Gen Y,
It’s time to learn about mutual funds and establish a relationship with them. First, there are over 10,000 funds and a gazillion data points and OMG it’s too much. So let’s figure out a way to drill down to the basics (it’s still gonna be a lot of stuff) and have a way to gain perspective so we can make intelligent decisions. Our approach is this: 1. make a check list of important stuff we need to pay attention to when we look at a fund, 2. find a couple of “families” we can get along with, 3. and finally – pull the trigger. This blog will be dedicated to #1, the checklist. Oh and then we need to learn about ETF’s too. See? It’s a lot.
1. Fund type: There are 3 basic categories in which a fund lives: 1. Equity (stocks) 2. Fixed Income (bonds) 3. Money market (cash).
2. Fund Objective: What kind of securities does the fund hold? There are many many many (keep saying many) kinds of objectives. An equity fund may hold stocks issued by large companies (large capitalization) or by small companies (small cap) or (I think you know what’s gonna happen here) medium sized companies (mid cap). And of course there may be a blend. And wait, it gets worse. Funds could be specialty funds and have objectives that align with a certain sector of the market. A sector is just a slice of the business world: health care, industrial, energy and financial to name a few. And there’s more. Other objectives include “appreciation” funds and focus on growth stocks that are expected to go up price and most likely are not paying dividends. There are value funds that focus on companies with stock prices that are too low based on number crunching and these probably pay a dividend. You’re hoping prices go up to reflect the current value, but if that doesn’t happen, you’re at least getting some dividend income. On the fixed income side of the world, funds could hold US Government securities only, or they can hold high yield corporate debt. And again, everything in between. Did I say many? I think I did.
3. What are the main sectors the fund is invested in? Remember, sectors are just slices of the business world, a segment of the economy and it’s important to look at sector concentrations. Let’s have a look at a fund and talk this through. There is a fund out there called Vanguard Windsor II Fund Investor Shares. It’s a value fund with a minimum investment of $3000 and it’s performed well. It’s top 3 sectors as of year end 2013, are Financial Services, Industrial Material, and Healthcare and make up 46% of the fund. That’s a lot, so we would need to check those sectors out in terms of past performance and future growth potential before we bought that particular fund. (sidebar: I am not advocating buying this fund, just using it as an example.)
4. Look at the top ten individual security holdings in the fund and determine how much of the fund they represent. If the fund invests in 500 companies you would assume it is well diversified and is therefore low risk. But if the top ten holdings make up a large percentage of the fund, like 40% or more, then the fund is riskier than you probably want it to be. If a few of the larger holdings take a turn in the wrong direction, the fund will suffer and you’ll be angry and poorer. Avoid this.
5. Stewardship. Who’s the captain of the vessel that’s holding all these companies? You need to check out the manager of the actual fund. The manager of the fund we referenced earlier is James Barrow and he’s been at it for 28 years. That is what we call reassuring.
6. Finally and VERY importantly are the fees you get charged for buying and owning a fund. First there is the fee to just buy a fund or the sales expense. I don’t even consider those types. I go into Charles Schwab research and filter for “no-load”. And also there is something called the “Expense Ratio” which ranges from below 0.50% to over 2.00%. This is an expense that gets taken EVERY year and clearly effects the returns you will earn. Funds have expenses. There are people behind the scenes analyzing, making decisions, trading, reporting, and they need to get paid. But let’s keep things reasonable. They all probably have time to go on Facebook and space out during meetings, so only buy a fund if the expense ratio is on the low side!! Did I mention this is important?
Now here’s a bit of homework. Go to Fidelity or Vanguard or Chas. Schwab or Blackrock or some other Fund family site and look at a few funds. Use the check list we made to analyze one or two funds. It’s just practice. Make sure you look at the expense ratios. Also look at the minimum investment amounts. Many are over $2,500 which could be prohibitive. But there’s a workaround through the use of ETF’s or exchange traded funds. We’ll learn about those later.
OK young people. I need to have a glass of wine and relax. Happy times and follow me on Twitter @cmchristian17
Connie
Invest Gen Y 