Advanced Personal Finance

Your mutual funds and ETFs are flagging.  The 401(k) balance is dropping almost daily.  Surely there’s a way for you to align your investment strategy to counteract these trends, right?  Well, once again Wall Street comes to the rescue.  There’s a new fad rippling through the mutual fund industry - the 130/30 fund.  Is this the common man’s hedge fund or just another money-losing gimmick?

The 130/30 Fund

So what the heck is a 130/30 fund?  It’s a mutual fund that is ‘long’ 130% of net assets and ’short’ 30%.  (An investor is ‘long’ a stock if he/she has purchased it in the hopes that the price will increase; a ’short’ is when the investor is hoping the price will decrease.)

That adds up to 160%; how, you ask, do they own 160% of net assets.  The short answer (no pun intended) is that the short position and part of the long position kind of cancel each other out.  It works like this.  When you short a stock, you borrow the shares and sell them into the market.  That nets you cash.  A 130/30 fund takes those proceeds from the short sale and reinvests them ‘long.’

Confused?  Don’t be.  In simpler terms, what a 130/30 is doing is just using leverage.

The idea behind the 130/30 fund is an alluring one.  By intelligently choosing which stocks to short and which to hold long positions in, you hedge against adverse price movements.  Just like the big boys at the hedge funds do!

Is a 130/30 fund for you?

Likely not.  There are a couple of serious negatives to 130/30 funds. 

First, they’re actively managed funds.  As we all know by now, actively managed funds never beat index funds over the long term.  They can’t - no advisor gets it right all the time.  Statistically speaking, you’re much worse off in actively managed funds.  Besides that, actively managed funds have higher expenses than index funds.  Expenses are one of the few ways you can truly influence your investment returns.

It’s even worse than that, though.  The second reason 130/30 funds are a bad idea is that their expenses are likely to be even higher than other actively managed funds for a couple of reasons.  First, when you short a stock, you have to pay dividends to the person you borrowed the security from in the first place.  Second, there are additional trading expenses associated with the ‘extra’ 60% of assets.

Another reason you probably don’t want to own a 130/30 fund is their whole reason for being - leverage.  As people learned in the recent real estate crash, leverage is great when prices are going up but murder when they’re going down.  Boiled to its essentials, what a 130/30 fund is doing is really just borrowing money to leverage up their exposure.  This is a way of end-running the mutual fund prohibition against buying on margin.

Though the idea is nice, I’ll personally be staying away from 130/30 funds.  But then again, I don’t invest in anything but index funds and ETFs, so I’m not exactly their target audience.

This article published only at Advanced Personal Finance.

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How would you like to invest in a product that returns high single digit returns that’s as safe as cash or a money market?  They’re called auction rate securities and they’ve been marketed as just that.  The only problem is, as investors are now finding out, these things are anything but a cash equivalent.  Here’s the deal.

An auction rate security is a debt instrument (usually a bond but can be preferred stock) that has its interest rate reset, usually once a week or month, through an auction.

The idea is that an investor will get a better rate of return than in a money market or savings account since they’re investing in actual corporate or municipal debt instruments.  The problem, as this Reuters article points out, is that when there’s a flight to quality in bonds, as there is now, there’s no market for the auction.  In other words, nobody shows up to bid on the auction rates.  Result?  People have lost significant portions of their investment.

It’s clear, then, that auction rate securities are not a juiced substitute for cash equivalents.  Now that formerly-high yield savings accounts and money market funds are paying such low interest rates, I fear more people will get suckered into these things.  It’s a great example of the old saw “if it sounds too good to be true, it is.”

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How’s that for a thrilling title?  Anyway, that’s what I’m going to write about. 

I quit a job recently and rolled over my 401(k) into an IRA.  I’d been hesitating on how to invest the money, so for the past couple of weeks, it was in a money market.  I wanted to do a reallocation of everything related to retirement savings but I wasn’t sure if different types of accounts (Roth and Traditional IRAs) should have different asset allocations.  Just a couple of days ago, I finally decided and invested the money.

Asset allocation - different accounts get different treatment?

So on the question of whether a Roth IRA gets a different asset allocation than a Traditional IRA, I came to conclusion that for my time horizon and risk tolerance (medium-long and high, respectively), they can be the same.  As I get closer to retirement, I imagine they’ll diverge, since you’re supposed to tap Roth funds last.

Here’s the allocation I settled on:

50% US stock index

40% Internation stock index

10% Bond index

Specifics of my investment

I had planned on using USAA mutual funds as my investment vehicle, but I ran into a couple of reasons not to.  First, they don’t offer a true bond index fund or an international index fund.  Second, I have a lump sum to invest, so ETFs really make more sense.  I won’t be trading, so commission fees aren’t an issue for me, nor will I be adding additional money.  With an ETF, I take a one-time commission hit, then it’s done.  More importantly for me, though, is that ETFs deliver what I’m looking for (boring, vanilla index funds) with super low expenses - even lower than an index mutual fund charges.

Specifically, I chose the following ETFs for my mix (numbers in parentheses are expenses):

50% Vanguard total market (0.07%)

40% Vanguard FTSE index (0.25%)

10% Vanguard bond index (0.11%)

So now Vanguard has a very substantial portion of my retirement money.  It’s still held through a brokerage account at USAA, incidentally.

Anybody out there have any thoughts/opinions about my allocation or use of ETFs?

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By one sensible measure, yes they did.

Adjusted for inflation, the S&P 500 is right where it started nine years ago.

Today the WSJ reported something I’ve been trying to wrap my head around for some time.  I’ve wondered on this blog before about what is the best hedge against inflation.  I’ve asked personal finance authors, asked myself, done research, read tons of articles.  Nobody ever had a satisfactory answer for me.  The closest I ever got was “stocks will outpace inflation.”

Well I guess not over the last nine years.  Here a link to a telling graph courtesy the WSJ.

From the article:

Conventional stock-market wisdom holds that if investors buy a broad range of stocks and hold them, they will do better than they would in other investments. But that rule hasn’t held up for stocks bought in the late 1990s or 2000.

That just happens to be the timeframe I’ve been investing.  Awesome.  T-bonds returned 4.7% adjusted for inflation over that time period for crying out loud!

To be sure, unless you bought this month in 1999 and didn’t add to your holdings, you’ve done better than this.  That’s why people like dollar cost averaging so much - it forces you to buy during down markets.  But analysis like this is disheartening.  Inflation’s a killer (and the government’s inflation numbers haven’t even been bad during this time period).

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I’ve written a couple of times now how I changed jobs and rolled my 401(k) into existing IRAs.  Right now the great majority of that money is sitting in a money market fund collecting 2% or whatever it is.  But having it there has created, if not a true problem, an annoyance.

My rolled-over 401(k) assets are sitting around for two reasons:

1. I haven’t decided what my asset allocation should be
2. With all the market volatility, I haven’t pulled the trigger.

I have to sheepishly admit that the real reason is more the second than the first.  See, like any reasonable person, I’d hate to invest a great deal of money (six figures, which is a great deal to me) just to watch it immediately lose 3% of its value as has been occasionally happening lately.  Yep, I’m trying to time the market in a manner of speaking.  I could dollar cost average, but as FMF recently wrote, that may not be the greatest move either.

So what’s the problem?

Most days, I log on to USAA and take a look at my bank accounts to make sure everything’s cool.  There’s a section for my mutual funds, which consist of our emergency fund and these IRAs.  Well, some of the IRAs are fully invested.  So on those -3% days, I get to see my retirement assets drop thousands of dollars at a pop.  That’s not a good feeling.

But it’s also a pretty good problem to have, I guess.

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