The universe of ETFs (exchange traded funds) has exploded over the last several years. In 2007 there were just 500 of them. Now that number is over 1,500 with $1.5 trillion in assets. The question is, how do those 1,000 new funds attract new investors, since they do not have a track record? The answer is backtesting.
Almost all ETFs track an index of some kind. Some of them are pretty common, like the S&P 500. And some are much more obscure, tracking things like the BRXX Brazil Infrastructure Index. That opens the door for companies to make deceptive claims about performance. When they advertise their new fund, they may show a chart of how wonderful the index has done in the past. But there are two problems with that. First, of course is the famous “past performance is not indicative of future results”, which is very true. But it’s worse with these funds. The fund probably did not exist over the period indicated. So they are not even showing a fund history. They are showing a hypothetical fund history. It’s kind of like artificial margarine is two steps away from real butter. This is two steps away from actually telling you what might happen with your investments. They use backtesting of historical data to show what *may* have happened and imply that it may continue in the future.
I do not much care for this practice. It’s another example of Wall Street using deceptive practices to sell a product. Don’t get me wrong, I think ETFs are a great invention for passive investing. But using backtesting to imply a particular outcome is just wrong. If you’re looking at buying an ETF, make sure that you’re getting the straight story about what the fund has done, and not what they wish they had done, with their backtested data.
Archive for September, 2015
Yesterday I received an offer in the mail for a credit card. In big letters on the front it says "0% interest on balance transfers for first 9 months". But read the fine print and it says "5% balance transfer fee or $10, whichever is higher". Well it turns out much to my surprise 5% is not 0%. And in fact that interest rate is even higher than 5%, as you're paying that all upfront on the original balance.
One of the things I truly hate about the industry I work in, is that they feel it's their obligation to trick the general public. Fees only disclosed in the fine print, special offers that are almost impossible to achieve, huge penalties if you make even a small mistake.
Here is the problem. Reading and understand that stuff is a) is boring as hell, and b) makes you feel like an idiot because you can't figure out what they are saying. But you have to do it. So here are a few things I suggest you do whenever you're dealing with any contract related to the financial services industry.
1. Ask them to tell you what the downsides are. Ask them what the fees are, what happens if you make a late payment. Getting it in email is best, it may give you ammunition down the road if they don't disclose something.
2. Get someone else to go over it with you. It really will be 1/2 as much pain if a spouse, partner or friend helps you go over it.
3. Ask in the financial forums like Savingsadvice about what to look out for.
Don't let them make you feel like a victim. You work hard for your money. Don't let the financial services firm trick you out of some of it with their confusing fine print.
There is a 'secret' way you can become wealthy, and it doesn't matter much how much money you make. The boxer Mike Tyson spent all of the over $100 million he made. On the other hand, I have a couple who are clients. She works as a clerk, he works as a carpenter when he can find work. They are worth well over $1 million. There is a 'secret' (well it's not very secret) to their success, and to Mike Tyson's failure.
The trick? Live on 85% of your income and invest the rest. If you save 15% of your income (generally considered to be the magic number), it almost doesn't matter how much you make, you will eventually accumulate significant wealth. And if you live on 105% of your income, you will eventually be bankrupt no matter how many millions you made. Easy? No. Though unlike a diet, it does get easier as you go. The more money you accumulate, the more you can accumulate.
This website is a great place to find ideas about how to get to that 15% number. There is *nothing* like the easy sleep you'll have when you have enough savings to weather any storm.
In almost every field, there is constant progress. Very few psychologists today use a strict Freudian approach to psychotherapy for example. But there is one field where the guy who really invented it hasn't been improved on very much. That field is investing. In 1934 Benjamin Graham wrote his seminal book on investing called "Securities Analysis". But it's pretty unapproachable for the average person. So in 1949, he wrote a book for non-professionals called "The Intelligent Investor". The book has been updated and revised many times to reflect the current environment. But the principles are exactly the same. Who was Ben Graham? He was the mentor of one of the richest men in the world, Warren Buffett. Buffett to this day still uses the principles taught him by Graham to choose his investments. Buffett calls "The Intelligent Investor" the best book on investing ever written. If you want to do your own investing, or just have a handle on the most practical investment philosophy, I'd start with "The Intelligent Investor".
Five Dumb Ways to Lose Your Money
Feeling overly rich? Thought so. So here are five ways you can quickly change that.
1. Switching loaded annuities.
If you buy a loaded annuity from a commissioned sales person they often have big upfront commissions. The best way to really lose money is to get someone to switch you into a different loaded annuity from a different company. You’ll pay that big fee all over again. It’s possible to have that cost you 12% of your investment each time you switch.
2. Frequent trading with a full price broker.
Frequent trading can really eat into your profits. But if you really want to shrink your pile fast, do this through a full price broker. If he does it for you, it’s called ‘churning’ and he can get into trouble. But if you do it, it’s called being broke.
3. Refinance mortgages with a pre-payment fee.
If you’re going to refinance your mortgage, there are a lot of fees involved. So it makes sense to only do it with a significant drop in rates. But the best way to guarantee you won’t take advantage of those rate changes is to do frequent re-fis into mortgages with a pre-payment penalty. It can soak up all the money you’ll save on the re-fi and then some, as each time you refinance you’ll be paying a pre-payment penalty.
4. Speculate in penny mining stocks.
Penny stocks (and by this I mean stocks literally trading for a few pennies) are a great way to shrink that estate. But to amplify it a bit, choose penny mining stocks. Only 1 in a 1000 has a remote chance to succeed, whatever the press releases might say.
5. Start a small business with just a few months of capital.
When you start or invest in a small business, you want to make sure you limit your chances to succeed. So start with less than six months of capital to support the business, instead of the two years (or more) worth that you really need. And if that business doesn’t do well at first, throw lots of money at it without a coherent plan. No reason to stretch out the agony.
There. If you have any money left at all, it’s not my fault.
ETF (exchange traded mutual funds) have been a great boon to the average investor. Generally they are low cost, and allow you to buy a fund during the day without waiting for the close. You also don't have to worry about hidden fees.
But there is a downside to ETFs and we saw it last Monday. A number of ETFs gapped down at the open. The market as a whole was down 5%, but some of the ETFs dropped 30%!!!
Why? Because the investors selling them did not understand the difference between a market and a limit order. For standard mutual funds, that's completely unimportant. You acquire the fund at the closing price at the end of the day. But ETFs trade like stocks, and so it's important for investors to understand about the difference between limit and market orders.
A market order says "Sell now at the going price". Which is usually fine. Except when you have a huge drop in the market like last week. In those instances, you want to use a limit order. A limit order says "Sell now, but at a price no lower than X".
Example: You want to sell the XYZ etf, which last traded at $20 a share. Instead of placing a limit order (sell at the going price) place a limit order, at say $19. That means "Sell at the best price possible, but no lower than $19". This will give you some insurance against a crazy day like last Monday.