Best Stock Market Articles I’ve Ever Read

This two-part series by Bryant Urstadt is some of the best investing writing I’ve ever read. Bryant gives a run down of exactly what-the-f happened this Summer 2007. After reading these two pieces, "it all makes sense, man".

Part 1: The Blow Up

Teaser:

On Wednesday, August 8, not long after the markets closed, 200 of the smartest people on Wall Street gathered in a conference room at Four World Financial Center, the 34-story headquarters of ­Merrill Lynch. August is usually a slow month, but the rows of chairs were full, and highly paid financial engineers were standing by the windows at the back, which looked out over black Town Cars below and the Hudson River beyond. They didn’t look like Masters of the Universe; they looked like members of a chess club. They were "quants," and they had a lot to talk about, for their work was at the heart of one of the most worrisome summer markets in decades.

Part 2: The Blow Up

If you’re prompted to subscribe, do it. It’s very quick, and I’ve gotten no spam from these guys.

(thanks, Ugly)

The Lure of Fundamentally Weighted ETFs

Many of you will have read about the advantages of Exchange Traded Funds over Mutual Funds. However, have you considered beyond the “ETF” moniker to ask: “What ETF index should I be looking for”?

ETF Basics

To start with, let’s quickly examine the basics of ETFs. These are generalities, but tend to hold true.

Exchange Traded Funds are managed such that the asset allocation of the fund matches the underlying index the fund is attempting to emulate. The indexes range from well known (e.g. S&P500) to obscure, created specifically for the
ETF (e.g. water focused). Management fees are generally less than 0.5%, but can be higher for specialized funds. ETFs trade daily on the stock exchange and can trade at a premium or discount to the underlying assets. Through fancy footwork, ETFs generally retain profits within the fund and make only small distributions each year.

As you can guess, I am a fan of ETFs. I previously held an actively managed mutual fund. While it performed well and has an excellent reputation, the distributions I reinvested each year were killing me, as I paid the tax out of my own pocket. Not only that, I was paying 1.5% a year in management fees, on top of administration fees. Due to this, I often only just outperformed the MSCI international index, before tax!

This led me to sell my mutual fund and buy ETFs. (Disclosure: I own 20 WisdomTree International Industrial units; 15 WisdomTree International Midcap Dividend units; and, 16 WisdomTree DEFA High Yield units).

You will note that my small ETF holdings are all backed by the same company – WisdomTree Investments. What was the reason I went with WisdomTree instead of ishares or any of the other big names? Dividend weighted indexes!

Dividend Weighted Indexes

In any index, there must be a quantifiable method for allocating weight to each component. In many indexes, such as the S&P500, stocks are weighted according to market capitalization. The bigger the stock valuation (notice I didn’t say company or tangible assets), the larger the weighting. While this method gives you broad diversification, it relies on markets correctly pricing each share. If you believe in the efficient market hypothesis, then you can stop reading right here.

However, if, like me, you believe that the efficient market hypothesis only exists on the pages of text books, then you should be aware that market capitalization has a few problems.

Market Capitalization, Largecaps and Value

The first problem is that weight is assigned to “big” companies ahead of “mid” and “small” cap stocks. If you look at the S&P500, you will see that the top 30 stocks dominate the index, with the top 10 stocks comprising almost 30%. As midcap stocks generally outperform large cap stocks over the long run, a capitalization weighted index is short changing you.

Secondly, and more importantly, market capitalization is not always a good indicator of value. In 2000, some of the highest market capitalization stocks were tech stocks. While not all were bad investments, many of them had poor management, little or no earnings, a concept rather than asset backing and huge price earnings ratios.

If you invested in market capitalization weighted indexes, you were underweight these stocks when they were small caps (i.e. before the big price surge), and then overweight when they had reached stratospheric levels!!! After the stock market crashed, and market capitalization for these stocks fell, the index moved back to underweight. In effect, the index bought at the top and sold at the bottom!

A similar scenario holds true for housing stocks last year and financial stocks currently.

Fundamentally Weighted ETFs – A Viable Alternative

If this seems crazy to you, you may want to consider fundamentally weighted ETFs. In the case of WisdomTree’s dividend indexes, stock weighting is determined by dividend yield. The higher the dividend yield, the larger the index allocation. You are effectively buying the same basket of stocks, but allocating to those stocks with the highest dividend yield. Ideally, you will be overweight stocks when they are “cheap”, with a high yield, and underweight when those same stocks run up in price but the yield does not follow. Each dollar you invest is buying more earning power for your pocket. As a bonus, you will not have an asset allocation to Pets.com unless they are paying a dividend!

So – what is the problem with this strategy?

Firstly, the concept is a new one and not many ETF providers have embraced the allocation as yet. Without a track record of out-performance, there isn’t yet market pressure to drive the creation of fundamentally weighted indexes. In fact, some of the bigger ETF providers have refuted fundamental indexing. Furthermore, with the explosion of ETFs, I suspect many people are either wary of new offerings, or embracing sector specific ETFs to chase performance.

Secondly, you may find yourself overweight some sectors. For example, traditionally financial stocks, such as banks, have higher dividend yields. This can result in a weighting that may be beyond that which you are comfortable with. In the current credit bubble, a heavier allocation to financial stocks may not have a huge downside. However, when the bubble pops and liquidity dries up (and that could be happening right now), there could be big trouble. The recent Bear Sterns CDO problems are just the tip of the iceberg. For that reason, when I invested in ETFs at the end of last year, I allocated about 25% of my investment to WisdomTree’s International Industrial fund. I wanted companies that made “things” to counter the paper assets of financial stocks. You may instead wish to allocate some portion of your portfolio to the consumer discretionary or commodities sectors.

In a similar vein, the international stocks of WisdomTree’s funds can be very Euro- and Australia-centric. Personally, I would like to see a Pacific ex-Australia fund, focusing on northern Asia, including India. Add in Russia, Brazil and Argentina and you could call it an “Emerging Markets” fund. Sadly, the best option of these markets right now appear to be ishares country specific ETFs or actively managed mutual funds.

Lastly, recent performance has not been as hoped, in some cases underperforming capitalization weighted ETFs. When the market is booming and growth stocks are heading for the stars (Apple anyone?), fundamentally weighted indexes may under-perform due to their value vs. growth focus. If you want to allocate to growth stocks, these may not be the funds for you.

Conclusion

Regardless of their flaws, I retain faith that in the long run, especially if volatility returns to the market, fundamentally weighted indexes will outperform their capitalization weighted cousins.

This post is for entertainment purposes only. No part of this post should be construed to constitute investment advice. The author is not an investment professional and assumes no responsibility for any investment activities you undertake. Prior to undertaking any financial decisions, you should contact an investment professional.

An Odd Thing To Read About Regarding Funds

I receive the Swiss Stocks magazine and something in Stocks caught my attention. An author said that the funds are going to be the problem spot once the market retraces. I did not quite understand his thinking so I kept reading.

The essence of the problem is that funds are buying stocks and driving prices up. Funds keep very little liquidity. This is good for the market going up. Where things get bad is when the market goes down. If a investor decides to pull out of the fund then the fund manager has to sell stock due to the lack of liquidity of the fund. This has a backdraft effect in that fund managers MUST sell regardless what the stock market is doing. Fund managers cannot time their sales and thus are caught in a bind. Now imagine if more and more people start selling. The market will plummet to the ground with an amazing velocity because more and more people will be pulling out of the funds causing required sales.

I saw a bit of this behavior recently with the Swiss market. People decided to lock into some profits and for two days the Swiss market was in a tail spin. I did not pullout, but I held my breath for two days as the market retraced about 7% and then bounced back.

What made this author nervous is the length of doing well, and the lack of volatility. It will be interesting to see if this person’s prediction is correct.

Mutual Funds ARE for Losers!

Kimber made a post about why Mutual Funds Aren’t for Losers, which was a good article and I see her point of view, however, in this case, I thought I would show the other side of Mutual Funds, which, in my opinion, suck to the point where vacuums should be named after them, or maybe they could rename the Chicago Cubs the Chicago Mutual Funds.

First problem is, they are overly diversified, bringing your risk down, but also bringing down your profits. Hugely bringing down your profits. Bringing down your profits to the point where you have to wonder why you bought it in the first place. You’re essentially saying, “I don’t care what I get, as long as I get something. Sometime. Maybe.” According to the Christian Science Monitor:

The average US diversified equity fund grew 6.7 percent in 2005, the third upside year in a row, according to fund-tracker Lipper Inc. “

I’m sorry, but 6.7% returns, on average, just isn’t good, no matter what the freaks on CNBC say and if you consider beating a risk-free CD by a measly 2.2% an ‘upside’, that’s pretty sad.

Secondly, you can’t trade them when the market is open. I know this goes against my strategy of only trading on weekends, however, if the world is ending, I want to know I can get out. You can’t get out with Mutual Funds.

Thirdly, the mutual funds are stuck at a limited percentage each stock can be within their portfolio. Let’s say Amgen finds a cure for cancer tomorrow. Can the mutual fund capitalize on this? Barely. You’ll be screwed watching everyone buy Amgen and seeing it go through the roof while the mutual fund sits with approximately 20% of their assets in the rocket ship and the rest in sinking stocks and you can’t even sell your mutual fund shares until the market closes to get the cash to jump on the bandwagon.

Fourthly, you pay taxes on trades you don’t make. You’re still invested in the fund, yet you pay taxes on the trades! Heck, in a mutual fund you can lose money for the year and still pay taxes because the fund could have had positive trades for some stocks and losses for others. It depends what year they sell the stock. (IE: if they buy a stock in 2000 for $10, it goes to $30 in 2001 when you buy the mutual fund, and then drops to $25 in 2002 and they sell that stock, you pay capital gains on $15, even though your fund lost $5 since you bought into it.) Not a good plan and not a good unexpected bill you have to pay at the end of the year. I’d rather take profits from my stock trades, set aside 25% of the profit for capital gains and know it’s there, or just hold my stock and not pay taxes until I feel like it or, better still, sell my stocks in January and invest my tax money for 16 months before I have to pay the capital gains on the sale. In any of the scenarios, if I’m trading stocks or Exchange Traded Funds, my taxes come out of the profits I’ve made, not out of my cash at hand.

The fifth reason they suck are the fees. Fees here, fees there, tons of hidden fees, added fees and for what? To pay a guy a million dollars a year to not beat the market? A big waste of money.

The sixth reason why they suck is they rarely beat the market. To quote our good friends over at Motley Fool:

“On the whole, the average mutual fund returns approximately 2% less per year to its shareholders than does the stock market in general. ”

and on the Smith Business website, in an article saying how great Mutual Funds are, they quote Motley Fool too:

About three-fourths of all managed mutual funds underperform the stock market’s average return, according to investor-run Web site “The Motley Fool.”

That essentially means, you’re better off buying Diamonds (DIA) or Spyder (SPY) (disclosure, I have SPY and MDY, which is the mid-cap index, as my ‘safe money’ investments), than to buy a mutual fund.

92 Million people currently own mutual funds, but how many people do you know who are invested in mutual funds say anything overly positive about them? Sure, when the market booms, things look swell, but realistically, over time, mutual funds don’t make people extremely wealthy, if they did, we’d have about 92 million millionaires saying how great mutual funds are and that’s simply not the case, not to mention all of the top traders trade stocks, not mutual funds, and I can show you dozens of people I know who have watched their mutual funds sit and do nothing or next to nothing while active traders killed the market consistently. Way back in 2003 I wrote an article over at my Undertrader.com site about dollar cost saving and buying ETF’s instead of mutual funds. If you had purchased Spyder (SPY) on the day of that article you’d be up $28.22 a share or 25.7% in 3 years and if you had bought the Mid-Cap (MDY) that day you’d be up $38.94 or 37.2% in 3 years and that’s without anyone managing anything, just a straight index.

Sure, it’s pretty swell that you can get percentages of shares in Mutual Funds and sure it’s cool that you’re instantly diversified, (which I don’t think is necessarily a good thing), however, an ETF is so much better than Mutual Funds that it’s not even a competition. It’s like Carl Lewis racing Emmanuel Lewis and individual stocks are like Carl Lewis racing Jerry Lewis.

If you only have $25 a month to invest, which is great and I applaud the effort and it’s a great start, I would rather you buy individual stocks from Sharebuilder and pay the $4 fee than to buy a mutual fund. In the long run you’ll learn more, you’ll come to grow and understand at least one specific company and it’s stock, and you’ll be investing on your own instead of letting some millionaire schmuck in a suit do it for you.

Invest in peace…

Mutual Funds Aren’t For Losers

A buddy quoted Robert Kiyosaki of Rich Dad fame to me a few days back, saying “Mutual Funds Are For Losers.”

(This same buddy invests in index funds which are technically mutual funds but that is an entire other post.)

Well, chock me up as a loser because I do hold mutual funds, both now and in the past.

Now, my emergency fund (or opportunity fund depending on whether you’re a half empty, half full type of person) is in a no load money market fund held via my bank. I can transfer in and out on the same day, have instant access to my cash, and I count it in the bond part of my portfolio make up. It isn’t going to make me rich but then, that is not the purpose.

But in the past, most of my holdings (meager though they were) were in mutual funds. You see I started investing $25 a month. Not much could be purchased with that (except maybe a few Starbucks coffees) and definitely nothing remotely diversified.

Add to that, I was completely ignorant in the ways of investing. I was an investment virgin. My only experience with investing was through safe and stable term deposits (or the equivalent). Yeah, I was a saver, not an investor.

I could have waited, saving my $25 in a high interest savings account until I could actually purchase something worthwhile (like a complete lot) but would this have pushed me to learn about the market? Would I have had the experience of comparing my mutual funds to other mutual funds? Looking at the investment make up, figuring out why the fund manager was making the changes in the fund, watching the market’s ups and downs?

Nope. With time pressures being what they are (tight, always tight), I would have said “I’ll learn that later” and never have. Without my own money in the market, there was no reason to do the work, no urgency.

I made my share of mistakes with my small, piddley dollars. I invested in sector funds that were “hot” (like technology, ouch) and got burned. I invested in bond funds when interest rates were rising. I lost hundreds, not thousands of dollars (the price of tuition). These were junior jammer mistakes and I was happy (okay, I wasn’t happy but…) to make them while still a junior jammer.

So do I think mutual funds are evil and only “losers” invest in them? Of course not. A mutual fund is just one tool in the investment toolbox. It will not always fit the job (unlike another buddy who thinks a hammer is good for all fixes) but its still available.

Where Are Vanguard Funds Going?

Note: This article was slightly modified from the original post, published at Investorial.com on 09/05/2006.

I know my writing often sounds like I’m preaching for everybody to be value investors. That’s simply not true! I only feel that some people can be value investors due to the temperament and the time needed to perform analysis. So what do I tell the general public who couldn’t care less about reading financial statements, or sitting in front of the computer day-trading?

Mutual funds are still the no-brainer solution for the average joe. Much “marketing” debate has been made about management fees. They’re not wrong to be critical but everything is really dependent on the “net” returns you’re able to achieve. My only concern is that consumers do the minimum work of researching the track-record of the fund and the fund manager. A long, consistent and positive tracking record is a must for active-managed funds.

But when John Bogle, founder of Vanguard, decided to balk the norms of the financial industry and aggressively market passive index funds, it was a strong indictment on the vast majority of managers who fail to beat their corresponding benchmark indexes. Vanguard’s promotion of this strategy still trumpets strongly, but there are signs of shifting towards actively managing their index funds, even if it’s just a little bit!

The Winds Of Change
The U.S. Senate recently passed the Pension Protection Act of 2006. Fellow InvestorGeek Kevin Hamrick had previously posted on the event. The new legislation makes it easier for retirement plan sponsors to offer investment advice to plan participants. Employers can implement auto-enrollment, and automatic increases in contributions; making employees opt-out rather than opt-in. There were also the obligatory updates to contribution limits.

What do all these changes mean? For starters, plan sponsors now feel more pressure than ever to take an active role in managing retirement accounts. All this time, we thought that the shifting to defined contribution plans, away from traditional defined benefit pension plans was to shift the responsibility back to investors. The “handcuffs” companies gave as excuses have now been released. With everything coming full-circle again, employers feeling helpless are looking to fund companies like Vanguard, Fidelity and T. Rowe Price for assistance.

Vanguard’s Target Retirement Funds – Active Management?
Many plans are making their first implementation by updating their “default” fund selection. Gone are the Stable Value and Money Market funds. In their place are life-cycle funds adhering to asset-allocation principles while correlating them to age and retirement years. The Vanguard Target Retirement (TR) funds (most not even 3 years old!) have been a popular adoption into many retirement plans as of late.

Essentially the Vanguard TR funds are a fund-of-funds that leverage Vanguard’s existing offerings of index funds. My eternal gripe with fund-of-funds are that they often include “under-performing” funds from the company’s offerings. These inclusions are not necessary by merit, but more of a business decision to boost a new unproven fund inception, or boost an unpopular / declining fund’s asset. But I admit that this concern seems different when index funds are being used.

Observers may argue that Vanguard is deviating from their guiding principle, by offering “active” management of these funds. I tend to agree partially since asset re-allocations and yearly adjustments are not insignificant passive actions! Critics of life-cycle funds note that investors may have different risk tolerance, different portfolio needs; even if they’re of the same age.

However, from my vantage point, Vanguard seems to be continuing their strategy of delivering a “one-size-fits-all” approach to retirement investing. They’re also continuing their ideology that indexes are beating the majority of fund managers by not including non-index funds.

The Brave New World of Retirement Plans
Vanguard already has a stable of actively managed funds, but they have never seen the spotlight. The TR funds however will see a major push with retirement plan sponsors and may mark the first meaningful active Vanguard management in its interaction with investors. With the right marketing, these index-mirroring life-cycle funds will further boost Vanguard’s popularity with retirement plans.

If your plan hasn’t yet adopted similar changes, you should be seeing them within the next five years. Yes, indexes have proven worthy of beating the majority of fund managers. But if I’m a smart shopper, why wouldn’t I be looking for those minority managers that beat their benchmarks consistently? I’m still an advocate for plan sponsors to find and offer proven actively managed funds such as Bill Mason’s Legg Mason Value Trust or Joel Tillinghast’s Fidelity Low-Priced Stock. The shift to life-cycle funds as default funds seems to be a better alternative to the traditional conservative choices.

The problem with the mutual fund industry is that there are too many choices, whether they are actively or passively managed, and only a handful of good ones. You may have differing opinions on which actively managed funds are worthy and I hope you’ll share with us. But keep in mind that I am Canadian and don’t monitor the U.S. mutual fund scene often!

For Canadians, I sincerely hope that governments take more interest than they have, into the employer retirement plans north of the border. However, if we can’t get any help to reform brokerage fees, unreasonably high mutual fund MERs compared to the true cost of operating a mutual fund (especially with the currency exchange where it is right now), there is little hope of any assistance from lazy bureaucrats.

A Buck, A Yen, A Mark or A Pound

Devaluation of currency is not uncommon in other countries, but so far has been moderate in the U.S (in part because the dollar is the world’s currency). I recently discussed this in an article titled Speculating on the Future of the Dollar. But given our massive debt, budget deficit and trade deficit, a significant drop of the dollar against other world currencies (and corresponding increase in inflation as all types of imports become more expensive) becomes a possibility.

How can you protect your portfolio from a significant slide in the dollar?
This is indeed a tough question, and I won’t claim to know the answer. However, based on what we’ve seen in other countries, when the value of a currency drops, the value of tangible assets remains roughly the same. In other words, devaluation and inflation go hand in hand.

The consequences for traditional investment vehicles are tough to predict. A value investor might say that stock prices would rise, especially for multinational companies that have significant non-dollar assets. But the stock market is.. a market. And if people are withdrawing money from their mutual funds to cover increased expenses, stock prices will drop regardless of the valuation of individual companies. The same applies at least in part to real estate, though again there are many other factors involved.

In short, you can’t count on stocks, real estate, mutual funds, or certainly dollar denominated or corporate bond funds to protect you from inflation.

So what are your options?

One is TIPS (Treasury Inflation Protected Bonds), that pay a base interest rate and a correction value based on the consumer price index (CPI). Not a bad approach, though there are risks involved for those who are more on the paranoid side – namely, you are trusting the government to accurately calculate the CPI and meet it’s payment commitments on the bonds.

Another traditional approach is gold. Gold is easier to invest in than ever now that you can purchase gold funds (one popular one is GLD). There are two problems with investing in gold. First, it really is a speculative investment – in other words, the price of gold seems more dependent on the action of speculators and governments than on currency values. Second, gold is a rather poor hedge against inflation. If you bought gold at $130/oz in 1975 and sold it at $600 last month, your overall return would be 5.06%, vs. an inflation rate of 4.63% for the same period. Gold might still be a good protective choice (especially if you are concerned about a worldwide depression including a collapse of all currencies, not just the dollar), but as an investment it’s not a particularly good long term play. Gold is also generally taxed as a commodity, not an investment – so you get to pay taxes at the regular rate – which wipes out much of the protection it offers.

You can trade in currency futures. This is just like trading option on the stock market – a technique for more sophisticated investors. I’ve actually done a bit of this, but more as a hedge to prevent a sudden increase of costs when traveling abroad. Currency futures suffer from the same problem as options – they expire. If you’re concerned about a drop in the dollar in the next few months, futures are a great deal. But if you’re concerned about a drop in the dollar over the next 20 years, they are an expensive form of insurance.

A newer approach involves currency ETFs (Exchange Traded Funds). These are funds that hold other currencies. You can now buy ETFs in Euros, Pounds and other major currencies (and a few relatively minor ones). These are especially nice if you’re in the U.S. where it’s typically difficult to trade in other currencies. Their disadvantage is that they really are a pure currency play. The currency in the funds is typically held in accounts that pay little or no interest, so you’re lucky if the fund’s income pays for the fund’s expenses. Another disadvantage is that the IRS considers these a form of commodity trading, and any gains are again taxed as regular income.

Finally, you can invest in an international bond fund. This is my personal favorite. Because the fund’s holdings are generally not in dollars, the fund will tend to do better when the dollar is weakening. At the same time, the fund holds bonds that actually do pay interest – so the fund has income that offsets both expenses and loss in value due to fluctuating interest and currency exchange rates. As a result, you have potentially the best of both worlds – an income fund that at the same time provides protection from a significant drop in the dollar. More important, depending on the individual fund, some of its return will be in the form of long term capital gains (with its more favorable tax rate). Plus, if you hold the fund for over a year and it increases in value, your profits will be taxed at the long term rate when you sell. There is risk – bond values drop as interest rates rise, so I would definitely stick with a short or intermediate term fund if you go that route.

Currency and gold ETF’s are the latest cool investment toy on the block, but frankly, I’m not impressed. Consider using a currency ETF if you’re planning a trip abroad and want to protect yourself from currency fluctuations. Consider a gold ETF for your IRA where the taxation rate isn’t a key factor. But at this time, for a good balance of income and security from a drop in the dollar, a short or intermediate term international bond fund might be just the ticket.

TD Ameritrade Has Most Mutual Funds Available

I was recently disappointed because I couldn’t purchase the Mairs & Power Growth Fund (MPGFX) or Artisan International Fund (ARTIX) through my T. Rowe Price Roth IRA. After doing some sleuthing on Morningstar I discovered I could purchase both of these funds through TD Ameritrade, from whom I have a standard brokerage account.

I was ready to transfer all my assets over from TRP to TD Ameritrade and it turned out that transferring a Roth IRA was extremely bothersome. So instead of jumping into anything I thought I had better check to see if there was another discount broker that offered more funds, because I didn’t want to have to do this again. I spent some time at it, and put together a screen using the Morningstar Premium Fund Screener (more info) that would show the number of funds each major discount broker had available, and which funds were covered by all of them. The results were fascinating.

As it turns out, my beloved T. Rowe Price, with its excellent service and $35 commissions offered the least funds to be purchased, and TD Ameritrade, my favorite discount broker offered the most with roughly 10 times the number T. Rowe Price offered. Here are the results of my screen:

Broker # of Funds
TD Ameritrade 14610
Fidelity 11341
Scottrade 10582
E*Trade 8738
Schwab 2828
Vanguard 1760
T. Rowe Price 1491
Available from all 227

*NOTE: Unfortunately, I wasn’t able to find Sharebuilder in the list of brokers on Morningstar.

I was surprised to see that so few funds were offered by all the big companies, suggesting that maybe it’s not a terrible idea to have funds from the top 3. In fact, if you had accounts from TD Ameritrade, Fidelity and Scottrade you’d have access to 15,700 funds. Now I’m not suggesting that you go ahead and open these accounts immediately. More accounts mean more hassles, and I would wait until there was a fund I couldn’t purchase before opening another account.

There doesn’t appear to be any adverse affects to owning multiple Roth IRA accounts, other than additional administration time on your part. The IRS treats all your Roth IRA accounts as one large account, and opening an additional account shouldn’t reset your 5-year holding clock. Motley Fool has an interesting article about multiple Roth accounts, which you should read if you’re thinking about opening another account. As always speak to a qualified professional (i.e. not me) before making any changes to your account, and I’ll keep you posted if anything happens with my move over to TD Ameritrade.

The Importance of a Mentor

Becoming wealthy is a full-time job. Successful entrepreneurs have worked for years to build a deep knowledge base in areas as diverse as sales, marketing, accounting, stock investing, real estate investing, leadership, team building and personal finance. For someone who is still laying his foundation, finding a mentor can help him avoid potholes he otherwise would not have seen, and is an invaluable asset as both a friend and a counselor.

A mentor is someone who has already done what you have set out to do. Whether that means becoming a successful stock investor, or real estate mogul, your mentor is an expert and is willing to share his experiences. Just as professional baseball players have pitching coaches and managers have leadership coaches, so should budding entrepreneurs have a mentor that can help steer them down the right path.

While mentors or coaches can be found in various fields for a fee, it is vitally important that your mentor is actively involved in their field, and truly wants you to succeed. Financial planners and stock brokers can work for a commission, and may not actively invest in the products they sell you. Therefore these would be poor mentors. While their professional opinions may be extremely valuable, they may not always have your best interests in mind.

Unfortunately, finding a mentor can be easier said than done, but networking is likely the best way to find someone you can trust. So join an investment club or networking group; talk to family members and friends. Those that keep their eyes open will eventually find someone who not only shares their passion for the field but also is interested in spending time with someone just starting out.

Using the Morningstar Prem. Fund Screener, Part II

In Part 1 of this article, we looked at how to use the Morningstar Premium Fund Screener, and I showed you two screens I use to select top funds for my portfolio. This article will move on from the screening phase of the stock screening process to the analysis phase, where we actually choose the candidates for possible investment. The key to successful analysis is understanding how to read the results views provided by the screener. In addition to the basic views provided by Morningstar, the premium screener also allows you to create up to two additional views. By creating custom views that package your most important statistics together, decision making can be more rapid and accurate.

*NOTE: It is recommended that you have the Morningstar Premium Fund Screener open while reading this article. Visitors can sign up for a free trial at the Morningstar web site.

The Analysis Phase

Once I’m happy with the screen criteria I’m using, I then need to make some informed decisions about the funds that Morningstar returns. Which funds best fit into my portfolio? Which funds provide the best long-term pre- and post-tax returns? How well-managed are the funds? Because in-depth mutual fund analysis is time consuming, it’s best to narrow down your choice of funds as much as possible before taking a detailed look. By utilizing the built-in and custom views in the premium fund screener, the best candidates can quickly become evident.

Built-in Fund Screener Views

Morningstar provides five pre-built search results views; each view focusing on a different aspect of the returned funds.

Snapshot View
This view provides a high-level overview of funds according to Morningstar data. While I like the idea of having a core set of statistics to provide a first glimpse at a fund, I’m a little concerned by this view’s focus on short-term results. I personally am looking for funds with long-term track records of success. Also, since this is my first look, I’d like to see a little more information to get a better-rounded picture, with data such as expense ratios, and portfolio roles. I ended up customizing this screen extensively, and it is discussed in-detail below.

Performance View
Unfortunately, this screen provides annualized returns and category ranks on funds up to 5-years. While performance information is critical in making decisions about which funds to purchase, 5 years is not long enough for me to make smart, long-term decisions. Additionally, I am not overly concerned about fund performance ranks within a fund category. While I wouldn’t discount the importance of this rank statistic, I would prefer other statistics with the limited space available to me. This will be discussed further in the custom screens section below.

Risk & Tax Data View
I really like this screen, as it provides a solid selection of risk and tax statistics used to judge funds. Additionally, it provides a solid, long-term look at the tax-efficiency of each fund, up to 10 years.

Portfolio View
This view looks at the makeup of each fund, such as where each fund belongs on the Morningstar Style Box, what each funds’ P/E ratio is, and what kind of turnover the fund has. Plus, this view also has stats for bond funds, such as credit rating, and duration. Overall, I like this screen and use it unmodified.

Nuts & Bolts View
More correctly labeled “Purchasing & Management,” this view contains statistics purchasing and loads, and how long each funds’ management has been at the helm. I don’t find this view particularly useful after building my custom screens, but I also think it can serve a useful purpose at the final stages of analysis.

Customized Views

After becoming familiar with and using the built-in screens, you’ll begin to get a feel for the information you find most useful, and how you’d most like information presented. That’s where the custom views come in. I’ve created two enhanced views of “Snapshot” and “Performance” that I use extensively when looking for new funds.

Enhanced Snapshot View
One of my biggest problems with the built-in snapshot view is its lack of long-term performance statistics and a broader overview of the fund type. My enhanced snapshot view includes more information about where the fund fits into my portfolio, how well the fund is managed, 10-year pre- and post-tax returns, and other key information.

It includes:

  • Morningstar Rating
  • Morningstar Stewardship Grade
  • Role in Portfolio
  • Morningstar Category
  • 10-Year Return (%)
  • AfterTax Return (with sale) 10 yr (%)
  • Total Assets ($ mil)
  • Expense Ratio (%)

I feel the four included Morningstar statistics are very important when looking at any fund. When building my portfolio, I narrow down my fund choices to only those that fit into roles I want to add to my portfolio. For example, I may be looking for a Core International fund, or a Non-core Growth fund. What role I’m looking to fill will determine what kinds of funds I’ll look at, regardless of how high another fund may be growing each year.

Plus, the Stewardship Grade is a very influential factor in the funds I buy. Morningstar analysts grade funds based on in-depth research, and summarize that information into a letter grade that describes how well a fund is looking after your money. While Bs and As are all included in my analysis, Ds and Fs are excluded.

You’ll also notice I include 10-Year after-tax returns. Since I purchase funds outside of my retirement accounts, I am subjected to short-term and capital gains taxes. This measure shows me how much I would keep after taxes if I sold a fund. Because some funds are more tax efficient than others, I often find one fund with higher returns before taxes and another with a higher returns after taxes.

Enhanced Performance View
The built-in Performance view is too focused on short-term results for my liking. I want to look out 10 or 15 years to see how well funds perform over long amounts of time. This custom screen includes Annual Returns and AfterTax Returns (with sale) for 3, 5, 10, and 15 years and also includes the expense ratio. While the expense ratio is used frequently throughout these screens, I follow the commonly held wisdom that funds with lower expense ratios are taking better care of my money, and producing better returns over the long run.

Wrapping it Up

Getting good investment ideas involve the right tools to help you make the best decisions quickly. It’s important to understand the tools you’re using and maximize their capabilities so you can get the most out of them. The Morningstar Premium Fund screener provides built-in views for investors to analyze various aspects of funds quickly, and with customized screens each investor can tailor the screener to his own personal needs. If you are a fund investor, I encourage you to take some time to play around with the premium fund screener, so can find the best funds out there for your portfolio.