Investing with Exchange Traded Funds (ETFs)

The Art of the Credit Card App-O-Rama

Airline Rewards Cards for the Taking

How Fed Rate Cuts Affect the US Dollar

ETF Guy — Mon, 29 Jun 2009 12:00:34 +0000

The U.S. dollar recently touched an all-time low against the euro. Part of the reason is because the financial markets anticipate a rate cut from the Federal Reserve's Open Market Committee. That may not seem entirely clear, though. Why does a Fed rate cut drive down the dollar? (For a great explanation of how a Fed rate cut affects the stock market, see Jim's recent post at Blueprint for Financial Prosperity.)

Interest rates down - Dollar down

As interest rates fall, borrowing becomes cheaper. Correspondingly, lending becomes less attractive. The U.S. is the world's biggest debtor nation, meaning lots of other countries have loaned us money. When we pay back those loans with interest, we do so in U.S. dollars.

What all this means is that investors overseas have lots of dollars in their hands. When a rate cut occurs, investors holding U.S. dollars see lower returns. When your bank offers a savings account interest rate lower than someone else's, what do you do? You move your money to the other bank. Same thing here. Investors dump dollars in favor of some other currency. That drives down the value of the dollar relative to those other currencies.

What a weak dollar means to you

A weak dollar has several different effects, among them:

Traveling overseas sucks for Americans because it costs much more. Conversely, anyone from another country vacationing in America loves it because their currency buys so many more dollars.
Because oil is priced in dollars, the price of a barrel goes up. This is part of the reason oil has hit a record high recently.
Overseas investments by Americans are more profitable. This is especially important for people who have a portion of their 401(k) or other investments in global mutual funds.
American businesses that do much of their business overseas will be more profitable.

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Short Selling a House

ETF Guy — Sun, 28 Jun 2009 12:00:58 +0000

With the deterioration of the housing market, there's been an increased interest in 'short selling' homes. I didn't know much about short selling, so I did a little research. I should say up front that I don't have any personal experience in this topic (thank goodness); here's what I learned, though.

What is a short sale?

I covered the definition of a short sale in a previous post, but this is a refresher. A short sale is the sale of a house that has a mortgage greater than the current market value of that property. The bank agrees to forgive the outstanding mortgage balance after the sale completes. Short sales aren't a given - the borrower must negotiate with the lender the accept the short sale.

Why would the bank agree to a short sale?

A short sale is isn't so much a win/win as it is a lose less/lose less for both parties. The borrowers don't have a place to live anymore. The lender's don't get paid back all they're owed. On the other hand, the property doesn't go to foreclosure, which is good for both of them.

In a foreclosure situation, especially in a down market, the lender can expect to recover less than if the property is sold short. Maybe they'd recover 75% 50% in an auction, but 85% in a short sale. It's obviously not ideal for the lender, but at least they don't have to sell the property.

The drawbacks for a borrower

As you would expect, there are several drawbacks to short selling for the borrower. Perhaps the biggest one is that they no longer have a place to live and any money they did put into the house is gone. Also, a short sale is going to show up on their credit report. It's hard to say exactly what the effect will be on credit score, but anecdotally it's somewhere in the neighborhood of a 80-100 point drop. That's nowhere near the penalty for a foreclosure, but still significant.

There's also another pitfall - taxes. The IRS treats the forgiven mortgage amount as income, so you're going to pay taxes on that amount. When you're talking about mortgage-size amounts of money, this could be very significant.

Other things to note about short sales

There are several other points about short sales to note. First, a lender might balk at paying the commission for a broker, which could complicate things.

Second, it takes some work to convince the lender to accept a short sale. You'll have to be several months behind on payments and most likely have to show evidence of significant hardship that caused you to get so behind. Your mortgage resetting to a too-high-for-your-budget payment isn't good enough. If you've lost your job, divorced, or have medical bills, you're in a better negotiating position. Well…regarding the short sale, that is.

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The 'Super 401(k)'

ETF Guy — Sat, 27 Jun 2009 12:00:16 +0000

Tired of the same old 401(k)? How about a Super 401(k)?

Some companies have started offering a new defined contribution retirement plan to employees. Here's how it works. In return to ceding control over how your contributions get invested, you gain a turbocharged contribution from your employer. As this article from Business Week points out, these plans are hybrid of a traditional 401(k) and a pension.

And the increased employer contributions can be substantial - think 15% to 20% of your yearly salary. That's in addition to the more standard 6% match on your contributions.

So what's not to love? Well, like the man says, there's no such thing as a free lunch. In return for the increased match, you turn over control of how the plan (and your money) is invested. Typically, the employer will select a so-called lifestyle or target date fund. Such a fund matches your projected retirement date to an appropriate asset allocation. I personally like target date funds and recommend them to people without much interest in investing. In this case, you'd be turning over control of the investment, but it would like be invested how you would have done it anyway.

That isn't so bad until you consider the down side of the equation. If how the employer invests the money isn't so smart and you don't have enough to retire at your projected retirement age, tough luck. You keep working.

I'm not so sure you'll see a lot of this in the future. I don't think turning over control of their money would appeal to a great many people. Besides that, there's the legal risk. You can sign all the papers you want, but if your company takes your retirement money and invests it inappropriately, I tend to think you'd have legal recourse.

401K Guide and History

IRA, Roth IRA, Roth 401K Guide

Investing for College

The Great Shrinking Emergency Fund

ETF Guy — Fri, 26 Jun 2009 12:00:42 +0000

There's near unanimity in the belief that you should have a cash emergency fund. The problem with that supposedly inviolate rule is that in low interest times like we're now in, your emergency fund gets smaller and smaller every day. I advocate alternatives to the large emergency fund thesis.

In times of low interest rates and high inflation, there's an awful effect for savers - negative real interest rates. Like a job where you never get a raise, negative real interst rates happen when your income (in this case from interest on your savings) declines after the effects of inflation. For a recent example, consider that in a typical 'high-interest' savings account, you are offered 3%. With official CPI running at 4%, you're losing 1% of your emergency savings in real purchasing power terms. To make things worse, I haven't even included the effect of taxes on those interest payments. To make things much, much worse, I'm using the CPI put out by the federal government which many, including myself, think is a fiction. (I believe true inflation is much higher and if you've bought food, gas, health care, or day care recently, I think you'd agree. See Shadow Stats for more information.)

The bottom line is if you have a cash emergency fund, it gets smaller in real terms every day.

Fine, you say, but a 1% decline isn't so bad. And besides, what's the alternative? I think there are two decent alternatives to an ever-shrinking emergency fund - a fully-funded Roth IRA and ready credit.

Among the great features of a Roth IRA is its withdrawal rules. Without getting into all the various tax treatments for withdrawals before retirement, for our purposes you only need to know one thing. You can always get access to your initial investment. That is, if you fully fund a Roth IRA in 2008, you can always get at your $5,000 initial investment without tax or early withdrawal penalties.

With that in mind, I think a Roth IRA is a very good vehicle for emergency savings (beyond a small to medium size cash account for 'mini-emergencies' like car repairs). You can invest the money with an eye toward growth (i.e. not in a passbook savings account) that should earn a higher return. But in a true emergency, you can still access the money. When the emergency passes, you can begin putting the money back into the Roth (for that year only).

The second alternative to a large emergency savings account is ready credit. Some people will recoil in horror at the thought of using credit in any form as an emergency fund. But I believe ready credit can make an excellent emergency backstop. I'd call any widely-accepted revolving credit line 'ready credit.' Examples are unused credit card balances and HELOCs.

The great advantage to using ready credit as an emergency backstop is that it puts the interest rate risk onto the bank. They bear the 1% loss you'd incur if you saved as in my example above. (Mind you, the bank doesn't actually suffer a loss. They obviously invest that money into higher-than-inflation investment vehicles.)

The disadvantage to this technique, and it is admittedly a big one, is the possible sudden loss of those credit lines just when you need them. Recently, people have experienced a decreasing credit line on their credit cards. And in the event of a job loss, banks are known to pull or reduce HELOCs. I don't deny this is a problem. However, I would point out that not all emergencies involve the loss of a job (the most common reason for a loss of credit). Examples of situations where you'd want access to a good bit of money without having lost your job abound.

Do I think you should abandon a cash emergency fund? No. I just think, ideally, the 'emergency fund' should actually be a set of concentric rings around you. Closest to you is money kept for day-to-day expenses and any extra in a checking account. Beyond that is a smallish cash emergency fund. Beyond that is ready credit and/or saleable investments.

What do you think? What's your emergency fund technique?

Where to Stash Cash

IRA, Roth IRA, Roth 401K Guide

Can I Be Sued for My IRA?

ETF Guy — Thu, 25 Jun 2009 12:17:58 +0000

If you're sued and lose, can they take your IRA?

That was the question a reader posed on one of my older posts. Here's the question from J. Brown:

"The majority of my assets are in retirement accounts (IRA's, specifically). I used to have an umbrella policy, but was told that if I were sued, the money in my IRA could not be looked at to satisfy any judgment. Is this true? Where can I go to find additional info on this?"

What's An Umbrella Policy?

Before I get to the answer, let me quickly review what an umbrella policy is. An umbrella policy is an insurance policy that provides liability protection beyond that offered by other policies. The 'other policies' are usually homeowners and auto insurance. If you look at your auto policy, you'll see a maximum liability amount. If a judgment is entered against you beyond that amount, you're on the hook for it (assuming you have that level of assets).

That's kind of confusing, so let me use an example. Let's say I have $100/$300 coverage through my auto policy and don't own a house. I have assets of $150,000 and cause a serious accident that results in a lawsuit. I lose and the plaintiff is awarded damages of $140,000. My insurance company pays $100,000 of that award and I'm on the hook for the rest.

Now if I had an umbrella policy, I wouldn't be writing that $40,000 check. For a few hundred bucks a year, an umbrella ups your liability coverage to $500,000 and up. You can get millions of dollars of coverage if you want. But remember you only need an umbrella if you have a lot of assets - enough to warrant the coverage.

So can they get my IRA?
So this brings us to the question. Is your IRA included in your assets? In my example, what if all of my $150,000 in assets is in an IRA. Can it be seized?

The answer, as with everything law, is "it depends."
It depends on where you live. State law determines whether these assets are included or not. That's not very helpful, so here's a great resource that gives the answer for all 50 states and DC. Look for 'IRA and Pension Plans.'

I didn't look at all 50 states, but in every case I checked, the answer was, No - IRAs are not counted and cannot be taken in a lawsuit. If you live in California, hire an attorney - I couldn't figure out the answer.

Now let's all hope this never comes up for us.

Does Buying An ETF Alter The Value Of The Individual Stocks It Holds On The Open Market?

Why Are The Prices Of TLT & TIP Going In Different Directions If They're Both Treasury Bond ETFs?

What Are The Investment Risks With Long-term Treasury Bond Exchange Traded Funds?

How to Deal With a 401(k) Plan That Sucks

ETF Guy — Thu, 25 Jun 2009 00:17:18 +0000

Most of the time when you read about 401(k)s, it's something like, "contribute at least up to the company match," or, "don't put too much in company stock." But what do you do when your company's 401(k) sucks?

Problem: Your company doesn't offer a match.

Solution: Contribute as much as you can to a Roth IRA, then contribute to your 401(k).

I recommend maxing out a Roth IRA before contributing to a Traditional 401(k). The reason is that Roths are funded on an after-tax basis, but you withdraw the money at retirement tax free. I believe most people will be paying more taxes in the future, so a Roth is usually the best solution.

I also recommend contributing to a Roth IRA even if your plan offers a Roth 401(k). The reason is because you can always withdraw your contribution to a Roth IRA without penalty before retirement if disaster strikes and you need the money.

After you max out the Roth IRA, go back to your 401(k) plan. A 401(k) has great tax benefits. It reduces your current taxable income. Your contributions compound tax-deferred or tax-free, depending on with type you use (Traditional or Roth). It's also an easy, automatic way to save for retirement. A company match is nice, but it's not the best reason to use a 401(k) to save for retirement.

Problem: Most or all of the funds offered in your plan suck.

Solution: Figure out just how bad the funds are and decide if saving outside a 401(k) makes more sense.

Great, so how do you do that?

I'd consider a fund 'bad' if it has higher-than-average fees for its type and middling or below returns compared to its peers over many different time periods. If just some of the funds in your plan fit that description, invest instead in the ones that are good, even if it means overweighting your asset allocation. That is, if you're offered a good stock fund in your plan, but no good bond funds, go ahead and invest in the stock fund. Outside your 401(k), say in an IRA, you can overweight bonds to compensate.

If truly all of the funds are bad, you have to consider not contributing to the 401(k) at all. Before you do, though, consider any employer match. If you're offered a match, you're almost certainly better off contributing to the match maximum and investing in bad funds. That's because the immediate 50% or 25% return a company match gives you counteracts the general suckiness of the fund you invest in. For example, if you're offered a 50% match on contributions up to 6%, go ahead and contribute the 6%. Even if your fund returns -20%, you're still netting a positive 30% return - great by any standard.

So what if you have the worst situation of all - the funds suck and there's no company match? In that case, there's a very good chance you'd be better off not contributing to the 401(k) at all. Instead, invest in an IRA. I recommend a Roth IRA, but Traditional is good, too. That way, you can choose any fund you want.

Problem: Your match is in company stock and the stock is going nowhere.

Solution: Sell your company stock as soon as you can.

Back in 2006, Congress passed the Pension Reform Act that allows 401(k) participants to sell company matching stock. For stock given before the law was passed, you can sell 1/3 of the total each year over three years. For future matches, you can sell immediately. I advocate selling matching stock as soon as you can anyway, but this is especially true if the stock is declining or flat.

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IRA, Roth IRA, Roth 401K Guide

The Art of the Credit Card App-O-Rama

Airline Rewards Cards for the Taking

ETF Guy — Sun, 21 Jun 2009 03:24:51 +0000

I once wrote about how I thought that buying a house isn't always the right choice for everyone. It also turns out that not worrying about buying a house affords you some great freedom to make the most of your credit rating. By that I mean, if you're not looking to buy a property in the next 5 years, you can aggressively pursue credit card deals (air miles, cash back, etc.) without worrying about the impact of a low credit rating.

At the moment, Citi is offering 30,000 American Airlines air miles when you sign up for one of their cards. Of course, you probably already have at least one credit card and don't really need another one. But why let that stop you!?

I actually just got through applying for and being approved for two credit cards for a total of 60,000 air miles. Will my credit rating take a hit? Probably. Do I care? No. And by looking at the sorts of flights I take, the monetary equivalent of those air miles to me is about $1,000 to $1,500. That's a pretty good return on my investment of 5 minutes of work applying for the credit cards and the 30 minutes or so it'll eventually take me to cancel the cards. I've got a co-worker doing the same thing.

Are we scammers? I don't think so. We provided full and accurate information to Citi during the application process. Citi chose to approve us. We will comply with the terms that Citi has set forth and in return they will deliver what they promised just like any legitimate transaction. If asked why we're canceling, our answer will be the truth — we don't need the cards. If asked if we signed up just for the points we'll say yes. It's just business.

Still not convinced? Think of it this way, have you ever tried a sample at a grocery store knowing full well that there was no chance you'd buy the product? Yeah, I have too :-)

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ETF Exit Strategy Considerations

ETF Guy — Thu, 18 Jun 2009 01:55:27 +0000

I have to admit that the massive decline in values for most, if not all, exchange traded funds through 2008 and 2009 has got me thinking about exit strategies. At the moment I'm relatively young, gainfully employed, and I have a comfortable cash buffer. However, I can see a day when I'm old, not so gainfully employed, and scared about about being in the market during a major crash. As someone who likes to be prepared, I've spent considerable time thinking about just what needs to be considered when it comes to an exit strategy for ETFs.

First, an assumption that I will continue to invest in equity ETFs. If my portfolio at some point becomes 100% bonds or treasuries, for example, then there's not much point in worrying about an ETF exit strategy.

Second, this is my thinking phase. Before doing research and reading the thoughts of others, I wanted to see if I could work out the various pieces of the puzzle. I find this approach makes the research more informative.

Stock Market Factors to Consider

The stock market is full of signals both for buy and for selling. The problem is that most investors, professional and amateur alike, aren't good at consistently interpreting these signals correctly. However, I was thinking that some simple ones to consider for an exit strategy are

The moving averages e.g. 200-day moving average which is sufficiently long enough to smooth out short-term spikes and dips.
Performance relative to other sectors. That is, a holding moving in lock step with the overall market is probably less risky than a high-flying holding.
Duration for which the sector has been outperforming. Since cycles exist why not acknowledge that outperformance can't last forever?

Economic Factors to Consider

Often lagging what's happening in the "real" world, the stock market isn't necessarily a good indication of the economy as it exists today. For instance, there were cracks showing in the mortgage industry well before those cracks were reflected in the prices of mortgage-related equities. So I think it's important to look for warning signs within the economy itself. Of course, you may end up getting out of the market too early, but I don't think many people would be complaining had they got out even a year before the recent crash.

Personal Factors

And of course everyone's situation is going to be different. Your expected need for the money you're investing is going to play a big part in determining how much stock market turmoil you're able to tolerate. For my purposes, I'm assuming that the money will be needed within 10 years. A somewhat long time, but perhaps not long enough to ensure that a portfolio decimated by a crash has had time to recover.

In future posts I hope to look at actual exit strategies that others have devised with the ultimate goal of identifying an approach that suits me. If you happen to already have one you like, please do share in the comments below.

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Save Money with Technology So You Can Invest More

ETF Guy — Wed, 03 Jun 2009 23:54:50 +0000

When the economy takes a nose dive, cutting back on investments seems like an easy way to free up cash, but doing that just makes it harder for you to reach your investment goals. Instead, looking elsewhere to save money is a more prudent move. I'm not the only one with this thought. According to a recent survey, eight in 10 adults have taken specific steps to reduce expenditures during these difficult economic times.

The Cost of Technology

In our fast-paced society, technology has become essential to how we live, work and play. And with a little planning, you can still enjoy your favorite gadgets and technology while cutting down on your family's monthly expenses.

Bundle your services. Tired of three monthly bills for Internet, phone and cable service? By bundling services, you could save $20 or more per month. Check with your current service provider and others to find the best deal.
Cut the cord. Use your cell phone for all your calls and cancel your traditional phone service. The typical local phone bill is between $30 and $50 each month. That could be $360 to $600 back in your pocket annually if you make the jump.
Unfortunately, more than 70 percent of consumers experience indoor cell phone signal service problems. So making an investment in a signal booster such as the industry-leading zBoost (www.wi-ex.com) can help make cutting the cord a smooth transition.
Go fluorescent. Did you know that fluorescent lightbulbs use 75 percent less energy than standard lightbulbs and can last about 10 times as long? An ENERGY STAR-qualified compact fluorescent lightbulb (CFL) will save about $30 over its lifetime and pay for itself in about six months.
Check your appliances' energy IQ. While new energy-efficient appliances are an initial investment, when you compare the power usage of your old washer and dryer to newer models, it's easy to see the long-term savings and how they far outweigh the short-term expense.
The average home spends about $2,000 on energy bills every year, and by changing to appliances that have earned the ENERGY STAR seal, you can save $75 a year in energy costs while helping to save the environment.
Get unplugged. TVs, computers, cable/satellite receivers and other electronics still use power even when they're turned off. Unplug them and save. U.S. households spend $100 per year to power devices while they are in this "standby" power mode.
The worst offenders among "off" powered energy users are televisions, game consoles (Wii, PS3, Xbox 360, etc.), DSL or cable modems, computers (laptop or desktop), printers, microwave ovens, sound systems, cable and satellite receivers, DVD players, VCRs and routers.

Manage Your Investing Expenses

Managing Investment Expenses

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Patience Is Key to Successful Investing

ETF Guy — Wed, 20 May 2009 13:59:30 +0000

When selecting an investment strategy that fits these times, it's important to remember that you get the chicken by hatching the egg, not by smashing it.

History does not always repeat, and there is a sizable hole that consumers and investors have to climb out from. However, there are reasons to think that the steps taken by the Federal Reserve and U.S. Treasury to alleviate the financial crisis and to get credit flowing again will ultimately bear fruit.

For example, the recent announcement of the Term Asset-Backed Securities Loan Facility (TALF), under which the Fed will spend $600 billion to buy mortgage-backed securities, has already led to a big decline in 30-year mortgage rates, making home buying more affordable.

Certainly, concerns remain about additional shoes that may drop in the credit mess–including credit cards and commercial real estate. There is also the concern voiced by some that Wall Street estimates for corporate profit growth in 2009 remain too high.

Still, there is reason to be optimistic for the long term. The yield on the 10-year Treasury has hit an all-time low and assets in money market funds are near record highs.

While valuations of many stocks are suggesting that corporate profit growth will not return anytime soon, gas prices are much lower in most places and many are expressing optimism about the economic team that President Obama has assembled. The result is a growing number of people now believe it may be a much better time to be buying than selling, even though it wouldn't be a big surprise if the lows of November are revisited.

As the American humorist Arnold H. Glasow said, "The key to everything is patience."

Experts say there are a number of reasons to think that the steps taken by the Federal Reserve and U.S. Treasury to get credit flowing again will ultimately bear fruit–in time. That's why patience is essential.

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Why Invest In Multiple Market Index Funds?

ETF Guy — Sun, 03 May 2009 04:59:58 +0000

Let me say at the outset that I am no stock trader and I am only an investor for the long term (over 1 year). After reviewing the results of the various market index funds (DOW Jones, S&P 500, NASDAQ, etc.) and seeing that the movement of each one mirrors the other, why wouldn't I just invest in one rather than a variety of them? Sure they may be slightly off of each other but basically the same general movement up or down. It doesn't seem that diversification is as important when investing in the overall market as it is when investing in a portfolio of individual stocks. Am I missing something here?

ETF Guy answered:
You make a valid point and I see little reason to invest in multiple TOTAL market funds. There are reasons to invest in multiple index funds that track different portions of the market such as large vs. mid vs. small. And of course, total market index funds are generally country specific so you'll need other index funds to capture international markets.

Bob answered:
You are basically correct. Invest in a single US stock index fund. If you invest enough, the fund may lower its expense charges. I like the Vanguard total stock market index fund: VTSAX. Then you can add some index funds for other countries (Europe or Emerging Markets) or perhaps in a specific sector (REIT or Energy, etc). If you buy alot of different stocks and are well diversified then it should act like a index fund for the overall market. Note that the nasdaq is heavy on tech companies so it typically goes up / down more than the S&P500 for example. The S&P 500 has something like 70% of the entire US stock market cap so it is a pretty good representation of the overall US stock market except for small cap companies.

L.G. answered:
Each investment company's index fund contains a different mix/percentage of the various types of stocks, which would affect how that fund reacts to the market's ups and downs. If an index fund was heavy in financial stocks, it would be more likely to tank right now.

Personally, I have Fidelity's OTC Index Fund and it has done quite well when compared to what the OTC itself is doing and how other OTC index funds have performed. It is not losing as much as some of the other OTC index funds and actually rises on some days when the OTC itself has tanked. So, you want to know how the index fund is weighted.

Space Invader101 answered:
No, you're absolutely right. For a long term investor who doesn't want to look at stocks every minute of the day like I do, I'd recommend buying about 5-10 blue chip dividend paying stocks in companies that profit year after year no matter what the market does to their price in the short-term. Coca Cola and Pfizer are good examples.

Alternatively a managed fund with large cap (blue chip) stocks would also be good. Not all stocks pay dividends.

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Are There Dangers With Investing Only In ETFs?

ETF Guy — Sat, 02 May 2009 03:09:29 +0000

Rolling over a sizable ($200k+) traditional IRA from a previous employer and don't have much time to pick investments. Found a collection of 12 ETFs that result in much more diversity than just the S&P 500 (small vs large; international vs US; value vs growth). Not interested yet in bonds since I still have 20+ years until retirement. Figure the ETFs will minimize annual expenses vs mutual funds. I do plan to rebalance annually using a discount broker and review prospectus information. My question is if this all seems reasonable or if I'm missing something about ETFs or good portfolio management practices in general that I should reconsider before I dive in.

Adam J answered:
Nope, that's entirely reasonable. That strategy will cover you against anything but a massive depression (which you have plenty of time to ride out) or a sizeable planetwide catastrophe (in which case your IRA will be the last thing you'll be worrying about).

And I'm not betting on the depression–while I could see a recession or two, advances in biotech, nanotech and computer science should keep the market moving upward at a solid pace.

Zenthema answered:
I don't see anything wrong in ETF's as long as you watch and trade them. Money in the stock market is at risk. You can't just let it sit..things go up and also down. You need to monitor prices and also get some
education in trading.

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Is The Buy and Hold Theory Now Defunct?

ETF Guy — Thu, 30 Apr 2009 16:59:49 +0000

The "buy and hold" folks have for many years said that the stock market averages a 7% return annually, and to keep investing in a diversified portfolio of mutual funds representing stocks and some bonds. But many investors following this strategy lost 30 - 45% of their retirement portfolio value in the last six months as the recession pummeled both stock and bond values. Should US investors be looking somewhere other than mutual funds to grow their retirement savings?

Joe answered:
I disagree with your theory that bond values were "pummeled" in the last 6 months. For instance, take the Vanguard Total Bond Market Index Fund, a fund that invests broadly trying to recreate the Barclays US Aggregate Bond Index. It averaged 3.96% over the last 6 months, 5.05% over the last year. The Index itself average 5.24% over the last year. This is not a specialized index, its a broad index of most bonds.

The basic concept remains. You should buy and hold ~100% diversified stocks in your 20's and slowly shift into bonds until by retirement you are ~50-70% bonds. When you are young you have plenty of time to recover from a crash. The older person is cushioned by their bonds. There are funds that automatically switch over into bonds as you grow older.

Most alternate investments are usually of lower return or higher volatility. One exception is real estate. Buying a home to live in is usually a good investment. However, this alternate investment was also hit during the recent recession.

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Are There Dangers With Investing Only In ETFs?

Canadian Index Funds?

ETF Guy — Wed, 29 Apr 2009 20:00:07 +0000

Does anyone know of a good site that will allow me to find Canadian index funds available? And, is there a site that will allow me to compare funds offered by different institutions?

ETF Guy answered:
Just like in the US, Barclays is a big index fund / ETF player in Canada. In the US their products fall under the iShares brand, but in Canada they're under the iUnits brand which you can read about at http://www.ishares.ca/. As you would expect, there is an ETF that tracks the TSX which is probably a good place to start.

strath answered:
What about ETFs - exchange-traded funds. These are based on indexes but their management costs are even lower than index mutual funds.

Largest family of ETFs in Canada by far is run by Barclay's Global Investors. No, not promoting them, it's just a fact. They also run an even greater number of US ETFs. You can find the US list at ishares.com.
For Canadian ETFs go to ishares.ca. Click on each of the tabs at the left to see the selection. A big broad-based ETF has the symbol XIU (under market cap tab). This one contains the top 60 TSX traded companies. It is, therefore, a conservative pick.

There are sector ishares - Canadian energy, financial, gold, etc. Also two or three bond ishares plus one based on the MSCI global index. One buys these ishares through a broker. Discount brokers are useful here if you wish to keep your management costs to a minimum.

One doesn't need to compare such ETFs because their price will fluctuate exactly according to the index each one contains. So any one management company's product will be the same as another company's product pegged to the same index.

muncie birder answered:
There are not a great deal of Canandian Index funds. I know of one– EWC. Expense ratio= 0.59%. Ten year growth rate 13.84% annually–not bad at all. The S&P 500 should perform so well.
By funds offered by different institutions, do you mean mutual funds? Yahoo finance. Forbes Morningstar.

Ron Mexico answered:
Use Morningstar.

cool_01 answered:
The Ethical Canadian Index Fund aims to provide long-term growth through capital appreciation by tracking the performance of the Ethical Canadian Index. It follows a sustainable approach to investing.
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Mutual Funds For Emerging And Developing Markets?

ETF Guy — Tue, 21 Apr 2009 10:59:56 +0000

I don't want to get ahead of myself, but these mutual funds seem extremely high-yielding, even over long periods, and make American stocks and funds look nearly pointless in comparison. I don't mind the risk involved, and would likely purchase shares of a diversified fund or several different regional funds. What do you think of these funds, and is there anything else I should be aware of?

zygote22 answered:
I guess the answer depends on what you mean by "extremely high-yielding" and "over long periods". Emerging markets have had a tremendous run in the last few years, but over longer time periods they don't look quite as attractive.

Take Vanguard's Emerging Markets index fund (VEIEX) as a typical example. Its five year performance is an exemplary 34.70%, while its ten year performance is a still good 12.96%. Since its inception on 05/04/1994, however, it has an average annual return of only 10.15%, which is extremely ordinary for a fund that invests entirely in stocks.

I would say that these numbers are indicative of an extremely hot investment that has been producing returns that are unsustainable in the long term. Still, a 10+% average annual return is certainly acceptable over a decade and a half. So if that's your criteria for "extremely high-yielding" over a decade and a half time frame, I'd say that emerging markets are a reasonable long term investment.

muncie birder answered:
Historically, you are absolutely correct. Their returns have been outstanding, especially developing market funds. Now, whether that will be true in the future remains to be seen.

Here is my hypothesis. Developing countries are almost assured to grow much faster than the developed countries. They have a lot of catching up to do. But certainly investments in developing countries have a great deal of risk. If there is the possibility of a 25% annual return, some risk is warranted. Heck the risk may actually be less than investing in the U S and the return greater, after all your investments are no longer dollar denominated.

Kir answered:
International Exposure: Yes
Emergeing Markets: NO

If you have a long time to invest, I would be putting 10-15% of my new money into developed country funds. China is a sucker bet. It has had huge returns the last few years, but if you bought late last year, you would have lost your shirt, and I don't think the blood letting is over. Don't walk, run away from Emerging Markets. Oh sure, they could bounce back, but it is equally likely that they will loose another 50%. Keep in mind that China is still up 200% from where it traded in 2005. And it's a communist country. Anyway, this should be a very small portion of your portfolio.

bud68 answered:
Everyone's portfolio should have some exposure to such international stocks - either through a combination of domestic and international stock funds or a "global" stock fund that includes both. Most target retirement date funds contain an international component. Its a matter of first determining the asset allocation that you want.

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If An ETF Selling Company Goes Bankrupt, What Happens?

ETF Guy — Sun, 19 Apr 2009 09:09:12 +0000

So I understand the risks of ETFs in terms of the market going up or down, but are there any other risks related to the company issuing them? For example most banks have insurance (CDID in Canada and an equivalent in the U.S.) to cover savings accounts if the institution goes under. Obviously a long shot, but if Barclays (that owns iShares I believe), goes under, what happens to my ETF stock? Is it still safe if the underlying investments are still OK?

Rabbit answered:
Barclays manages unit trust funds. Each trust is a stand-alone, so a different management company can be easily selected by the bankruptcy judge.
Additionally, these are minimally traded accounts, so they don't have a bunch of churning like a traditional mutual fund. Essentially, they map out a set of stocks that fit an advertised criteria, buy a batch with a set budget (usually a $50k minimum) and it just sits there. When dividends come in, then they buy more, but that is also chalked up to the amount from which those basic administrative costs are paid and then make a disbursement of the difference at some preset calendar time. If the demand rises, then another batch of shares is bought and a new set of unit trust shares is sold at market. If a stock no longer fits the criteria, but another one does, then the position in the former is closed and that money buys a comparable position in the latter. That is just about it.

My interest in ETFs, particularly iShares, is that Barclays has been so very good, reliable, and frugal that they are almost a cheaper money manager than I am were I to do the exact same thing.

Of all the economic choices, you could so very easily do worse. If the ETFs tank, it is because those stocks they are holding plummet, not the trust, and probably not the trust administrator.

This question reminds me of when I was selling for Mutual Benefit, one of the very oldest insurance companies in the country. When they folded, not a penny was lost to people in the trust and annuity products (the whole life policy holders, unfortunately, got hosed). Trust and annuity money was simply managed and accounted differently. Check the underlying organizational structure of your ETF, if it is a trust and the funds are likewise minimally managed (buy and hold strategy), then you are okay.

MVD34 answered:
ETF's, yes.
ETN's, maybe not.
ETF's are pools of investment money separate from the company that manages the assets. Unless fraud is involved, you have not direct risk. If fraud, then the underlying fraud "insurance" — details aren't really important here — will kick in.

ETN's are pools of investment money that are in some important ways guaranteed by the company issuing the notes — underwriters risk.
The strength of the company controlling your assets always matters, but risk in these products is not really any greater than in mutual funds and much less than hedge funds.

If Mutual Funds Distribute All Of Their Capital Gains And Dividends, Why Does The Nav Increase Over Time?

ETF Guy — Thu, 16 Apr 2009 04:59:14 +0000

If mutual funds use most of the capital gains and dividends of their portfolios to make distributions to investors, why does the fund's net asset value (NAV) increase over time? It seems that distributing these gains would cause the NAV to remain steady, or to decrease.

Thor answered:
They only have to distribute the gains that are realized. This is one reason with mutual funds you might want to pay attention to the turnover rate. The more a fund buys and sells, even to the point of being called "churning" that generates more fees for the company, not you, will affect how much in capital gains they distribute.

That is one aspect people are seeing now. Most funds have large losses this year but because of the trading they have also realized capital gains along the way. So you end up paying taxes on distributed gains even though overall you have losses in the fund.

jeff410 answered:
Capital gains distributions come from the profits of securities (stocks and bonds) they have sold. They reinvest the principal and obtain more money to invest. And many fund shareholders reinvest their capital gains and dividends. So they are continually investing in securities and those securities change value. Just as if you sold a stock for a profit and only took the profit out and reinvested the principal and maybe added more money to buy other stocks. The value of your portfolio is going to change.

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How Do I Report A Mutual Fund That Was Rolled Over To Buy More Mutual Funds?

ETF Guy — Wed, 15 Apr 2009 13:59:25 +0000

I started out with two mutual funds. When I transferred them to a new investment company those two funds were used to buy three new mutual funds. This year I sold all three funds. I'm using turbo tax and I understand how to report the three I sold but I really lost on how to report the first two I had and never actually got any cash for. There were no gains or losses on them so I'm not sure how to enter the information. Help!

cynic47 answered:
You don't need to "get cash" to have a capital gain or loss. From your description, it appears that you sold the first two funds to get money to buy the last three funds. When you sold the first two funds, the amount you received for them determines whether you had a gain or a loss on each, which you have to report on your tax return. Then, your initial investment (or "basis") the in the last three funds is the amount you paid to buy them, not the amount you paid to buy the first two funds which you later sold.

Summary: Report all 5 transactions as if you sold the first two funds for cash, and then bought the last three funds also for cash.

efflandt answered:
It is very unlikely that the original 2 funds were sold for exactly what you paid for them. So you likely do have some gain or loss on them.

If these are in a taxable account, you need to account for the cost basis of the original 2 funds (ie, the total you paid for all shares, including any dividend reinvestment). Otherwise the government would think the liquidation (sale) of those funds to buy the other funds was 100% profit.

However, if this all took place within and remained within an IRA or other qualified retirement account, there would be nothing to report about any sales.

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Why Are The Prices Of TLT & TIP Going In Different Directions If They're Both Treasury Bond ETFs?

ETF Guy — Tue, 14 Apr 2009 06:08:55 +0000

eternal student answered:
They are both Treasury bonds but one is inflation protected the other is not. Therefore, they are subject to different set of factors that drive their volatility.

As you know, for a regular bond, coupon rate and the principal or face value are fixed at issue. If the required yield for the long term bond (TLT) changes, the market price of the bond will change. The required yield on a long-term risk-free government bond is real rate + expected inflation. As expected inflation changes, the required yield will change, and thus the price of the bond will change. There are other factors such as flight-to-quality etc. which we can ignore for simplicity. The real interest rate depends on long-run economic factors and doesn't change often. Thus expected inflation drives 80% of the volatility of long-term bonds such as those included in the TLT.

Now as you know, TIPS is by design inflation protected. Coupon rate is fixed at issue. But the principal is semi-annually adjusted for inflation. Thus the coupon rate reflects the "real rate." Then by definition, TIPS should not go up or down by changes in expected inflation. (Since it is only adjusted semiannually, it does vary a little by changes in actual inflation or the anticipated next adjustment as explained in the previous answer, we can ignore this effect for simplicity). That means you have taken away the factor - expected inflation - that drives 80% of the volatility of long term bonds (TLT).

This means only the "other factors" such as change in real interest rate are responsible for most of the volatility in TIPs. Whereas for a TLT these other factors drive only roughly 20% of the volatility. Hence, TIP and TLT do not always move together (showing lower correlation).

On a related note, since the yield on the TIPS is a measure of real rate, the spread between the yield on the TIPS and regular bond is taken as a measure of expected inflation signaled by the bond market.

Dhiraj Shekar answered:
A TLT invests in treasury bonds which pay back regular and fixed coupon payments. So during periods of inflation, the nominal interest rate changes and the bond prices come down. This is because, if the coupon payment is 3% and if inflation has caused the nominal rate of interest to go up to, say, 3.5%, there would be less no. of buyers for a bond that offers a coupon payment that is lesser than market interest rates. This causes the price of TLT to go down. Whereas, on the other hand, TIP invests in Treasury Inflation Protected Securities (TIPS). The actual principal of a TIP is tied to inflation. If inflation increases, the principal also increases and even though the interest rate on a TIPS in fixed, due to the variable nature of the principal, the amount that is paid back to the investor increases with the inflation. This increase in the rate of return on a TIP would cause more demand and will eventually increase its price. The converse would be true during deflation.

Clark Kent answered:
TLT is a long-term bond and interest rates are going to move in inverse relation to interest rates, going up when rates drop and vice versa.

TIPs move based on inflation and deflation. They have been selling at a discount by pricing in anticipation of deflation. It is confusing but that is the best I can tell from what I've read and which does not explain it very clearly.

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