Buying low cost mutual funds and ETFs


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Do your mutual fund and ETF investment research – and do it BEFORE you buy

Screened mutual fund and ETF lists are very helpful to any investor who wishes to focus on low cost mutual funds and ETFs. However, this is just the beginning of the investment process and not the end. Always understand any security that you are going to buy – before you buy it. Visit the mutual fund company website. Do some research. Get the prospectus. Read the prospectus.

Yes, actually do read the prospectus, so you that really know what you are buying. Many individual investors skimp on doing their research and the majority of people do not even open the prospectus. To some degree, this is understandable, because most investment fund lawyers slather on copious quantities of cover-your-ass (CYA) risk exposure and other boilerplate language in these prospectuses. Nevertheless, a lot of useful information can be found in the mutual fund or ETF prospectus along with all of this CYA verbiage. With some practice, you will learn where to focus your attention, when reading a prospectus.

Think of the situation this way. When you finally figure out that low cost mutual funds and ETFs are the better way to invest, you will also understand that these are funds that you can hold for many years without having to revisit your decision. Therefore, take some time to read the prospectus so that you know what a particular fund is committed to do for you. If you do not like something, do not buy that fund and move on to investigate another fund, until you find the set of mutual funds or ETFs that will meet your needs.

When you buy a house, you (should) get a termite inspection report before your money in committed and locked in. Would you buy a house without a termite report? Are you willing to take the risk that you later might find that half the wood in the walls is already sawdust? Think of a prospectus as the termite report for your mutual fund. If more investors were to investigate seriously the mutual funds that they buy and were to read the prospectuses, they might wake up to just how infested the mutual fund industry is with excessive costs and other self-serving and risky behaviors.

Yes, in my research informed opinion, a wide variety excessive mutual fund and ETF costs are the termites that continually eat away at your net long-term investment returns. When you begin to view these excessive costs as termites, rather than as justifiable costs that will reliably enable you to beat the other guy, then maybe you will behave differently. Investment fund termites come dressed in all kinds of appealing garb, including historical performance charts and lots of stars with smiling confident advisor promotion, but ultimately excessive investment fees and costs rot your portfolio from the inside.

In addition, if you choose to invest in ETFs, you have even more reason to read the prospectus. ETFs are a subset of a broader group of exchange-traded products or ETPs. ETPs come in a variety of structural flavors and the tax treatment of returns can vary significantly. In common parlance, people incorrectly call the general class of exchange-traded products, ETFs, instead of ETPs. Since any ETP can be bought via an online transaction with an order quantity, trade type and the punch of a button, many “ETF” investors are surprised to receive a Form K-1 for tax purposes just after year-end. They scratch their heads trying to figure out why, and their tax accounting costs go up. Worse, they might end up paying substantial unanticipated taxes. Reading the prospectus could have prevented this.

Buy funds only to implement a very long-term buy-and-hold-and-hold strategy

You should purchase passive, broad index funds with the intent to hold them for a long time. You should expect a return that is close to the broad market return and should not have to concern yourself with market over-performance or under-performance. When you buy index funds, they should track their market index benchmarks relatively closely.

From the perspective of their promoters and the brokerage industry, ETFs were introduced to provide a tradable competitor to mutual funds. The industry’s objective is to profit from ETF management fees and transactions fees that otherwise would have most likely gone to the mutual fund industry. Of course, thousands of mutual funds are also available from through brokers for a fee. However, the lack of real-time pricing with mutual funds inhibited high trading volume.

Because of their easy tradability, the number of different ETFs has grown very rapidly in the last several years. A wide variety of narrow sector and strategy ETFs has been introduced. ETF trading volume has simply exploded.

I suggest that you not participate in any short-term ETF trading strategy of any kind. Instead, I strongly suggest utilizing a long-term buy-and-hold strategy with ETFs, if you purchase any ETFs. Similar to low cost no load mutual funds, once you invest in one of these low cost, broad market ETFs, you should expect to hold it for years without needing to sell it except to withdraw funds to meet expenditures or to rebalance your portfolio. Otherwise, there would be no reason to trade.

The mutual fund and ETF screening criteria and process that I employ eliminates the increasing proliferation of narrow sector ETFs from consideration. Because I suggest a very passive, low cost, broad market tracking investment strategy, there is no reason to choose sector funds, since low cost ETFs are available that track the much broader markets at lower costs.

How many mutual funds or ETFs?

There is no precise answer to the question of how many different investment funds a person might hold. I suggest that you avoid a proliferation of accounts and investment funds. Perhaps you could set a maximum limit of two or three different mutual fund companies and discount brokers combined where you would have accounts.

Of course, you could have multiple accounts with each vendor. Multiple accounts with a vendor are prompted usually by the need to segregate taxable assets, traditional tax-advantaged retirement accounts, and Roth accounts. Furthermore, sometimes there are reasons to maintain multiple tax-advantaged accounts of the same type to maintain a separation between different sources of tax-advantaged assets. For example, if you did a series of traditional to Roth asset conversions over the years there are reasons to keep each conversion in a separate Roth account for tracking purposes.

Overall, I suggest that you might hold ten or fewer different mutual funds and ETFs across all these accounts, but the total number could be higher or lower, depending upon your assets and whether you have a proliferation of tax-advantaged retirement accounts. You could hold shares of a particular mutual fund or ETF in different accounts, which again probably would be dictated by the need to keep certain tax-advantaged assets segregated.

Each vendor would provide a consolidated report on your family accounts either monthly or quarterly. Frequency may depend upon account activity. To save money, these vendors will try to get you to accept email delivery of electronic reports in lieu of hard copy statements. Personally, I prefer to receive the printed reports despite the additional physical filing. For me, printed reports are just more “accessible.”

However, you would need to keep these printed financial records in a save place and dispose of them properly, given the increasing menace of identity theft. See this very extensive article: “Identity theft protection and prevention” at:    http://www.theskilledinvestor.com/wp/identity-theft-protection-638.htm

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