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The Freshness Factor: The Price of Mutual Funds
On much more everyday basis, there is a similar pricing taking place in the grocery store. When you pick up a steak from the meat counter or can of corn, the price on it is what you will pay after you tolerate the checkout lines. The grocery industry always understood the value of correct pricing. The consumer they felt would appreciate current pricing. What the car industry discovered and the grocery industry has always practiced, the mutual fund business has not. At the heart of what is turning out to be the topping on a scandalous sundae of insider greed, is the price you pay for a share of a mutual fund. For those of you who are unaware, when you buy into a mutual fund, the price you pay is based on the next days closing price. Most of us never gave it much thought until we found out via the investigative digging by the New York Attorney General's office that certain privileges were being dispersed to those with additional money to pay. So how does the little guy get even? It seems that the answer might be exchange traded funds. Exchange Traded Funds have been around for years but over the last three or four they have begun to gain the average investor's interest. The attraction is lower cost but that is mostly an illusion. ETFs may have lower expenses but many people replace that cost and then some with the commission costs charged by the brokers who sell these funds, which are essentially stock. I say essentially for a reason. They are primarily traded on the American Stock Exchange and are basically a basket of securities (stocks issued by companies) that follow an index. Vanguard and Fidelity have entered the market recently with ETFs following Merrill Lynch and Barclays who have been using these types of passive funds for years. So what are they really? They are clever instruments designed by clever institutional investors who play this game at an entirely different level than you and I. The first ETFs were dealt directly from the brokerages or mutual fund companies to the individual. Buying meant that you bought the basket of securities but selling was another thing altogether. When an ETF is sold back to the brokerage, the investor does not get their money returned but the underlying stocks in the fund. This is good for those who can buy the fund at a discount to its Net Asset Value in the morning and sell those discounted stocks for a profit in the afternoon. The Net Asset Value of ETF is calculated in much the same manner as a mutual fund would. The NAV calculated by the mutual fund does not reflect supply and demand. Supply and demand are primary forces in the open market and because of that, the share price of an ETF may be trading higher or lower than the underlying worth. ETFs outperform mutual funds in terms of flexibility though. The ability to trade throughout the day is one of the primary attractions for investors interested in ETFs. Frequent traders however may fell the sting of commissions more than those who chose another longer term strategy. Two things make these shares worth avoiding. The first is that pesky problem of discount. In a market correction, ETFs may be on the surface, worth more than the NAV of the securities they represent. The second deals with expenses and the possible illusion that you are saving money. I have always encouraged dollar cost averaging, low expenses, and low entry fees for the mutual funds here at the BlueCollarDollar. ETFs would not fit that criteria. Dollar Cost Averaging, the act of making regular and steady contributions to a fund to offset high and low markets would rack up an enormous amount of commission costs. One lump sum purchase, perhaps with a windfall or a tax return check would be the best wait to fully realize the value of such a trade. This is the very reason Dollar Cost Averaging works so well. Buying the NASDAQ 100 or ticker symbol QQQ, a tech laden grouping of the top stocks on the NASDAQ at the high dollar mark of $110 would find you with a share worth two thirds less today. Using dollar cost averaging, the hypothetical investor would be purchasing shares at this greatly discounted price and with any luck, it will offset the share they bought back in '00. Expenses are considerably less than many index funds but this is also a smoke and mirrors effect. Unless you hold onto the ETF for a sufficient amount of time to offset the cost of the purchased ETF and the expenses, you are probably better suited for a mutual fund. One of the most under considered expense is taxes. In a mutual fund, an investor sells shares and the whole fund feels the ripple effect. In order for that investor to receive the value of their investment, the fund must sell something to pay off the departing shareholder. This can negatively impact the remaining long term investors. If the stocks that are sold have experienced gains, taxes must be paid. In the world of ETFs, this exchange is done between other shareholders and doesn't impact anyone other than those involved. Be aware though of two things that can be considered taxable and unavoidable. The securities in an ETF may still pay capital gains distributions. The second one is an indexing problem. When the fund needs to rebalance because of a change in the benchmark, stocks sold may have capital gains as well. The choice of ETFs over mutual funds should be considered very carefully. In a long term investment strategy that employs dollar cost averaging, the benefits of ETFs fade very quickly. The attractiveness of fresh pricing losses its luster as well in spite of the current claims that this is a much cleaner investment. Below you will find a list of these funds along with some pertinent information.
The NASDAQ 100 Index Tracking Stock, commonly referred to as Qubes from its ticker symbol QQQ, is an exchange-traded fund that tracks the NASDAQ 100 Index by investing in the constituent index stocks. This index, which is reviewed quarterly and rebalanced annually, is a modified market-capitalization weighted composite of 100 of the largest and most actively traded non-financial companies listed on the NASDAQ stock market. The NASDAQ 100 Index reflects NASDAQ's largest companies across several major industry groups, including computer and office equipment, computer software and services, telecommunications, retail/wholesale trade, and biotechnology. SPDRS
SPY SPDR 500
iShares Funds iShares are a family of open-ended exchange-traded funds that seek to track the performance of any of an array of market indexes, such as the Russell 2000 Value Index or the Dow Jones US Consumer Cyclical Sector Index. IWM iShares Russell 2000 Index Fund
Diamond Funds DIAMONDS is the common name for a specific index ETF that seeks to track the Dow Jones Industrial Average (DJIA) index by investing in the constituent stocks of this index. streetTRACKS Funds streetTRACKS is a family of exchange-traded funds that are marketed by State Street Capital Markets and represent ownership in the streetTRACKS Series Trust, an index fund that consists of separate portfolios of common stocks. Each fund is designed to track a specific index, such as the Dow Jones Total Market Index Series (US Large-Cap Value, US Large-Cap Growth, US Small-Cap Value, US Small-Cap Growth), Morgan Stanley Internet Index, Fortune 500 or the Fortune e50 Index. DSG streetTRACKS DJ US Small Cap Growth
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