401k pains, part 2

At my (almost) new job, 401k is handled by a private company. Not that their mutual funds are atrociously expensive (they are, average expense ratio is about0.4%), but these guys also charge 0.1% management fee on all the money under management.

Most doctors will be fast asleep if your start talking "expense ratios" to them. No wonder they are oblivious to the fact that, if you believe the Wall St. gurus, the market returns are about 8% a year in a very long run, they are loosing 6 to 7% of these money- no, much more if you counting compound interest- it'll be close to 10%.

The other thing worth mentioning is that even those doctors who were entrusted to make decisions for the whole group about their 401k know very little about money in general let alone investing.

I heard one of the "seasoned" members of the fringe benefits committee seriously suggesting to "just select the best mutual funds out there and just invest in them" My humble statement that, in the long run, statistically speaking, half of the mutual funds' money managers will fail to keep up even with the average market returns, and it's close to impossible to predict which funds they are, was met with dead silence. When doctors have nothing to say....

401k pains, part 1.

Now, what I wanted to write about for a long while but didn't have time to do:the 401k for those lucky (or unlucky) enough to have one (unlucky because it usually means working for a paycheck).

Anyways, I was once ( in a very recent past) a member of the fringe benefits committee for our small group. As it turned out, you always need a broker between you (i.e. , doctors' group) and a 401k provider ( Vanguard, T.Rowe Price, Principal etc.). Always. Now, this broker (obviously!) has to be paid, even though he/she doesn't do ANYTHING for your group other than being on record.

As it turned out, our broker did not produce a single piece of paper or a statement or a letter or a recommendation to add or drop a mutual fund in 10 years of being our broker, all the while being paid $70,000/yr.

Once we discovered it, they were immediately fired while a new group recruited. Bye-bye $ 700,000....

More on traditional to Roth IRA conversions

So, Happy New Year to everyone! It's 2010 now, which means we can start converting our traditional IRA's to Roth!

Now, one more thing I found on these conversions- you may be able to "re-characterize" your newly converted Roth IRA back to traditional within the year after the original conversion.

Why to do that?

Suppose you had $10,000 in your traditional IRA, which you funded tax-free. Upon conversion, you'll owe your going rate (28-32% or whatever your tax bracket is) on this converted amount.

Suppose now, that within a year your original 10k dropped in value to 8k. Then you can do "re-characterization" of your Roth back into traditional IRA to avoid paying taxes on already depreciated asset.

Some authors even advise to create several Roth IRA's and transfer each kind of assets

( US large, US small, emerging markets, bonds, etc) into a separate Roth IRA. That way, you can see what depreciates ( hopefully none, but you never know), and "re-characterize" it, leaving appreciated assets in their respective Roths.

Taxes and Roth IRA

Haven't posted in a long while due to various reasons. And guess what, economy is not better since my last post. In fact, it looks like it might be worse. In addition to California, 9 more states are in trouble
http://features.csmonitor.com/economyrebuild/2009/11/11/pew-report-nine-states-join-california-in-facing-fiscal-crisis/

For all of us, it means only one thing: more taxes. On everything. ( I had to renew my car registration- it's $186 for 2 years, compared to the previous $ 120 !!)
So this change for Roth IRA rules for 2010 becomes more and more attractive- you will be able to roll over your traditional IRAs into Roth IRA regardless of your income, obviously paying taxes on gains( this can be spread over 2011 and 2012). But since a market took such a hit lately (with some latest recovery), it might be that you won't owe anything in taxes, since you pay taxes on the conversion amount.
They can start taxing Roth IRAs too, sometime in the future, however...

What we thought we know about financial safe haven

There's an interesting article on Marketwatch.com about municipal bond funds once considered to be a safe haven for people who don't want to take too much risk and yet enjoy tax-free dividends. Municipal bonds once were this safe haven, benefiting people in higher tax brackets(doctors?)
No more, no more... Munis took a whopping hit- 30% decline this year.

http://www.marketwatch.com/news/story/Muni-bond-fund-investors-face/story.aspx?guid=%7B72B8F338%2D452A%2D4DE0%2D891C%2DF683B8DF213B%7D

Safe heaven... Does one truly exist these days?

Market troubles: part 2

Now that the Dow took a bit of a nose dive, and panic is widespread, the question is: what is an average investor to do? Convert all your holdings in cash? Withdraw all the cash and keep it in a safe deposit box, knowing that, as banks start to fail en masse, FDIC will not be able to cover all the deposits(it's my uneducated guess) and will have to impose a withdrawal limit on your deposits? I certainly felt this way yesterday.

Nevertheless, despite all this doom and gloom and threats from the Wall Street that economy will collapse if they are not given those $700 bln, I thought to myself: where would all global investors invest their money if not in the US? Will it be China? China is a rising giant, but still almost completely dependent on exports. The rest of the emergent markets are very volatile, unpredictable, and subject to political turmoil( Eastern Europe)).What about Western Europe? Economically speaking, they don't have the same prowess as American economy due to over regulation and big shadow of their governments cast on their economy.
So it seems that the American economy is something those investors cannot live without.
And after that bloodletting on Wall St. on 09/29, they flocked to... US Treasury bills!

Besides, even there will be a massive collapse of the current financial institutions, there will be fast growth of the new type of financial industry, which is not burdened by the collective "sins" of the old good boys. That will happen just because the American economy is the most flexible and resilient in the world, and no banker would want to pass the opportunity of a lifetime.

Therefore, we probably should continue staying the course and even consider getting into a buying mode (I can't believe I'm saying this..). But will see in, say, 5 years, what will be going on

Market troubles. What next?

After recent tumultuous days of bankruptcies, forced sales, mergers and nationalizations I have 2 questions: first, what does this all mean for a long term market outlook (this is a question from an amateur investor in me), and, second, is it possible that health insurance companies are facing the same grim prospective as their cousin AIG?
I suspect that the answer to my first question is that , eventually (maybe after years of trouble and stagnant growth) market will rectify itself. Then again, after so much governmental intervention, would government play a much, much larger role in the market?
Now, the second question: is it possible that at least some health insurance companies which had a misfortune of investing their collected premiums into anything that is mortgage-related are also on the brink of insolvency? Would then they be bailed out, effectively bringing us to a one-payer model? And what would that mean for doctors?

Morningstar study: Do fund managers invest their own money in the funds they manage?

Another interesting article from Marketwatch.com:

http://www.marketwatch.com/news/story/most-funds-managers-have-none/story.aspx?guid=%7B907D8FC0%2DA948%2D415A%2D8133%2DF57A365CC367%7D

Yep, those fund managers won't invest their own money into the funds they manage. And that's taking into consideration life-cycle funds ( suppose, those managers are very young and they happen to manage the fund designed for people about to retire) and state-specific bond funds.
I can think of only 2 reasons: either they have an access to much better investment options (such us private equity) than the people investing in their funds, or they know something about the funds they manage the rest of the investing public don't know.
I won't eat at a restaurant where its chef doesn't want to eat its famous entree.

Who's watching over your money: here we go again

As the collapse of once mighty financial system unravels, we again see the unpleasant truth: financial professionals do not have your financial well-being as their primary objective. These two hedge fund managers started moving their money out of their hedge funds while reassuring the investors(I doubt that there were any doctors among them, though) that everything is great.

Lesson learned(or , rather, confirmed): investors should watch out for themselves, without much reliance on "professional" help http://money.cnn.com/news/newsfeeds/articles/djf500/200806191633DOWJONESDJONLINE000932_FORTUNE5.htm

And yet another hedge fund manager, this one faking his own suicide to avoid going to jail:

http://www.iht.com/articles/2008/06/16/business/16fugitive.php

Educate thyself, part 10 : Technical analysis

Technical analysis has to do with the trends in the market (or segments thereof). By analyzing the chart some professionals say they can predict the troughing(peaking) of a given security or a segment of the market.
That is clearly not my choice of investing, since it's very time-consuming and of questionable long-term profitability.

Educate thyself, part 9 : Efficient market theory

According to efficient market theory (EMT), markets, you guessed it right, are efficient. That is, the news about favorable and unfavorable developments (we've been getting more of the latter lately) spread so fast that over- and undervalued securities would rectify themselves in price as they would be sold or bought by the investors armed with their newly acquired knowledge. As the popular joke about EMT goes- a professor and a student walk down the street and student sees a $10 bill. Professor says "Don't bother picking it up, for if it was indeed a $10 bill, it wouldn't be there"
But we all know that there are wild swings in the market, they happen all the time. So the markets cannot be efficient, right? The real question is not whether or not the markets are truly efficient or inefficient- it doesn't matter. What matters is whether or not there are EXPLOITABLE inefficiencies in the market allowing us to make money.
So, thinking about the joke above, the question is not whether to pick up a $10 bill, the question is whether walking around looking for scattered $10 bills is the way to make money in the market.

Educate thyself, part 8: Value investing

Most of what I know about value investing comes from Warren Buffett's article The Superinvestors of Graham-and Doddsville,which is based on his speech at Columbia Business School in May of 1984, celebrating 50th anniversary of publication of Security Analysis by Graham and Dodd. ( I have a PDF version of it, but don't know how to upload it, for those who're interested, i can e-mail it to them).
The message is rather simple: find the undervalued (by the market) securities, and buy them.Then sell those that are overvalued. He shows the track record of many students of Graham ( like himself), which speaks for itself: most of them beat S&P 500 returns by 60-80% annually, on average. The point Buffett is making is that all these people are buying the business, not its stock.
You just have to find those undervalued but strong businesses, and profit from it.
Some authors (for instance, Burton Malkiel in his A Random Walk Down Wall Street) argue, however, that the information investors( even the professional ones) have to evaluate businesses is far from accurate and include "creative" accounting and other gimmicks to inflate the stated earnings. ( memories of Enron are too fresh in our minds...)
However, Buffett has his record- can't argue with the facts.

Educate thyself, part 7. Investment theory

Depending on what investment theory you're subscribe to, you can either immerse yourself in so-called fundamental analysis of each company you might buy (and be the next Graham or Buffett), do a technical analysis ( has to do with the prevailing trends in the market), or believe in Efficient Market Theory, stipulating that by en large, the markets are efficient, and there are almost no exploitable opportunities to get rich quick off of. Then there's this Modern Portfolio Theory , described by Harry Markowitz (and he got a Nobel Prize for it), according to which you can't really make anything over and above of what market return is, but you can reduce the risk (fluctuations in the value of your portfolio) by proper diversification(at least, that's my understanding of his theory).

Dizzying choices... And all these theories has strong arguments on their side. For instance, fundamental analysis- Warren Buffett made a fortune sticking to this theory.
What an amateur investor to do?
It reminds me of a common issue we all face almost every day- out of multitude of studies, what would we take as a new guideline for our practice? And if in medicine we have a benefit of a prior experience, in investing we're left on our own devices.
I guess, just like in our everyday practice, if we don't know the exact answer, we do what we think is right.

Educate thyself, part 6. Trades are free. Now what?

In my previous post this month I described my quest for inexpensive investing. What I actually arrived at was free trades. Now, what to do with them?

I decided to stick with ETF's as opposed to mutual funds for reasons of lower costs, and somewhat better tax efficiency. Also, there's no minimum initital purchase for ETF's -you just have to have enough money to buy in whole shares (rarely more than $150-$200 a share, and most of the time much less) in contrast with mutual funds, where initial investment might be anywhere from $2000 and more.

By reading the books of financial academicians (those that have nothing to sell to you), I started to understand that it's kind of hard to beat the market in terms of your real returns. It's very difficult even for professionals to do it. So to get a broad exposure to the markets, I decided to go with index ETF's. They provide as broad an exposure as the index allows it, at the same time, it's not actively managed, i.e, they don't constantly buying and selling underlying securities. They do that only if the proportion of such securities or the securities themselves change within the index. All this would keep the expenses low.
Besides, you can buy and sell ETF's throughout the day. For mutual funds, it's only once a day at the closing.
So, will go with index ETF's.

Educate thyself, part 5: Quest for inexpensive investing

In the early 2000's I had an account with one of the big brokerage houses (now gobbled up by even bigger brokerage house). It was a full-service brokerage. I could not trade by just clicking a mouse. The problem was that my significant other was working for that brokerage house, and we couldn't have a brokerage account anywhere else due to "compliance".I had to call my broker and ask him to buy or sell something for me. Usual cost of such 30-sec. conversation was $49-$53. Not that he did anything special. He would just say: "Lemme see what the ask is..." and then declared that he "put it in". That was it. He never bothered me with his sales pitches, probably because I had a minuscule account balance. But even back then I wasn't that naive to think that this broker thinks about my financial well-being first before his own.

Now, immediately after my significant other changed jobs I closed that account and moved whatever was in it into a discount brokerage house ( back then it was Ameritrade). Now the trades were $9.99. Customer service was bad, transaction cost was much better but still way too high for regular investing. I was still better off just having an account with, say, Vanguard or T. Rowe Price and buy an broad-based index fund a little bit at a time without having to pay for a transaction (those big mutual fund companies even provide postage-paid envelopes for those sending their contributions in form of checks). So I was going the mutual fund way for a while.Then I learned about ShareBuilder. It allowed you to buy regularly for about $4 per buy. ( and I think, more for sells).Better, I thought, but for some reason I didn't open an account with them.



The real opportunity came when Wells Fargo announced ( about 2 years ago) that if you hold $25,000 in combined assets with them (even including 10% of your outstanding mortgage), then they'll give you 100 trades per year free through their so-called PMA account. They also waived the IRA custodial fees and the yearly fees for maintaining the HELOC with them.Yea, that's what I'm talking about. Now I could buy very inexpensive index ETF's for free!
Then bank of America started offering something similar. Also, there's this Zecco website-they also give free trades. Now I minimized my investment expenses as much as I could. Good.

Educate thyself, part 4: Expenses of investing

Now, there are all kinds of expenses when it comes to investing, expenses that you have to pay no matter whether you're up or down.
Here's an incomplete list of them:
1. Expense ratios of mutual funds and ETF's- these are percentages of the money invested that are deducted by mutual fund companies to compensate themselves ( from 0.18% for Vanguard S&P 500 Index Fund to 2-3% for actively managed mutual funds, and from 0.09% for S&P 500 ETF's to... I don't really know what is the highest)
3. Additional fees on certain mutual funds ( 12b-1 fee, for instance, is paid by a mutual fund to whatever organization is selling this fund to an investor, but these fees are coming out of investor's pocket)
2. Brokerage fees. These are paid for a transaction (buy/sell) only if you have a real brokerage account.If you invest directly into certain mutual fund , those fees are not paid. ( these brokerage fees can be as low as zero, yes, nil with certain discount brokerages, esp. on a limited number of trades and as high as $50 with so-called "full -service" brokerage.)
4. Custodial fees for IRA accounts. Sometimes they're waived for accounts with higher balances.
All of the above mentioned fees are going to financial industry.
5. Taxes for taxable accounts. Sometimes taxes are due on mutual funds even though you as an investor didn't sell your shares. These are , obviously, Uncle Sam's cut.

So the easiest and the surest thing in investing is to minimize all these multiple fees so it will be more left for us to really invest.
In the next posts I'll try to describe what I did to cut these costs.

Building wealth part 4: educate thyself, part 3

Now, since the stock market is the way to go if I was to achieve my goal of being financially independent, while learning basics of investing, i came across the book of renowned John Bogle ( I quoted him and provided a link to his interview in one of my previous posts) called The Little Book of Commonsense Investing. The first most interesting thing I learned is that, per John Bogle, it's close to impossible to control your rate of return on your investments, since you can't control the market. But what you CAN do is to control your expenses, that is, the expense ratios of your mutual funds, if you have them, brokers' commissions, annual custodial fees for IRA's etc.
That made sense to me since if fell into this frugality category, which can bring substantial benefits whether you're investing or simply saving.
So I embarked on the search for minimum expenditures while investing, which I'll try to describe in my next posts.

Educate thyself: mutual fund mechanics

Mutual fund was first created back in 1924, 5 years prior to the worst stock market crash (so far) in history. The idea was truly ingenuous- collect the money from investors, invest them in all kinds of securities, and issue the mutual fund shares to those investors in exchange for their money. What securities the investors' money will be invested into is entirely up to the management team of the mutual fund.

The upside of this idea was that all of a sudden, the average investor gained access to the very broad spectrum of securities-stocks, bonds, real estate etc., and all for a relatively small initial investment. Before this invention, you've got to buy individual securities to achieve diversification of this kind.
Now, the downside: the expenses. In an actively managed mutual fund, the expense ratio (percentage of the money under management that is deducted each year) can be as high as 2% annually (we're talking about mutual funds bought outside retirement vehicles like 401k, where you can find even more "expensive" funds). It means that no matter whether your investment goes up or goes down in price, you've got to keep paying these percentages to the mutual fund company. Billions of dollars each year are collected that way from investors.

How do they use all these money collected from investors? At least 70% of it goes toward managers’ salaries.

Building wealth part 4: educate thyself

Complete lack of even basic financial knowledge among doctors is nothing new. There's no better way of killing an otherwise lively conversation than mentioning the choices of mutual funds by a particular 401k provider.
However, what truly amazes me that despite of adverse economic conditions, increasing pressures from insurance companies and HMO's, diminishing wages and growing pessimism and dissatisfaction among many doctors and other professionals ( here's a link to a recent NY Times article titled "The Falling Down Professions" to illustrate the matter)http://www.nytimes.com/2008/01/06/fashion/06professions.html?_r=1&oref=slogin, they continue to be oblivious about their own financial matters. And we're talking about some of the most educated people in our society!
So for me, my journey to financial freedom started with education. Surprisingly, the good literature on the matter is not advertised on TV or radio. I had to really search for books, articles and blogs that would be useful for my financial knowledge.(I forgone the glossy booklets from major brokerage houses and 401k providers.)
Since the mutual funds are the main investment vehicle created for the middle class ( and we are the new middle class), I decided first to look into the mechanics of an average mutual fund. I'll describe my understanding of it in my next post.

Building wealth part 3: got some money saved,now what?

My savings started to accumulate bit by bit. But without some more powerful money growth solution financial independence was nowhere in sight. I did some "investing" in 2000-01( I use parentheses here because it was far from real investing-investing as I understand now) during the Internet stocks' boom(and bust!), and , sure enough, lost money . Back then, I was still in the fellowship, so by virtue of being a "subspecialty resident" I didn't have enough money to lose. However, stock market returns are about 8-10% annually( that is, obviously, over long stretches of time), so I saw it as a main vehicle to get to my financial independence, regardless of my prior painful experience.
Back then I was enrolled in the Master's of Science program in biostatistics. So as I was learning all these bivariate, multivariate and survival analyses , I was getting better at my recognition of quality from junk research papers and articles. But I needed financial education 101, too! Little by little I started using my new statistical knowledge to help me distinguish what I call a "financial propaganda" (the bulk of financial info unloaded into our ears/eyes every day) from the statements based on some real scientific financial studies.