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Stop Reading About Last Year’s Top Ten Mutual Funds

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Okay, play before work: when theOtherGuy and I were designing the new site last Friday, it was a total nightmare. I wanted to get the Blog Post of the Week! up before midnight (so that Andrea from SoOverDebt.com could get both of our reader’s attention). Running out of time, I just grabbed a pic of my blog-writing friend Cooper. My cat.

Yesterday, my friend Doug—who has a lifetime of tech work behind him–was commenting on the new site layout:

(finally) Doug: …and one more thing, get rid of the cat picture.

me: Ha!

Doug: I know you think I’m joking. I’m not. It’s a deal breaker. Take down the cat.

me: (suddenly miffed for no reason whatsoever): Ha!

So now, completely out of spite, Cooper’s pic is going to stay on the site for the next seven days. Our Alexa site rank will probably plummet. No advertisers will touch us (nothing new there). But because Doug said “deal breaker”, Cooper gets his seven days of near-fame.

Now, on with the show……

SmartMoney.com yesterday published a list of the top 100 funds of the past 5 years. We’re inundated with these types of lists in January. I had a rare opportunity to read USA Today on my way home from Disney last week, and long-time finance writer John Waggoner penned a piece titled Fund Investors Ran in Place in ‘11. The story discussed what we already know: 2011 was a roller coaster year, with the average stock fund, according to Lipper, losing 2.9 percent. Investors are scrambling to find better results.

That wasn’t shocking.

What I found annoying was the story’s partner: “More on Funds, Quarterly, Yearly Results Tables….”. It was pretty much the same story I saw yesterday at SmartMoney. The obvious (unstated) connection I believe readers will make is that they’ll find better fund by reviewing the best ones from last quarter or last year.

USA Today and SmartMoney wouldn’t run stories featuring the top ten mutual funds (or 100….or whatever) if people didn’t search for this information. I don’t fault them at all. It sells. Turning to the USA Today piece, here’s a listing of the 4th quarter’s best and worst, as well as the 12 months’ best and worst funds. One page over I find the list of the top funds over 5 and 10 years.

Yuck.

Stop reading about the Top Ten Mutual Funds.

In his seminal investing book The Truth About Money 4th Edition’ target=_blank>The Truth About Money, financial advisor Ric Edelman discusses this thirst people have to throw money at last year’s winners. We want to own winning funds. Many of us have heard grandpa tell stories about the legendary returns of Fidelity Magellan back in the day, or of that high-flying Janus Twenty fund in the months leading up to the tech wreck. We want those days back. We’d love nothing more than to be invested with some manager who always makes us money. But as Edelman describes, history works against you if you’re trying to find great results this year by reviewing last year’s winners.

Looking at the top ten mutual funds rarely produces winning result.

WHY SHOULDN’T I INVEST IN LAST YEAR’S WINNERS?

  • When everyone clamors to enter a fund, investing millions of new dollars, the fund is doomed to failure. According to this study: Star Power: The Effect of Morningstar Ratings on Mutual Fund Flow, funds with high returns one year and Morningstar rating upgrades nearly immediately experience an unnaturally high gain in assets. These assets must be invested by the manager, who finds it more difficult to spread the investment among quality names. You’ll rarely find a manager can keep up with these huge asset spikes.
  • Often, the top ten mutual funds and ETFs are in specific categories which spiked during that calendar year. In 2010, commodity names like silver and cotton performed handsomely. In other years, real estate, large company stocks, or internet stocks have been big winners. If you invested in silver or cotton in January, 2011 based on 2010 results, you stepped in it. To mis-quote Sarah Palin, “how’s that workin’ for ya’ now?”
  • You may pay handsomely for a top fund. Funds with high expenses which spike may be especially dangerous. One top fund of 2010, Morgan Stanley Focus Growth B (AMOBX) carries an expense ratio of 1.77 percent. This fund competes against the S&P 500. If you’d purchased iShares S&P 500 index exchange traded fund, your expense would have been 0.09 percent, plus any trading costs. Big difference.

Here are some top funds, ETFs and ETNs listed in “best of” 2010 publications and their 2011 results:

Fund Name2010 Result2010 S&P2011 Result2011 S&PWho Listed
M.S. Focus Growth B AMOBX25.8715.06-6.432.11The Street
Fidelity Growth Co. FDGRX20.55 0.67 The
Street
Fidelity Contrafund FCNTX16.93 -0.12 The
Street
Proshares Ultra Silver AGQ182.44 -47.47 USA Today
iPath DJ-UBS Cotton Index96.22 -22.71 USA Today

In November of 2010, TheStreet.com listed the top performing funds competing with the S&P 500 here.

In January 2011, USA Today published a chart of the top performing funds of the year, which included ETFs and ETNs.

HOW SHOULD I PICK FUNDS?

(Photo credit: Crosa: Wikimedia Commons)

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A Goal Setting Plan that Actually (Gasp!) Works

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When I was a kid, I’d tell my mom proudly that my room was clean. After a quick glance, she’d send me back in, saying something about “my version of clean” and “her version.” While I’m still not sure what she was talking about, many people set New Year’s Resolutions with good intentions, thinking they’re pretty good.

Then they’re disappointed when a few weeks later they’ve failed.

Do you want to be a failure when you practice goal setting?

Of course not.

Let’s find a better way. Today let’s try setting goals the way that financial advisors do with their clients. I can’t speak for everyone, but this method I’m going to describe worked well for me.

Never been in a financial advisor’s office? That’s why we call this site the Free Financial Advisor (irony, huh?). Here’s what I did with my clients in early meetings.

We set goals that stick. Here’s how:

…after we chained people up and made them swear off credit cards, we’d…

…of course I’m joking.

I’d begin a meeting by asking my client “what do you want for yourself?”

Although this is the same question people ask themselves when they make New Years resolutions, I received a much different answer. People would give me the goals they thought I’d want to hear, not what they really wanted.

Most often, they’d say:

1) I want college for my kids

2) I want retirement for myself

After I gasped in feigned surprise from hearing the same answer yet again, we’d dig deeper. gauri_gasp

But let’s discuss these two goals (education and retirement) for a moment before moving on. These two goals aren’t at all the same ones that you give to yourself OUTSIDE of a financial planners office. Outside, goals are exciting. You want a new boat. You want to write a book. You want to quit your dead end job and go work for yourself.

You want to be a masked man in tights, fighting common financial planning mistakes.

Oh, wait. That’s mine.

So here’s step one: Write out your true goals. If you give yourself the goal you think “you’re supposed to have,” do what I did with clients. Ask yourself “what else” until they’re exciting. Then keep searching until you can’t dream up any more.

Goal setting sessions should include both short term and long term goals. I’d make clients outline all their goals. Here’s why:

Every goal affects the other ones. How you plan for college is going to have a dramatic impact on your retirement plan. Whether you join the country club will be affected by how quickly you get your new business off the ground.

By this time, clients think we’re done. This is the end for people who complete a New Year’s resolutions list. We’ve outlined the goals.

We’ve gotten a good start, but we ain’t anywhere near done, sister.

Next, step two: we prioritize your goals. Here’s the question I’d ask to help someone prioritize their dreams during our goal setting session. I’d ask,

“On a scale of one to ten, how important is it that you reach this goal, the way you’ve described it to me?”

Here’s what people would answer…

– Oh, I really really want all of these.

Then, I’d ask: “If you can have goal 1, but not goal 2, which would you pursue?” Using the retirement and college example above, I’d ask, “If you could give your children the best college possible, but it meant retiring later, would you retire late or find other education options for the children?”

Everyone thought I had an agenda and that I knew what they were going to say. The answer was obvious. This was the cool part for me. The answer was obvious, but not to me. It was obvious to them.

At this point, people would give a nice sigh of relief. In their mind, goal setting was over.

But it wasn’t. Although your average New Year’s Resolution was way over, we were now halfway.

My next job? If I’m a professional asking about goal setting, I still don’t know the goal. Sure, for you it’s retirement or your kids’ college. For me, the goal is an amount of money.

We’ve done a ton of work, but still haven’t actually set the goal.

How do you know how much to save for a goal if you don’t know the target? I’m often amazed when I see people saving five or eight percent into their 401k plan at work.

I’d ask, “Why are you saving that amount?” I’d usually hear answers like:

– It’s what I can afford.

– It’s the amount my company match.

– It’s the cap in my retirement plan.

I can’t remember a time someone answered, “Because that’s the amount it will take to reach my objective.”

But isn’t that what you’re really trying to do with a New Year’s Resolution? Aren’t you trying to reach a goal?

Here’s what we’d do next: in step three, I’d ask my client how much they’re saving toward each goal. My goal wasn’t to embarrass them, but it was to make them understand that there’s a lot more to goal setting than just throwing out a list of dreams and prioritizing them.

Quickly, we’d proceed to step four, finding out what each goal costs. Every goal has a simple equation to reach:math joke

Money x Return = Goal

Money can be expressed as either savings or new contributions, and return depends on the amount of risk you want to take. Both factors affect each other. As an example:

If you need to save $10 (yeah, right….but let’s run with it) and achieve an 8 percent return to reach the goal, you now have some numbers to play with.

If you save $11, you could reduce the risk you take on investment.

If you achieve a high return, you can spend money on other things, speed up the goal, or Super Size it!

Once we know these numbers, then we can proceed with step five: create the plan to reach the goal. It doesn’t take long and we’re able to

Here’s my question: how do you know which you’d do until you’ve followed these steps:

1) Write out your true goals. Both long and short term.

2) Prioritize the goals.

3) Write out how much you’re currently saving toward the goal.

4) Find out the cost of the goal.

5) Create a written plan to reach the goal.

And there you have it! You’ve successfully completed New Year’s resolutions that are sticky.

Here’s the funny part: I didn’t do this process for my clients.

I did it for me. Because as their financial advisor, I knew they were going to hold me accountable to the goal, and I needed a clear picture of the goal and what it was going to cost before I recommended a plan of attack.

If the hired help does it this way for your goals, why don’t you?

Okay, now it’s your turn: What’s your #1 priority in 2012?

Mine? Lose 10 pounds. Cost: Weight Watcher’s membership. I work better on a team. Timeframe: 1 lb. per week/10 weeks till finished, then maintain.

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What Did 2011 Teach You About Money?

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What’s one of my favorite activities this last week before the New Year? Once I’ve finished watching the Swamp People marathon, I like to turn the mirror on the preceding twelve months and determine what lessons I should remember to avoid future pitfalls. We won’t count lessons like “always check your fly before you walk into the bank” or “some people don’t appreciate grocery store coupons as stocking-stuffers.” Those are lessons we should have learned long ago, but refused.

No, there are bigger lessons that we should have learned in 2011. Not all of them had to do with money.

Here are five of my favorites:

Protect Your Downside

When I was a financial advisor, I was appalled by the sheer number of people who wanted to avoid insurances. 2011 taught us that bad things happen when we least expect it. Whether it’s the awful house fire in Connecticut this weekend, massive tornadoes in Alabama and Missouri, or the nuclear meltdown in Fukushima, Japan, we were reminded in the media that bad things happen suddenly. Because we don’t know when or where disaster is going to strike, it’s a good idea to put your financial house in order while times are good.

Related Ideas for Next Year:

– Build an Emergency Reserve

– Review Insurances

– Finish the Estate Plan

Know Your Money Managers

If you didn’t believe it when Bernie Madoff ran off with carts of other people’s money, the situation at a money management firm called MF Global should be another wake up call. After over $1.2 Billion (with a B) dollars went missing, the head of the firm professed to Congress that he has no idea what happened to the money. While I’ll admit that it’s impossible to know how a manager is keeping your assets safe, handing all of your money to one person is asking for disaster.

This doesn’t mean you should keep all of your funds in an FDIC insured savings account, but it does mean that you should perform due diligence.

2011 Here are some good questions you should be asking yourself:

How many different funds is my money spread among?

If all of your money is under the umbrella of one mutual fund, one asset manager, or one trader, you’re asking for trouble. This isn’t the same as having a single advisor. Good advisors will recommend you spread your money among many different managers, partly to ensure your safety.

How are your dollars protected against someone running off with your money?

Insurances such as SPIC cover investors, but you should know how it works.

What is the objective of each manager?

This question won’t help your funds from being stolen, but it can help you identify whether your advisor is actually recommending investments with your end goals in mind. If a fund is too aggressive, you may lose

How long have the managers of my funds been around?

Asking these questions won’t guarantee that your money won’t get stolen. Nothing can stand against a crafty criminal who’s working hard to steal your money. But you don’t have to make it easy for him. And, with a little planning, you can minimize your losses.

Related Ideas for Next Year:

– Meet with Your Advisors and Ask Questions

– Go to the FINRA BrokerCheck website to review your advisor’s record

– Diversify Your Financial Managers

Don’t Wait on Legislation to Make Decisions

Wow. Was there ever a more politically contentious year? Although there have always been (and will always be) fights between political parties, Washington has divided into two well-armed camps and compromise is a dirty word. It seems that the only legislation being passed are stop-gap measures to keep the government open. For the most part, these same issues will be voted on again in a matter of months.

When I have discussions with people about financial planning, I’ll frequently hear that someone is “waiting to see who wins the next election/whether the bill passes/how taxes are going to shake out/what the market is going to do.”

These are excuses.

There will always be new legislation, new market conditions, new headlines. An effective financial planner doesn’t wait to see what’ll happen. He adjusts to change.

Related Ideas for Next Year:

– Review Your Financial Plan

– Put a New Savings Plan in Place

Your Diploma Won’t Buy You a Job

Whether you agree with the Occupy movement or not, we’ve learned that there are many, many people out there who paid money they didn’t have for a degree, only to find out that there wasn’t a market for their services. Historically, people follow their dream through college and then beginning thinking about which career to enter. Sadly, it’s been proven to us now that before seeking a degree, we have to consider a cost-benefit analysis before deciding on a degree.

This doesn’t mean that you shouldn’t follow your dream. Certainly, you stand a better chance of being successful in your chosen profession if you love what you do. Following the theory that we only have one life to live, you owe it to yourself to establish yourself in a fulfilling career. But you should do some research about the career and how you plan to enter the market before you take on lots of debt.

An example: If you were to open a Mexican restaurant in a town full of other Mexican restaurants, you’re bound to fail to the leading establishments unless you can quickly identify how you’re different and how the competition is vulnerable. Armed with this knowledge, instead of taking out a loan to build another “me too” restaurant, an entrepreneur may decide that a Tex-Mex offering with live entertainment and only waiters fluent in Spanish is a better idea. You may change the hours or the decorations to stress your strengths. Will these moves guarantee success? Nope. But it’s a far better plan than taking out a loan and hoping to succeed, which is what many college applicants now do.

Related Ideas for Next Year:

– Review cost/benefit when taking on debt

– Build written plans to evaluate major financial decisions

Your Banker Might Not Be Your Buddy

Ah, my favorite topic: Bank of America. Like Darth Vader on steroids, BofA decided (without any thought about their reputation) that a five dollar debit card fee was a good idea. This time, protests by consumers and bloggers helped block the move. But the message is still clear: banks are searching for creative ways to replace income lost in failed mortgages and new credit card oversight rules.

Historically, bigger banks have been able to help you in ways that smaller firms couldn’t. Before I woke up, I used Bank of America for one reason: they had a larger network of ATMs than other banks. Then I discovered a little bank that would pay other bank’s ATM fees (I’d give you the name, but they no longer do this for new customers). Online banks are becoming highly competitive. As we move into the mobile banking age, the need for a ready ATM machine is dwindling. It’s time to review your bank and decide if it’s still competitive.

Related Ideas for Next Year:

– Review Your Bank Fees

– Explore Other Banks to Determine If There’s a Better Fit

There you have it. These were the five big lessons I learned in 2011. I’m sure there were many, many more.

Now it’s your turn: What were your biggest financial lessons from 2011?

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Facebook and Zynga IPOs – Should You Buy?

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We’ve all felt the magnetic pull of an IPO. The roaring 90’s come back to us. Why am I a blogger? I could invest in an IPO and be knee-deep in a Carribean island swimming pool holding a margarita the size of my face. Then again, I wouldn’t hold the margarita. I’d hire someone else to hold it.

So…the upcoming Facebook and Zynga IPOs – Should You Get In or Stay Out?

IPOs (initial public offering) seem to have lost a little of their luster over the past decade or so, but nevertheless everyone still turns their heads when a “big name” walks by and announces an IPO. Earlier this year it was the Groupon IPO, last year it was the “new” General Motors.

When a company announces their IPO, many people want “in” – it’s easy to see why: who among us hasn’t asked (at least to themselves, if not aloud) I wonder what would’ve happened if…

• I would’ve bought Microsoft in the 1980s;
• I would’ve bought Apple when Steve Jobs came back on board;
• I would’ve bought Google at $85/share…

As a financial advisor, my goal is to make sure my clients don’t “should” all over themselves.

(OK sidebar: If you didn’t laugh at that last sentence, you really need to read it out loud. Go ahead…get it? “Should” on one’s self? I can’t believe my comedy career never took off…okay….back to our regularly scheduled programming)

It tempts you because it seems like easy money. Who doesn’t like to live in fantasy land for a few minutes each day? My fantasy investment purchase? Greek debt insurance 2 years ago. That’s some serious jenga. But I digress.

So, here’s the deal with IPOs and why they’re not your best option:

1. Unless you have an “in” (think: your brother works for Facebook) you’re not gonna get any IPO shares

This means that if you try to buy into the Facebook IPO the day it opens, you won’t receive the IPO price (which is what everyone will talk about on CNBC). You’ll purchase your shares at a different–and often much higher–cost.

2. They don’t usually make money – at least not right away:

Image representing Zynga as depicted in CrunchBase
Image via CrunchBase

Like visions of gold, we conveniently remember IPO “winners” like Google or Amazon. We block out the long, tired stack of losers. Remember Pets.com? How about Vonage…they aren’t dead, but that IPO was a mess. eToys? Amazon.com, a mammoth stock by today’s standards, IPO’d in mid-1997…and didn’t make any percentage gains for several months. Google’s IPO occurred in 2004. The stock experienced a big spike, and then lay flat for 6 months. Often, IPOs don’t pay off for years, even when they’re winners like Google or Amazon.

3. The people who make the real money? The CEO, executive team and investment bankers. This is a big cha ching! event for them.

The Blackstone Group, a private equity and asset management firm, announced in 2007 announced they were going public. The issue drew so much attention that no one really paid any attention to the prospectus.

Why does it matter?

Well, it turns out that The Blackstone Group IPO launch only included “part” of their business (not that part that made money, mind you). After all the shares were gobbled up and the CEO and investment bankers off-loaded their shares (the CEO made $2.6 Billion–lovin’ the capital “B”), any gullible shareholders were stuck with a 42% loss in the first 12 months.  Here’s a great book discussing the lengths at which dirty CEO’s will go to cover their fraud.

Here’s our thoughts:

If you want to own a “cool new shiny Zynga IPO”, but don’t want to do the homework involved with reading the prospectus or making friends with an employee to get the “insider” price, buy a mutual fund in that same space. If it’s as awesome as you think, the fund manager will buy some (probably at the actual Zynga IPO price) and you’ll own some by proxy. If it’s a sham, the fund manager, who has a thousand times more resources than you, will probably pass – allowing you the easy way to decide whether to pass as well.

Plus, really, do you think it’s a good idea to put every dollar you own in Zynga shares–even if you could? What’s the best that could happen? Your money could double? Triple?

Sure. But what’s the risk?

We’re curious about your opinion. What do you think about the Facebook or Zynga IPO? Are you buying the hype?

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Exchange Traded Fund: A Low Cost Tool to Reach Your Goals

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If you’ve been living under a rock and haven’t heard of exchange traded funds (ETFs), today’s lesson is for you (though I still can’t figure out how you managed to get a wi-fi signal under there). An exchange traded fund is:

– often referred to as a “basket” of investments. This means a single ETF includes a collection of investments, so to some degree, you’re already diversified.

– investments that share a similar quality, such as all large companies, all oil companies, or all value-oriented firms. Sometimes they’re really quirky: all water companies, for example.

– usually aligned with an index, which is an unmanaged benchmark set of investments that people use to gauge the economy or success of their own investments. Some popular indexes are the Dow Jones Industrial Average, the S&P 500 and the NASDAQ 100. Some unpopular indexes are the Joe’s Favorite Boardgame Index and Best Doughnuts Ever Index, though I tried diligently to gain support for both products.

– unmanaged OR managed on “autopilot” based on predetermined criteria, not based on the whims of a manager.

According to Clark Howard, exchange traded funds are the fastest growing investment type, and with good reason. Although they compare favorably with mutual funds, they’re more attractive in many portfolios for a few reasons:

– Lower fees. Some investors believe that lower fees equal better results. I’m not that guy. But I do think that if I’m going to get middling results, why not pay less money for it? The average mutual fund fee is around 1.4 percent, while the average ETF fee is only 0.32. That’s a HUGE difference in fees. Think it isn’t a big deal? Check out this:

Story Problem!

Sally just sold her illegal street-rod and wants to invest the $10,000 profit. Over one year, an exchange traded fund will add an additional $108 more to her account than that average mutual fund her friend Jimmy uses. That $108 cost savings, invested for 30 years at 7 percent nets Sally an extra $11,738.01 for free, which she plans to invest in new headers and purple undercarriage lighting when she’s 65 years old. ….stuff Jimmy won’t be able to afford. HAHAHAHA

– Many investment options. A few years ago there were limited choices. Now if you can dream it, someone has probably created an ETF to emulate that investment idea.

– Downside protection. As a side benefit, exchange traded funds trade like a stock, meaning that you can use protection measures such as stop losses on an ETF. Stop losses can’t be used with mutual funds, because they only trade once daily.

Exchange traded funds aren’t the end-all, be-all. There are downsides:

– You’ll pay trading costs when you buy and sell exchange traded funds. This will take some of the $822 back out of your pocket.

– You won’t beat the index you’re competing against. Because your investment is tied to the performance of the applicable index, your returns will most often be slightly lower than that index (because of fees).

– In fact, your results will be pretty ordinary. The only way to beat the index is to invest in the hottest investments only. By capturing the returns of the entire index, you’re getting the best and worst picks of the crowd.

There are other downsides, but they’re more technical (such as dividends and volatility due to stop-losses). For the beginner, this is what you should know.

When is an exchange traded fund in order?

Just like you don’t bring your own hot dogs to a wedding reception (lesson learned), there is a time and place for exchange traded funds. Here’s where they really shine:

– ETFs are a great “hull” of a portfolio. Think of a ship’s hull. It holds the rest of the ship above water and cuts a straight path. Any position that you need in the portfolio to mimic market conditions AND you aren’t going to trade often is perfect for an ETF for two reasons: 1) trading fees won’t kick your butt (you don’t trade in and out of the “hull” of your ship) and 2) you’ll get the same diversification as a mutual fund at a lower cost.

– You want market-like results but fear volatility. I love psychology. Everyone wants two things from their portfolio (what’s with the two things today?): 1) Big returns and 2) no risk. Am I right? Of course I am. The market doesn’t give you Burger King (have it your way), but you can limit volatility. As I explained earlier, exchange traded funds trade all day long, while mutual funds only trade once per day. Why’s this a big deal? Mutual fund investors can’t limit volatility during a trading session. ETF investors can use instruments like stop losses to curb losses. Sure, you’ll pay trading fees, but if the market tanks, your nest egg will only have dropped to your stop loss point.

– You want to take a risk, but don’t want to bet on a single company. Because some ETFs emulate sectors of the market, you can gain exposure to precious metals, commodities and other risky asset classes without betting the farm on a single stock, bond or commodity. Sure, you can do this with mutual funds also, but with the ability to buy and sell all day long (as described above), ETF investors enjoy a greater degree of flexibility.

– Wrap and low cost trading accounts. If you have an account where you don’t pay for individual trades or pay a minimal amount, trading fees on ETFs are no longer a bridle on your results.

So, minions, that’s our Exchange Traded Fund lesson for the day.  Here’s my question to you: If you use exchange traded funds in your portfolio, how do you deploy them? Why do you like them? If you don’t use ETFs, it may be a marvelous idea to read the comments and see if some of our brilliant readers have additional ideas. Enjoy!

Evaluate a Mutual Fund in 10 Minutes

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Part II of our thrilling series, Evaluating Mutual Funds (or How to Cure Insomnia)

I think whatever intern created yesterday’s headline inferring that my mutual fund post would put you to sleep REALLY messed up. Both of our other readers told me it was scintillating discourse. Mom especially liked it. Looks like an intern’s head is going to roll at Average Joe, Inc.

MOST ways to evaluate mutual funds are snorers AND take too much time. THIS method (using Morningstar) is like have a hamburger for dinner and then your spouse surprises the whole family with ice cream for dessert. All in 10 minutes. This saves you time for a beer and pizza. It’s exciting and time-saving without the Tums.

If you haven’t read yesterday’s post, I’ll implore you to start there, because iin that magical discussion I showed you how to get to the page we’re going to explore today. If you don’t want to read yesterday’s piece, just click this link to open a Mutual Shares page on Morningstar.com and follow along.

This lesson will be oh-so-awesome with that little bit ‘o background.

So….when we last left our hero, he’d pulled up ING Franklin Mutual Shares, Portfolio I and was staring at the page. You should be doing the same now. Today I’m going to show you my secret 5 point program to quickly decide if this fund is worthy of your money or not. Before we start, I’ll remind you, this isn’t the place to start! You should be already hunting for a specific type of fund based on your financial plan. Once you know what you’re shopping for, Morningstar will help weed out ugly ducklings. In investing the ugly ones don’t turn out to be pretty swans. They just become ugly ducks.

1) Purchase Info.

I don’t like to go into the store until I’m ready to buy. It’s the same concept here. We don’t want to waste our time evaluating a fund if we can’t buy it. Click the tab that says “Purchase” just below the name of the fund.

– First’, we’ll find out the minimum investment. Across the left column are statistics about how much it’ll take to buy this fund. Thankfully, it’s zero. I can afford that.

– Second, let’s make sure it’s open to new investors. The last two lines of this same column tell me that, no, it isn’t closed. Bonus.

– Third, I’ll see if it’s available where I have my money. I’m in luck. I do all of my investing through Matrix Financial Solutions. If I had used a bigger, more well-known firm like E*Trade, TDAmeritrade or another, I wouldn’t be able to use this fund. (No, this isn’t an advertisement for Matrix, and no, my funds really aren’t there….sometimes my readers are so very literal….).

So what, Joe? – We probably can’t buy this fund. That saves us a ton of work. We’re going to keep going for the sake of comparison, but there’s a reason I started here. Over the years I’ve wasted a ton of time evaluating funds that I can’t invest in….only to find out a half-hour into the exercise. There is good news if you like Mutual Shares. This fund has other classes available for purchase if you have money and like it. Search “Mutual Shares” and you’ll find several other versions of this same fund with a different cost structure.

…which brings us to the last point. Costs. The Morningstar front page on this fund listed the costs as “below average.” Click the “expenses” page to get a better idea. Expenses are such a big deal, that we’ll do a more in-depth look another day.

2) Management

I don’t want to evaluate a fund and find out there’s a new captain at the helm. So, quickly, we’ll click on the Management tab and take a look. Yup, all three managers have been there from the beginning. I may do more in-depth research on these people later, but for now, I’m satisfied.

3) Category

To compare a fund against it’s true competitors, let’s begin by verifying exactly what  type of fund this is. To the right of NAV (the share price), you’ll find the header “Category”. It lists this fund as a “large value” fund. Further right, the header “Investment Style” shows a graphic Morningstar calls a “style box.” This box, which resembles a Rubic’s Cube, represents nine possible types of investment (This particular box is for stock-based funds. Bond based funds have a different style box.).

As you can see, the stock style box has nine sections. The top row of boxes represent large company investments, while the bottom depicts small companies. Guess what the middle is? You’re so smart! You’re right. It’s mid-sized investments. You’ll see that Mutual Shares is a large company fund. It invests in large firms.

The three columns represent value investing on the left, considered more conservative by many investors, a blend in the middle, and growth-oriented funds on the right. This fund trades in the value column.

Put these two criteria together and you’ll find that Mutual Shares is a fund which invests in large, value oriented stocks.

So what, Joe? – There’s a BIG “so what” here. Funds sometimes drift from what they say they’re going to do. Some analysts call it “cheating.” If I’m starting with my goal in mind and I think that a large, value oriented fund is the way to go, I may look toward Mutual Shares. But what if I looked at the style box and it showed up in the blend or growth column? – or the fund really bought more mid-sized companies? It might be a good fund, but not right for my goals.

4) Risk

Evaluating risk is something I love to do, especially since we had that fireworks fight in 6th grade and I nearly had my eye blown out. risk Long story….but let’s just say two things: I’ve never been particularly excited about looking like a pirate and I’ve become passionate about weighing risk before participating in any activity.

To find out how risky this fund is, let’s maneuver over to the “Risk” tab and click to that page.

You’ve seen how “those damned kids” know all the right buttons to press with their video games and whatnot. (That was a poor imitation of my dad, btw.) If you’re going to play the mutual fund game, it’s important to know the right buttons to press. These risk statistics look difficult, but it’s important to gain a basic understanding if you’re going to be a skilled investor.

A note to financial gurus reading this page….remember our audience. This is the 101 version. I won’t be covering all the stats and I’m probably going to do a quick fly-over only. Put your protractors away and let’s begin.

The area we’re going to focus on is the MPT statistics box in the center of the page. It isn’t important for our discussion what MPT means (although, to fill you with the soothing knowledge that your teacher has mad fly skillz, I’ll tell you that it’s Modern Portfolio Theory. Happy?)

Notice that you can tab between 3-year, 5-year and 10-year statistics. That should be the first clue that it’s impossible to know what risks the fund is going to take tomorrow. We can only evaluate the historical track record over time. There are two basic measures: against the S&P 500 and against the “best fit” index. Without getting into another diatribe, we don’t care about the S&P 500 here. We want to know how this fund compares with others it competes against in the “Large Value” sector we identified above.

On the 3-year record, you’ll see that Mutual Shares has a beta of 0.87 and an alpha of – 2.68. What the heck do these numbers mean?

It isn’t easy, and I didn’t learn it in a day, so you won’t either. But here’s the training-wheels version:

A beta below 1.0 means the fund has had a history of producing less volatility than the index it’s compared against. A fund above 1.0 takes more risk. So, if funds have betas of .5, .8, 1.1 and 1.6, the one with a beta of 1.6 is the hot tamale while the one with a .5 takes the least risk. A beta of 1.0, by the way, would mean that the fund takes the same amount of risk as the comparison index. Got it? So, with a beta of .87, this fund has taken less risk than it’s competitors.

So what, Joe? – If you’re looking for a large company value fund that takes big risks, this ain’t it.

The alpha number rates the manager of the fund. If the fund has a positive alpha, that means that the manager’s picks have added value to the fund. If the alpha is negative, the manager is taking away value. With a low beta, I’d expect this manager to also have a negative alpha when compared to the index. Why? A fund that’s geared to take less risk is going to make more conservative plays, resulting usually in correspondingly low results.

…and what do you know? The alpha IS negative….

So what, Joe? – We’re finding that this management team takes less risk and provides less value than some competitors. A fund with a low beta and high alpha (obviously) is my favorite type of fund. You’ll find those, unicorns and four leaf clovers in the same place.

5) Performance

Left of the Ratings & Risk tab, you’ll find the “Performance” tab. Click that.

This page opens onto a chart which shows the growth of $10,000 over time. Let’s look at the data below the chart. I want to focus on one line: “% Rank in Category.” This measurement tells us how well the fund has performed competitively against others during that year. in 2008, it’s rank was 61, meaning that 61 percent of all funds in it’s class beat it’s performance. It wasn’t much better in later years. Although in 2009 the fund was in the top 30 percent, it declined to be only top 72 percent in ‘10.

Let’s play a little Sherlock Holmes here. I’d bet that in 2009 the market was lower and in ‘08 and ‘10 the market was a little better. Why? This fund, according to the beta we evaluated above, should hold onto money better during poor years. True in this case?

Not at all.

Surprisingly, the fund actually beat the market in 2009 and was trounced in 2008 when the market was horrible and in 2010 when the market had a pretty average year.

So what, Joe? – You can see what we’re getting at here. This fund has been a mixed bag in terms of results, but on a daily basis takes less risk.  This means there is still more for me to know. This fund is apparently doing something else with money to keep the beta low. It seems to be a fund that walks to it’s own drum. This could be good or bad. All it really means is that I need to know more. The good news? I know roughly what I’m looking for.

In 10 Money-Making Minutes we’ve learned:

10-minutes – The costs of the fund are low, and I can only get it at one firm.

– The current management is responsible for the results I’m evaluating.

– Mutual Shares bills itself as a Large Value fund and it’s investment style reflects the same.

– The fund takes less risk and produces lower results than the average fund it competes against.

– The fund doesn’t seem to uniformly win in an up or down market.

– It might pay to dig into the management philosophy more so I’ll have a better idea of what to expect.

Clients used to pay me to show them how to quickly evaluate a fund. Today you got the same treatment for free. Yes, I am a heck of a guy.

– Joe

Okay, minions. Here’s a question for us to play with: What other criteria make your “10 Minute Fund Evaluation” list?

Researching Mutual Funds (or How to Cure Insomnia)

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Part I – Introduction to an Investment Analysis Tool: Morningstar

 I’ve become a tool deviant. I feel like Tool Man Tim when I walk into Home Depot. My wife had to nudge me to stop grunting in the paint aisle last week; Cheryl is convinced I’m thinking about leaving her for a Wagner Paint Sprayer.

Unfair, unfounded and not true. I just grunted. It could happen to anybody.

My tool obsession began with financial planning tools. The good news is, if you like to carry a tax table in your pocket and wear tape around your glasses like I do, financial calculators are every bit as hot as any U joint in aisle 7 at Lowes. Financial geeks like me drool over an HP 12-C calculating 30 year mortgage payments at six percent interest.

Morningstar

In one of my favorite recurring dreams, I’m on a deserted island with an investment analysis web tool called Morningstar. This website, found at www.morningstar.com, is the single best place to find third-party mutual fund advice. Period. There aren’t any others nearly as robust available to the general public for free.

That doesn’t mean Morningstar is perfect, but I’ll show you what to avoid.

Morningstar is to mutual funds what Consumer Reports is to toasters. If you’re pretty anal about your toaster (and really, who isn’t?), Consumer Reports will point you to the absolutely best model at the lowest cost. Similarly, Morningstar divides funds into categories and then ranks competing funds against each other. Each fund has it’s own pages, displaying the inner-workings and past performance of the product.

In financial geek circles, it’s awesome.

Different than Consumer Reports, Morningstar can’t predict the future of the fund. This is an important distinction. People think a fund that’s highly rated is going to perform in the future. Don’t make this mistake. It’s become a cliché in the money management industry, but it’s true: past performance is no indicator of future results. Where your highly-rated toaster should rock-n-roll all over your bagels, a top-rated mutual fund could lose significant money tomorrow.

Using the Site: Front Page

Before you reach the front page, you’ll be presented with an advertisement. You may click “direct to Morningstar.com” to leave the ad at any time. This is the price you pay for solid advice. Morningstar is littered with advertising and not every link will work (some force you to sign up and others are only for paying members). Although you don’t need to ever register to use Morningstar, significant benefits are available for people who choose the free membership option. As a recovering money manager, I’ll recommend that you avoid the premium sections. These are generally sections that give you Morningstar’s feelings and advice about investments (there are some nifty tools also, but none that you can’t live without). I’d rather you learned how to evaluate funds on your own before paying for someone’s advice.

Morningstar’s front page covers many types of investments. The Chicago-based company has expanded over the years to also deliver ratings and advice on stocks, bonds, exchange traded funds, and closed-end funds. Although I’ll use this site as a secondary place to review my investments in these other areas, there are many competitors who offer similar services. In my opinion, Morningstar still shines brightest in the area where they began: mutual fund research.

From the front page, click on the “funds” tab to see the mutual fund front page. You’ll notice top stories in the middle, analysis tools on the left, and Morningstar favorites on the right. Only paid members can access most of the buttons on the right and several on the left.

Using the Site: Search Function

If you know the name or ticker symbol of the fund you’re hoping to evaluate, there is no reason to click the mutual fund tab. Nearly every page of the site allows you to type either the name or ticker symbol into the “Search” box at the top of the page. Find your fund on a drop-down menu that appears. Click on the link to bring up a page about your fund.

About Star RankingsSea_Star

On the fund page, next to the fund’s name is most user’s favorite tool: the Morningstar star ranking. Morningstar ranks funds the way Zagat’s categorizes top restaurants.  They use a five star system with five stars being the highest rank and one star being a near-sure sign to stay away.

A word of warning: don’t pick a fund based solely on the star ranking. Do you often disagree with movie critics? You’ll find that, much as critics pick top films based on criteria different from your own, it’s better to know how to review the fund on your own. Choose a fund for your money based on goals and evaluation of the fund management. A fund with a five-star ranking is likely to become bloated with lots of cash over the near future because dollars rush in when funds achieve a high score ranking. A fund managing lots of cash often has trouble investing it all, creating mediocre returns.

Tomorrow we’ll continue the tour of Morningstar. For our purposes, we’ll evaluate ticker symbol IFMIX, ING Franklin Mutual Shares Portfolio I. If you want to practice, find this fund page for tomorrow’s exercise.

I’d love to stay and chat longer, but I’m headed out to oogle alternative minimum tax criteria. Sexy!

The Secret “Get Rich” Equation

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My mom used to tell me, “there’s a time and place for everything,” which sounds like good, solid meat-and-potatoes mom-speak until you learn that she followed it up with “and now’s the time for gin!”

But the point holds. There is a time and place for everything, including gin, stocks, bonds and real estate.

Every investment has a proper use.

So, today, we’re going to begin the journey toward the pot o’ gold, friends. We’re going to put on our boots and hunt for the secret “get rich” equation that’ll help us choose the perfect investment.  Like a good doctor, we’ll focus on a patient with a problem.

Luckily, we happen to have one right here.  Julie is a good friend of Average Joe. She’s 32 and wants to retire at 60. She’s in the medical field, and hopes to accumulate enough to have the option to retire even earlier.  On the other hand, she currently enjoys her career and isn’t sure if she’ll even want to retire that early.  Because of this, she’s looking for flexibility.  Good for her. I like to hear stories about people loving their work.

This also helps us eliminate investments.  Hear the word “flexibility?” That immediately eliminates several investment choices, narrowing the field.

Isn’t this fun?

And to go faster, we can chuck any discussion about how much money Julie has already saved or which investments she’s currently using. Sure, both are important, but our goal today is to show you how to start choosing the right investment, not to oogle Julie’s assets.

Get your mind out of the gutter. You know what I mean.

Diatribe:  Countless advisors I’ve met begin this process in the wrong place, as do plenty of online helpers. This isn’t rocket science. We don’t have to start with today’s hottest investment or the perfect opportunity.  Instead, we begin with a simple equation.

I’m back off my soapbox.

The equation is this:  Money (times) Return (equals) the Goal.

It’s painfully simple. Julie is going to need so much money and have it perform to a certain specification to reach her end game. It’s math time, boys and girls. If we know two of the factors, we can solve for the third.  In this case, what do we know?  We already have the goal, and Julie knows the amount of money she currently has stashed away.  At this point, she needs to solve for the minimum return she’ll need (at this current pace) to reach her objective.

Ta-da! Once we know the return we need, it’s time to begin choosing investments.

But, before we do that, let’s not gloss over some problems.

We made some assumptions. If someone else performs an analysis on your behalf, you must understand what assumptions were used! If you don’t you’re bound to forget the entire equation.  Here are Julie’s assumptions:

–          She’s going to continue to save at the same rate until retirement. This could easily change (for better or worse).

–          The tax treatment of her assets will not lessen her return between now and retirement (we’re assuming that her return factor will be an after-tax amount).

There are others, but those are the biggies.

Tomorrow we’ll accomplish a single goal:  I’ll show you free places online where you can complete this equation.  I know, isn’t it exciting?

–          Joe

 

Read more:

The Least Funny Financial Joke Ev-Ar

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We used to tell a joke. I know, when you think “financial planner”, all you imagine is a group of suits clowning around, and general hilarity, right?  Me neither.  But, we did have a joke.  Maybe you’ve heard it.

A woman walks into a financial advisor’s office. After leading a good discussion about her goals, the advisor asks what investments she’s using toward her objectives.  She tells him she has CDs at Bank of America, Wachovia, the corner bank, and her credit union.

The advisor says, “why do you have the CDs spread around at so many banks?”

To which she answered proudly, “I’m diversified!”

Yeah, now you know why my wife never wanted to attend our work Christmas parties. We are cray-zee.

There’s a point here, though. Diversification is about much more than spreading your money around. Although there is a certain leap of faith when diversifying, that leap is far beyond where most investors begin to jump. There’s a ton of science you can perform before you throw your dart toward the target.

Many people begin with the dart. Gold sounds like a good idea. The guy at work l.o.v.e.s. small company stocks. Your boss has ridden Apple all the way to the top. Your cousin invests in rental properties and is making a killing.

These may all be fine investments, but none might reach the goal.

Different investments have performed better or worse depending on the time frame. Historically, the stock market has been a horrible place to invest for short term goals. Bonds have been wonderful during most five year periods. Still, both stocks and bonds have performed poorly over short time periods (such as a year).

One tool that advisors used well during my time in the field was an asset allocation tool. Luckily, you can find these all over the internet. With an asset allocation tool, you’ll find out what investments give you the historically least amount of risk with the greatest chance of return. These tools work very well for someone who’s new to investing, because at the least, they help you find a sensible approach to diversifying your money.

Tomorrow, I’ll have a few places for you to look for good asset allocation tools.  For now, if someone would like to be Joe’s guinea pig, how long do you have until your goal? I’d love to have a real-live person to use as an example.

– Joe

Why Junior’s Education Might Be Cheaper Than You Thought

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My son went to a private school for a year. If we hadn’t moved from the region, I think I may have had to start selling plasma on the side to afford tuition.

It’s that expensive.

But you can’t deny the value of a good education. In fact, Dr. Jeffrey Sachs presents a horrifying case in his new book, The Price of Civilization. I don’t want to devolve this blog into the politics of this book. This blog, which refuses to stand for anything, doesn’t endorse any politics associated with the piece (enough disclaimers for ya’?).

My only point:  the statistics in the tome don’t lie: the key to life isn’t in getting an advanced degree, but there’s a more-than-high probability that your quality of life is seriously screwed if you don’t have one.

You’re still going to have to work hard and secure a job, two factors that ain’t gonna come easy, even with the degree in-hand.

So, you being the amazing parent that you are, decide to begin saving for junior’s education.

And that’s where the fun begins.

Most people start from square 10, rather than square 1.  That’s because the silly marketing departments for investment companies encourage you to start from the middle, with their emphasis on whether you should use a 529 plan or a pre-paid tuition option. How about mutual funds?  Coverdell?  Decide what you want to save into already?

Remember the moldy financial advice to look at the map before starting your car?  It’s advice that’s been rolled out often because it’s true.  Start with your goal.

Of course, it’s impossible to ask a two year old where she wants to attend college.  I take that back. You can ask, but the answer won’t be very accurate. So, as a financial planner, I had to get creative. We had to start with affordability.  My question became “what can a parent afford?’

Good News on the Affordable Front

You can probably afford more education than you believe. I know that scholarship opportunities are overrated. It’s actually the calculation most financial planners use that are inaccurate.

Let’s visit a reliable website and view the college costs.  We’ll focus on Kentucky University. Mostly because I’ve never been accused of being a fan of this school for no greater reason than I always want their basketball team to lose.  I know. I’m petty.  Let’s move on.

We’ll begin by finding reliable third-party information:  Peterson’s College Search. At thefreefinancialadvisor, we like to use websites which don’t have an axe to grind. Petersons is a great site because they only want to be your go-to place for education statistics and information.  (and no, thank you, I’m not being paid by Petersons, either.)

So, let’s start here:  http://www.petersons.com/college-search/university-of-kentucky-cost-and-financial-aid-000_10001934_10003.aspx

We’ll pretend you’re in-state for this exercise.  See the bottom line?  No?  You’re right.  We’re going to have to perform some math.

First, there’s tuition at $7,656.  Then we skip down to fees, which are $954 for full-time students.  Finally, gaze a paragraph down to room and board.  That’s an additional $9,439.

The total cost of education, per year, is going to be $7656 + $954 + 9,439 = $ 18,049. 

For this exercise, we’ll assume that you plan to pay all of these costs without scholarship aid. At least for planning purposes with your two year old, you shouldn’t count on aid. What happens if you plan on aid and don’t receive a package?

At this point you should be asking yourself, what about this number is affordable? 

The good news is that the $9,439 number for room in board is correct. However, you may discount a portion of this price from your family budget.

In many financial planning meetings, the advisor will neglect to back down your costs associated with junior living at home. If your little-pride-and-joy moves away to college, you’ll no longer be responsible for food at home, and if your child leaves lights on as much as mine does, your utility bills will drop.

Why doesn’t an advisor back down these costs?

There are possible two reasons:  either she isn’t very good at her job, or the much more malicious reason.

She is hoping to jack up the cost of education to raise the amount you’ll need to save. This amount will go into a fund she receives a commission for.

Now you’re thinking to yourself, there’s no way this really happens.

Sadly, you probably aren’t thinking that. So much for imagining our readers are all happy-go-lucky, believe-everything-you-read people. Nope.

Whether malicious or not, when you’re ready to start saving for college (and based on these numbers above, you should have started yesterday), be sure and discount the room and board numbers to factor in the savings you’ll find when junior is no longer eating you out of house and home.

Happy Education Planning,

Joe