What looks like a mutual fund, pays dividends like a mutual fund, is compared to a mutual fund and most recently, up against the S&P 500 index, actually has performed better, yet isn’t one?  REITs, which stands for real estate investment trust is often confused by investors as a mutual fund.  As as to the performance comparison, it was actually a sector of the REIT world, the commercial REITs that outperformed the S&P 500 in a year-to-date comparison (REITs, as of 08.26 were up 11.7% while the index of large cap stocks posted a 4.9% loss).

Before we get ahead of those who aren’t quite sure of what REITs are, let’s take a moment and break down.  REITs fall into five basic categories. Retail REITs focus on malls and free standing retail operations.  Residential REITs invest in multi-family dwellings such as apartment buildings. Healthcare REITs are involved with the hospital, healthcare facilities and retirement home operations. Office REITs are also self-explanatory while mortgage REITs, suggest that the REIT actually owns homes.  Instead the own mortgage backed securities.

When you buy a REIT, you are buying a stock in a trust that focuses their assets on the profitable purchase of real estate.  Aside from mortgage REITs, most of these trusts look at the need for buildings to house businesses or numerous families.  These trusts invest in these properties acting as a company rather than a fund holding numerous underlying securities.  because they are essentially a stock in that respect, investors should be aware of their record of good profits, strong balance sheets and as little debt as possible, especially the short-term kind.

There is no shortage of buying opportunities for well-positioned companies.  This doesn’t mean it is the next big thing and no analysts suggests more than 5% of your overall holdings should be focused here.  But it does provide for some intriguing diversification.

The bet with REITs is that there are still numerous properties that could face financing problems and with almost a billion dollars in refinancing obligations set to expire in the coming month, those who have been keeping their cash on hand may se a lot of low-cost opportunities.  The second bet here is that the economy will eventually recover.

REITs that own apartments have found their businesses to remain robust as people continue to sit on the sidelines despite lower mortgage rates and depressed housing prices.  Well financed healthcare REITs have been focused on consolidation and look to be invested consistent with projections of need in the future.

REITs aren’t real estate. They are companies that buy real estate and you are an investment partner.

Here are several articles concerning REITs from Bloomberg, David Shulman, a Distinguished Visiting Professor at Baruch College and former Lehman Brothers Managing Director and Head REIT analyst, REIT.com, and Janet Morrissey writing for Time

The world of conservative investing that has developed over the last couple of years has done so with sound reasoning.  People who buy fixed income believe that in doing so they are protecting their investments in the safety of debt.  That debt, be it from Treasuries or corporate bond issues has seen prices rise while yields drop.  yet they continue to put money in what many are now seeing as the next bubble.  But many equity fund managers are now suggesting that this bull market in bonds is about to end as unemployment continues and economies around the world still struggle.  Are equity funds worried about the investor or the fees they are (or are not) generating?

David Pauly, writing in Bloomberg pointed out that “These managers are concerned about their fees: On a dollar- weighted basis, stock funds on average collect 76 cents in fees for each $100 invested compared with 61 cents at bond funds.” Even as money flowing into bond funds increases, PIMCO, the world’s largest bond fund company predicts that this bull market in bonds is poised for collapse. When is subject to debate.

We have near zero interest rates, the housing market continues to see price stagnation and there doesn’t seem to be any concerted effort by the government to get back into the stimulus game.  Unfortunately, it is the stimulus provided by government that has allowed us to get this far, even if “this far” is still short of where we should be in this economic recovery.

Because investors still see the potential for yet another slide into recession, bond fund inflows have increased as a compared to their equity counterparts.  While these investors are doing so because the believe that bonds still are far less risky than stocks, they may simply be kidding themselves.  Risk, the much needed element in any portfolio seeking to grow, is not something bond investors necessarily believe they are taking when they channel their money into these investments.

That risk is the price.  Bonds are priced based on the willingness of investor to pay for safety and the more they believe this, the higher the price goes.  As the price goes up, the yield falls.  Should the economy double dip, this bet will be worth taking.  But if investors (even if they are prompted by their money managers to get back into the stock market – as Mr. Pauly suggests because of better fees charged by the equity funds they represent) decide at some point that the economy is improving, the sell-off will leave a lot of late-to-the-game investors holding losses they didn’t think possible.

Mark Trumball, writing in the CSMonitor outlines this risk: “It’s hard to predict when a shift will occur, but at some point, many investment strategists warn, Treasury bonds will become the worst-performing bonds of all. That’s precisely because these bonds are considered to be among the safest investor havens during hard times. If a crisis mind-set eases, Treasuries have run up so far in price that they have the furthest to fall.”  Should this shift occur suddenly, not only will individual investors be in trouble, but large pensions funds who have difficulty moving quickly, will also suffer.

Inflation also plays a role.  Bond investors will demand some compensation for the increase in inflation, something that has been so far, benign. Robust recoveries usually indicate an increase in inflationary pressures and there is no indication that this recovery could be described that way. Bond gurus also point out that if the bond bubble should burst, should inflation suddenly spike, the retreat away from bonds will not mirror that sudden retreat investors in equities often exhibit.

Vanguard points out that the safety in bonds is likely to be less dramatic in large part because as bond prices drop, yield will increase. And this will keep many investors with a choice: keep the bonds they have flocked to or sell them for the rising opportunities in the equity markets. But Vanguard’s prediction that investors will simply freeze may not take into account the nature of investor behavior. They are in bonds because they were frightened of losing their hard-earned money.  But if they see a return to out-sized gains in the stock markets, they may just vote with their feet again.

Vanguard argues that in no matter what happens, bond investors will still do good. In a bad economic situation, the point to historic likelihoods by suggesting the investors who stayed in bonds saw a high relative return.  In a good one, they point out the higher nominal returns will occur. They point out that the rise in interest rates will affect the short-term bond more than the long-term.  Their analysts see a rise (over the next five years) in 2-year Treasuries from 0.81% to 5.28% (rates for longer termed bonds will rise less dramatically from 4.43% to 5.56% over the same five year period).

But this depends on numerous factors including a steady inflation rate, the continued purchase of US debt by foreign banks, predictable increases in the Feds fund rates, modest GDP increases and you. If you hold steady, these predictions will probably come to fruition.  But if things improve in the equity markets and you panic, the bond bubble will burst, albeit slowly, in spite of Vanguard’s argument that you will still do okay if you had done nothing.

Part one of our series on the Middle Class: The Money Class? can be found here.

Who are you? The mutual fund industry has been asking that for decades and the answers still aren’t quite clear.  But they are getting closer to understanding that the vast majority (85%) of the owners of mutual funds are households.  Careful with that stat though, because in truth, less than half (43%) of the households invest in mutual funds.  Which means that although the vast, majority use these funds in their retirement plans (such as 401(k)s and IRAs), the majority of us don’t use those plans at all.

So as we peer into the ownership of mutual funds, we will see the still vast disconnect the public has with their own future. Although the ICI’s FactBook suggests that the median value of these mutual funds is $80,000, this represents, at least according to their research, about the same amount as their current household income.

This middle class (money class) is about 50 years old, three quarters of them are married, less than half are college graduates with about two-thirds of their assets invested in mutual funds.  Once they are invested, they tend to do so via IRAs (67% of the time) or through defined contribution plans (78%). The median ownership profile suggest that these investors (with about $150,000 in total financial assets) own 4 mutual funds, three quarters of which are focused on equities.

Its no surprise that these investors are using mutual funds for retirement.  With the 401(k) now well over two decades old, the mutual fund’s growth in popularity was forced by participation in these plans. Not surprising, the higher the income in the household, the greater the likelihood you own one or more funds.

What was a surprise was the involvement of advisers in the process. Advisers do add another layer of fees – perhaps the biggest complaint that comes from fund owners even though those fees are half of what they were just a decade ago – but half of these investors tapped them for some sort of advice in the recent financial downturn. In fact, between June of 2008 and May of 2009, the report noted that of those that had advisers, nearly everyone contacted them.

So what about the other half of those investors, the ones without advisers? The FactBook suggests that they instead contacted their mutual fund directly during that period.

Shareholders in these investments have altered their risk, following a relatively predictable pattern of sentiment following markets.  If the market was down, the sentiment followed with the opposite happening in good markets.  But risk can tell us some interesting things about the investor’s view of the mutual fund itself.  If you like funds, you were more likely to take above-average risks.

Although the report doen’t suggest why this group of fund advocates assumes greater risk that those who merely tolerate the tool because it may be all they have, but we can speculate.  It may have something to do with their belief that the mutual fund manager knows best, the investment carries an feeling of “mutual ” involvement and if they had done well in the past, perhaps they believe they will also do well in the future.

Retirement seems to be the reason most folks use mutual funds in the first place.  Of the 117 million households that do invest in retirement planning, a third of them use mutual fund in both IRAs and defined contribution plans.  That number matches the group that do nothing, have no access to a plan at work or invest on their own. The rest had one (29% with employer plans only) or the other (8% in IRAs).

This doesn’t mean that those with IRAs used them.  In fact, only 15% made contributions to them in 2008 with far fewer using the catch-up provision.  Of course, those that did tended to be older and if they used their employer’s 401(k) plans, their balances were usually much higher the longer they worked.

The most troublesome aspect of this participation is the focus on fees, not only by the employer (who tends to share the cost of their plan with their employees) but the employee, who, with choices that tend to charge lower fees, invested accordingly.  This put the focus on fund offerings in these plans on low-cost, low-turnover funds and that meant, lesser risk.  The study also suggested that the smaller the firm, the higher the fees.  The higher the fees, the smaller the balances.

Much of the popularity of life-cycle funds or target date funds (ICI refers to them as target-risk) is due to the auto-enrollment feature of many of these plans.  Designed to boost retirement interest, these plans often enroll their new participants in these types of funds or a generic, low-cost, low-risk index fund. While it may have increased the overall number of people in the plan, the growth of those accounts has slowed.

Based on this information, the average investor could do better, much better. But how do you get the middle class to invest more?  Lower fees doesn’t seem to be an adequate selling point.  Lower risk only tends to keep balances lower longer and have the net effect of luring investors to make additional or increased contributions.

Plan sponsors are still offering plans with a high expense profile (although it is lower the than fund industry overall) and may penalize their participants during poorly performing markets by withdrawing incentives such as matches or if they retain those matches, lowering other benefits such as health insurance coverage.  Those same plans are concerned, if not worried about their fiduciary responsibility perhaps more so than the wealth these plans could generate.

In short, the success of your retirement plan using mutual funds relies on your continued and increased participation. And based on the numbers, we are a long way from calling these efforts a success.

Exchange Traded Funds or ETFs, those index funds that mimics those of the mutual fund world that trade openly on the stock exchange throughout the day have made investors who don’t use them wonder if they are missing something and those that do, want the F in ETF to stand for free. But they only come close.

There are definitely advantages to owning these types of securities.  Among those reasons are the ease of buying and selling, the ability for the investor to focus on a specific sector and of course the fees.  The leader in this space is still Vanguard, the Malvern, PA mutual fund giant. Their offerings cover the gamut of investment opportunities and make their money on volume.

But that hasn’t stopped others from entering the fray.  And this has the financial rep world just a little concerned.  It is widely acknowledged that folks who use Vanguard are a specific group of investors. And based on sheer volume, it can offer lower fees and commission free trades for all of its 46 ETFs.  But that is where it ends and Vanguard investors seem to be cool with that idea.

Schwab is also trying it hands at that sort of approach for its 8 ETFs.  But the hope is that there will be more to the relationship that just.  For instance, you can use the trading platform at Schwab do buy any ETF but the cost of that trade is $8.95 plus a five dollar service charge.  If you need a broker to do the deed for you, $25 will be charged for the service.

Fidelity, which offer 26 program funds charges slightly less than Schwab for trading in ETFs not part of their fund family.  According to a recent article in Registered Reps “The Fidelity program offers a diverse mix of 25 iShares products: 16 domestic equity funds, four international equity portfolios, four ETFs tracking U.S. debt benchmarks as a well as an international debt fund. The Nasdaq Composite Index Tracking Stock — Fidelity’s lone proprietary ETF — is also included. Fidelity is not doing the iShares deal out of pure altrusim. The firm receives a fee-split from iShares’ sponsor for marketing the funds.”

So should the average investor interested in these products be concerned about what amounts to near-freebies?  There has to be a catch, right?  There is but based on what Fidelity, Schwab and the other discount brokers (who have yet entered into the deep discounting of ETFs – yet) and aside from simply gathering assets, these firms have a management side of their operations that they hope will be attractive.

Because you can only build the most basic of portfolios using the program funds that Schwab offers, the investor is likely to buy – or ask for help to advise – on how to build a better portfolio. It becomes a “get what you pay for” scenario that these full service brokers hope to capitalize on in the future.  If you want a call center, then you will look to the cheapest available option.  But is you want someone to help you, someone with at least some alphabet letters behind their name (CRD/ADV and educational distinctions such as CFP, CFA, ChFC, CRPC or RFC), then you will also be willing to pay a little more.

The line in the Vanguard press release dated October 6th, 2009 offered the following: “We also caution against using short-term performance figures—however attractive—to guide your investment decisions.”  Why would they say such a thing after the run-up, that even they suggested was, too-far-too soon?  And could the worry that this short-term outlook would tempt the 3.2 million investors in their 401(k)s under management to jump on the hottest fund in the hope of recouping what was once theirs?

The rebound in 2009 was quite the stunner.  If you stand back and look broadly at it, it makes absolutely no sense and at the same time, does.  A 10% unemployment rate could be seen as a 90% employment rate, better than most economies around the world, even the good ones. While foreclosures mounted, not everyone was suddenly outdoors.  While businesses were trying new ways to make money, such as not selling products but instead hoarding cash and consumers were finding ways to be prudent, the stock market was running away enthusiastically and the fund king of the index was concerned.

Now, not so much.  They even sound a little boastful.  Seems that 2009 was good enough to announce that two-thirds of their accounts had done so good that at the end of 2009 they had recovered to their late-2007 levels. That is good news and I don’t want to diminish the reasons for that success.

But pointing towards automatic enrollment and target date funds as the reason doesn’t make sense. Target date funds were mostly ignored by the investment buying public prior to the downturn in question.  Mediocre returns did not play to the investor the company was warning to be careful.  They became the safe-haven of many who lost sizable sums, and any gains these funds made were muted by some of the aggressive funds that these same investors fled.

Auto-enrollment helped the market move steadily north during this period, getting more investors in the market as it approached the top.  Once in, they experienced a sudden wealth effect and artifically inflated the overall success of the group.

But so far this year, the story is wholly different.

Almost all of the information you receive on this epic battle suggests that it will rage on for years with no apparent winner.  And, ironically, almost every financial writer who stages this event always comes down on the side of index funds.  They cite important considerations like tax efficiency and costs.  But the real conversation isn’t about the fund itself, but how you utilize them and where.

Index funds are for the complacent, the investor who really trusts the ability of the index to do no trading throughout the year, sell the losers at the end of the year and buy the winners, and charge you next to nothing for the privilege.

There are essentially three things at play here. No trading throughout the year does in fact keep costs such as transaction fees to a minimum – at least quarter over quarter and because there are no trades, there are no tax implications. There are dividends paid and taxed as such which are offset by the selling of losers as the fund rebalances. Which is why it seems as though the fund is tax efficient – it generate fewer profits than an actively managed funds might do.

That selling the losers to buy the winners makes little sense.  Granted, the key selling point in an index fund is trust.  Trust that index will poke along on average for years, even decades and you will not have to do a thing.  But each time the fund rebalances, it panders to the marketplace created by the active investor and the actively managed funds.  Is it just me or does that make no sense.  An index fund essentially waits for the market movers to give a stock new meaning – in other words they do the legwork, do the research and do the positioning so an index can come along and agree.

There are low costs.  But people approach those costs from the wrong direction.  Leaving an index fund in your retirement account, a tax-deferred situation simply doesn’t make sense.  If the index fund is so tax efficient, why not pay the taxes now, as you go, in the relatively tax-friendly environment we are in.

Most comparisons to index funds, which are all created equal, are compared to the actively managed mutual fund, which are not.  In fact, the comparisons are often so unfair as to be a mote point. When the comparisons are made, the whole of the actively managed world is grouped together – small caps, mid-caps and large-caps, funds that hold as few as 20 stocks to those that chase value and growth, and specific sector offerings.

Indexers will suggest that you have a one in three chance of picking a hot fund.  But who wants a hot fund knowing that the fund’s “hot-ness” is the result of either investor enthusiasm or the fund manager’s prowess.

Indexers also sell their idea based on the assumption that you do not have the time to keep track of your investments. (Really? You just send thousands of dollars to a fund without regard, year-over-year, for decades!)

But why chose one over the other when you should be using both.  Inside a retirement plan such as 401(k), you should seriously consider the potential of the actively managed fund, contribute at least 10% of your pre-tax income to a selection of four to five funds in different sectors, and stay invested.  Most defined contribution plans have a limited amount of choices so this shouldn’t be all the difficult to achieve.

Once that is done, invest in an index fund – outside of your retirement account in a Roth, pay the taxes and hedge your bet against the future tax environment of retirement.

While most arguments will always point to how much more you could have made in an index fund based on the lower fees disregards the possibility that you might just make up that difference in performance.  The last decade was not good for any investor.  But I would much rather have a nimble fund manager who is looking for the next best opportunity rather than one who does nothing more than wait for the rebalance.

For most us, our lives are, for lack of a better analogy, painted into a corner. While we may not feel good about our need for a car we still drive, the way our mortgage might be structured or even the promise we made to ourselves to finance our children’s college education. But we have made these commitments or choices and want to follow through the best we can. And this unfortunate situation extends to our retirement plans and our effort to get our working selves to that point.

Is it necessarily wrong to accept with the hand we have been dealt, a possible comparison that plays directly into what financial advisor, entrepreneur, and coach to financial professionals Garrett B. Gunderson’s asserted recently suggesting that “401(k)s and similar qualified plans is not investing at all–it is one of the riskiest gambles for most individuals”?

He thinks that the whole scheme is basically a marketing strategy which sweeps us up and that we are mostly unaware of the motives these folks (plan sponsors, our employers, Wall Street, etc.) have. The inability for the average participant in these types of plans to grasp the true nature of the plan that, he claims is simply a one-sided profit game where we have little knowledge of what we are getting into and fewer opportunities that we should have is at the heart of what he claims is our retirement option. And lastly, using the buzzword that gets the ear of folks who think that control changes everything, Mr. Gunderson takes these plans to task, listing fifteen reasons why this type of plan is too risky.

Briefly, he believes that “Qualified retirement plans, such as 401(k)s and IRAs, do not provide immediate cash flow”. And rightly so. For the vast majority of us, the concept of evenly contributing to a plan such as this, in a pre-tax environment allows more than the stagnation of cash flow “letting the money sit allows it to compound”, it provides investment discipline.

He further posits that this method essentially leaves your money “tied up with penalties attached for early withdrawal”. Why? Because, otherwise we would withdraw it at each bump in the road we experience. The recent downturn offered us evidence of this as folks were willing to tap these funds for loans, redirect contributions to income or simply ante up the penalties and withdraw the money to cover short-term losses.

Mr. Gunderson then attacks the use of the stock market (“that most individuals do not have the knowledge nor the ability to understand or mitigate”), the free money of the employer match that he calls a myth (he doesn’t suggest exactly why, when an employer physically puts money into your account that this is somehow a bad thing), and that you are doing all of this investing without so much as the basic knowledge of how, once this money is invested, it accomplishes what you intend it to do.

Granted, there are far too many plan participants who are not as well versed as they should be. If there were, default investing efforts would not be needed for those who are either underinvested or not invested at all. But nothing comes without costs and your 401(k) will charge you for the service. How much is the right amount is debatable but those fees will always be there.

These plans were set-up based on a line in the tax code. That said, he attacks the tax incentives that are offered with these plans, the potential that these plans are “sitting ducks” for estate taxes and the most glaring assumption about plan participants is that they do not know how to get out of these plans.

Most of our problems with these plans, aside from the government’s efforts to get us more involved in what is truly our best opportunity, he worries about withdrawals and “the most destructive aspect of 401(k)s is that they cause many individuals to abdicate their responsibility, abandon self-reliance, and neglect their stewardship over their own prosperity”.

Personally, I think we are much smarter than Mr. Gunderson portrays us to be and getting smarter each day. He does conclude that using a 401(k) or similar plan is part of a whole plan. But by then, you wonder if you can unpaint yourself from the corner he claims you are in.

His article can be found here.

As a rule, I tend to keep it general when writing about investing. Even drilling down into people’s attitudes towards retirement is extremely difficult given the myriad of choices, plans and options each person faces. But when non-investors like my wife for instance ask about our, or better yet my position on gold, perhaps it is time to look at why she would ask.

Gold is in the news and will remain a topic of conversation in the coming months. The whole of the world seems poised to step back several economic decades to a time when austerity was the only option. This will be a move to a time when life was what you had made for yourself, class distinctions were drawn by the economic ability of your personal wealth to get you through your later years – which ironically were not-so-later, and when the government was busy doing something that seemed to have little effect on the day-to-day activities of the average citizen.

The good ol’ days. We had pensions. We had Social Security.

Now we can’t live without entitlements and yet, we can’t really afford them. We can’t seem to save enough for a rainy day let alone invest enough for a future that holds more uncertainties than we had previously assumed. Our grandparents, if they are still alive could tell you how different things are today. But they secretly thank their good fortune that they won’t need to experience the future we face.

The reason: the world has a problem. As Sara Glakas recently pointed out, in spite of all the we have been through recently, the crisis is not quite over. She writes :”Make no mistake, the next crisis will be debt-related, too”. This debt is due to borrowing done by a wide variety of market participants based on potential.

This potential reached a fever pitch, noted by the sudden shock of 2008, and what we are left with is a situation none of the world’s borrowers was able to see at the time. Eventually you will have to pay it back.

in the past, debt could easily be rolled into new debt, sometimes with lower costs than the debt they were already carrying. But if the only option was to borrow at a much higher cost to refinance the old debt, the cost of the new debt increased. But if the underlying and assumed potential of what the debtor borrowed the money for in the first place no longer exists, meaning they will have no money to pay it back, the lender might balk. Then what?

Ms. Glakas points out some very troubling statistics in her recent article titled “The One Key Financial Statistic You Must Know”. The World Bank must borrow $5 trillion in the coming years due to their current loan’s maturities and when they do, they will be facing competition from the US, which is estimated to have $4.2 trillion of their own to refinance.

Some countries may seem to be in an enviable position. While the US and the EU can essentially print money to fix this issue, this opens the door for yet another problem. That of a lowered value for its currency often referred to as debased.

Its is the “other” debt that needs to be refinanced that could create the next problem. She lists the problems waiting in the wings from 2011 to 2014:

• $1 trillion in junk bonds and other high-yield debt, much of which financed the leveraged buy-out craze of 2005-2007;
• $2 trillion in commercial mortgages, most of which were used to buy malls, condos and office buildings that today aren’t worth even close to their original purchase price; and
• $1.2 trillion in debt issued by fairly stable, investment-grade companies.

Which leads us to the gold question. Is there any doubt that this commodity will go well beyond its current price? With a finite supply, purchasing gold is probably more than a good hedge against inflation (which is the net effect of printing your own money; goods made with debt will need to go up in price as your dollar is worth less). Yet it is still a risk. Priced in dollars, which we will know will be worth less, the potential meteoric rise in price – some have predicted $3,000 and ounce or higher, how much of the price is actually yield is less than what you might assume.

But it will still be hefty. Suppose everyone buys gold and because the price seems to be heading ever higher, borrowing to do so. Are the world’s debtors going to heed the siren’s call of yet another bubble or simply overextend as they chase the price higher?

So yes, I tell my wife, we have committed some of our portfolio to gold via an ETF that actually has gold as an underlying possession. You buy, they hold. Now I have been written in the past suggesting that some ETFs hold too much of a temptation for those who have access to them in their retirement funds. Much of the savings in these funds in the form of fees is often eaten up in the costs of trading. And I believe that ETFs are somewhat responsible for the wild swings in the market as investors retrench at the beginning and the end of the day. ETFs reprice throughout the day and today’s price might be the result of caution rather than conviction.

But in the case of gold and with such a small amount invested (less than 10% of my total portfolio, well within the range of diversification and with a stop sell at 5% should it fall below the purchase price), I can answer her question honestly. I am concerned. This site believes you can retire in 15 years or less which means between now and then, we will experience another, possibly larger shock to what we own and what we owe.

Oddly, retrenching with a more conservative approach will bring the whole, as Ms. Glakas calls it “looming tsunami” on all of us even sooner. Taking too much risk by believing that the worst is over will make the predictions come to fruition possibly even faster still. So if you are now more than a little scared, its understandable. What will still be key is how well you keep your house in order now in order to survive the oncoming storm. And its coming. We just don’t know how severe it will be. Buying gold is, for want of a better analogy, like carrying an umbrella on a partly cloudy day.

Ms. Glakas’ article can be found here.

Mirror, mirror on the wall, can a mutual fund react like me? Not poetic but truthful; we all want a mutual fund that gets skittish when we get nervous, divests itself to cash when the market looks to be headed lower but gets back into the fray when the markets look to rebound and fails to be easy to define with any sort of style box. But is what we want always good for us, our retirement plans or our investment profile?

Mutual funds offer us something we can’t do for ourselves: broad-based investing across a wide variety of opportunities, the ability to be a player in the marketplace that many of us barely understand and do so with all of the expertise a robust investment resume can offer. Yet, even with those loosely defined parameters in place, we still wonder if we made the right decision and then, wonder whether the manager we hired has made the best decision for us.

Makes for a chaotic and sleep-depriving investment experience. But suppose there was a fund style that took money out of the market when it felt as though the news would turn bad for their investments and to be able to do so before the worst occurred – would you buy into the concept? If the Osterweis Fund is any indication, the answer is probably yes.

This actively managed mutual fund allows its managers to shift from a primarily stock exposed position to one where half of the assets were in the safety of cash and even short-term bonds. If it does its job correctly, a fund like this, considered to be flexible, could serve the worrisome investor in most of us. That said, look for more funds like this one to begin to offer their services to the general investing public.

There are basically three things wrong with this approach. First, we want discipline. If a fund manager is allowed to shift their investment style based on certain information, mostly short-term in nature, even if the goal is to minimize losses, we will pay the price. Not just in fees and trading costs but also on the possibility that the fund’s style might find itself on the wrong-end of the wager.

Two: If the fund manager employs this sort of strategy, it could be due to information it may have accumulated or simply due to a miscalculation. It woud be difficult to tell for sure from the outside. Moving out of a certain stock or basket of stocks signals such an error rather than offering some sort of prescient insight into the future. Worse still for the average investor: how do judge performance or even compare this investment style to other funds?

Three: How can you possibly diversify with such a fund? While I am not a big fan of style boxes or even stars, they do give us some sort of insight into how the fund will invest. Institutional investor in particular like to see a fund manager invest where they say they will, avoiding cross-over exposure. The average investor appreciates a fund manager that does what they say they are going to do, investing in the manner we choose if only to appease our risk tolerance.

These funds will be sold to the general public under a variety of names such as flexible, tactical asset allocation or as an asset strategy. Many will be launched by large firms with good reputations. All will appeal to a certain type of investor. But for a retirement plan, it simply doesn’t seem to be a good place to put your future dollars. If they miss an opportunity you may lose more than the rest of the market and not be in a good position when the market recovers.

To read more about these types of funds, here is a report from MarketWatch by Sam Mamudi

Meg Green of the Miami Herald fielded a question about mutual fund performance from a 62-year-old retiree. His question is often asked by current investors, soon-to-be retirees and current retirees and those of who write about this topic always struggle with the answer.

Her answer kept to the basics but did little more than suggest an over-the-counter solution for an ongoing condition. That’s not her fault; it is an industry-wide problem that offers little in the way of a concrete method of determining how a fund is doing. In this case, the person asking owns a conservative investment portfolio, at least according to the query, and wants to know whether his return is acceptable.

The best line in Meg’s answer: “But little in investing is ‘pure’, or totally style specific.” You could look to Morningstar, she suggested with their in-depth rating system, which she points out is often the very system used by professional advisors. Or perhaps not because as she later explains, “last year’s five star could be this year’s dog.” This could be a the most worrisome problem for a retired person, who has begun to draw down the balance in the portfolio and is concerned that “out-of-favor” fund might be a long-term condition. (But for someone still contributing to the fund, this might be considered an opportunity to buy low.)

When a fund hits the 5-star rating offered by Morningstar, the fund’s coffers usually swell with new investors creating the possibility that the fund will close or the fund manager will simply have difficulty finding good investment opportunities. Which is why, in many instances they fall from those lofty rankings. Meg could have offered a longer range look backward at the fund considering how long it has been rated highly as some sort of guide. Steadiness over the long-term shows the investor that the fund is focused and its shareholders are believers.

She can be forgiven when she recommends that this person have their portfolio reviewed by a professional on a yearly basis (she is a certified planner herself). What she doesn’t recommend is that this person ask themselves what they would consider “good performance”. If the portfolio is being used based on a worst case scenario basis or is the outlook too rosy. In other words, is he drawing the fund down too fast to withstand a long stretch of poorly performing years?. If that is the case, he will be constantly chasing the trailing returns of funds that hit those high ratings. Meg is right when she says “you need to factor everything”.

Looking at performance from the recovery of the worst year the fund had might be a good indication of how well a fund might perform should such a string of bad years occur. The retiree has, based on many current estimates, a twenty (maybe even thirty) year draw down period.

You would hope that this person’s choice of funds, considered conservative, would already be tax efficient and be low in expenses. If not, that would be one of the single best moves he could make in the short-term. Each expense point saved is extremely important in this sort of instance.

Now just a brief thought about that draw down: Some suggest 4% is best by claiming you will never run out of money this way; some say 4% is too frugal in the early years when you might want to actually do something with your new found freedom and suggest 6-8% in the initial years and cutting back in the later ones; some others worry about the potential health care costs that might lurk in those later years. I would like to think you could wait as long as possible to make the initial draw by working some and in the process contributing some.

The bottom line is much simpler. Stocks (based on the S&P 500) have earned about 8% and that is over a very long period of time. So 4% might net this person some leeway. But this approach (using stocks in retirement) isn’t considered conservative by any means. How much does the person need to break even is the question he should ask of himself. And although Meg can’t answer his question with a question, she never mentions risk and his ability to take some as one the main prerequisites for any investment.

Read more of Meg’s response here: