June 2, 2016

Investment Newsletter for the end of May, 2016

The market this month continued its very slow upturn. Almost all portfolios were up this month.

Last month, I started rehashing some basic education. Today, I want to discuss mutual funds. I always ask in client meetings about definitions. Very few clients understand a mutual fund. Congratulations to you if you passed.

A mutual fund is simply a collection of things. Rather than buy 30 different stocks, I pay someone to buy and assemble them into a basket of stocks. It could be a basket of stocks, a basket of bonds, a basket of new startups, a basket of anything. I then buy a piece of the basket. The main benefit of a mutual fund is diversification. It is basically a fancy version of the expression ‘don’t put all your eggs in one basket’. So if one of the stocks or bonds in the fund fails, there are other stocks/bonds to make up for it.

A second benefit is that it allows smaller players to own wide sections of the market. A mutual fund might have hundreds of stocks within it. Unless you had substantial wealth, it would too expensive to research, trade, and allocate portfolios across hundreds of holdings. You would also have potentially thousands of trades, many only a few shares at a time. The commission cost would overwhelm any potential gain.

Mutual funds usually have a declared style. The style would be the kind of thing they invest in. Small Cap Value, Emerging Market, International Bonds, etc. are examples. A S&P 500 fund would hold the stocks that make up the S&P 500. The fund would attempt to weight the holdings in the same way as the stocks are weighted in the S&P 500. Other mutual funds may have style based on a person. The Daniel Dollinger is a Superstar Fund would not use categories. Daniel Dollinger would use his magnificent judgement across all categories. Of course, I have no such fund and I do not believe there are superstars – just super marketing.

The typical mutual fund has 2 major types of fees that the shareholder has to pay. The first fee is the management fee which is some percentage of the fund’s market value. This fee can be very significant and should be carefully considered. If the management fee is 2%, the portfolio has to go up in value 2% in order for you to break even. The second fee is a commission (or load). A fund can be front-loaded, back-loaded, or no-loaded.

In a front-loaded fund, the manager removes part of your invested money before they buy securities. For example: Susan invests 100 dollars into a front-loaded fund. The fund pockets 5 of those dollars, and the remaining 95 dollars is invested into the stock or bond markets. In a back-loaded fund, the manager removes some of the proceeds when you sell your shares. However, the amount they take out decreases the longer you’ve held the shares. For example: Susan sells within one year of purchase $100 worth of shares of a back-loaded mutual fund. The fund pockets 5 dollars and you are given 95 dollars. If Susan sells within 3 years of purchase $100 worth of shares, the fund pockets 2 dollars and you are given 98 dollars. A no-load fund does not charge a load. These funds are often called index funds. A fund can only be one type of load (front, back, or no).

You need to be careful when you invest in mutual funds due to these fees. For example: You invest 100 dollars into a mutual fund that is front-loaded (at 5%) and there is a management fee (at 2%). The value of the stocks the fund is invested in goes up 6%, but you end up losing money due to all your gains being eaten up by the fees.

The funds I have you in have very low management fees and no loads. I trade with Schwab which is on the lower end of commission rates.

Yours Truly,

Dan

Daniel Dollinger CPA CFP®

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