Friday, January 31, 2014

Mutual funds vs. index funds

I wrote this in 2007. 

Many people don’t want to spend the time, or don’t have the interest, to follow a variety of individual stocks in their portfolio. So what are some choices? Both stock based mutual funds along with stock based index funds have been very popular options for people who fit that profile. I’d like to cast some light on each of those types and point out some key tidbits that every investor should be aware of. Also, I hope that by the time you are finished reading this, most of you will come to the conclusion that index funds make a lot of sense for the savvy investor.       

Mutual Funds

I’m not a big fan of them but I still think everybody should be at least aware of them. They are actively managed funds that contain money from a variety of investors, spread out over many companies, just like index funds. Sometimes people feel more comfortable with the fact that a mutual fund offers professional management.  Of course, nothing is free and this professional management carries with it an expense ratio which is higher than what you would typically find with an index fund. The average typically hovers around 1.5% or so, and, over time, this can really take a big bite out of your earnings. You’ll have to decide if this is this is the price you want to pay for active management.

Index Funds

Index funds operate in much the same way as mutual funds in the sense that there are many companies that are owned within a single fund. In contrast to mutual funds, however, index funds simply mirror a particular index. The nice thing about index funds is that they have historically outperformed mutual funds, all without the added management fees. Again, inactive management can translate into more money in your pocket! 

I chose to go with a total stock market index fund, which allowed me to allocate my investments amongst the entire U.S. stock market (3,500 stocks). It has an average yearly return of 10.77% (as of 8/31/’07) since its inception in ’92. (In the long term, the S & P (Standard and Poor’s) 500 index has appreciated at approximately 10 percent). People sometimes ask me if I get stressed out when it does down and the answer is not really. In fact, I usually think I should buy more in to it. If you can weather the downs the chances are that you will be up in the end. Another nice thing I like about this index is because I can usually just turn on the TV and instantly see how’s it’s performing. Why? Because it’s a mirror of the market as a whole and commentators on TV talk about the market in general terms all the time. I’ll touch upon this below when I get into the r-squared. 

Analyzing the Risk

You’ve probably heard the terms large (blue chip), medium, and small cap. Each term corresponds to the size of the company (for instance large-cap funds contain huge companies). Large cap companies are generally thought to be a more stable investment than small cap, with the medium cap in between. If you’re a conservative investor, or are closer to retirement, large-cap funds are generally the best bet as they are more stable. On the flip side many younger investors like to pursue riskier (smaller cap) investments because the potential for payoff is greater, along with the available timeline for recovery. It all depends on your personal objectives and circumstances.

There are three primary stock styles to be aware of: value, blend, and growth. Growth stocks, simply put, are anticipated to have a strong growth rate. Of course, the flipside of growth stocks is that they are more shaky, and could therefore more likely to plunge in value. Value stocks are generally thought to be ‘bargains.’ They are bought when their price is at a low point, hoping that their price goes up. Blend stocks are simply a blend of growth and value stocks. Check the historical rates of return for the particular fund you are interested in. They are often reflected in 1, 3, 5, and 10-year intervals, in addition to performance since inception.

When you are looking at particular fund’s risk there are two terms that you may run across, specifically, the “r-squared,” and the “beta.” The r-squared is a range from 0-1, which corresponds to how closely it matches the market as a whole or a particular market index (1 being a perfect match). The beta compares changes in a fund’s share price to changes in the overall market/index. For example, if the market that is being used in comparison increased by 8% (so it then has a beta of 1.00), and the beta of the fund that you are checking out is 1.10, your fund is 10% more volatile than that particular market. A beta higher than 1.00 has the potential for greater payoff but at the same time is riskier. Because the beta is tied to market variations, when a fund’s r-squared is low, the beta figure becomes less important. As you could have probably guessed, both the r-squared and beta of a broad-based index fund will be 1 or close to it. 

Money Saving Tips

You may run across some funds which have a purchase fee or a redemption fee. I think these terms are pretty self-explanatory. There are many funds out there that do not charge these fees so it is a good idea to avoid them!

Try to look for a fund which does not have a 12b-1 fee. This nondescript name (taken from the Investment Company Act of 1940) is supposed to cover the advertising costs of the fund.  It is taken right out of the fund’s assets. This fee often hovers around .25-.75%, depending upon whether or not it is a load-based fund. (Note any fund with a 12b-1 fee over .25% is a load fund.) 

As a rule of thumb avoid investing in an index fund with an expense ratio (these are operating costs taken from your fund) of more than .21%. If you are paying more than that you are cheating yourself (shop around). Again, mutual funds have higher expense ratios and usually don’t beat the market.  

Go electronic. Since it costs investment management companies a lot of money to print out documents, they have created incentives to encourage their customers to select “e-delivery” or “e-service.” By receiving fund reports, confirmations, statements, and so forth through e-mail in formats such as pdf’s, you can often reduce fees. I saved a yearly charge of $20 because when I started my balance was under $10k, and balances below $10k were subject to that fee, unless the investor chose e-delivery. Regardless of what you decide, it is pretty easy to change your preferences online or by calling your investment management company’s customer service number. 

There may be some other fees that are particular to IRA’s, ect., and they typically vary from investment company to investment company. Make sure you analyze the fee schedule closely so there are no surprises. If you have any questions, companies typically have a customer service number on their Web site and you can talk with a representative who can fill you in. 

Choosing an Investment Company

There are so many different companies out there--it’s difficult for many investors to know where to begin. It’s a good idea to go with a well-established company with a sound reputation. Here’s some that are worth taking a look at: Vanguard, Fidelity Investments, Scottrade, Ameriprise, Merrill Lynch, T. Rowe Price, Charles Schwab, and the list goes on. 

To me, customer service is a very important. I want to be able to call in and have a knowledgeable person answer the phone quickly. Find out what’s important to you and do a little research. I’ve found that many trade financial magazines and journals seemed to be tied up in conflicts on interests (advertising contracts, ect.). Because of this, I tend to read blogs and ask friends and acquaintances what their experiences have been like with particular companies before making any decisions regarding who I’ll end up choosing.

Thursday, January 30, 2014

A look at multitasking

To a certain degree we all multitask as we go about our daily lives, whether it’s in school, work, leisure, or other activities. It seems that over the last five years or so an increasing amount of attention has been paid to the topic of multitasking, with most being rather critical of it. Multitasking does indeed have its drawbacks if it’s engaged in unnecessarily, which is all too often the case. However, it’s not always bad and it has advantages when done appropriately.

The ability and propensity to multitask is hardwired into our brains. Take for example physical action and talking. In the past small groups of people who could successfully vocally communicate while hunting were certainly more successful than those who could not. Multitasking’s advantages certainly extend to today’s world too; listening to music while exercising comes to mind.

For a moment imagine you have a steady stream of water coming out of a garden hose that you are using to water a tree. After watering you move on to watering a patch of grass but this time you use a sprayer which causes the water to sprinkle over a wide area. You have access to a limited stream of water and you are allocating it in an effective way to accomplish your job. But let’s say you decide you want to water a very large patch of grass. So, you adjust the sprayer to its max spread setting and some water is spread out but eventually it malfunctions and less is released.

Just as you had a limited bandwidth of water in the above illustration you have a limited bandwidth when it comes to thinking, memory, and focus, all of which are intertwined to a certain extent but aren't always used proportionally. For example, you would likely use a greater proportion of your focus bandwidth relative to your thinking bandwidth if you were to engage in a routine project of soldering tiny wires compared to studying for an exam which would relatively tax a high amount of your memorization bandwidth.

Certain tasks lend themselves more to multitasking than others as they tap smaller portions of your respective bandwidths. For instance you’ll likely have no problem with simple and repetitive tasks like the earlier example of listening to music while exercising. This contrasts working on tasks that when combined require high amounts of your bandwidths. Studying while the television is on will probably cause you to be spread too thin and lead to a malfunction of sorts, resulting in reduced productivity.

Many organizations have a culture which promotes multitasking. It’s not always a top-down phenomenon though. Employees often take pride in it. When the worker shows he’s multitasking he intends to signal he’s getting a lot done, putting forth a great deal of effort, and that he has little to no downtime. One common problem though is that this can lead to the misallocation of time as there can be a shift to a less important task. For instance have you ever worked to prepare a document that taps heavily into your thinking and focus reserves and at the same time you are lured into checking emails that pour in your inbox every 20 minutes or so? These emails may have dominated your time and not only that, when you finally switched back over to work on your document it was probably more difficult to reach a state of deep focus where you were your zone, so to speak, because such a state is typically achieved after sustained focus and thought. And it is in this stage where many are at their most insightful and productive.

Ultimately our multitasking habits are dependent on our training and self-talk. For most people, these habits are ingrained to the point where they are almost like muscle memory, that is, they’re done automatically with little to no thought. It is our duty to challenge these mindsets, to analyze our situations and work patterns so that we can consciously determine if multitasking is the best course of action.

Monday, January 20, 2014

High-intensity interval training

High-intensity interval training yields substantial benefits:
A one hour high-intensity workout provides the same fitness benefits as 50 hours of walking, a major Flinders University study has found.

And an hour of high-intensity exercise – defined as exercise which pushes your heart rate up to 75 per cent of its maximum capacity or more – results in the same amount of fat loss as two hours of moderate-intensity exercise. 
The study, led by Flinders health sciences lecturer Dr Lynda Norton with researchers from the University of South Australia, measured the health benefits gained from every minute of vigorous activity compared to the same time spent in moderate-intensity exercise. 
They assessed the affects on four disease risk factors; body fat and weight, cholesterol, hip and waist girth, and aerobic fitness. 
More than 620 adults completed the six-week exercise program, with participants divided into two groups and asked to perform either a one hour high-intensity workout, such as circuit training, boxing or step classes, three times a week or 30 minutes of moderate-intensity exercise, such as walking, seven days a week.
While the moderate-intensity exercisers still gained some health benefits compared to 135 adults who did not participate in the program, Dr Norton said significantly greater benefits were achieved by the high-intensity exercise group.
"Most physical activity guidelines recommend a 30 minute daily walk but we found that it would take 50 hours of walking to achieve the same aerobic fitness that you could get from just one hour of high-intensity or vigorous activity," Dr Norton, based in Social Health Sciences, said.
For the past year or so I've gotten in the habit of doing high-intensity training. With the low time commitment and a high payoff it's hard to come up with excuses not to.

Wednesday, January 1, 2014

Daily aging

Most people go day-to-day without spending much if any time thinking about the aging process. It’s not exactly a fun topic to think about, but there are certain situations in life that put it front and center. For example, have you ever seen someone, perhaps a friend or family member, for the first time in over six months or so, and you are taken back by the fact that she looks noticeably older? The next thing that likely comes into your mind is that you, too, probably look somewhat older. Being polite, no one says anything. I've been in that sort of situation a number of times. My guess is you have too.

Each of us has a time-lapse type image of ourselves that’s embedded in our memory. Over the course of a year it moves along slowly because we see ourselves hundreds of times and therefore we have a lot of images to process. On top of that our focus is skewed toward recent images which are fresher in our memory. So when a year passes we usually aren't able to notice much of an outwardly change in ourselves, nor are others who see you often. Aging for many remains cloaked.

In contrast when we see others after many months or years it’s almost as if we see fast-moving time-lapse photography. The big middle portion of what would be a mental sequence of images is missing, and instead we see a limited number separated by sizable gaps in time. This brings about a jarring realization, the unpleasant fact that, for healthy people post-prime (unhealthy people can often improve), each passing day brings with it a slight physical deterioration, and a little bit of life.

I think that it’s important to think about daily aging, at least once in a while. It makes it easier to savor experiences. It can help with motivation and time management.  Ultimately, it can help you put your life in perspective.