Investing Advice
Stocks Get Less Risky
A blog at the Wall Street Journal notes that investors tend to think of risk as something that falls as prices rise:
If the history of the financial markets and the psychology of investing have anything to teach us, it is that present emotion and future returns are inversely correlated. Today’s feelings of pain and fear are the building blocks for tomorrow’s wealth. Eras of good feeling are terrible times to buy stocks.
The corollary is that perceived risk and actual risk tend to be polar opposites. When did your house feel like the safest investment? Just as its appraised value hit an all-time high, of course. The Dow felt safe when it was at 14000, and it feels risky as hell now that it is clinging to the edge of 8000 with its fingernails. That’s perceived risk: low when prices go up, and high when prices go down."
Investors often could do better doing the opposite of what they think will happen.
Wall Street Worries
Well, these are interesting days on Wall Street to say the least. We aren't going to pretend we know exactly how things are going to shake out (though we've been commenting on the dangers of the real estate bubble for years), but SmartMoney has some basic, sound advice for frazzled fund investors that could help ease the pain during the next market meltdown.
If, indeed, you haven't been able to step out of the way of these events, here's some advice to follow before the next downturn comes along (and, by all accounts, the next one may be sooner rather than later). First, don't make any knee-jerk reactions. If you think you can stave off further loses with a couple of trades you're fooling yourself (and probably selling at the worst possible time). If you are living off your retirement account, you may want to reconsider how much you are pulling out of it for household expenses. At least one study has shown that you can severely cut into the life of a retirement account by tapping it at its lowest balance.
You should also check to see how your funds react to these big downturns. We like the idea of a diversified portfolio in these situations. In concept, at least, a diversified portfolio should smooth out any wild rides. If, say, your portfolio of large-cap stocks takes a sharper dive than the overall market you may want to re-evaluate it, especially if you realize you can't stomach these ups and downs.
Finally, every investor needs to sit down after days like these and do a gut check. Once the dust settles there will be some prime buying opportunities for those with cash and the nerve to put it to use... Indeed, last week we polled some fund managers about where they saw bargains in the financial-services industry. This morning one of our interviewees, Anton Schutz, who runs Burnham Financial Services (BURFX), reiterated on CNBC what he told us last week: 'There will be great opportunities.'"
Target Date Drawbacks
Alex Anderson at Forbes does a nice job highlighting what we see as the major drawbacks of target date mutual funds, the popular funds in which portfolio managers slowly move from more aggressive to less risky as the fund's target date (and presumably investors' retirement) approaches.
First, within the equity oriented target funds, the portfolio consists largely of mutual funds. Management fees piggyback on both the target-date fund and the underlying mutual funds. Unless the sponsoring fund company is committed to low fees (like Vanguard), the total fees associated with the newer version of target-date funds can be double those of other funds.
Second, many target-date fund sponsors upped their average equity exposures during the recent bull market--probably in an effort to juice up investment returns. This has been unfortunate of late, as the bear market has hurt the recent performance of those target-date funds with heavy stock allocations.
Finally, the newer target funds have a 'one size fits all' approach. There are many valid reasons why two investors with the exact same retirement date should have dramatically different asset allocations. Perhaps there are differences in health and life expectancy, in risk tolerances and in basic financial circumstances.
The major drawback of the bond-oriented target date funds is reinvestment risk. Should investors receive their lump sum payments at a time of inflated equity prices and/or low interest rates, they would have limited opportunity to reinvest the lump sum proceeds advantageously. A second drawback is the fact that the investment structure is completely bonds.
Historically, equities have provided higher returns than bonds over the long term, and some portfolios with a conservative mix of both bonds and equities can actually be less risky than those that are completely bonds."
While a quality target date fund is a good choice for smaller portfolios and set-it-and-forget it types, they just aren't a substitute for a low cost portfolio of funds specifically tailored to an investor's retirement goals.
Buy Low Advice From A Legendary Investor
When the stock market hits bear market territory and the Dow seems to drop by triple digits every day, it may help your returns (and sleep) to remember investor fortunes tend to be made buying when others are scared.
Sir John Templeton, sort of the Henry Ford of international mutual funds, just passed away this week. The Globe and Mail takes a look at some of what he has given society, and notes his optimism during times of distress:
It's 1939, and American investors are worried about protecting their portfolios. Not John Templeton. He was busy buying undervalued European stocks as the continent teetered on the brink of war.
Mr. Templeton bought shares in 104 European companies listed in New York – only four of the investments didn't work out – and that cemented his reputation as a stock picker with global savvy who would revolutionize the mutual fund industry.
Nowhere would that reputation loom as large as in Canada, where he incorporated his Templeton Growth Fund in 1954 – essentially founding the country's mutual fund industry – and introduced investing to the masses.
Mr. Templeton died of pneumonia yesterday in the Bahamas at 95."
He was a guy who knew how to look for the market's silver lining - even while everyone else was running for cover. And while current market conditions might not be as scary as they were back then, next time you consider cashing in your chips and heading to the safety of money markets after a significant market drop, ask yourself this: what would John Templeton do?
Mutual Funds for Saints or Sinners
Mental Floss give a quick rundown of mutual funds designed to allow investors to put their money where their morality is.
Ave Maria and the Timothy Plan are two fund families whose aims are to invest in accordance with Catholic or Christian values respectively. Amana Mutual Funds' investment policies are guided by Sharia, the body of Islamic religious law. They won't invest in (among other things) any companies whose principle business is alcohol, pornography or pork processing companies.
The most interesting fund on the list, however, could be the Vice Fund (VICEX), whose aim is to attract investors whose moral compasses point squarely toward Las Vegas:
The fund focuses on four sectors: defense/weapons, gambling, tobacco, and booze. As the fund’s website proudly boasts in all caps, no other fund concentrates solely on these four sectors. As fund manager Charles Norton told the Financial Times in 2006, '[N]o matter what is happening in the world economy, people will continue to drink, smoke, gamble and nations will need to defend themselves. As a result, in general these companies tend to be steady performers in good times and bad—they are mostly insulated from economic slowdowns.' In short, the fund has targeted four areas of the economy where it thinks demand is fairly inelastic whether for reasons of addiction or necessity as a hedge against market downturns. It works, too; for 2006 the fund had returns of over 23%."
All that fun comes with a price though - the Vice Fund comes with a sky-high 1.93% expense ratio. As for the theory that people will continue to gamble regardless of economic conditions, it's worth noting that Market Vectors Gaming ETF (BJK), a new exchange traded fund launched just five months ago that specializes in casino and other gaming stocks, is already down about 25% - far more than the less sinful stocks of the S&P 500.
Popular Move Into Battered Financials Doesn't Pan Out
Many investors - both great and small - have bought bank and other financial stocks over the last year. Rationales for these purchases probably included "the worst was over" or "the stocks were cheap and more than reflected the problems in lending." Early this year in we noted that there was more money going into the popular Financial Select Sector SPDR (XLF) after it fell sharply - a rare flip-flop in normal fund investor buy-high/sell-low behavior.
How have investors done since moving into financial stocks? Not so well. Yesterday Financial Select Sector SPDR (XLF) was near the 52-week low, down about 15% from early February.
Barron's discusses the bargain hunt that hasn't led to many bargains so far:
After riding out the credit crunch, the subprime-mortgage debacle and the March collapse of Bear Stearns, investors in April and May began bargain-hunting in the group. But June struck like a thunderbolt, with Lehman Brothers (ticker: LEH), the new hedge-fund whipping boy, plagued by rampant rumors about its liquidity. There were reports Lehman planned in response to push up its earnings release and announce a rights offering to raise capital."
As far as we're concerned, we're largely staying away from financials until something REALLY dramatic happens and scares away fund investors - a big commercial bank failure, a Fannie / Freddie catastrophe - before we'll consider a broad recommendation to bottom fish financial sector funds. As we noted in February, it's not a true buying opportunity until only a few people want to buy.
ETFs vs. Mutual Funds - The Debate Continues
When you spend every waking hour for a decade working on a mutual fund investing website, you get a little cranky over fund-related innacuracies. We were so annoyed about that trader/gibberish panel discussion about exchange traded funds vs. mutual funds the other day we decided to make our own video about the very same subject. Sort of. Well, it's really just a segment on a business TV show about said topic. At a bar. Hey - we're not Morningstar or CNBC - we don't get to have a conference at a fancy hotel with thousands in attendance. Anyhoo, we're pretty sure MAXfunds.com co-founder Jonas Ferris hadn't had a drink before participating in this enlightening ETF discussion.
ETF or Fund Better? Depends Who You Ask...
An audience member at some sort of live CNBC event asks a seemingly simple question about exchange traded funds:
"For the small investor that wants to hold their investment for awhile and they are looking at a mutual fund verses an ETF and it's the same sector and it's the same kind of portfolio, why would you buy a mutual fund over an ETF given that the ETF usually has lower costs?"
...and in response gets day-trader mumbo jumbo from the expert panelists. The conclusion seems to be that ETFs are essentially always better because investors can buy and sell them intraday (so much for the 'small investor that wants to hold their investment for awhile' part), because the market gains big on some days and you don't want to miss those days.
Of course the market also falls big some days and investors would want to miss those days - and could benefit from ordinary open end funds which only execute investors' buy trades at the end of the day. For a longer-term investor, intra day price swings are irrelevant because those investors have no idea if the market is going down or up the day they buy in.
What is relevant is that ETFs can be cheaper to own, but can also be more expensive than similar open-end funds if not managed correctly.
For those who are going to add money to their holdings along they way, no-load funds that are bought directly from the fund family can save money on commissions if the fund fees are not far more expensive than an ETF. Most Vanguard and Fidelity index funds are as cheap as ETFs (and in many cases cheaper) and offer a cost advantage when considering the commission and bid/ask spread to buy and sell ETFs.
The trouble of course is figuring out which actively managed fund will beat a benchmark index going forward - a task bordering on impossible. On the other hand, what are your chances of beating a benchmark index buying and selling ETFs like a mad hatter?
We prefer a mix of lower fee actively manged open-end funds and index funds to an all-ETF portfolio. Depending on how you are using them, the index funds can be open-end or ETFs. We also think more harm than good will ultimately be caused by most of the new fangled ETFs being launched nowadays.
Gold Funds Attract Gobs Of Money, Promptly Fall
Fund investors have a knack for bad timing. TheStreet.com notes "Money Pours Into Precious Metals Funds":
Investors continued to pour into precious metals in March, adding a hefty $1.2 billion into the mutual funds and exchange-traded funds that concentrate on the specialty sector.
That brought the total flow of cash into the subsector for the first quarter to $3.6 billion as investors sought safe-haven assets amid the ongoing credit crisis."
Recently gold was about where it was when it started the year, but this doesn't mean investors are flat for '08. According to Lipper, these flows into gold funds were skewed to March. Gold ran up into quadrupole digits from January through early March only to fall back sharply. If much of the money went in during March, this money is at a loss for the year.
As a group over the last few years fund investors have made money in precious metals funds. Most funds in this category have sizable net unrealized gains on the books. But gold funds were unpopular years ago, and have grown in popularity as the shinny metal rose in price (and the positive coverage rose as well). It won't take a fall to the old prices to wipe out all the gains made in gold funds - even a dip to $500 per ounce could do the job given how much money has piled in during the last two years.
The volatility and hot money flows are some of the reasons why we have a hard time stomaching gold's increasingly popular "safe-haven" moniker. Anything that can fall 15% in a few weeks shouldn't qualify.
Take That Rick Santelli
CNBC reporter Rick Santelli recently had his 15 minutes of fame when he went on a rant about having to pay for the mistakes of 'losers' through a recently announced government mortgage payment subsidy program. He then made the very big mistake of standing up the Daily Show with Jon Stewart. Payback was delivered in the form of a mini-documentary of bad CNBC advice and commentary spanning the Dow's slide from over 14,000 to under 7,000.
Surprisingly the Daily Show doesn't note that the parent company of CNBC, GE, has received government support in the form of over a hundred billion in taxpayer backing of GE debt, without which GE could have failed during the commercial paper panic of 2008.
As the Great Real Estate Bubble deflates, those without sin should cast the first stone.