Making Wise Investment Choices

By Bob Moeller
WEAC Member Benefits

March 2002

Financial Planning Seminars
Achieving Financial Independence

Here’s the dilemma. You don’t want to spend a lot of time making investment decisions. As a good friend of mine put it “I’d rather play tennis!” Furthermore, you believe that you do not have a lot of knowledge regarding investments and might make a bad decision. Yet, you know that just leaving your money in CDs or savings accounts is not a good route. You simply cannot earn enough to justify that approach. You’ve heard the message about how stocks outperform other investments so many times that you realize it must be true. This article will attempt to give you some insight into the decisions you might make to minimize your time and your costs to invest.

You’ve already been attuned to the advantages of a good tax-sheltered annuity, I hope. Dealing either through a no-load mutual fund family or the WEA Trust TSA product, you have maximized your investments into a TSA. You’ve avoided any investments with any life insurance company as being too expensive with fees etc. But what to do with your additional investments, the inheritances, the proceeds from a home sale, your IRA at a brokerage house, etc? Certainly you want to be invested in the stock market to some degree. You do not have the time or inclination to research individual stocks (except for small sums you want to have fun with). You conclude you might have to turn to someone for assistance. How much is it going to cost?

First, forget the assumption that the stock market will have large increases each year for the rest of your life. Many of you learned that in the past two years. Your assumption might be something more realistic, such as 10% a year over a longer period of time.

Experts don’t agree on the best number, but in the area of 9% to 11% a year is commonly suggested. Note that the Wisconsin Retirement System fixed account has 50% to 60% of its money invested in the stock market, and overall assumes actuarially it will earn 5% per year. Any fees you pay will reduce your return, pure and simple. Various brokerage houses, advisors, mutual funds, etc., are thinking of ways to increase their fee income.

I wrote this article not long after meeting with a member and spouse who inherited $400,000 and parked it with a brokerage house paying 1% a year ($4,000 a year) in fees. Part of the “management” was advising placement of some funds into a mutual fund that charged another 1+% per year to manage the money.

Thus, on a long-term expected return of 10%, more than 2% is already spoken for. Does this make sense? There is a relatively new way to invest in various index funds called Exchange Traded Funds. They have very low management fees. Already one brokerage house has announced a “service” to help you select these funds. The service costs you 2+% a year.

If you want to spend minimal time and minimal money and still have a reasonable investment approach I suggest the following:

• Don’t even try to pick individual stocks in an effort to beat mutual funds or the indexes. Neither you nor your broker or adviser will succeed.
  
• Deal only with true no-load mutual funds.
  
• Concentrate on index funds, particularly the S&P 500 Index Fund with perhaps 50% of your stock market invested money.
  
• Place another 30% or more of your stock market investments in mid-cap (middle-sized companies) and small-cap index funds.
  

With most of your money in index funds, you have essentially “invested in the entire stock market.” If the market goes up, so will your index funds. You could do a lot worse than just putting your stock investments in index funds and spending the rest of your time playing tennis.

If you wish some income funds and can’t balance your TSA money to generate a certain portion of “fixed” income, use a medium-term bond fund with minimal management fees. When you earn 6% on average, you can’t afford to pay 1+% in fees. Don’t forget, when interest rates go up, the value of your bond fund holdings are going to go down.

If dealing with a broker, make sure you understand the commission charges and what you will get in terms of service. Commission charges of 2% are not unusual from so called “full service” brokers. On the other hand, discount brokers may charge only $25 per trade.

Never agree to a set fee, or “wrap” fees unless you trade a lot and the set fee is in lieu of commissions and you fully understand what you are paying and what you are getting. NEVER allow brokers or advisers to “trade” your account on their own.

Posted March 11, 2002