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Prospecting Many moons ago, I ran a rather successful newsletter that morphed into a syndicated column in February, 2002. This feature article appeared in the 01.01.01 newsletter. For the sake of timeliness, I have cleaned up a few links in the article otherwise, it remains much the same.
Over the last two weeks, both my son and daughter have come to their old
man for a little financial direction. Unlike you folks who have to write
or visit the site for answers, I am there for them to ask. That's not to
say that I won't make them understand what they are doing first before they
invest, but to understand it, you have to first have it explained.
Both kids are faced with investment issues pertaining to 401(k) enrollment,
401(k) rollover, and the son has a monthly paycheck from the military that
he wants to set aside before he has a chance to spend it. Makes me think
that they were listening at some point. Crazy, huh!
One of the first things that they will encounter is the prospectus. This
is the investment manual that is sent out by the mutual fund company
telling you what they do, how they do it, and what you should know about
how and what they do. Strong funds*, by coincidence, had just sent their
prospectus to me for the Growth funds that my wife and I invest in (I'm in
the Opportunity Fund (ticker look-up: sopfx) (ytd...9.19%, a mid-cap value
fund) and my wife is in the Growth Fund (ticker look-up: sgrox)
(ytd...-7.05%, a large cap growth fund). So we will walk through what is
close at hand.
The first thing that confronts you is the Key Information. Under the
"funds goals", they have written one simple line. Each fund seeks capital
growth. In even simpler terms, this means that these funds are not into
protecting your money for current income. They are there to grow your cash
and have a broad set of rules that allows them flexibility to do so. This
is good if you want growth. If you are trying to protect that little nest
egg you have built after forty or so years of labor, these kinds of funds
might be a little too fast lane for you. Although there are plenty of
funds that go even faster, these types of funds have acceleration
possibilities that can be a little scary for those that don't want or need
to take any additional risks.
Below that is the individual investment strategies of each of the five
funds listed in their Growth group. Words in these paragraphs give you a
little more insight into what the fund was chartered to do with your money.
The manager of the Discovery fund will invest in securities (stocks) that
have an attractive opportunity for growth and he can buy companies of all
sizes to do that. This fund manager also has the ability to invest in what
are termed fixed income investments such as high grade corporate bonds and
possibly some foreign investment as well. The manager of this particular
fund has room to move to make you money, and in the last line tells you
that the fund's active trading style might have tax consequences.
The Growth fund seeks to buy companies that are reasonably priced with
accelerating growth but they are also looking for old standards such as
cash flow (money being generated), earnings (read: profits), and asset
value. Another actively traded fund with the same kinds of tax
consequences, this fund engages in a variety of strategies that involve
making you as much money as possible with the tools available to those that
live and breathe the market.
The Mid-Cap Disciplined fund invests a set percentage in medium sized
companies that are flying under the radar. These companies are not part of
the Standard and Poors Mid-Cap 400 Index, so the fund manager spends a good
deal of time investigating and according to the prospectus, visiting each
company and their management team. The investment team is not obligated to
hold a stock that has run its course.
The Opportunity fund chases companies that are mid-cap in size that are
under priced based on a formula to determine the company's private market
valuation and can sell their investments whenever that company changes
enough to no longer fit the fund's objectives.
Lastly, the prospectus talks about the Strategic Growth fund which holds a
basket of stocks that usually doesn't exceed 50 companies. This fund wants
solid leadership at companies, good plans, and market leaders in growing
industries. They want proven products from large or mid-cap sized
companies. This probably the least volatile of the five funds in this prospectus.
There is a mention of cash. Cash investments did pretty good this past
year, and some fund managers moved huge chunks of their portfolios to cash
to protect themselves and their shareholders. Some fund managers had to
keep larger than necessary cash on hand to give to investors who were
jumping ship because they wanted the same returns as last year this year.
Redemptions are bad for a fund. First off, having cash out of the market
to pay folks who are leaving is money not invested. Secondly, they were
forced to sell stocks to get cash and if those stocks had gains, those
stocks had taxes. And the remaining shareholders are left with paying
those taxes. Buy and hold is extremely important in mutual fund
investment, but that's not to say, hold until the boat sinks. Sometimes a
fund just isn't doing well and selling your investment might be all that's
left to do. It is a tough choice, and later in the month, I hope to go
into it with more detail.
The next pages of the prospectus outline risk. Whenever you read the words,
"actively traded" you are assuming some risk. An Index fund mimics the
stocks of certain indexes such as the S&P 500, or the Russell 2000. An
actively managed fund has a charter and the manager invests according to
that charter, he does as he sees fit. We'll also talk about managers later
in the month and their importance to the fund, the fund's performance, and
the fund's future.
Next up in the prospectus is the performance. Strong compares its funds
based on a year end total from 1999. That was a very good year, and
without suggesting that they are being deceptive, it was one of the better
years for actively traded funds. A quick glance at the chart they provided
compares the funds from the family against indexed funds whose returns will
not be the same because those indexes were not actively traded. So what do
you do?
Call the company and ask them for current information of the fund you like.
Remember, you are buying into an investment philosophy. The higher the
risk, the greater the chance of rewards and the same for the flip side of
the coin, losses. Month to month fluctuations are not the issue here.
Year to date returns are not the issue here. Investment style is the
issue. Historical returns, three to five years, are what you should be
looking at especially if the fund has retained the services of the same
manager over those years. Although they will always point out that past
results don't guarantee future returns, their job is returns. If they
have been successful in executing the plan, they will probably be able to
continue to stick with it.
Expenses are next up on the list. Always, always, always, buy no-load
funds. You should not have to pay money to make your money work, at least
not up front (front load: a percentage of your investment skimmed right off
the top, before you have even made a dime) or backside fees (back load: a
percentage taken after you chose to leave the fund, on money that the fund
has made for you). Sure you will pay fees, but you shouldn't have to pay
fees and loads!
Expenses should be low, under 1.5%. For instance, the expenses for the
Growth fund (the one the wife owns) is 1.24%. Over the course of one year,
and a one thousand dollar investment returning 5%, she will pay $14.40 in
fees and expenses. Assuming the same conditions and returns, ten years
down the road those expenses will amount to about $150.00. That's cheap
money for skilled management.
The remainder of the prospectus deals with performance over the course of
several years, the buying and selling of shares and other customer
services, policies and plans. But the important part of the prospectus is
out of the way. You only have determined what type of risk you would like
to take.
We'll take a closer look at risk and taxes and when to sell next.
My daughter was given a basket of funds to choose from, none of which
particularly thrilled me. The first question I asked her was if she had
any objections to the business practices of any certain companies because
they weren't offering any socially responsible or green funds among their
choices. She said for the sake of getting started, she didn't. I
suggested she take out as much as the company match which was 5% and see if
that had any effect on her take home and to keep adjusting it to find the
most she could deduct pre-tax and still be able to maintain the lifestyle a
21 year old requires.
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