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What prompted you to write Mutual Funds For Dummies?
Growing up, I observed family and friends struggling with and being disappointed by personal financial decisions. Personal money management is not something we teach people how to do. It's not taught in high school, college, or graduate school. From a personal standpoint, I learned a lot about personal finance at a very young age. My father was laid off during the 1974 recession, and for his severance pay, he received a lump-sum payment. It was the first time he ever had to think about managing his money. To figure it out, he would go to the library and do a lot of research, and that led me to an interest in personal finance.
I hear that a lot from people who are involved in personal finance; there aren't many opportunities to learn about mutual funds or personal finance for young people.
It can be a problem. My family certainly played a large part in teaching me about spending and saving, but not everyone is brought up like that.
When I talked with William O'Neil, founder of Investor's Business Daily, I asked him what he thought was preventing people who were curious and interested in investing from doing so. He said, in a word, "Fear." What do you think keeps people from participating in mutual funds more?
Fear is certainly a part of it. But overspending is also a big part. Many people simply don't have the discretionary income to invest because they spend a lot of their money on things they might not really need. Shopping malls are everywhere, and credit cards are easily accessible. And if you don't want to leave the house, of course, you can shop around the clock online. People have a real tendency to overspend, and that takes money away from investing.
That point is really worth making, given the low savings rate in the U.S. I note you don't suggest that people's incomes are too low to allow them to invest, but that poor spending priorities keep most people from wisely spending their discretionary income.
I don't want to say that there aren't people out there who are hurting, or who aren't making enough to live on. But for the great number of people who do have disposable incomes and don't invest, I think these are problems that have a lot to do with not being able to distinguish wants from needs. I think the top prerequisite for people who want to invest is to cut back on their overspending. Otherwise, they are not going to have the cash to put into any investments. In order for more US households to own stock, it's not just a matter of getting comfortable with learning about and investing in stocks. It's also a matter of cutting back on spending and differentiating between true necessities and luxuries.
The second half of the 1990s saw huge inflows of capital into mutual funds. Was much of it "new money," money that hadn't been invested previously?
I think so, but a lot of the increases in mutual funds also came about as a result of stock appreciation. As for large inflows of money, I think there are fewer people playing the market than there were a few years ago. For a while, you kept hearing about people who invested in Yahoo! at $10 a share and saw their stock skyrocket. Now, with the downturns in the market, you don't have too much of that. Investors are probably a lot more cautious than they were before. Whether they have the kind of wariness and caution that you see at market bottoms is another question.
You talk about "great fund portfolios" in your book. But when you say "great," you don't necessarily mean the top performer of the most recent quarter, or last year's hot mutual fund. What do you mean by a "great fund portfolio"?
That's a good question. You might think of it as "slow and steady wins the race," or if you're a baseball fan, you might say you're picking a team based on long-term performance expectations rather than who hit the most home runs last month. A lot of people just want to buy the hot fund, but it's not that simple. I would say a great fund portfolio is one that looks at the overall view, one that is not expensive when it comes to fees, and one that includes funds with good track records.
If you chase after the best-performing fund from the quarter just past, you are by definition missing out on the performance that attracted you to the fund in the first place.
Exactly. There have even been studies that suggest if you pick the least-performing sector or category in a given period, you will stand a better chance of future outstanding returns than if you selected the best-performing sector or category. For example, a few years ago the value funds were really down. You couldn't get people interested in value funds when the growth funds were really performing. Now, value funds are doing very well; some have gone up 50% over the past 12 to 18 months or so.
Many people who want to invest in mutual funds have other financial priorities as well paying off debts, saving for short-term goals. Do people need to get out of debt before they start putting money in the stock market?
Generally speaking, yes — especially if the debt is high-interest credit card debt! This type of debt is probably one of the worst, as it isn't tax-deductible. The situation may be different for other kinds of debt, such as student loans or mortgage debts where the interest rate is fairly reasonable. But everyone should eliminate high-interest credit card debt as quickly as possible.
What is the best way to buy a mutual fund? Is it dollar-cost averaging or lump-sum payments at the beginning of the year or something else entirely? What does that timing depend on?
Over the long term, it doesn't really matter when you buy. But over the short term, it makes a difference. If you bought a fund in March 2000 when the markets were at a top, then you may have suffered some losses. This won't make you feel good at the moment, but from the vantage point of several years later, that will probably not be the case.
The bottom line is to set up a regular investment program so you are investing a certain amount every month or every two months or quarter.
When should an investor sell a mutual fund?
The rules for selling should be just the opposite of the rules for buying. When you decide to buy a fund, your decision is based on certain expectations. When the fund stops meeting those expectations, it's likely that certain events will come up. For example, when Michael Price, who was a popular and successful mutual fund manager a few years ago, sold his funds to Franklin, the fees for those funds increased. But after Price left, the performance also deteriorated. That's why when you see such situations arise, you may want to consider selling your mutual fund. Overall, though, it is important to be patient. Every fund is going to be down some time. You need to compare your fund's performance with others within its peer group.
I would imagine using benchmarks would be one way to help keep track of your fund.
Yes, you would have to use the appropriate benchmark. For example, if your fund is a large-cap fund, then the Standard & Poor's 500 index would be the appropriate benchmark. It is one way to analyze and compare the performance of your mutual fund.
The Vanguard fund family comes out well in Mutual Funds For Dummies. In fact, near the end, you ask why more fund families don't approach mutual fund investing the way Vanguard does. What is it that you especially like about the Vanguard approach to investing?
Vanguard has that great combination of very low management fees coupled with a very disciplined approach to weeding out nonperforming or underperforming managers. Vanguard is one of the few companies that is structured in such a way that the shareholders are actually the primary owners of the funds in the fund company. The parent operating company operates all of those funds on what's referred to as an at-cost basis. This means that the parent company, unlike most parent companies, such as Fidelity or Franklin, does not extract a profit. Technically, Vanguard is not a nonprofit organization, but the funds operate on a not-for-profit basis so the shareholders end up paying the operating costs of the funds.
Generally speaking, do you think that the average investor is better off with a larger, better-known mutual fund family such as Vanguard and Fidelity?
The larger mutual fund families like Vanguard and Fidelity certainly have some advantages. They offer a greater variety of products, for example, between bond funds and money market funds. In addition, moving money between funds is generally easier and less costly when the funds are part of the same mutual fund family. That's not to say there aren't good small mutual fund companies out there. In fact, there are several funds out there that are less well known, but still do very well.
What's your opinion of exchange-traded funds (ETFs), which became popular last year? Do you believe they will hold up as longer-term investments?
Most exchange-traded funds have a low fee advantage over the traditional mutual fund, but that may not always be the case. You have to make sure before investing in them. But this advantage is less of a big deal if you are choosing between an exchange-traded fund and an index mutual fund, which typically have the lowest fee structure. One of the biggest advantages with exchange-traded funds is that you can determine the net worth of your fund at any time during the trading day, as opposed to waiting for the markets to close. The other advantage is that you can sell an ETF during the trading day, whereas with a mutual fund, you can only buy or sell them at their end-of-day price. For the longer-term investors, though, these two factors may not be a consideration.
Proponents of ETFs have also brought up the issue of transparency. Do you see that as a challenge to mutual funds?
Well, it depends. Again, if you are holding onto a mutual fund for the long term, I don't think transparency is a big deal. It's good for those who want to know how their portfolio is doing during the course of the trading day. But if you're a long-term investor, and you've already given your portfolio to a professional whom you can trust to manage it, you don't really need to pay attention to your portfolio every single minute. It's not necessary to worry about every move in your portfolio — especially if it is with a professional or a mutual fund company — when you are investing for the longer term.
What changes in the mutual fund industry do you anticipate as more people invest in mutual funds?
Fees may become more important, especially if the markets continue through a period of low performance or negative performance. It's easier to overlook fees during years of high returns such as the ones we enjoyed during most of the 1990s. However, when there is an extended period of low returns, the pain of high fees will become more apparent.
Funds of mutual funds are new, also. What they do is cut down even more on the amount of work you have to do to choose the right mutual fund. I particularly like Vanguard's Lifestyle Strategy Funds.
Speaking of fees, one of the biggest issues of debate for investors is whether to use a financial advisor. How does someone know when to use a professional?
That depends on your personal situation. But whatever you decide to do, it's important to take the time to educate yourself before talking with or even thinking of hiring a financial advisor. Unfortunately, many people who call themselves financial advisors are really nothing more than salespeople. If you walk into a car showroom and start talking to the person who's there, chances are he or she is a salesperson who is working on sales commission. People need to make sure they know just who they are talking to when they seek out financial advice. There's nothing wrong with sales, of course; it's part of our economy. But people should educate themselves, just as with any purchase, so they know what they are buying before they buy it.
So you're saying that people need to both educate themselves on investing and mutual funds and educate themselves on some of the participants in the business of finance.
Yes. A financial advisor who isn't trying to sell you something probably charges by the hour. That hour is just for getting financial advice. It is important that individuals know what they're getting into before taking the step, and there's no better way than to get educated.
RELATED READINGTyson, Eric . Mutual Funds For Dummies, 3d ed., Hungry Minds, Inc.
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