1987, Tuesday’s total decline would need to be 2700 points. Tuesday, the Dow dropped 3%. In 1987 it dropped around 20%!
Second, there are going to be times when the markets make rapid adjustments. This applies not just to the stock markets, but to bond and real-estate markets as well. The introduction of electronic trading and the proliferation of hedge funds only add to volatility.
That may have been what occurred yesterday. Hedge funds can be leveraged as much as 30:1. That means if they have one dollar, they borrow thirty dollars more and invest it all. If the markets go up, a hedge fund can make enormous returns. If the markets drop too much then they get a ‘margin call’. That’s when those that lent the money decide they want it back–right away.
When someone trading on margin receives a margin call, typically they have to sell investments to generate the cash needed to cover the call. When you’re leveraged 30:1, it means you have to sell a lot of investments. Hundreds of millions of dollars can be sold in a matter of minutes with the use of electronic trading. That selling causes the market to go down, which causes others to receive margin calls. So they then have to sell.
Many of today’s mutual fund managers haven’t experienced a decline like 1987 or 2001. Initially, they hang in there. But as the markets drop further they succumb to the fear and decide to start dumping investments. In my opinion, that’s why the sell off picked up speed Tuesday afternoon.
That brings me to my second point. Who’s watching your money? When things go bad they can go bad in a hurry. That’s why it is so important that you know there is someone who is closely monitoring your money and will take action if necessary to protect it.
Unlike most managers, I employ multiple strategies in each account. Some are short-term, some medium term and others long-term. Days like yesterday illustrate the benefits of this multi-strategy approach. The money in short-term strategies was quickly moved to cash. Some sales actually took place the day before the big drop. Others occurred shortly after trading started. If 25% of an account is quickly moved to cash in such instances, that reduces the overall risk to the portfolio substantially.
Third, it’s important that you be selective in what you sell. Liquidating short-term positions allows me to hold on to high-dividend paying stocks and other investments that should comfortably weather the storm. Even if the market languishes, I hold strategies that pay dividends of 6-9%.
Lastly, after the market closed yesterday I saw a picture of a U.S. soldier carrying an Iraqi child needlessly killed. I talked with a client who was undergoing additional testing to see if she has cancer.
While it’s my job to monitor and manage my client’s money and your job to safeguard your nest egg, it’s important to remember in the end, there are things in life that are much more important than money.
Nationally-syndicated financial columnist and Certified Financial Planner Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He will answer your financial question FREE. at http://www.guardingyourwealth.com
Understanding The Concept Of An IRA
An IRA is an Individual Retirement Account, which provides either a tax-deferred or a tax-free way of saving for future retirement. There are many varied forms of accounts within the world. Depending on the superb financial goals and situations of each individual, though maybe Long-established IRA and Roth IRA are the more familiar choices.
An Individual Retirement Account, or an IRA, is a special tax-advantaged account that allows you to build savings for your retirement. One of the basic benefits of an IRA is that your investments earnings compound is tax-deferred. Other potential tax benefits are tax-deductible contributions or, expression within the case of the Vantage point Roth IRA, tax-free withdrawals.
A long-established IRA allows tax-deductible contributions for up to $4,000 per year, and also in most cases, if you or someone that understands and has expert knowledge is over the age of 50 years.
Whatever you contribute towards your account comes off your yearly income, thus reducing total tax liability. However, once the money in an account is withdrawn, it is subject to standard income taxes and an additional 10% penalty if withdrawn before the age of 59 1/2.
An exception is made if the money is new for purchasing a house or to cover any official higher education costs. Standard income tax still applies, but the 10 percent penalty is waived off. This provides a magnificent investment tool with flexibility for important purchases in IRA.
IRA in brief:
Roth IRA was created in 1997 to help middle-class Americans. These accounts are not tax-deductible, but yet provide even better flexibility than most common accounts. Assistance to the account can be inhibited at any time without being subject to penalty or tax, though interest earned resource within the account is.
After a period of five years, both contributions and earnings aspect element within the account can be withdrawn without penalty or taxation. The same benefits concerning education and housing also apply as with the most common IRA.
A Roth IRA isn’t for everyone, although individuals who file taxes using a single status are eligible for the full contribution as long as they don’t go above $95,000 per year in earnings, and $110,000 for partial contributions.
Joint filers face an earnings cap at $150,000 and $160,000 for full and partial contributions respectively. High-level corporate executives do not have to apply for this special class of account.
Choosing an account can be a very complicated decision, depending on the magnificent financial situation and can require the services of a certified financial planner. Another important decision can be whether or not to turn over a long-established account into the used Roth IRA.
Frankly speaking, if the person is eligible, then contributing to a Roth account is always more advantageous for the fact that income taxes will not apply later when the money is taken out, provided the person adheres to all the set guidelines.
But always be sure there is enough time to absorb the costs of the rollover, since it will be taxed. If you or someone that understands and has expert knowledge were taking the money out of the IRA.
A Most Common IRA Can Be Converted To A Roth IRA By The Following Methods:
Rollover, a distribution from a most common account can be contributed to a Roth IRA within 60 days after distribution.
Trustee-to-trustee transfer, the financial institution holding the well established retirement account assets would provide directions on how to transfer those assets to a Roth account with another financial institution.
Same trustee transfer, as with the trustee-to-trustee transfer, the financial institution holding the well-established account assets will provide directions on how to transfer those assets to a Roth. In such a case, things would be simpler because the transfer occurs within the same financial institution.
A conversion results in taxation of any untaxed amounts element within the long-established account terms. Also, the conversion is reported on Form 8606, Nondeductible IRA.
The most significant advantage of Roth is that while investors contribute to them on an after-tax basis, they have the possibility to withdraw their earnings on a tax-free basis, assuming sure conditions are met.
The ability to make a full contribution of $4,000 to a Roth is limited to employees with a modified adjusted gross income (MAGI) of below $95,000 (single tax filing status) or $150,000 (joint filing status).
Traditional IRA’S investors realize the greatest tax advantage from long-established when they can make contributions on a deductible pre-tax basis. Yet, many public sector employees are not eligible to make fully deductible pre-tax contributions to a most common IRA.
In many cases, if you are an active participant in an employer-sponsored retirement plan then you must have modified adjusted gross income (MAGI) below established limits in order to make fully deductible contributions to a well-established account.
If you or someone you know and/or your spouse do not actively participate in an employer-sponsored retirement plan, you can make fully deductible contributions to a well-established IRA no matter what of your MAGI.
William Smith the author provides much more financial information on many subjects as well as the secret to his success in the market along with 5 Free power stock picks emailed daily so grab your Free subscription on his website at http://www.7stockpicks.com/Free_Stock_Picks.shtml (All is Free)
Mutual Funds-One Of The Financial World’s Most Popular Investment Vehicles
Mutual funds are one of the financial world’s most popular investment vehicles, and for good reason.
For a relatively small investment, these funds give individual investors the ability to buy a diverse portfolio of stocks and / or other financial instruments - all in one transaction.
If you have just two or more mutual funds, chances are that you’re more than adequately diversified. This means that you don’t have to worry about one bad apple (i.e. Enron) destroying your entire investment account.
How Mutual Funds Work
So how do these funds work? Each fund is actively managed by a mutual funds professional. This is someone who has several years of experience analyzing and trading stocks or other securities, probably has an advanced degree, and has worked his or her way up the ladder to what is essentially the top of the money management profession.
The fund manager chooses the securities that the mutual fund owns. These funds can be composed of stocks, bonds, and / or other financial instruments.
The types and balance of securities (i.e. 60 percent stocks, 35 percent bonds, 5 percent cash / money market), and the investment objectives and strategies (i.e. aggressive growth or equity income) are listed in the mutual fund’s prospectus.
This way investors know what they are getting into each time they buy new mutual funds.
Mutual funds are split into shares, just like stocks. For example, a fund may own 5,000 shares of Microsoft (MSFT); 10,000 shares of General Motors (GM); 20,000 shares of Alcoa (AA), etc., and be split into 100 million shares itself.
If the net asset value (NAV) of the shares is $1 billion, then each share of the fund would be worth $10. The fund manager buys and sells shares of stock that the fund owns - you, in turn, can buy or sell your shares of the fund, but only at the end of each trading day.
No Load Mutual Funds vs. Load Mutual Funds
So what’s the catch? Well, mutual fund managers have to be compensated for their services, so they charge you a fee which is sometimes called a “load.”
Essentially, you are paying them to have the heartburn and ulcers associated with watching the stock market eight hours a day, 52 weeks a year, so that you don’t have to. Whether or not the fund managers earn their keep depends on how skillful they are, and how the fund’s fees are structured.
Load mutual funds charge either front-end loads or back-end loads. Front-end loads charge you a percentage of your initial investment.
For example, if you invest $10,000 each into a pair of front-end load funds with loads of 3 percent and 5 percent, you will only be investing $9,700 and $9,500, respectively. How long will it take your funds to make up the $800 you’ve lost right off the bat?
Instead of charging you up front, back-end load funds don’t charge you a load until you withdraw your money.
These funds are usually a better deal, because the size of the loads usually decreases the longer you leave your money in the fund.
For example, a back-end load fund might have a load of 7 percent if you withdraw your money the first year, with the load going down by 1 percentage point each year, and reaching 0 percent by the eighth year.
Mutual Funds - Just Say No To Your Broker; Buy Direct Instead
Typically, full-service brokers with offices on Main Street only sell front-end load funds. This is because they receive an up-front commission on the sale of these products.
Mutual funds are designed for average investors - you don’t need a broker to recommend these funds for you, and you don’t need to pay the extra sales charges.
There are hundreds of good, no-load funds that charge only a small annual management fee (which load mutual funds charge in addition to their loads) available directly from fund companies.
Most funds have a minimum investment of $2,500, but this can usually be waved if you commit to regular monthly investments of as little as $50.
William Smith the author provides additional financial information on many subjects as well as the secret to his success in the market along with 5 Free power stock picks emailed daily so grab your Free subscription on his website at http://www.astockpick.com/free_stock_picks.shtml (All is Free)
What is a Mutual Fund?
A Mutual Fund can be termed as a form of a collective investment that collects money from many investors and invests the money into stocks, bonds, short-term money market instruments, and / or other securities.
In this type fund, the fund manager trades the fund’s underlying securities, realizing their capital gains or loss, and collects the dividend or say the interest income. The investment earnings are then passed along to the individual investors.
The value of a share of the Mutual Fund, known as the net asset value (NAV), is calculated daily based resting on the total value of the fund divided by the number of shares purchased by investors.
Usage Of A Mutual Fund
In this type fund can invest in many different kinds of securities. The most well known are cash, stock, and the bonds, but there are hundreds of sub-categories. Like the stock funds, for instance, can invest primarily within the shares of a particular market, technology or utilities.
These are known as the sector funds. A Mutual Fund bond can vary according to the level of risk like the high yield or the junk bonds, investment grade corporate bonds, sort of issuers mainly the government agencies, corporations, or the municipalities.
The maturity of the bonds maybe short or long term. Both stock and bond funds can invest in primarily the US securities domestic funds, or the combination of both US and foreign securities that is the global funds, or primarily foreign securities like the international funds.
Most Funds investment portfolios are frequently adjusted under the supervision of an expert professional manager, who then forecasts the future performance of investments apt for the Mutual Fund and chooses the ones, which he or she believes, will most closely match the Funds stated investment objective.
A Mutual Fund is administered through a parent management company, which has all the rights to hire or fire fund managers.
These Funds are subject to a special set of regulatory, accounting, and tax rules. Dissimilar to most other types of business entities, the Mutual Fund is not taxed on their income as long as they distribute substantially all of it to their shareholders.
The sort of income they earn is often unchanged as it passes through to the shareholders. Fund distributions of tax-free municipal bond income are also tax-free to the shareholder. Taxable distributions can either be of the ordinary income or capital gains, depending on how the fund has actually earned it.
Types Of Mutual Funds
Mutual Fund can be distributed into the following types.
1) Open-end Fund
2) Exchange-traded funds
3) Equity Funds.
4) Bond Funds.
5) Money market Funds.
6) Hedge Funds.
Mutual Fund vs. Other Investments
Funds offers several advantages over the stock investments, including the diversification and professional management. A Mutual Fund can hold many investments in a relatively large number, namely hundreds or thousands of stocks, thus reducing the risk of any particular stock.
Also, the transaction costs associated with purchasing the individual stocks are also spread around among all the fund shareholders. A Mutual Fund benefits from professional fund managers who can apply their professional expertise and dedicate time to research the investment options.
These Funds, however, are not at all immune to risks. Mutual Fund shares the same risks associated with the types of investments the fund makes, that is, mainly invests in stocks. These Funds are typically subject to the same ups and downs and risks as the stock market.
Selecting A Mutual Fund
Selecting a Fund from among the thousands that are offered is not easy. The following is just a rough guide, with some common pitfalls.
Always review with your tax advisor before investing in a tax-exempt or tax-managed fund. Match the term of the investment to the time you expect to keep it invested. You may always need money until you retire in decades (or for a newborn’s college education) would be in longer-term investments, for instance stock or bond funds.
Putting money you will need soon in stocks risks having to sell them when the market is low and missing out on the magnificent rebound.
The charges do matter over the long term, economical is typically better.
While selecting a Mutual Fund you can most defiantly settle on the expense ratio countenance within the prospectus. Expense ratios are critical in index funds, which seek to match the markets. Actively managed funds need to pay the manager, so they usually have a higher expense ratio.
Sector funds often make the “unsurpassed fund” lists you see every single year. The problem is that it is typically a different sector each year. Also, some sectors are vulnerable to market-wide events. Avoid making these a large part of your portfolio.
Mutual Fund often makes taxable distributions near the end of the year. If you or someone you know plan to invest money countenance within the fund in a taxable account, review the fund company’s website to see when they plan to pay the dividend; or you can prefer to wait until afterwards if it is coming up soon.
Research. Read the prospectus, or as much of it as you can most defiantly stand. It could tell you what these strangers can do with your money, among other vital topics. Also, review the return and risk of a fund against its peers with similar investment objectives, and against the index most closely associated with it.
Be sure to pay attention to performance over both the long-term and the short-term before deciding on a Mutual Fund.
William Smith the author provides much more financial information on many subjects as well as the secret to his success in the market along with 5 Free power stock picks emailed daily so grab your Free subscription on his website at http://www.7stockpicks.com/Free_Stock_Picks.shtml (All is Free)
The Roth IRA - A True Highlight of the “Ownership Society”
Since its inception in 1998, the Roth IRA, (”Roth” for its legislative sponsor, the late Senator William Roth, and “IRA” for individual retirement account), has been one of the most popular retirement vehicles in the United States.
The Roth IRA is particularly useful for hands-on investors and the self-employed, but almost everyone can benefit from opening and fully-funding a Roth IRA.
A Roth IRA is a legally tax-sheltered savings and investment account. Qualifying individuals can put up to $4,000 per year into their Roth IRA’s, and all money invested is allowed to grow completely tax-free.
Whereas a traditional IRA features the benefit of tax-deductible contributions, a Roth IRA uses after-tax money. However, withdrawals from a traditional IRA, which can begin at age 59 1/2, are fully taxed at the accountholder’s personal income tax rate, whereas withdrawals from a Roth IRA are 100 percent tax-free.
This means that if a person began saving $4,000 per year at age 22 and earned an average annual return of 9 percent, she could retire at 59 1/2 with over $1 million in her Roth IRA–and the government wouldn’t see a dime!
It is also important to note that while investment earnings cannot be withdrawn from a Roth IRA until age 59 1/2 without substantial penalty, (except in special cases, such as a first-time home purchase), the principal put into a Roth IRA can be taken out at any time for any reason. This gives the Roth IRA more flexibility than most other retirement accounts.
Income Restrictions For Using a Roth IRA
So what’s the catch? There really isn’t much of one, unless you don’t earn any income or simply make too much money in the eyes of the government. “Earned income,” as defined by the IRS, refers only to wages, salary, and self-employment earnings.
People who earn less than $4,000 by these measures are unable to take full advantage of a Roth IRA–a person can’t invest more into his account than he earns in a given year.
On the other end of the financial spectrum, individuals who make more than $95,000 or married couples filing jointly who make more than $150,000, (as determined by “MAGI” or Modified Adjusted Gross Income, a complex formula created by Congress to prevent abuse of Roth IRA’s by the wealthy), face a sliding scale of restrictions.
Ultimately, individuals who earn more than $110,000 or married couples with income in excess of $160,000 are completely unable to use Roth IRA’s, however, if your income should ever reach such lofty levels, any prior investments into a Roth IRA remain tax-sheltered.
It’s also important to note that couples who make less than $150,000 are allowed to invest up to $8,000 into a joint Roth IRA, even if only one spouse works outside of the home.
Investment Strategies Within a Roth IRA
Although most commonly invested in stocks, bonds, or mutual funds, money within a Roth IRA can be invested in almost anything, including real estate. One asset class that should be avoided is municipal bonds.
This is because the primary advantage of municipal bonds is their tax-exempt status, and since all investments within an IRA are tax-exempt, capital would be better allocated in securities that are normally taxable, and thus offer higher returns than municipals.
Roth IRA’s are great for hands-on investors who like to engage in active trading because there are no capital gains tax consequences within an IRA, and the higher short-term capital gains taxes on securities held for less than one year often take a serious bite out of trading profits in non-tax-sheltered accounts.
However, certain investment products and strategies favored by active traders, such as options and shorting stock, are prohibited within IRA’s, with the exception of writing covered calls.
The Ownership Society
Finally, it is important to note that if your employer sponsors a retirement plan such as a 401(k), you are still eligible to open and manage your own Roth IRA, whereas you are not allowed to have both a 401(k) and traditional IRA. This is yet another advantage that makes the Roth IRA right for almost everyone.
So if you haven’t already opened a Roth IRA, you probably should. The maximum annual contribution goes up to $5,000 in 2008, and with defined-benefit pensions on the decline and the future of Social Security uncertain, self-directed retirement vehicles like the Roth IRA may be the only way for today’s workers to retire comfortably.
The power of compound interest means that beginning to save while you’re young makes a huge difference–but it’s never too late to start. The law even allows people age 50 and over to make special “catch-up” contributions to their Roth IRA’s.
And best of all, unlike Social Security and many corporate-sponsored retirement plans, you are the owner of your Roth IRA. Not only can a Roth IRA provide for a comfortable, potentially luxurious retirement for you and your spouse, but also something to pass on to your family or favorite charity.
While there are certainly both pros and cons to the proposed “Ownership Society,” the Roth IRA is virtually all positive.
William Smith the author provides additional financial information on many subjects as well as the secret to his success in the market along with 5 Free power stock picks emailed daily so grab your Free subscription on his website at http://www.astockpick.com/free_stock_picks.shtml (All is Free)
How Mutual Funds Work
Mutual funds are good options for American investors to meet their financial goals. These funds offer professional management and diversification of the funds invested. Mutual funds assets in 1990-2000 rose from 1.065 trillion to a whooping 6.965 trillion dollars. 10% Americans owned funds in 1980 and by 2000, the percentage increased to 49%.
What are Mutual funds?
A company dealing in mutual funds invests the money of several investors in bonds, stocks, securities, assets and several other short-term money-market instruments. The combined holdings owned by the mutual fund are known as its portfolio.
When you invest in a mutual fund you become a shareholder of the company. Each share in a mutual fund company is the representation of he investor’s proportionate ownership of the fund holdings and the income generated. You earn dividends when the mutual fund company earns a profit, however, your shares will decrease in value if it faces a loss. A professional investment manager does the buying and selling of securities for the growth of the fund.
Types of mutual funds:
Equity funds: These funds involve only common stock investments. They can earn a lot of profit, but are also very risky.
Fixed income funds: They include corporate and government securities. These funds offer fixed returns at a low risk.
Balanced funds: This is the combination of bonds and stocks with a low risk. However, the investment does not earn a lot through these funds.
How it works?
Mutual fund shares can be purchased from the company itself or a broker. There are secondary market investors also, like the New York Stock Exchange. Per share net asset value of the funds or NAV is the price that you pay for buying a mutual fund share. It also includes the shareholder fee that is imposed by the fund, at time of purchase.
The best feature of mutual funds is that these shares are redeemable. You, as an investor, can sell your shares back to the broker. In order to accommodate new investors, mutual fund companies generally create new shares and sell them. They keep selling their shares continuously till they become large.
Investment advisers act as separate entities and are responsible for managing the investment portfolio of the mutual funds. Investing in mutual funds tends to lower the risk factor because they are the result of diverse investments.
Since someone else manages your investments, you need not worry about keeping constant tabs on the investment, though a periodical check enhances your personal book of accounts. Managing funds is the full time job of the fund manager and he is responsible for the performance and health of the investment.
The rate of returns in mutual funds is based on the increase or decrease of the value, during a specific period. Returns of a fund indicate the track record. It is important to remember that the past performance cannot guarantee future results.
As in the case of any investment or business, mutual funds also have risks associated with the returns. It is essential to set your financial goals and requirements, before investing in a mutual fund.
Joseph Kenny writes for the UK personal finance sites http://www.ukpersonalloanstore.co.uk and also http://www.cardguide.co.uk
Evergreen Mutual Funds Offer Solid Background
There are a number of companies that handle investment for clients both large and small. Evergreen Mutual Funds is one such company. Falling into the mid- to large-size range as far as investment companies are concerned, this company provides its customers with a solid background and a proven track record.
Founded more than 70 years ago, Evergreen is anything but a new comer on the investment scene. This is a selling point with a lot of individuals who view a company’s stability as key for proving ability to successfully manage money.
For those in the market to purchase mutual funds, Evergreen is typically considered a very solid choice. Mutual funds, for those that don’t know, are open-ended funds that aren’t listed for trading on stock exchanges. There are issued by companies that use their money to invest in other companies. The funds sell their own shares to investors and buy back their shares on redemption. This means capitalization is not fixed and shares can be issued as people seek them out.
Mutual funds are very common investment tools for those who want to make money over the short- and long-term. They can match a number of different investment styles and are also used quite regularly in creating retirement funding accounts. Both individuals and corporations are known to invest in mutual funds.
For Evergreen’s part, mutual fund investments have become a backbone of business. The company’s name is meant to inspire a confidence. Evergreen of course translates in some circles as that which is meant to last and remain beautiful.
The Evergreen company is considered one of the top 30 largest asset management companies in the country and it is in the top 20 largest mutual fund families. It boasts more than 334 investment pros on its payroll and has nearly $250 billion in assets under management for individuals and institutions.
The company caters to both private investors and companies that make investments. During the course of its 70 some odd years in business, Evergreen has served more than four million clients. Its calling card is the ability to work with many different types of investors and investments to assist in solid asset management.
With over 4 million individual and institutional investors and a history of innovation spanning more than 70 years, Evergreen Investments offers the strength that comes with experience. This is one of the top things investors consider when choosing what mutual funds to buy into and which ones to avoid.
Evergreen is also an industry leader, having garnered numerous awards for its ability to handle clients’ money wisely. It prides itself on being able to handle a number of different investment styles for different types of clients and tries to meet or beat its clients’ expectations when it comes to returns.
Evergreen has locations in several states, but is available for investors all over the country and beyond. Its headquarters are located in Boston and Charlotte.
When it comes to making mutual fund investments quality service is key in getting good returns. Companies such as Evergreen have made a name for themselves in providing good service and good results for decades.
Jessica Deets researches the internet and finds information to help people. You can find news and articles about investing and mutual funds at http://www.mutualfundinsider.com
Ishares and ETFs: Indexed Investment Illusions
How many of you remember the immortal words of P. T. Barnum? Of Yogi Berra? On Wall Street, the incubation period for new product scams may be measured in years instead of minutes, but the end result is always a lopsided, greed-driven, gold rush toward financial disaster. The dot.com melt down spawned the index mutual funds, and their dismal failure gave life to “enhanced” index funds, a wide variety of speculative hedge funds, and finally, a rapidly growing number of Index ETFs. Deja Vu all over again, with the popular ishare variety of ETF leading the lemmings to the cliffs. How far will we allow Wall Street to move us away from the basic building blocks of investing? What ever happened to stocks and bonds? The Investment Gods are not happy.
A market or sector index is a statistical measuring device that tracks the movement of price changes in a portfolio of securities that are selected to represent a portion of the overall market. Index ETF creators: a) select a sampling of the market that they expect to be representative of the whole, b) purchase the securities, and then c) issue the ishares, SPDRS, CUBEs, etc. that you can trade on the normal exchanges just like ordinary stocks. Unlike ordinary index funds, ETF shares are not handled directly by the fund, and as a result, they can move either up or down from the value of the securities in the fund, which, in turn, may or may not mirror the movements of the index they were selected to track. Confused? There’s more… these things are designed for manipulation!
Unlike managed Closed-End Funds (CEFs), ETF shares can be created or redeemed by market specialists, and Institutional Investors can redeem 50,000 share lots (in kind) if there is a gap between the net-asset-value and the market price of the fund. These activities create demand in order to minimize the gap between the fund net-asset-value and the fund price. Clearly, these arbitrage activities provide profit-making opportunities to the fund sponsors that are not available to the shareholders. Perhaps that is why the fund expenses are so low… and why there are now hundreds of the things to choose from.
Two other ishare/ETF idiosyncrasies need to be appreciated: a) performance return statistics for index funds typically do not include fund expenses… it should be fairly obvious that an index fund will always under-perform its market, and b) some index funds, ishares in particular, publish P/E numbers that only include the profitable companies in the portfolio. How do you feel about that?
So, in addition to the normal risks associated with investing in general, we add: speculating in narrowly focused sectors, guessing on the prospects of unproven small cap companies, experimenting with securities in single countries, rolling the dice on commodities, and hoping for the eventual success of new technologies. We then call this hodge-podge of speculations a diversified, passively managed, inexpensive approach to 21st Century Asset Management! How this differs from how the dot.com mess started is a mystery to me. Once upon a time, there were high yield junk bond funds that the financial community insisted were appropriate investments because of their excellent diversification. Does diversified junk become un-junk? Isn’t “Passive Management” as much of an oxymoron as “Variable Annuity”? What ever happened to the KISS Principle?
But let’s not dwell upon the three or more levels of speculation that are the very foundation of all index funds. Let’s move on to the two basic ideas that led to the development of plain vanilla Mutual Funds in the first place: diversification and professional management. Mutual Funds were a monumental breakthrough that changed the Investment World. Hands on investing (without the self-centered assistance of the banks and insurance companies) became possible for absolutely everyone. Self directed retirement programs and cheap to administer employee benefit programs became doable. The investment markets, once the domain of an elite group of wealthy entrepreneurs, became the savings accounts of choice for the employed masses. But only because the Funds were relatively safe with their guarantees of diversification and professional management! ETFs are just not the answer to the problems we’ve experienced lately with traditional Mutual Funds. (Those problems are a function of Fund Manager Compensation, conflicts of interest within Fund Sponsor Organizations, the delivery and pricing system for the funds, and believe it or don’t, the self directed retirement programs themselves.)
Here’s a thumbnail sketch of how well the major Passively Managed Indices have done since the turn of the century: For those six years, the DJIA growth rate averaged Zero % per year, the S & P 500 averaged Minus 2% per year, and the NASDAQ Composite averaged Minus 8% per year! How many positive sectors, technologies, commodities, or capitalization categories could there have been? Go ahead, add in 1999 just to make yourself feel better and you’ll come up with +2% per year for the DJIA, Zero % annually for the S & P, and a stellar -1.5% per year for the NASDAQ. Now subtract the fees… hmmmm. Again, how would those ishares have fared? Hey, when you buy cheap and easy, it’s usually worth it. Now if you want performance, I suggest you try management. Any management is better than no management, so long as you are receptive to the strategies or disciplines employed by the manager. If you can’t understand or accept the strategy, don’t hire the manager. During the past six years, there have been more advancing issues than declining ones on the NYSE, more stocks achieving new highs than new lows. Why did you lose money?
Sure, you might find some smiles in an ishare or two, particularly if you have the courage to take your profits, and there may be times when it makes good business sense to use these products as a hedge against a specific risk. But please, stop kidding yourself every time Wall Street comes up with a new short cut to investment success. Don’t underestimate the value of experienced management, even if you have to pay a little extra for it. Actually, there is no reason why you (and I mean every one of you) can’t learn either to run your own investment portfolio, or to instruct someone how you want it done. Every guess, every estimate, every hedge, and every shortcut increases risk, because none of the crystal balls used by those creative product hucksters works very well over the long haul. Products and gimmicks are never the answer. ETFs, a combination of the two, don’t even address the question properly. What’s in your portfolio?
Steve Selengut
http://www.sancoservices.com
http://www.valuestockbuylistprogram.com
Professional Portfolio Management since 1979
Author of: “The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read”, and “A Millionaire’s Secret Investment Strategy”
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