Archives for August 2010

Shown up by a man sporting a European shoulder bag. The horror

The title of the post doesn’t refer to the man in the photo, but rather to the author.

Someone found the one inaccuracy* in Control Your Cash: Making Money Make Sense, the only financial primer you need to buy for the fiscally inattentive person in your life. Thanks to Matthew Amster-Burton (pictured above), author of Hungry Monkey: A Food-Loving Father’s Quest to Raise an Adventurous Eater, for entering my life a few months too late to give any input for the book’s first edition.

Class, turn to page 128 in your books and follow along:

Let’s look at a typical fund, the Legg Mason Value Trust Fund. Like the 47 components that comprise it, the fund itself trades on a stock exchange (in this case NASDAQ, under the symbol LMVTX). That makes it an example of an exchange-traded fund.

Folklore, all of that. Amster-Burton, who evidently knows more about this than me AND who’s had a book distributed by a major publisher on a completely different topic AND who socializes over sweetbreads with Anthony Bourdain AND who transcribes guitar tablature in his spare time, explains it (edited to make me look slightly less retarded):

LMVTX is not an ETF; it’s a mutual fund. However, it has a NASDAQ ticker symbol because like most mutual funds, it uses NASDAQ’s Mutual Fund Quotation Service. You can tell LMVTX isn’t an ETF because it prices once a day at close. ETFs price in real-time like stocks. Also, mutual funds usually have 5-letter ticker symbols while ETFs have 3- or 4-.
Mutual funds still vastly outnumber ETFs, although ETFs are growing faster. There are about 7500 mutual funds in the US (according to ICI**) and about 1000 ETFs.

Hopefully, you’re so bombarded with jargon that I can come in and sound intelligent as I reattempt to explain the difference between exchange-traded and mutual funds.

A mutual fund is a basket of stocks – a few million dollars’ worth of Corning stock, a few million more of Office Depot, some Qwest, some Sirius XM, etc. The mutual fund company purchases the stocks, assembles them into a whole, then sells pieces to shareholders. Your 401(k) or IRA likely consists of a piece of a mutual fund.

There are a few dozen companies that sell mutual funds in the United States, of varying notoriety (State Farm, American Century, BB&T, Franklin Templeton etc.) Each company sells around 10-30 funds, each of those with varying degrees of risk and potential to appreciate. The funds themselves each consist of – well, in the case of the Legg Mason Value Trust Fund, the stocks of 47 companies. The funds are all pretty diffuse, too. An unscientific study shows that it’s the rare company that comprises even as much as 10% of any particular fund.

(Seriously, buy the book for a more detailed explanation of this. We’re trying to keep this post short enough that you can inhale it in one sitting.)

If you own part of a mutual fund, find out what’s in it. For all you know, your fund is heavily invested in Fannie Mae and Freddie Mac. This is easy to research, even if you already forgot the name of the fund you’re in. You receive a monthly statement, either online, in the mail or at work. Find the name of the fund company (e.g., Baron Funds), enter the name of the particular fund (e.g. Asset Fund), then click on “portfolio holdings” or something similar. Don’t click on “top holdings”, which could leave as much as 80% of your fund holdings unaccounted for.

As Amster-Burton indicates, you can track a mutual fund’s performance daily (there are several sites where you can do this; we still think Yahoo! Finance is easiest to read and navigate.) But don’t ever check your investments daily, it’ll drive you insane. Monthly is good.

The Control Your Cash definition of an exchange-traded fund is still valid, if bloodied by Amster-Burton’s necessary assault. His point above accentuates the major difference between ETFs and mutual funds, the difference that’s outlined in ETFs’ very name: you can buy them on whichever exchange they trade on. Not only that, but they don’t necessarily sell for the price of the underlying stocks divided by the number of shares (the Net Asset Value.)

If enough people want to buy a particular ETF, it’ll sell at a premium. If you’re connected, motivated, savvy and fast enough, you could conceivably buy shares of the ETF’s component stocks and then immediately sell equivalent shares of the ETF. Or vice versa, if the ETF is selling at a discount. This is arbitrage, the definition of a market inefficiency and not for the rookie investor. Or even the intermediate investor. It’s basically panning for astatine.

Most, but not all ETFs are index funds (again, read your book. It means the fund contains enough constituents to track an entire stock market index.) Watch enough Sunday football and you’ll see the ads for SPDRs, pronounced like the arachnid. That stands for Standard and Poor’s Depositary Receipts, the first and largest family of ETFs. The namesake SPDR, which is also the biggest in the cluster, corresponds to the S&P 500 Index – the Dow’s more comprehensive sister.

There are ETFs that specialize in precious metals, in commodities, even in bonds or currencies. For the last couple of years, ETFs have also included a handful of actively managed funds – meaning ones whose components are chosen by a professional manager whose job, or aspiration, is to beat the market. Only about 25 of these exist, issued by a total of six companies, and few people deal in such ETFs. The ability to trade before the market closes at 4 p.m. every day doesn’t seem to be enough of a selling point for these exotic securities.

*There’s also a superfluous pair of parentheses somewhere in the book. I’d draw it to your attention but I’m thinking of doing a contest around it.

**The Investment Company Institute. ICI.org.