Mutual Fund Investing: Heads They Win…Tails They Win

I have not written at length about the mutual fund scandal as of yet but this press release I recently came across has caused me to at least mention it briefly.  Having followed mutual funds for many years I have come to the conclusion that some are simply a part of the scam which I coin as “Wall Street Greed.”  The media entices people to invest in mutual funds saying they are great vehicles because they offer professional management, built in diversification and convenience.

The dark side of some mutual funds is what takes place behind the scenes:  market timing, excessive fees and poor performance (relative to benchmark stock indices.)  When all the smoke clears it becomes pretty apparent of what Wall Street’s motive is…to keep your money as long as possible.  Why?  Because Wall Street makes its money by managing your money…plain and simple.

So when a company like Putnam got exposed during the mutual fund scandal for its role in hurting its shareholders with its illegal practices they have to find away to “reinvent themselves” after investors in their funds left in droves.  Thus it peaked my interest when I came across  this recent press release in the Boston Globe:

Putnam fund fees will drop or be linked to performance

By Todd Wallack, Globe Staff  |  July 29, 2009

Putnam Investments, which has drawn complaints from some investors for charging high fees while delivering sub-par returns over the past decade, announced plans yesterday to dramatically overhaul its fee structure.

The Boston money manager said it plans to lower the management fees for many of its fixed income funds on Aug. 1, to make them more price-competitive. And it plans to tie fees for many of its other funds to performance, so Putnam will only be paid a premium if it delivers strong results and will be paid less if it stumbles badly.

“This puts us on the same side of the table as the shareholder,’’ said Putnam chief executive Robert Reynolds.

Among the more dramatic examples, the Putnam American Government Income Fund’s management fee will be reduced from 0.62 percent of the money invested to 0.41 percent a year. The average fee reduction for bond funds would be 13 percent, and 10 percent for asset allocation funds. Putnam has $102.8 billion in assets under management.

The new price structure is just the latest in a series of changes introduced by Reynolds, a longtime Fidelity Investments executive, who took over Putnam a year ago. Over the past 13 months, Reynolds has added products, recruited dozens of investment professionals, and changed the way Putnam manages its funds.

Where they sorely lagged in previous years, Putnam funds generally have performed better than average so far this year, according to Morningstar, a Chicago research firm that tracks mutual funds.

Morningstar analyst Jonathan Rahbar praised the fee reduction as “shareholder friendly’’ and said it could help Putnam in its battle to attract investors.

“It’s something that opens another door for them’’ Rahbar said. “But performance and consistency will be the main factors behind whether investors go back to Putnam.’’

Avi Nachmany, executive vice president of Strategic Insight, another research firm that tracks mutual funds, said Putnam management fees are currently about average for mutual funds. But Nachmany said the changes are another example of how Putnam has become “very innovative and forward looking’’ under Reynolds.

Reynolds said the management fees for its stock funds are already among the lowest in the industry and he wanted fees on Putnam’s fixed income funds to be as well; currently, he said, the fees on fixed income funds are about average.

Fees on mutual funds have been getting a bad rap lately as seen by the number of lawsuits filed and congressional involvement.  So let’s get this right…Putnam is enticing investors back to their funds by promising to lower fees that are already too high and if they beat performance expectations (not defined in release) they get MORE money but if they don’t they get less money.  This sounds like a WIN-WIN for Putnam.  Any way you slice it Putnam makes money…its just a matter of how much.  Now the underlying danger lies in how rich risk Putnam will take with its funds in an effort to “beat performance expectations.”

If Putnam truly wants to be “on the same side of the table with investors” how about Putnam saying they make money ONLY if their shareholders make money.  That’s true innovation!

Perception vs. Reality: Are African Americans Getting What They Deserve?

Growing up I was told to always do my best in whatever I did – whether it be school, sports, or whatever.  A constant reminder was instilled in me that those that study the hardest got good grades and those that trained the hardest tended to be the best athletes.  The pursuit of excellence in everything was always embedded in me as a child.  Now if such statements and mindsets hold true, can a similar analogy be used to describe the current plight of African Americans in this country or are we simply getting what we justly deserve?

It seems as though for many (not all) African Americans complacency is becoming the norm and idea of trying to get ahead is the exception rather than the rule.  When I look around my community or visit the local businesses there is one thing that has become very apparent…hardly anything is owned or operated by an African American?  Dry cleaner…no.  Restaurant…no!  Grocery store….no!  Seven eleven…definitely not!  So where are the black businesses….barbershop, hair salon and /or local club promoter.

I recently had a conversation with a friend (African American) who told me her hairdresser had recently attended a convention in Atlanta and the majority of attendees were Asian.  She asked a question of one of the presenters (whom was also African American) about how he got a higher priced clientele and the presenter’s response was “that is for me to know and for you to find out.”  Not one to be ignored she responded “you see all these Asians up in here…this is why we can’t get ahead!”  She was not meaning to be disrespectful to the Asians that were present but she knew that her potential competition was sitting right beside her in the same room!

We are all familiar with “take out” spots as they are fairly common is the black community.  A couple weeks ago I picked up a flyer from the barbershop advertising a new take out restaurant with the type of food I liked on the menu (i.e. soul food).  So always willing to support a local business I decided to go to the restaurant for lunch.  Everything was fine until I walked in and noticed it was run by a Asian family.  Nothing against Asians but I was shocked momentarily then quickly asked myself was I truly surprised?  I ordered my food (which was good) and went on my way.  It was simply another example of what I am talking about.

I will be the first to admit that I am not exactly living in a “black” community but why should I have to be?  There are black people here and that is all that matters.  It hasn’t stopped the local Korean from putting up shop or the local Chinese people from opening numerous Chinese restaurants.  The local food court in the mall is on lockdown without even a Caucasian owning a space.  Yet no black business of the retail variety exists.  After awhile one would start to believe that this has become the norm rather than the exception…blacks just don’t own businesses (for the most part) outside of hair, nails, clothes and music.

I have heard conspiracy theorists say that the reason is because people born outside the United States can start businesses alot  easier because they can get special loans from the government and qualify for preferential tax treatment.  Ever heard that one? Now I am not sure if that is true or not but I have heard it many times.  What usually goes along with it…”that is probably one family that got together and bought the business and they just pass it along through the generations.  Matter of fact that is probably the family that is running it.”  Really?  What a noble concept?  Obviously something African Americans are not capable of doing as well…right?

What have we instilled in our generation?  What are we passing along?

So a person born in the United States does not have as great a chance of accomplishing the same thing because their skin color or race?   Sounds like an excuse as foreigners are getting it done day in and day out!  People risk their lives in boats with everything they have, walk miles and miles, crawl under and climb over barbed wire fences just to get to America because of the opportunities that exist.  Americans simply take it all for granted and chances are would not want to live in the countries these people are risking their lives to get out of.

What is really a shame is the perception of African Americans when it comes to business.  Why is it that people expect to get bad service when they shop at a black business?  Why is it that waiters / waitresses hate to serve black people in restaurants for fear they won’t get a tip?   Why is it that if you do shop at a black business you are looking to get a “hook up” on the merchandise?  Ever try talking down the price on an item at Macy’s or Bloomingdale’s?  Happens all the time with black businesses.  Then we wonder why black businesses never seem to last.

We have to realize that perception becomes the reality until we choose to change it.  We should support black businesses and expect to receive the same level of professionalism and customer service we would expect from any business we chose to spend our money with.  No exceptions!!  Black businesses should treat everyone with respect and realize that the customer always has a choice of where to shop and a great experience will keep customers coming back.

African Americans can do better but realize there is a mountain to climb in doing so.  Look no further than the numbers of African American males incarcerated.  The fact that more are in jail than in college.  HBCUs facing threats of going under due to lack of funding.  The poor quality of schools in black neighborhoods.  The rise in the illiteracy rates and single parent families.  The list goes on and on…

While CNN’s Black in America series (second version having aired recently) does not and can not tell the plight of black people in its entirety, it does show that there are black people that are striving for excellence and obtaining it.  We simply need the effort from the masses in order for things to truly change.  And above all “crabs in a barrel” cannot continue to be the label by which we are defined when it comes to supporting one another.

“Insure” Your Children Retire As Millionaires

As I’ve written in previous blogs, saving for retirement is extremely hard to do.  Saving for retirement as a parent is even harder to do.  The wild gyrations of the stock market give many people sleepless nights wondering if they will ever be able to retire.  As such, I think that desperate times call for extraordinary measures and ideas.  As a parent we realize that our children will one day be in a similar position of needing to plan for their retirement. For the majority for parents we would like to leave money behind one day as an inheritance to our children or perhaps grandchildren but not at the expense of sacrificing our own future lifestyle.  I propose that parents become a part of your child’s retirement plan.

Here’s what I mean….

It is no secret that I believe in life insurance and think that many people miss out on one of the greatest leveraging tools of our society.  Conventional wisdom is that life insurance goes on the parent so that if something happens to them then the surviving spouse and/or children (the dependents) are taken care of.  Now think about how hard it is to save money for the future and the two things they say are guaranteed in life:  death and taxes.  No one will live forever that is a simply a fact of life.

So as a parent why not allow your children to put a life insurance policy on your life and let them pay the premiums as part of their retirement plan?

Sounds weird but if you think about it doesn’t it make sense?  You do nothing (as a parent) other than allow yourself to be insured and your children pay the premiums and get a lump sum of money (tax free) to assist them in the future for their retirement.  Chances are your children will one day be traveling down the same path you went down of investing in 401ks and IRAs, saving money in bank accounts and tapping home equity, etc…everything you did to try and make it.  Why not have them redirect some of those funds into a life insurance policy on a parent?

Which would be easier…trying to invest $500 a month (hypothetically) into a 401k plan earning a supposed 8-10% for 30+ years to try an reach a million dollars or paying the premiums on a million dollar policy on a parent?  Obviously there are a lot of variables that come into play such as how much money your children have available, the amount of the premiums, health conditions, etc… but the premise is worth looking into.  Even if it isn’t a million, heck, 350,000 or whatever it is, would be beneficial compared to the alternative of trying to grow that amount of money in the stock market over time.

I did this with my parents years ago and decided it made more sense than contributing to a 401k plan.  And yes they were hesitant at first as their initial reaction was “you trying to get rid of us” (jokingly) but after some thought they saw that it made sense.  No money out of their pockets plus they got a free physical.  And when times got rough (as they eventually always do) my parents were willing to help out with the premium payments.   They realize that every little bit will help in the future and they were willing to help out any way they could.

The 2010 Roth IRA Rule Change

The rules for Roth IRAs will be changing next year…just not like you think.  Many people find that because of the income limits (105k for single filers, 166k for joint filers*) associated with Roth IRAs they are no longer eligible to make contributions because they make too much money.

Starting next year (2010) a tax law change will allow those currently ineligible access to a Roth IRA with one simple caveat….it must be done via a Roth conversion.  A conversion simply means that the Roth must be established as a result of converting an existing “Traditional” IRA into the Roth IRA.  Current rules state that you cannot make over 100k modified adjusted gross income (single or joint filing**) in order to be eligible to convert.  Thus many people and married couples have been stuck in traditional IRAs or with no IRA contribution eligibility at all.

So what’s the catch?  First, when you do a conversion you owe tax on the converted amount as if you had made a withdrawal from the traditional IRA however you skip the 10% penalty usually applicable before age 59 ½.

The conversion can be a good thing as withdrawals from Roth IRAs are tax free in the future and not subject to the mandatory withdrawal rules at age 70½ that face traditional IRAs.  You can also convert all or part of the traditional IRA to stay within your tax bracket.

So why is Congress doing this?  Two words: tax revenues.  They projected a need for additional tax revenues years ago (perhaps due to all this spending) and put this on the books as a way of enticing people to convert their IRAs thus giving the government an infusion of taxes.  The current economic conditions makes it even more necessary now.  (It is quite interesting the year the tax cuts expire this rule takes effect.)

So why convert?  Well this is a individual decision that basically it boils down to 1) do you have the money to pay the taxes on the conversion  and 2) do you believe taxes will be higher in the future?  Being in a higher tax bracket in the future makes the Roth IRA more attractive since withdrawals are tax free however biting the bullet to paying taxes today is a tough pill for some to swallow.  So congress to the rescue…

Also hidden in this new law is a ONE time provision for the 2010 tax year that allows the converted amount to not be counted as income in 2010.  You can report half the income in 2011 and the rest in 2012, effectively allowing you to spread out your tax liability.

The press and mass media are sure to make this a topic in the coming months so prepare to be inundated with information about this law change.  Keep in mind that Roth conversions may not be appropriate for everyone so make sure you talk to a qualified professional to see if it makes sense for you.

* – denotes eligibility for a full contribution to a Roth IRA
** – joint filing separate cannot make over 10,000

Risk Free Investing…Is It Possible?

When the stock market is volatile as it has been this past year we start to hear stories of people moving money from the stock market and putting it into cash (money market accounts or certificates of deposits). Money markets are viewed as “safe investments” as they look and act like savings accounts. I have always pondered this behavior as I realize more and more that people tend to invest via their emotions rather than fundamentals.

A statement echoed all the time regarding investing is “I would like to invest in something that has a high rate of return and no risk.” Guess what…so would I! Unfortunately such a thing DOES NOT exist as every investment, regardless of what it is, has some risk. It just may not be what you think.

Lets take a look at some of the different kinds of risks associated with investing:

1.Market Risk – perhaps the most well known, this is the chance that the stock market will decline in value, in turn, causing investment values to decline .

2.Liquidity Risk – this is the risk that an investment cannot be easily be converted to cash or when converted to cash might lose money (i.e. real estate).

3.Interest Rate Risk – the risk that interest rates will rise resulting in an investment losing value. Think about it…would you buy an investment paying 3% when you can get one paying 5%?  This is what bond buyers face when the price of bonds drop.

4.Inflation Risk – the risk that dollars invested today will buy less goods and services in the future, as prices tend to rise over time.

5.Credit Risk – the risk that a company may fail to make their promised interest payments or don’t repay principal when it becomes due.

6.Tax Risk – the risk that rising taxes will make certain investments less attractive over time.

7. Currency Risk – the risk that the performance of international investments can be impacted by the strength or weakening of the U.S. dollar.

8. Country Risk – the risk that political instability, or problems occurring in another country can affect their economy and thus the people of have investments there

9. Opportunity Risk - the risk that you have your money tied up in an illiquid investment thus miss the opportunity to invest in

something else that has the potential for higher returns.

10. Regulation Risk – the risk that the government changes the laws or rules regarding an investment thus changing the

potential earnings of the investment in the future.

These are just some of the examples of “risk” when it comes to investing. Using a real life example…a person that moves money

to or keeps their money in a savings account technically does not lose money, per se. However they are still exposed to risk.

This person will experience:

Market Risk / Opportunity Risk because if the market goes up in value they miss those returns (known as opportunity costs).

Inflation Risk because the low rate of interest will not keep pace with inflation which has averaged around 4.2% historically (so

they are really losing money keeping it in the bank even though the account balance may not be going down). Credit Risk

because the bank may fail thus causing them to lose the money not covered via FDIC.

So while it can make sense to try to shelter money from losses simply realize that when it comes to saving and investing there is no such thing as a safe, risk free investment.