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Color of Money
Mutual Funds 101
with Michelle Singletary
Post Business columnist
Wednesday, July 18, 2001; 1 p.m. EDT
Welcome to The Color of Money with Post Business columnist Michelle Singletary. Today's guest is Steven T. Goldberg, a senior associate editor of Kiplinger's Personal Finance Magazine, covering investments.
I often hear people say, "I'm not investing in the stock market. I just have a mutual fund." Come along for an online discussion on the basics of mutual funds. Increasingly everyday folk are saving for retirement or their children's college education by investintg in mutual funds.
But how much do you know about your mutual fund? Do you know what at 12 (b) fee is? Do you carefully read your quarterly statements? How can you find the best mutual fund? Do you think the directors of mutual fund companies are truely independent? Are the directors really looking out for the interests of
shareholders? What about sector mutual funds, are they are good idea?
Goldberg is the author of "But Which Mutual Funds: How to Pick the Right Ones to Achieve your Financial Dreams." He also writes a weekly investing column for Kiplinger.com.
The transcript follows.
Editor's Note: Washingtonpost.com moderators retain editorial control
over Live Online discussions and choose the most relevant questions for
guests and hosts; guests and hosts can decline to answer questions.
Michelle Singletary:
Good afternoon. Sorry about the cancellation last week. But here we are today so ask away about mutual funds.
rosslyn:
i hear so much about investing, buying stock, mutual funds. i'm a 33 y.o. college-educated professional woman and yet i have no idea of how to invest. what is the first step in setting up a mutual fund? who do i call? how does it work?
also, i am a pro at squirreling away my money, but i like to have it accessible just in case. are mutual funds for me?
Steven T. Goldberg: This is going to sound very self serving, but reading Michelle's column or my book, "But Which Mutual Funds?" are good places to start. If you don't want to spend too much time on funds, index funds--and the best of these are Vanguard's (800-635-1511)--are a good bet. They are very simple.
For long-term money, stocks or stock funds have always been your best bet. Keep your short-term and emergency money in the bank.
Arlington, Va.:
My husband and I are interested in tax-free bonds. If we buy a mutual fund which invests in tax-free bonds, do the tax benefits flow through to us? Also, are there tax-free bonds which are tax-free on both the federal and state level? Thanks.
Steven T. Goldberg: The tax-free interest from the bonds owned by bond funds flows to you tax free, as well. However, a bond fund may sell bonds, and if the fund makes money on those sales, you'll have to pay some taxes. Still, most of your money is shielded from taxes.
There are lots of single-state tax-free bond funds, but most of them have very high expenses. You're generally better off with a national municipal bond fund, unless you Vanguard offers a tax-free fund in your state. For a decent buy in Virginia, you might explore the T. Rowe Price tax-free funds. I believe the offer one.
Arlington, Va.:
My son will go attending college in 5 years, which funds should I be looking at for this purpose?
Steven T. Goldberg: Half your money in a bond fund such as Harbor Bond fund would be a good start. The rest could go into a fund of funds, such as T. Rowe Price Spectrum Growth, or into a mult-manager fund. My favorite in the latter group is Master's Select Equity. By the way, to find web sites and phone numbers for these funds, www.google.com is a great search engine.
Arlington, Va.:
I am interested in investing in companiess such as Walmart, CVS, and Safeway, which fund should I be focusing on for short term purposes (approximately 5 yrs.)?
Steven T. Goldberg: As I told the last poster, with five years to go, you'll want about half your money in bonds--or even in the bank. A fund such as the one I recommended to the last poster would be good. Another good conservative fund is T. Rowe Price Capital Appreciation. I don't know the companies you write about well enough to give you an opinion without doing some research.
San Francisco, CA:
I have heard that small and mid cap companies will out perform large caps in the near future. Do you agree? Can you recommend a few no-load, low expense, mutual funds which focus on small and mid cap companies?
Steven T. Goldberg: Small stocks go through periods when they beat large stocks. Then things change. There's no predicting these changes. That's why it's always best to own a mix of stock funds. I like, for long-term money, about 50% in large U.S. stocks, and 25% each in small stocks and in foreign stocks.
Among stocks investing in smaller and mid-size companies, I particularly like Skyline Special Equities. Turner Small Cap Value is also an interesting choice.
rockville, md:
With the increased globalization of US & foreign companies and the increased connection of foreign economies with ours, does it still make sense to buy international funds?
Thanks
Steven T. Goldberg: Yes, it does. The correlation between U.S. and foreign stocks--the amount they move in unison--has increased markedly in the last five years. But that can change. Moreover, there's still enough of a difference that it's worth owning both foreign and U.S. stock funds. The U.S. stock market beat overseas stocks in the 1990s. But foreign stocks won in the 1980s and 1970s. No one knows what will happen in this decade, but it makes sense to diversify as much as you can.
Michelle Singletary:
Can you settle this debate for me once and for all (or at least for this hour). Why is it the many financial planners trash index funds? They go on and on about how people are "settling" for returns when managed funds outperform index funds. Do they? Are we suckers and just settling for mediocre returns if we invest in index funds (I do).
And by the way Steve's book is a really good primer on mutual funds.
Steven T. Goldberg: Some financial planners use index funds--in fact, some of the ones I respect the most use them. But most don't. The average fund is always beaten by the indexes, simply because it has higher expenses. Index funds are dirt cheap. I still believe that skillful picking of funds can give you funds that will beat the indexes, but it's an awful lot harder than it appears at first blush.
The other reason some planners recommend actively managed funds is that they feel they can justify charging you more when they have to pick funds.
Baltimore, Md.:
When you're just getting started, how do you select a mutual fund when there are over 10,000 offered?
Steven T. Goldberg: The easiest way is to stick with Vanguard index funds. I must sound like I work for the company, but I don't. A good stock portfolio can be built with two index funds: Vanguard Total Stock Market and Vanguard Total International. Put 75% in the U.S. fund and 25% in the foreign one, and you'll beat most people who spend hours every day tracking their investments. If you want to know more, I would recommend my book, "But Which Mutual Funds?" You can buy it at kiplinger.com or Amazon.com or any book store. Make sure to buy the newly updated and cheaper paperback version.
Michelle Singletary:
Are the directors really looking out for the interests of shareholders?
Steven T. Goldberg: Unfortunately, when someone starts a mutual fund, he or she often turns to old friends to serve on the board of directors of the fund. Under the law, these directors are supposed to look out for the fund shareholders--not their buddy who is running the fund. But the record shows otherwise. A board almost never fires the fund manager, and rarely lowers its expense ratio. Boards need to do a lot better job. But I wouldn't hold my breath. Caveat emptor.
Vienna, Va.:
Hi, Steve, seems like one of the big problems with bond funds is that usually a 4-5% load fee is charged on block purchases, which is usually waived if the monthly dividends are automatically re-invested in new shares. While this doesn't sound like much (especially on smaller block orders) it CAN be a real issue when you are putting, say, $100,000 into a fund....you're paying upwards of $5,000 just for the service charge. This seems to make straight bond purchases a more attractive option.....if you buy a municipal bond, say in a $5,000 or $10,000 dollar amount from a broker, you'll get EVERYTHING you pay for, not just 95% of it. And you will not have 12B-1 charges either. Of course, there is the accrued interest due, but you will get that back at the first payoff (usually in 6-month intervals). Unless you do ALL of your fund investing in automatic re-investing, it seems to me that bond funds are a ripoff.
Steven T. Goldberg: I would never buy a bond fund with sales charge (load). If I were working with a broker or planner or other financial professional, I'd have him or her buy individual bonds for me. If I were investing on my own, I would always buy no-load bond funds, such as the Vanguard or Strong funds or T. Rowe Price funds. And make sure you're annual expenses, even on the no-load fund, are no higher than .7% per year. Vanguard charges about 0.2%
Vienna, Va. :
As a first time investor. Can you go through the basics step by step for me? Do I go online? Do I go straight to my bank? Where do you recommend I start first?
Steven T. Goldberg: It takes longer than we have to go through the basics step by step. Vanguard.com has a lot of basic stuff. So does fidelity.com and the T. Rowe Price web site. So does Michelle's column. My book, "But Which Mutual Funds?," is aimed at beginning investors.
Michelle Singletary:
Can you clear something up. Some people think bond funds are as "safe" as putting money in the bank because it's called a "bond" fund. Are they? What risks do people take by investing in bond funds?
Steven T. Goldberg: Bond funds are a lot safer than stock funds. The worst year ever for stocks was a loss of something like 45%. The worst year for long-term bonds was a loss of about 10%. But bonds can lose money. How? When interest rates go up, bonds actually drop in price. On the other hand, when interest rates fall, bonds go up in price.
washington, dc:
In general, what should I do to "rebalance" my 401(k)? I am 30, have about $30,000 in the account, and havent adjusted it in a while. Currently, I am all in aggressive, growth stocks with one index fund (4 funds total). What sorts of things should I look at?
Steven T. Goldberg: I'd put all my retirement money in stock funds until I was five or ten years from retirement. It sounds like you are doing just fine. Rebalancing is kind of a pain, but it can work. To do it, you take a little money every three months out of the funds that are doing best and put it into the funds that are doing best.
Rockville, Md.:
I had been up to over $150K in 4- and 5- mutual funds before the bust. I didn't heed the advise to diversify. Now that I've crashed and burned on tech mutual funds (Janus 20 & TRP Sci Tech), I've come back to earth and am looking to diversify my roughly $80K portfolio. Is there anything I can still do to get a 5% return this year, 8-10% thereafter?
Steven T. Goldberg: Alas, there's no way to guarantee returns, except by buying Treasury bills or putting your money in the bank. And you can't make much on what they yield. Stocks and stock funds are still the best way to make money over the long term. As we all know too well now, though, you can't put all your money into one type of fund. You have to own foreign stocks and U.S. stocks, big stocks and small stocks, fast growing stocks and undervalued stocks. There are funds that invest in each of these kinds of stocks.
Washington, D.C.:
Thank you for taking my question.
I am 25 years old and have started investing through a SEP-IRA at work. I have no experience in the stock market and no relatives who invest I can ask about it.
As I tried to research mutual funds I found that some investment firms will assign you to a financial advisor only if you have, e.g. $10,000 to invest.
I don't have anywhere near that kind of money, but at the same time do not want to go into this blind just because I am not investing a lot of money all at once. I find it rather unfair, but I guess they are entitled to their policies.
What resources are available for people like me who want to make the most of their invesetments, but don't have the expertise and or the time to go back to school just to learn about this. I would feel better about what I am doing with my money if I had some guidance, be it from an advisor or any other source.
Steven T. Goldberg: Don't pay a financial adviser to do this. Instead, take your SEP-IRA to Vanguard. Put 75% in Vanguard Total Stock Market fund and 25% in Vanguard Total International fund. Keep adding money to both regularly. Do that for the next 25 years, and you'll be fine.
Arlington, Va.:
My husband and I got married last year, and Uncle Sam smacked us big time (for us anyway) in April... had to pay by credit card (check, no fees) and are just about ready to pay that off. For next year, we want to avoid this as much as possible (via increased payroll deductions and better investments) but unfortunately combined we are solidly in the 31% tax bracket so I think we'll get smacked around for many years to come. I'm looking into tax free bonds... I'm leary of the stock market since ideally we'll want the moolah within 5 years for a downpayment, and as long as we are doing safe might as well be safe and tax free... Right now we have the $$ in a CD at our credit union, but that is coming up next month and we need to figure out what to do with it.
Are bonds purchase via a mutual fund tax free? Should we purchase directly from the Treasury? Also, are federal bonds exempt also from state taxes (VA)?
Steven T. Goldberg: With five years until you need your money, you may want to put half your money into a good, well-diversified stock fund, such as Master's Select Equity. The rest does belong in bonds. A good tax-free bond fund, such as Vanguard Tax-Free High Yield, makes sense for 25% of your money. Put the rest into Vanguard Tax-Free Intermediate, which is lower risk. These funds aren't free from state taxes.
Silver Spring, Md.:
Why won't the SEC ban the load charges on fund share purchases? Would this be considered an unreasonable intrusion into free market investing?
Steven T. Goldberg: Loads, or sales charges, go to bay the broker, planner or other financial professional who helps you select funds. These people have to make a living. There's no reason to buy a load fund if you're choosing funds on your own. But they make sense if you're buying through a professional.
Michelle Singletary:
Why shouldn't people pay a load? I was told by a planner that over the long haul you pay less in fees since you pay it all at once if you pay a load up front for A shares, for example. It that advice a load of dog droppings?
Steven T. Goldberg: Loads come in a bunch of different flavors. Some loads are all upfront--usually class A shares. Some loads charge you when you cash you're money in, and some funds charge you every year regardless.
If you're buying a load fund and expect to hold it a long time, you're almost always best off buying the class A shares. Your planner friend was telling you the truth. A lot of planner mislead clients into class C shares, which charge you every year.
Michelle Singletary:
Is there ever a good reason to hire a financial advisor just to help pick a mutual fund or funds? Sounds like you think people can do this on their own.
Steven T. Goldberg: I think people can pick funds on their own. This is not rocket science. But you can't just buy last year's best performing funds--that's what hurt so many investors after 1999. You have to buy funds that excel in different types of markets. Educate yourself at a fund company web site such as Vanguard.com or Fidelity.com or Vanguard. Or, read the Post personal finance coverage regularly. Or, read a magazine or a book on investing. But don't just plunge in.
If you're unwilling to do it yourself, you should hire a financial adviser.
Bowie, Md.:
Hi Michelle and Steven:
About three years ago, I moved a rollover IRA from a "dandy little fund" that my parents' financial planner chose to an S&P500 index. Frankly, since I'm young, I wanted more risk than that "dandy little fund" was willing to take. (I knew I was in the wrong place when I saw a financial magazine article about the fund headlined, "A fund that never loses money".)
For the first time in who-knows-how-long, managed funds BEAT the S&P500 index--and I now have less money in the fund than when I opened it three years ago.
Is this a sign of changing "wisdom" about index funds?
Steven T. Goldberg: Things change, but then they tend to change back. Actively managed funds are beating the S&P 500 index this year and they beat them last year. That's because smaller companies beat the larger companies that dominate the S&P 500. I'd switch to a Wilshire 5000 Index fund. These are sometimes called total market indexes, and are offered by Vanguard, Fidelity and T. Rowe Price, among others. They invest in small as well as large stocks. Long-term the S&P 500 and the Wilshire 5000 will almost certainly beat the average actively managed fund. They always have.
Syracuse, N.Y.:
My college-freshman-to-be daughter has accumulated about $6000 in savings and grandparently gifts. It does not seem she will need this for college or graduate school. What kind of mutual funds would you recommend for her? Would it be worth putting an amount equivalent to her summer work earnings (about $1100 expected) into a Roth IRA? Can the Roth IRA be in a Mutual Fund?
Thank you.
Steven T. Goldberg: Roth IRAs are great, and mutual funds offer them. While you don't get a tax break, as you do with regular IRAs, your money compounds tax free until you take it out. What a great way to invest if you're young, and you have decades to watch that money grow?
Michelle Singletary:
So are people who use index funds lazy and not willing to work hard to find the right managed fund? Come on Steve make me feel better :)
Steven T. Goldberg: Oh, I change my mind on this myself every day or so. My job is to try to pick actively managed funds that will do better than the indexes--but, believe me, it's not easy. Index funds have such low costs that they are hard to beat. Still, my personal belief (at least today) is that with a lot of work, you can pick funds that will beat the indexes. Most investors are better off with index funds, though. They're much harder to make mistakes with.
Michelle Singletary:
Do you think the directors of mutual fund companies are truely independent?
Steven T. Goldberg: Don't we wish. Most of them have close ties to the company that manages the fund. They really aren't independent in most instances.
Alexandria, Va.:
First off, michelle, saw you on Oprah and want to give you big kudos for your advice and your stand against car leasing. You are so right!
Secondly, I'm recently married and my husband and I are trying to figure out the best way to save for a house. Currently, we live off his salary and bank mine in a money market account, where we are earning modest interest. What else should we be doing if our goal is to buy next year? (we also both participate in our company retirement plans). Michelle Singletary:
Thaks for the "shout out" as the kids say today. I had fun doing Oprah and giving my two cents worth of advice on saving money. And by the way Sue leases cars for a living. It was a fact she neglected to tell people as she defended car leasing. Anyway, take it away Steve.
Steven T. Goldberg: Keep the money in an interest-bearing savings account, a certificate of deposite or a money market mutual fund. I think Strong offers one of the highest yielding in the last category. You don't want to take any risks with money you're going to spend in a year. Stay away from stock and bond funds.
Rockville, Md:
I bought 2 aggressive tech funds several months ago. They have lost about 30-40% of their value. Since they total about 10% of my portfolio, what advice would you have about holding on, or selling (take a loss) to buy back later. It's hard to say about their future of tech in the next few years. I am about 2 years away from retirement. Thank you.
Steven T. Goldberg: I wouldn't want to have more than about 25% or so of my stock money in technology. Who knows when they'll come back? I sure don't, and I can guarantee you no one else does either. Before deciding on your tech funds, you'll need to figure out how much money in your other funds is invested in tech. Look at your annual report or call the fund companies for info.
Forestville, Md.:
Hi, I work for the Federal Government and I have all my Thrift savings tied to the C-FUND,which is the stock fund of course. What do you suggest I change my investment too with the current state of the stock market? Thanks
Steven T. Goldberg: It depends on how far away from retirement you are. If you're at least five or ten years away, you're doing fine. When you get close to retiring, you'll want to gradually move more money into bonds and cash, such as a bank account or Treasury Bills. I'd aim to have half my money in bonds and cash by the day I retired. Starting at about age 75, I'd only want about 1/3 of my money in stocks.
Vienna, Va.:
Do you still feel that stocks are the best investment for the long run? One of the big advantages of munis are the double-tax-free status if you invest in your home state. This greatly increases the effective yield, and one can use the money generated by bond interest to help buy more bonds....generating even MORE interest, you get the picture. Using this method, my portfolio has gone from nothing to over $200,000 in just 9 years. Meanwhile, loads of money weas made in stocks....but much of it, of course, is gone. Municipals, unlike stocks, rarely default...most are AA or AAA rated...but, of course, it can happen on rare occasions.
Steven T. Goldberg: Jeremey Siegel wrote a book called "Stocks for the Long Run." He looked at stock returns since the early 1800s in the U.S., as well as abroad. He included Germany and Japan which were devastated economically. He found a remarkably consistent performance for both stocks and bonds. Stocks get you about 7% more than inflation, which is running about 3% these days. Bonds get you about 1-3% more than inflation. Stocks bounce around a lot more, but the long-term returns are superior.
Oakton, Va.:
Hi, Steve. Question: With so many stock prices being dependent company earnings (and the prospect for earnings), how can a lowly investor like me know two things?: One, that
the reported company quarterly earnings are true and accurate and not being falsely reported for financial or political reasons, and Two, that the stock prices being reported on Wall Street are the TRUE prices and not phantom prices being manipulated, again, for polital or financial reasons? Please do not scoff, this is a serious question. Example; look at the MSRP for a new car....in most cases, what you actually pay for it is dependent on many factors. Thanks.
Steven T. Goldberg: There's no question that some companies have monkeyed around with their earnings reports--most in legal, but questionable ways, some in illegal ways. The only comfort you can take here is the high-paid stock analysts are usually as much in the dark as you are on anything illegal.
A company can't control its stock price, for the most part. It's recorded by the exchanges. I would watch out, though, for really tiny companies. Sometimes they do illegally manipulate their prices by buying or selling a lot of shares. So do crooked brokers.
Tysons Corner, Va.:
Hi, I have a $500 savings bond my parents bought me 12 years ago, should I cash it in and invest it elsewhere (I need to build my emergency savings so it would probably go in a money fund) or hold on to it until final maturity in 18 years? (I'm 24) Thanks!!!
Steven T. Goldberg: I would check it out at a U.S. Savings Bond web site. Searching www.google.com ought to get you there. Or, call a bank and get the numbers. But I'd be willing to be you'll do better in a money market fund.
St. Paul, Minn.:
My wife and I just sold our house for a nice profit, but it may be 6-12 months before we buy our next home. What should we do with the money in the meantime? Is there a fund you would recommend that isn't too risky?
Steven T. Goldberg: You need to be safe with this money. Put it in the bank or a money market mutual fund.
Upper Marlboro, Md.:
Hello,
I'm looking to invest in a Roth IRA and I would like to use dollar cost averaging, my question is how do you go about finding a good Roth IRA? What makes one Roth better than another? With everyone and there brother offering you lost in trying to find which way is up.
Steven T. Goldberg: You just need to pick a good mutual fund. Some of my favorite picks would be Oakmark, Harbor Capital Appreciation, or Selected American Shares.
Washington, D.C.:
How can I get started with Mutual funds? I plan on saving for my retirement and I can not make up my mind what I want to do? Any advice on how can I save? How much do I need?
Steven T. Goldberg: The best bet is to find a good basic book on investing in mutual funds to get started. Or, subscribe to a magazine, or follow the personal-finance coverage in the Post. This is not rocket science, but you are right to want to spend some time doing research before you invest your money.
Laurel, Md.:
I believe the stock market as a whole is severly over-valued, but my mutual fund family doesn't have a "contrarian" fund (do any?), so how can I practice contrarian investing?
Steven T. Goldberg: Betting against the market, over the long term, has been a loser's game, since the market has returned, on average, 11% annually since 1926. The Prudent Bear is a good fund that bets the market will go down. Rydex funds also offers several funds that bet on the market going down.
Michelle Singletary:
Boy that hour went fast. Thanks for all the great questions. And, thank Steve for answering so many questions. We will have to do this again. Clearly, there is lots to learn about mutual funds. Speaking of learning pick up Steve's book. It's a good one and easy to read. It's "But Which Mutual Funds?: How to Pick the Right Ones to Achieve Your Financial Dreams." It's also available at Borders.com. Be sure to get the latest version. It's in paperback and it's cheaper than the hard cover copy!! Many of you know I like cheap. Come back real soon.
washingtonpost.com:
Steven Goldberg's "But Which Mutual Funds?: How to Pick the Right Ones to Achieve Your Financial Dreams" is available at Borders.com.
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