Avoiding “Fund Poisoning”!

This post may make you miss the cute squirrel and the hard-shelled curmudgeon as it will be a little more technical, but still understandable. I am committed to the KISS principle, which stands for Keeping Investing Simple and Straightforward. I’m also working on my second book, tentatively titled: The Investiphobic Portfolio – What To Expect From Your Advisor. It should be available before year-end, perfect for Christmas, Birthdays, of any day ending in “Y”(sorry, couldn’t resist)!

In some ways, this book is the missing middle section of Investiphobia. The middle section became too large and I, as you know if you read the book, became uncomfortable providing detailed investment information that could be used by the “do-it-yourselfer”. This is because I strongly recommend readers, who suffer from investiphobia, to avoid the “do-it-yourself” approach and hire an advisor. Because I strongly made that point in the first book, I am comfortable getting into investment details and philosophy in the new book. The Investiphobic Portfolio will still be easy to read and understand, hopefully not boring, and it will contain an overview of individual and packaged investments, asset allocation, and investment objectives. I think it will be in a “cookbook” format, since I don’t know anyone who hasn’t used a recipe at some point in their lives. So individual investments, like stocks and bonds will be in the chapter on Individual Ingredients and mutual funds will be in the chapter on Prepackaged Ingredients. Recipes for Income, Growth, or Balanced portfolios will be in the Recipe Chapter. Feel free to comment if you either love or hate this idea.

Speaking of recipes and eating, what’s your favorite meal? An all-American cheeseburger with fries? Fried Chicken with Cole Slaw? Lo Mein? Spaghetti Carbonara? We all must eat for the same basic reason but we each have our own preferred styles. A friend of mine has never eaten anything other than oatmeal for breakfast. It works for him. Whenever you dine out, there is always the small risk of food poisoning but it rarely happens in the US and, for some adventurous diners, there are meals that are simply worth the risk. Sushi comes to mind, but not for breakfast. With food, there are different cuisines and, with investing, there are different approaches. The new book will contain a section about the debate professionals and regular investors have between active management and passive indexing.

Let’s start with passive indexing. There are many, many, stock indexes but most people are familiar with the Standard and Poors 500, or S&P500. If you watch, listen, or read the news, this is one of the most common US Stock indexes reported each day. The S&P500 Index represents larger companies in the US Stock market, minimum company size is $3Billion, and the 500 stocks that it contains change periodically based on criteria established by the index provider, Standard & Poors. Although you cannot invest directly in the index, there are several ways to invest passively in funds that are designed to “mirror” the performance of this index. These funds come in different formats and examples include, Spyders, Vanguard S&P500, IShares S&P 500, Schwab Index 500, etc. Investors who buy this type of fund are not attempting to “beat the index” or “outperform” it. Rather, they simply want to participate in the performance of the index.

Active investors believe that it is possible to beat the index. They either buy specific stocks themselves or invest in funds whose managers buy specific stocks. Specific, in this case, just means that the manager isn’t attempting to match the index. They are attempting to beat it by investing only in the stocks that they believe will outperform the index. So, an active fund might only invest in 20-100 of the 500 stocks in this index. If they are right, they outperform and, obviously, if they are wrong they underperform. Sometimes this under-performance is severe and gives the investor a bad case of “fund poisoning”!

So, to avoid fund poisoning, you could avoid active investing altogether and invest only in index funds. This is actually a valid solution, keeping in mind that you would still need to invest in other index funds for midcap, smallcap, international, and emerging markets. Not to mention other asset classes like cash, fixed income, etc. But that will require more space and more explanation and I committed to keeping this post simple and straightforward. Index funds typically have very low expenses in comparison to active funds, so this approach is also less expensive.

My approach is to combine active and index methods. By using the index funds as the primary ingredient, the chance of fund poisoning is reduced. The effect is certainly less than it would be with no indexing. The decision to only invest in active or passive funds, or to combine them, requires much more information than I am offering in this post. But, it is a decision that should be consciously made. Active fans and index devotees would both be disappointed in my lack of a decision, but for me, it is the best compromise.

For those that would like to investigate the indexing approach, I am adding a new book to my recommended list. Actually the book isn’t new, The Boglehead’s Guide to Investing came out in 2007. The authors make a compelling case for investing in index funds, provide guidance in designing investment plans, and they also started a forum, http://www.bogleheads.org, where investors can discuss issues relating to investing and investment management. All of the books authors, Taylor Larimore, Mel Lindauer, Michael LeBoeuf, and John Bogle, will probably be reading and writing with you should you visit their blog. It’s free, but you will need to create a screen name and a password to access it. Of the investment websites I have visited, and it’s quite a few, this forum consistently educates and entertains. Keep an eye out for several great authors with books that are also on my recommended reading list!

I’m still looking for a forum of active investors that provides consistent advice. The discussion area at Morningstar’s website is currently in the lead, but few websites are able to prevent the occasional member from giving incorrect, or sometimes bad, advice. When discussing active investment management approaches, the risk of fund poisoning is increased. However, Morningstar is the leader in information on mutual funds and exchange traded funds and I use their software regularly. The discussion group at Morningstar is available at http://www.morningstar.com, just click “Discuss” on the far right. You can browse the discussions without an ID or password. There is also some excellent educational material on this website that you might find helpful.

The only difficult part of writing the new book is that I am absolutely committed to presenting investments and investment management without recommending any particular approach. Investors, both active and passive, can experience investiphobia and my goal is to offer all who experience this condition a cure. If you felt during this post that either active or passive were favored, it was unintentional. It is not my goal to teach investing or investment management but to help you find the sources that can help you regardless of the method you prefer.

Like eating sushi or other raw or undercooked foods, some diners think the risk of food poisoning is worth the taste and flavor of more exciting food experiences. Some investors believe that the risk of fund poisoning is worth the excitement of beating the market. But, make no mistake, fund poisoning can be as irritating and painful as food poisoning. The decision is up to you, and possibly, your advisor.

And remember, Money is not your life. It is simply the means to the life that you want!


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