Investing - More Fun with Investing

Investing - More Fun with Investing

For an introduction, see my post on investing, from last week. This post will just be useful terms and concepts. It will not be an organized lesson in investing. Having just read and edited it, I must say it's pretty boring. But your financial future is at stake, so read on.


I hate to spend time on annuities because they are generally not good. But financial advisers will push them, so you might want to understand them.

An annuity is a contract where you give a big chunk of money to a financial firm and they promise to make regular payments to you until you die. This is like buying a pension.

There are different types of annuities -

  • "Fixed" these pay a fixed rate on the contract value.
  • "Variable" - the contract value is based on a basket of mutual funds chosen by the user.
  • "Indexed" - the contract value rises with, but not as fast as, a rising stock market.
  • "Immediate" - the payments start immediately.
  • "Deferred" - the contract starts as a pure investment and the payments begin when the user "annuitizes".

Sounds good, but you will generally hear these issues - the fees are high and obscure, you give up control over your investment, your money vanishes when you die (not that you will care, but others might).

If I've said anything that is incorrect, it is because I have no experience with annuities. Buy only from a fiduciary and read any contract carefully.


Types of bonds -

  • "Municipal" - issued by state and local governments, the interest is generally tax free, some are subject to the Alternative Minimum Tax (AMT).
  • "Government" -  issued by the federal government, the interest is generally tax free at the state and local level, but taxed by the IRS.
  • "Corporate" - issued by corporations, which may fail. Bond holders have first rights to corporate assets on corporate failure (unless our leaders decide to change the law retroactively, such as the General Motors failure during the housing crisis). The interest is taxed.
  • "Junk" - bonds from companies that have a questionable future, you get high interest rates in return for relatively high possibility of failure. Taxed interest.

If you have a lot of money, such that the income from AMT-free municipal bonds is all that you need, you can live tax free. A lot of people get upset when they hear that these rich people don't pay taxes. But in return, they are getting very low interest rates, and they are supporting government borrowing (which I get upset about).

Interest rates have been dropping since about 1980. This has given a nice boost to bond fund performance. But they can't go much lower and they are starting to creep up. Rising interest rates will hit bonds. See "duration" in my previous post. If you are looking for a safe place for money, THERE ISN'T ONE.

(2023-09-13 - this post was published 2018-01-25. Interest rates have gone up significantly in 2023 - the Federal Reserve Board's (the Fed) response to inflation. Interest rates are likely to continue to rise, but bonds may be a lot better investment than they were in 2018.)

Mutual Funds

Mutual fund fees include a sales fee, called a load, (front end for type A shares, etc.), a management fee, and a 12b-1 fee (advertising fee). The 12b-1 fee and the management fee are included in the total expense ratio (ER). Earnings are reported after expenses have been deducted.

For load funds, the front end loads are absurd, usually 5% of your initial investment - avoid these funds. They are sold at full service brokerages, banks, and directly from some mutual fund companies. You will NOT get better fund management by paying a sales fee.

No load funds are available at discount brokerages (Fidelity, Schwab, etc.) and directly from some mutual fund companies. Discount brokerages charge a transaction fee on some no load funds, but this is about $50 for a purchase or sale. No transaction fee (NTF) funds at discount brokerages usually have higher expense ratios to help pay brokerage management costs.

Total expense ratios (ER) range from about .25% to 1.5%. That's how much of your fund is taken from you every year. There are two way to look at this fee - as a fraction of the total value of your investment it seems innocuous, but as a fraction of your earnings it can be very high. If a fund has a 1% ER and reports a 4% gain (after expenses are taken) in a given year, management has taken 20% (1/(4+1)) of the earnings. Another fund might have a .5% ER and make 4%. Here management has taken only 11% (.5/(4+.5)) of the earnings. But net to you it's the same 4% - earnings are reported after expenses are deducted. But the first fund has to earn 5% to report 4% earnings, the second fund just 4.5%. A lower expense ratio gives a better chance of making better earnings. And since you would ask if this were question and answer - higher expense ratios do not buy better management.

Vanguard has become the biggest mutual fund company in the US by offering very low ER index funds and actively managed funds. It is owned by its own mutual funds, so any profit goes back to the fund holders. If Vanguard has a fund that meets your needs, it is likely the lowest cost choice (for some index funds, maybe not, but very close).

Allocation to different market segments can be useful to diversify investments - large cap, medium cap, small cap - growth stocks, value stocks, - US, foreign - short term bonds, intermediate term bonds, long term bonds, junk bonds - stocks, bonds, real estate, precious metals. "Allocation" or "balanced" funds can help with this.

If you have decided on a balance of investments, stock to bonds or value to growth for example, you should maintain that balance by "rebalancing" regularly. This requires moving money from more successful investments to less successful investments. Not easy, but remember that may be moving money from volatile investments (stocks) to steady investments (bonds), or maybe from segments that have grown to segments that are poised for growth. Balanced or allocation funds handle this without intervention.

Mutual fund names - sometimes the names describe the fund, sometimes they don't. Be careful.

(2023-09-13 - Funds may be actively managed by a manager or group of managers or they may track an index such as the S&P 500, referred to as index funds. Exchange traded funds (ETFs), most often tracking an index, have a different structure that has various advantages - trading via the stock market, generally lower management fees, and lower forced distributions.)

For actively managed mutual funds - past performance is not a good predictor of future performance. If the performance was due to strategy, structure, low fees, maybe. If it was due to a genius manager, maybe - the difference between genius and luck is hard to determine. If it was due to a genius manager who has been replaced - no. If it was due to cherry picked time frames - no. If it was due to fund merging with selective reporting - no.

Past analysis will tell you that you cannot successfully time investments in the stock market. You can put new money in the market immediately or "dollar cost average" it in, that is, put money in a little at a time, to prevent immediate loss due to a crash. Statistics show that the former method works better, but may be more psychologically stressful.

My suggestion - balanced/allocation mutual funds, US (DODBX, MAPOX, PRWCX, VWELX, VWINX for example) and global (RPGAX, VGWIX, VGWLX). Buy and hold - let the fund manager worry about navigating the financial markets. This is a conservative approach. If you are young, or need to build savings fast, or like to take risk, there are other approaches.

(2023-09-13 - I have come to appreciate ETFs. S&P 500 - VOO and others, high dividend stocks - SCHD.)

Stupid Stuff

Stock market changes are generally quoted in dollars. This is STUPID. What counts is percent change. The news keeps exclaiming how fast the $1000 marks keep coming for the Dow Jones Industrial 30 index. About ten years ago it was at $10000, a $1000 increase was 10%. Now it's at $25000, a $1000 increase is 4%.

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