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A, B, C, Shares, And So On

Question: I have some investment and savings questions. I'm 24 with about 12,000 in CDs and no debt. I recently went to a financial planner from Primerica Financial Services. They are suggesting for me to open up a Roth IRA with one of their Mutual Funds...to be determined. Because I am going to have these funds for the long haul should I buy A or B shares? They have suggested B. Are there calculators available see what the difference will be for the different shares because of the different fees? What should I look for in a mutual fund company? There seems to be so many. Over the long haul, what % gain can I predict?...Thanks Much, Ray

Answer: It's great that you want to open up a retirement savings plan. But I wouldn't buy shares labeled A, B, C, D, and so on. Instead, why not open up a Roth-IRA with a no-load mutual fund company?

Here's what I mean. The fees you pay to own mutual fund shares matter a lot. There are all kinds of fees, but essentially you can divide the mutual fund universe into two basic types: "load funds" and "no-load funds." Load funds charge a levy when you buy or sell. They also assess a fee for ongoing expenses, the costs associated with running a fund.

The load is the commission paid to the broker who advised you to get into a particular fund. Typically, the load is paid when you buy the fund (those are so-called A shares), but some mutual fund companies impose the fee when you sell (B shares). The other letters represent combinations of the two.

A no-load fund doesn't impose a fee on either end. It does charge a fee to meet ongoing expenses. But it's realistic to expect to pay a fee -- you're not going to get something for nothing. The important thing to remember is to evaluate exactly what those fees are in total and how much will they cut into your return on investment.

So, if I invest $1,000 in an equity mutual fund with a 5% load, $50 goes to the mutual fund company (or broker) and $950 goes into my investment. Now, let's say I invest the same $1,000 in a no-load fund. No one steered me toward this fund. I did my own research, spent my own time. The payoff is that the full $1,000 goes into my mutual fund investment. But in both cases -- load fund and no load fund -- I'll pay an operating fee. And that fee can range significantly, from around 0.10% to well over 2%. .

The Securities and Exchange Commission offers a Mutual Fund Cost Calculator at its website. It makes it easy for investors to compare the costs of owning different mutual funds over time. The Cost Calculator takes the mystery and math out of the cost equation, revealing how costs add up over time. And to get you started on investing and personal finance, I'd recommend taking a look at Burton Malkiel's The Random Walk Guide to Investing: Ten Rules for Financial Success. It's short, and full of good advice.

03/04/08 by Chris Farrell

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Money Market Savings Accounts

Question: Chris -- You mentioned money market mutual funds a couple times on last week's show. Are money market mutual funds the same as money market savings accounts? Can you get them at banks, or just brokerages? Are they still as liquid (make deposits, withdrawals) as money market savings accounts? Thanks -- I appreciate all of your and Tess's advice. Brian, Auburn, AL

Answer: Money market mutual funds and money market savings accounts are similar in many respects, but there are critical differences between the two. A money market savings account at a bank typically pays a higher rate of interest than a regular savings account. The account usually has a higher minimum balance requirement and limitations on the number of withdrawals a month. A money market savings is insured up to $100,000 by the Federal Deposit Insurance Corporation (FDIC). In other words, if the bank goes belly up, your money is safe (assuming you're under the insurance limit).

The same isn't true with a money market mutual fund. There is no FDIC insurance backstopping the account. In return, you'll get a slightly higher interest rate with the money market mutual fund compared to the money market savings account. Still, money market mutual funds are among the safest investment options available to individual investors. There are two simple ways to reduce risk with a money market mutual fund. First, invest with a brand-name financial institution with the resources to backstop a money market fund if it gets into financial trouble. Second, choose the most conservative fund option. It's the one that is comprised of mostly short-term U.S. Treasury securities and federal agency debt. There's no reason to chase higher yields by taking greater risks with this money. You want your principal safe and earn a decent interest rate.

04/23/08 by Chris Farrell

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Diversify Financial Companies?

Question: We have just finished our annual retirement portfolio re-balancing. All of our accounts are with Vanguard. Should we consider having some accounts at a different company to spread the broker risk around? Howard, Bozeman, MT.

Answer: This question is coming up a lot recently, and with good reason: The collapse of the investment bank Bear Stearns, the handful of bank failures, the frozen auction rate preferred market, and the ongoing turmoil from the credit crunch.

What do I think? For many of us, it's easier to manage our retirement portfolio if the money is at one institution that offers good service, low fees and investment choice. But does convenience increase your risk? It does a bit, but not by much in most cases. I've gone back and forth on this issue several times over the past couple of years. In essence, my answer is "no", but...

First of all, the biggest protection you have is that your money is invested in securities. So, even if Vanguard, Fidelity, or some other major financial institution got into trouble you still own the securities. (Of course, ownership doesn't prevent the value of your portfolio from going down.) There is also Securities Industry Protection Corp. backing that provides an additional layer of security in case of fraud and malfeasance. (You can learn more about it at www.sipc.org.)

What's more, most of us end up with a kind of natural financial institution diversification. You have your retirement portfolios with Vanguard. I bet you have savings at a bank or credit union, a life insurance policy with a life insurance company, and so on. If you look at your household as a single entity you're probably reasonably diversified overall--even if your retirement portfolios are managed by one firm.

Now for the proverbial "but." In an era of financial supermarkets and one-stop-shopping it's possible to concentrate amost all your financial assets with one firm. At that point say "stop," and diversify. The lack of diversification is one reason why I have never been enamored with the financial supermarket idea. The other is that experience shows a firm good at managing mutual funds isn't necessarily the best at creating other competitive financial products. It always pays to shop around.

08/15/08 by Chris Farrell

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Should I stick with mutual funds?

Question: In 2006 I decided that I would move my (significant) individual mutual fund holdings to a managed account with my investment firm (a major mutual fund company). I did this because I have been busy in the military and have not had time to manage my mutuals and keep track of recent goings on. I am young, so they determined I should take risk. I agreed. Now that whole amount is down 35% from when I put it in. I am 38 years old. What should I do? Chris, Ft. Worth (deployed to Baghdad), TX

Answer: It hurts when our savings decline by that much. You do have a lot of company, however. And your portfolio is probably reasonably well diversified with a tilt toward equities (because of your age). The reason I say that is you would be down a lot more without some bonds holding down your paper losses. (Conservative bond mutual funds with a big dose of government securities did well last year.)

Normally, I am a skeptic about managed funds, but in your case it was a smart move considering all the demands on your time in the military. I would ask myself the same question everyone should address during this market meltdown. Is my portfolio too risky for me? Here's a safe forecast: There will be other bear markets -- probably several -- during your lifetime. Are you okay with that? You're still very young, and you have a long time for the money to compound. That argues for leaving it alone. But if you don't like the losses, I would direct the managed account to create a more conservative portfolio over time. There's no rush, but you'll want to reduce your exposure to equities.

02/20/09 by Chris Farrell

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Investment grade corporate bonds

Question: Most investment grade short term corporate bond funds contain about 30 % financial holding in their portfolio. Would this stop you from investing 20% of your portfolio in this type of fund in retirement for income? Milton, Albuquerque, NM

Answer: Outside of the U.S. Treasury-only bond funds, a majority of funds in the bond market mutual fund category posted losses in 2008. The performance has been better in so far this year. To take one representative example, the Vanguard Short-Term Investment Grade mutual fund had a total return of -4.7% in 2008, according to Morningstar, the fund rating service. It has sported a total return of 3.13% year-to-date in 2009.

Investment-grade short-term corporate bond funds are increasingly popular. These are the debt obligations of brand-name blue-chip companies. The risk of the owning the debt is further reduced by short-term nature of the I.O.U. The yield on these funds is much better than the yield on comparable Treasuries. And you're diversified within the corporate bond sector with a mutual fund.

Still, there is credit risk with the downturn. Some of the companies in the portfolio might be downgraded, and others could fall into financial trouble. That's why owning a portfolio with nearly a third of the IOU's the obligation of financial institutions gives me pause--as it does you.

A fifth of your portfolio in retirement exposed to one sector seems like a lot to me.

I imagine you want the higher income. The questions I'd be asking are: Am I being compensated enough for taking the risk? How much of my portfolio do I really want to expose to this sector? What is my downside if the economy takes another step down, inflation picks up or something else happens that affects the value of this investment? How much would a poor performance mean to me and my income in retirement?

I think the economy is doing better, thanks to a combination of fiscal stimulus, Federal Reserve policy, mortgage refinancing, TARP funds, lower inventories, and fiscal spending and monetary easing overseas. It's one reason why more investors are feeling confident enough to put money into corporate bonds. But the economy remains fragile. My bias is to stick with financially safe investments and only take greater risks if your household balance sheet is strong enough to ride out another round of bad times. This is especially true for retirees.

04/17/09 by Chris Farrell

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Dividend funds

Question: Hey Chris, I'm just finishing up my second year at Wake Forest University, and I recently started investing in the stock market with the belief that it will rebound eventually. One of my friends recommended that I invest in dividend funds. From the research I've done and they seem like a very profitable with relatively low risk option compared to individual stocks. But, I feel like they are too good to be true. Can a dividend fund collapse or go bankrupt? Besides looking at there individual holdings what are other indicators that might indicate if a dividend fund is safe? Patrick, Cranston, RI

Answer: It's great that you're investing so early. Terrific. Here's a grief look at dividend funds, also known as equity income funds.

The income from dividend payments typically moderates the volatility of mutual funds that focus on owning dividend paying stocks. That's why these funds are often recommended to retirees that want to stay exposed to the stock market and earn an income. Dividends are a big part of the long-term return of stocks. However, the importance of dividends shrank during the Go-Go '90s when the investing game became a matter of chasing high flying growth stocks that didn't pay dividends. Think dot.com. Companies started hiking their dividends around 2003, and investors have been eager buyers with the tax rate on dividends reduced to a low 15%. That favorable rate is scheduled to disappear in 2011. Dividends will be taxed as ordinary income, although who knows what Congress will do between now and then.

I don't see a dividend fund collapsing or going bankrupt. (It is far more common for a poorly performing mutual fund to be quietly closed or merged with a better performing peer.)

That said, there are risks. The bear market has mauled these funds this year. For instance, the T. Rowe Price Equity Income Fund is down 3.97% year-to-date and it has fallen 35.41% over the past year. The Vanguard Equity Income fund is down 9.11% year-to-date and -34.16 for the past year. What's more, companies usually raise their dividend to keep shareholders happy in good times and bad. But the Great Contraction is forcing a swelling number of companies, especially financial services firms, to slash or eliminate their dividend. According to the Wall Street Journal, there have been 45 dividend reductions and six dividend suspensions among the Standard & Poor's 500 companies.

When it comes to picking an equity income fund the single most common mistake is putting money into the highest yielding funds. The yield is nice, but it also means there is a lot of risk built into that portfolio. I would stick to well-diversified equity income mutual funds with a track record. Better yet, there are equity index funds that focus dividend paying stocks and exchange traded funds (ETFs) that do the same. You research your choices at Morningstar.com. Good luck.

05/01/09 by Chris Farrell

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TIPS: mutual fund or bonds

Question: I retired early and am over 55. I plan to keep enough money in my 401k to meet my needs until I'm 591/2. To take advantage of things outside of my former employers 401k plan, I'm planning to rollover the rest of the money into an IRA. One of the things I'd like to buy is TIPS (treasury inflation protection securities). When I do this, which is better, buying TIPS via a broker or financial planner where I have the IRA or putting the money into a TIPS mutual fund. So far, I did a quick review of both Vanguard & Fidelity's TIPS fund. P.E., Brandon, FL

Answer: As you know I am a big fan of TIPS--Treasury Inflation Protected Securities--in a retirement savings plan. TIPS are a savvy and safe way to preserve the value of your savings over time. It's a hedge against inflation gnawing away at the purchasing power of a dollar.

The low cost mutual funds you mention are extremely convenient to own and manage. Problem is, bond mutual funds don't have a specific maturity date. The money is always being reinvested in a basket of TIPS. This means that you'll never be quite sure what the payoff from the investment will be in the future. A TIP mutual fund still provides protection against inflation. But it's a more volatile option than owning the securities directly.

The advantage of buying the actual bonds is that you get to control the timing of your inflation-protected investment. You can purchase TIPS with different maturity dates: 5-year, 10-year and 20-year. Fluctuations in the market won't matter so long as you hold them till they mature. It allows for easy financial planning.

However, you can't buy TIPS directly from the U.S. Treasury in an IRA. (When you buy TIPS from the Treasury there are no commission costs.) You'll have to pay a brokerage commission or fee. It's a minimal charge with online and discount brokerage firms.

11/11/09 by Chris Farrell

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Reward companies not Wall Street

Question: I will retire this year at age 65. My husband and I are both conservative financially. We own outright our farm and two rental properties. I moved all the assets in my 401K to a cash account two years ago, so I have not suffered loses there (a good thing since I work for AIG!). I realize I must move some money into equities to keep up with inflation over time, but I don't trust any financial advisor (I have some experience) and I certainly don't want to invest in a way that will pour money into the coffers of Wall Street analysts and traders. Here is my question: when one invests in stocks (funds or individual) on the NYSE or Nasdaq, does Wall Street automatically profit? I want to 'Invest in America,' but I don't want to reward unethical financiers. I bet there are a lot of small investors who feel the same way I do. Thank you for any words of advice. Melinda, Burns, TN

Answer: Many people agree with you. And I imagine you have some stories to tell about living through all the turmoil at AIG.

Wall Street profits in most cases when it comes to buying stocks. But there are ways to limit the amount that goes into the pockets of financiers.

Now, you already know this, but to reiterate: When you buy publically traded stocks the money usually doesn't go to the company. The investor who sells the stock gets the gain or the loss. Companies get investor money during an initial public offering (IPO) and with any subsequent additional sales of shares. However, it's easier for a company to get access to capital--such as borrowing--when investor show their enthusiasm for its business by bidding up its stock price.

With funds, one way to limit Wall Street's gain is to buy a major stock index, either through a mutual fund or an exchange traded fund. The annual fees on both types of fund are razor thin. You can take another step in this direction by purchasing socially responsible index funds. This kind of investment combines low fees along with putting your money into companies you like and managements you'd like to reward.

With an index fund you aren't paying for the services of a professional money manager or advisor. You're your own money manager.

With individual shares, I wonder if it would work for you to buy stock directly from a company? There are a number of large companies, typically major national and multinational corporations, that offer shareholders direct purchase plans--you can buy company stock without going through a broker.

You can learn more about companies offering this kind of plan by going to betterinvesting.org. It offers a long list of companies with direct purchase plans, starting with 3M and ending with Zion Bancorporation. (Betterinvesting is the website for the National Association of Investors Corporation, the umbrella organization for many investor clubs).

I do believe that there are many ethical financial firms in the country, from many credit unions to a number of mutual fund companies. I'd do business with financial companies with a strong track record of good service and low fees, along with a proven willingness by management to steer clear of fads that eventually harm customers.

One last point: Do you need to invest in stocks to stay ahead of inflation? Don't get me wrong. I am a big fan of equities. But would purchasing Treasury Inflation Protected Securities--a hedge against inflation--be a better bet for you? It's worth exploring.

11/16/09 by Chris Farrell

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