Investing Advice
Should You Target Target Funds?
The idea behind target date mutual funds is that the funds get safer by adjusting their allocation as the investor grows older and nears retirement. A young investor just out of college might buy the Fidelity Freedom 2050 (FFFHX), which has 90% of its holdings in Fidelity stock funds and just 10% in Fidelity bond funds. In ten years the same fund would be 85% allocated to stock funds and 15% to bond funds. If an investor sticks with the fund for the long haul, when they reach the fund's target date their investment allocation would become more balanced with 50% in stocks and 50% in bonds. After 2050 the fund gets even more conservative, ultimately hitting 20% in domestic stock funds and 80% in bond funds - and half of that 80% in short term bonds - about ten to fifteen years after the target date. Eventually the fund merges into Fidelity Freedom Income (FFFAX).
David McPherson, a financial planner writing for ABC News' website, posts a solid overview of target date mutual funds. His bottom line, and ours: Target date funds can (being fund of funds) be a little pricey to own, but are a good option for many investors:
When might a target-date fund be right for you?
First, when you are gripped with uncertainty. The truth is many retirement savers are overwhelmed by choice and can't make up their minds. Quite often, I see clients who when forced to make a decision seize up and put their money in a safe money market or bank CD. This tends to happen when somebody must roll over funds from an employer-sponsored plan into an IRA.
The problem is that due to inertia this money is likely to sit too long in that low-yielding account and not earn the returns it should over the long haul.
Second, if you are in your 20s or 30s, a low-cost target date fund could be the perfect solution. At those ages, an individualized portfolio is not critical and maybe even unnecessary. Rather the most important factors are that you are putting aside money, it is invested for the long term and it is diversified among different types of investments.
It is when investors grow older -- in their 40s, 50s and 60s -- that a customized portfolio constructed with the help of a qualified adviser is most needed. At those ages, you're losing out on the benefits of time that younger investors enjoy and most need an investment mix suited to your individual circumstances.
Third, if your access to professional financial advice is limited, a target-date fund may be the right choice. The truth is that most paid financial help is out of reach for low-income workers and even many middle income workers.
Let me say that I do believe many do-it-yourself investors are quite capable of constructing and managing their portfolios. With a little interest and a little reading, most folks can learn the basics of sound investing. The fact is, however, that many workers will never learn enough about investing to do it themselves.
In such cases, I say give them a target-date fund."
We'd add another benefit of target date funds (and other funds setting fixed bond and stock percentage allocations): these funds rebalance aggressively and end up buying low and selling high by selling stocks after big moves up and buying after big drops. Investors typically do the opposite and underperform the market over time.
Funds mentioned in the article:
Fidelity Freedom Funds
Vanguard Target Retirement Funds
See also:
Ask MAX: What does MAX think of the Vanguard Target Retirement Fund?
Long Short Funds Excel At Charging Fees, Investing….Not So Much
Image Source: Wall Street JournalWe’ve been critical of this category in the past but have been recommending some long-short funds in our Powerfund Portfolios this year, notably American Century Long-Short Equity Inv (ALHIX) which was up 7.6% for the year through yesterday. This decent return disguises a very scary patch for this fund in August during the market gyrations that sent many heavily shorted stocks up, up, and away (and many funds that short down big on certain days). This fund has closed to new investors.
We also recommended both 1st Source Monogram Long/Short (FMLSX) (up 6.34% this year) and SSGA Directional Core Equity (SDCQX) (down 3.84% this year and one of the stinkers noted in the WSJ article) as alternatives to ALHIX for Powerfund Portfolios investors... ...read the rest of this article»
Capital Gains Questions?
Mutual fund coverage at The Motely Fool is, to put it mildly, hit or miss - but today they post a nice explanation of what is a confusing issue for many fund investors: capital gains distributions.
When a capital gains distribution is made, the fund's value is adjusted downward accordingly. If you buy just before the distribution, you'll face taxes on an investment you didn't own for very long -- and in many cases, one you never owned. Funds often wait nearly the entire year before paying out gains from a sale early in the year."
The article lists several legitimate techniques you can use to minimize your capital gains exposure, including buying funds with high capital gains potential through non-taxable accounts like your IRA and investing in ETFs (which aren't subject to capital gains distributions).
One note: unlike most fund reporters and analysts (including the author of The Motley Fool's article) we are not big fans of reinvesting dividends in funds held in taxable accounts unless the fees to buy other funds with the distributions are excessive (loads, commissions). It can be very difficult to determine your cost basis later when selling after random reinvest points determined by fund distributions. We prefer putting the cash from various fund distributions into new funds, or to rebalance your current stock / bond / cash stake.
Go Big Or Go Index?
The largest funds (in terms of investor assets) are often the ones with the best track records – they don’t get big by accident. These monster funds deliver huge profits to the companies that run them, so they can afford to hire the best managers. Giant funds also tend to have lower fees because they have so many shareholders to cover fund operating costs. Sounds like a recipe for continued success.
So what is the better investment – a big successful actively managed fund or an index fund?
Morningstar takes a look back at how the ten biggest funds of 1997 in the large cap blend category did in the ensuing ten years.
Of the 10 biggest large-blend funds back in 1997, six have outperformed the majority of their rivals since October 1997. We recommended five of those funds for purchase at that time….The other four funds in that group of 10 have underperformed their typical large-blend rival since 1997. True, we did recommend all four funds at the time…"
The takeaway from this article appears to be that big funds do well (and that Morningstar seems likes recommending big funds…). But a 60% success rate is not particularly impressive.
Throwing darts at large blend funds in 1997 and falling asleep at the wheel for ten years should lead to a 50% success rate – odds are half of the dartboard funds would be in the top half of the performance curve... ...read the rest of this article»
Like Funds, Newsletters That Sink Can Swim
Mark Hulbert has been tracking financial newsletter performance (via the Hulbert Financial Digest) longer than anyone else.
Judging financial newsletters by their past performance is just about as useless as judging mutual funds by their past performance. Top performing financial newsletters one year can be at the bottom of the heap the next.
As we’re coming up on the 20th anniversary of the greatest one day drop in stock market history, Hulbert took a look at some of the best and worst performing newsletters during the 1987 crash, and how they did afterwards:
On the whole, the best performers during the 1987 Crash have been below-average performers ever since, and vice versa. As an example, consider one of the newsletters with the best performances during the month of October 1987: Bernie Schaeffer's Option Advisor, with a gain of 61.5%, according to the Hulbert Financial Digest, in contrast to a 24.5% loss that month for the Dow Jones Industrial Average Since then, according to the HFD's calculations, it has produced a 3.4% annualized loss, and is very near the bottom of the HFD's performance rankings for performance over the past 20 years."
This means that doing well in a crash environment can mean crummy performance in a non-crash environment. Conversely, newsletters portfolios that fall hardest in down markets can perform very well post crash. The Prudent Speculator, a financial newsletter that performed poorly during the crash, has posted “… an annualized gain of 21.5%..[since 1987].”
It’s also interesting to note that Bernie Schaeffer’s newsletter has a negative twenty year track record (while the S&P 500 climbed more than 600% with dividends including the crash of 1987), but he still has a vibrant newsletter business and is sought after for market opinions and analysis.
Only four mutual funds have posted a worse performance than Shaeffer’s newsletter in the last twenty years. They are either gold funds, bear funds, or sky high expense ratio funds with no assets.
Too Much Fund Focus – A Bad Thing?
An article in the Chicago Tribune warns of the risks of mutual funds with too few holdings:
No equity-fund manager has made a clearer confession than William Nygren, co-manager of the Chicago-based Oakmark Select Fund, a so-called focus fund holding stocks in just 24 companies at the end of June. Fourteen percent of the fund was in mortgage lender Washington Mutual.
The fund's performance has been 'dreadful,' Nygren wrote to shareholders last month. So far in the quarter, the fund is down nearly 9 percent….Ed Maracinni, co-manager of the JohnsonFamily Large Cap Fund in Racine, Wis., said the pessimism in stocks has been overdone, apart from financial and real-estate-related stocks. The fund is down nearly 5 percent in the current quarter….This summer's concentrated disasters prove the risk of narrow bets on a few stocks or a few sectors..."
We’d counter with "Too much diversification spells mediocrity for most stock funds".
While it is true that diversification lowers risk, it also reduces upside. At MAXfunds we tend to prefer more focused funds with fewer than 100 holdings (in fact it has been a component of our ratings and is highlighted on each funds data page). While these funds can fall the hardest in down markets, they tend to outperform in up markets. Why is this a good thing?... ...read the rest of this article»
Backdoor Men
Some fund managers are the financial equivalent of rock stars - investing idols that pack their famous funds like Springsteen fills Giant Stadium. But as anyone who's ever been stuck in the nosebleeds when attending a concert at a mega-arena can tell you, sometimes smaller is better. Same goes with mutual funds. Rob Wherry at Smartmoney
points out that investors can get more intimate access to some of the biggest names in fund management by investing in their lesser-known offerings... ...read the rest of this article»
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In The Red
If you had to sum up the current financial problems of the U.S. economy and stock market in one line, it could be this: consumers are just maxed out. Day after day we are hearing more stories of consumers not able to make payments on their obligations - this week's tales of woe ranged from homes to cell phones to credit cards.
In Thursday's Wall Street Journal "Fiscally Fit" column, Terri Cullen walks us through the steps she went through refinancing her six figure home equity line of credit:
A home-equity line of credit works a lot like a credit card -- we have a set credit limit and can borrow as much or as little as we need. Our current credit line charges a variable rate of interest, much like a credit card, so how much or how little we pay in finance charges depends on the direction of the prime rate. But unlike revolving credit-card debt, which is unsecured, our line of credit is secured by our home equity -- if a financial crisis hits and we can't pay back the loan, we could lose our house.
We chose a home-equity line of credit for convenience. We knew we'd be financing a number of large projects over several years, but weren't sure how much we'd need to borrow in total. The flexibility of the credit line allowed us to borrow only what we needed, when we needed it, which would keep our monthly payments low. We spent $45,000 on a mid-level kitchen remodel; another $10,000 to update our leaky family room; $25,000 to install a deck, patio, and landscape our backyard; and most recently another $3,000 for maintenance costs to replace an aging furnace and central-air conditioning unit."
The lengthy article is informative. Every single thing the author does makes sense. Certainly lower rate debt that is tax deductible is smarter than higher rate non-deductible debt. But when I step back and think about the scope of her thought process, I come to the conclusion that there is something wrong even when everything seems right.
The notion that a home is a perpetual equity producing machine that magically turns $1 in renovations into $2, that home equity is an asset that can be tapped, that using home borrowing for consumption is smart, that things you want are worth financing, and that any low interest credit available should be claimed and not questioned as too much credit may be what is now unraveling in the economy.
We're not being critical of the author's path or sound advice and logic - rather questioning when these kinds of moves became normal and "fiscally fit". Don't hate the player, hate the game.
LINK