In the semiannual report for the Janus Worldwide Fund (JAWWX), the fund manager made special note of the fund’s investment in derivatives.  While I knew that mutual funds are allowed to invest in derivatives, I had not thought to investigate which mutual funds use them, how they use them, and how (or whether) they assess the impact of the derivatives on the risk level of the mutual fund.

Derivatives

When you buy stock, you’re purchasing a slice of a company — you are actually buying something for your money.  Derivatives are a bet.  They can wager that a company’s stock price will go up or down (options), or that a foreign currency will go up or down (currency options), or they can be more exotic (credit default swaps).  They are a contract for a specified length of time, during which, if the terms of the contact are met, one party owes the other some money.  After the contact expires, the contact has no value.

Derivatives are not all bad

Like a gun, there are good and bad uses for derivatives.

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Tags: derivatives, derivatives in mutual funds, J:COM, Janus Worldwide, JAWWX, Jupiter Telecommunications

Citizens Bank is advertising a college savings program.  To help motivate you to save, they’re offering a $1,000 bonus when the child turns eighteen.

Deal or no deal?

What is the underlying investment?

It is not a 529 or otherwise tax-advantaged account.  It is simply a savings account.  The bad news is that you don’t receive any tax benefit (unlike a 529 account).  The good news is that you don’t actually have to spend it on Jane’s schooling — you can actually use this money for any purpose.

The current annual yield on the savings account is a whopping 0.4% for account values between $1,000 and $10,000.

Is the $1,000 bonus a good deal?

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Tags: 529 funds, Citizens Bank, CollegeSaver, investing for college, saving for college

Yesterday, I received the following note:

Hi Helen –

My name is Lynne Ward and I’m the Executive Director of the Utah Educational Savings Plan (UESP). Your blog was discovered by one of our staff members and of course, we’re all very happy that you chose UESP over any other 529 plan. I am very impressed by the level of analysis you did in making your decision. Our account owners’ due diligence ranges from the man who read Money magazine’s recommendation of UESP while he was laying on a beach in Hawaii  - –  to you, who actually read the Program Description!

Your category of the Program Documentation may be “geeky” as you say, but we try very hard to ensure that it is clear and complete. It is gratifying to know that our hard work results in a better educated investor and new college savers.

Welcome to UESP and if you ever want to communicate with me directly, please e-mail or call me.

Thanks so much,

Lynne

Lynne Ward

Needless to say, I’m terribly impressed by anyone who takes the time to contact a little blog like mine.

Before becoming director of UESP in 2004, Ms. Ward was the Deputy Chief of Staff to the Governor of Utah.  Under her leadership, UESP net assets have increased from $0.8 B to $3.3 B — not bad for a state with a population of 2.7 M.  Put another way, New York, with a population of 19.5 M, has $8.4 B in its investor-directed 529 fund, or about $430/person.  California has a measly $3.3 B/36.9 M residents or $89/person.  In contrast, Utah has $1,222 per capita in its 529.  Of course, some of that dinero comes from out-of-state investors (like me), but it is indicative of a well-run fund.

With regard to the Program Documentation, I’ll say it again:  UESP has the easiest to read program description.  I wish the Federal Government would require a standardized description for 529 investments and fees, much like the disclosure mandated for all credit card applications.  They could do worse than adopt Utah’s documentation as the standard.

I’ll also give some extra bonus points to the UESP web interface.  The process of creating an account with automatic monthly contributions was completely smooth.

Thank you, Ms. Ward — both for your letter and for running such an investor-friendly 529 program.

More importantly, thank you on behalf of my six-year old son who today discovered the world of Tintin.  Whatever he wants to study when he reaches 18, I’ll be ready to open that door (I hope).

Image Credit: debaird at Flickr.

Tags: 529 funds, 529 plan, investing for college, UESP, utah

Business Week has a concise review of which bond funds are exposed to Greek bonds.  You might check to see if yours is listed.  Legg-Mason is apparently doubling-down by both buying Greek debt and shorting the Euro.

Greece’s debt is 113% of its GDP, making it the 8th most indebted nation on earth. The top ten countries are:  Zimbabwe, Japan, Saint Kitts and Nevis, Lebanon, Jamaica, Singapore, Italy, Greece, Sudan, Belgium and Iceland.  Portugal is #19 at 75% and Spain is #45 at 50%.  The USA comes in at #42 at 53%.

Japan is a surprising #2.  Its debt is almost 200% of GDP.  Perhaps it is no surprise, in light of what is happening on the other side of the world, that the IMF is calling for Japan to reduce its debt.  Japan will soon be reeling from the combined impact of more retirees, lower tax revenues, and decades of stimulus spending.

Will sovereign debt crises be the dominant economic story for the next decade?  They say the teenage years are the most difficult.

Image credit: noticelj on Flickr.

Carnivals: This post was included in this week’s Carnival of Personal Finance hosted at A Gai Shan Life.

Tags: bond funds, Greek bonds, Greek debt crisis, soverign debt

I am a firm believer in mutual funds and the power of diversification, but every now and then I find it useful to question my assumptions.  I wrote recently about “creating your own personal mutual fund,” questioning whether the decline in trading costs might motivate more investors to trade in large numbers of individual stocks, instead of mutual funds.

If I was to buy an individual stock, what would I buy?  There is a lot of chatter these days, that there is no more alpha in the market — that stock prices reflect the true value of the stock — that there aren’t any hidden nuggets out there.  While I’m not entirely sure I buy that premise, I do believe that the smaller the company, the fewer eyes are watching it.

Market Cap: Companies with less than about $1.5B in market capitalization tend to have zero to four analysts tracking them.  Companies that are too small can have liquidity issues and are more volatile.  So I chose companies with a market capitalization between $0.5 – $1.5B.

Steady Growth: I wanted to see some steady revenue growth, >3% for the last three years.

Price/Book: Normally, I would search on Price/Earnings, but the recent market turmoil, I thought Price/Book would be a better metric, so I searched for P/B < 3.

I entered the search in Morningstar and found about 150 stocks that met the criteria.  What surprised me was the number of stocks that are trading for less than book value.  Here is the list of stocks with P/B <1.

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Tags: BRS, IBA, LEAP, POR, PZE, small cap stocks, SPWRB

Susan asked:

“How does the Utah 529 plan compare to the Ohio CollegeAdvantage 529? I’m having a hard time choosing between the 2″

This is such a good question, I thought the answer deserved its own post.  So here it is.

Overall ratings: Both plans are rated well by both Morningstar and Saving for College.

Program Management Structure: Utah and Ohio are different than most 529 plans in that the programs are managed by state organizations, the Utah Educational Savings Plan Trust and the Ohio Tuition Trust Authority, respectively.  Most other states hire a financial company to do the administration.  By keeping control over the program, these states keep a tighter grip on the investment reins.

Program Management Fees: Both states offer 529 plans with low management fees.  Ohio charges 0.17-0.19% for an administration fee, in addition to the underlying expenses of the investment, which vary from 0.05 – 0.89%.  Utah’s program charges 0.22% for most of its investment options, on top of the underlying expenses of 0.025 – 0.132% .  The fees for the underlying funds are lower for Utah because it sticks to Vanguard funds; Ohio offers investments through a wider range of companies, so its top end expenses reach a bit higher, but there are plenty of good low-expense options within the Ohio Plan.

Investment Options: Both programs offer plenty of investment options.  Ohio offers 23 investment options, including four age-based options.  Utah offers 12, of which five are age-based.  Both of them offer equity- and bond-based investments.  You will likely find an appealing option in either program.

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Tags: 529 funds, asset allocation, investing for college, ohio, saving for college, utah

One of the best reasons to buy a mutual fund, instead of individual stocks, is that a mutual fund spreads the risk over many companies.  Individual stocks are relatively volatile, but holding many stocks averages out the daily noise, and as the group gets larger it tends to track the overall market.

How many stocks does a mutual fund hold? The smallest number of holdings are in focus funds that carry 20 to, perhaps, 50 positions.  These funds aspire to find real winners and don’t want to be held back by losers.   (Of course, it doesn’t always work out that way.)  Many mutual funds hold a hundred or more investments.  Funds that mimic broad indexes such as the S&P 500 hold (surprise!) 500 positions, and in the extreme, funds mimicking the Wilshire 5000 — the broadest measure of the American market — hold positions in 5000 stocks.

How many stocks are needed to diversify? Putting your retirement nestegg in one stock is risky.  (Just ask former employees of Lucent or Enron.)  Spreading out to two is better, five, ten, fifty holdings reduces risk further.  You start covering broader sectors of the economy: durables, consumer goods, technology, financials, and so forth.  But surely at some point, adding one more stock doesn’t significantly reduce your risk.  What is that magic number?

Morningstar’s on-line training states that the magic number is eighteen.   Surz and Price calculate that it takes sixty stocks to reduce the non-systematic variance (a measure of risk) by 88%.  So the real number is probably somewhere between 20 and 100.

What do you mean by “a personal mutual fund” and what would be the advantage? Well, technically “personal mutual fund” is a bit of an oxymoron, because a mutual fund, by definition, is a fund owned mutually by a group of people.  But, what I meant to suggest is that you could own a large number of stocks directly, instead of through a mutual fund.  I can think of a few advantages to the DIY approach:

• You don’t have to pay the fund’s expense ratio, which can range from 0.09% for the least expensive index fund to more than 1.5% for many managed mutual funds.  If you have $100,000 invested, expense ratios take $90-1,500 out of your pocket — each year.  Multiply by ten years or more, and that’ll pay for a lot of margaritas on your retirement beach.
• You can control how the capital gains are realized.  Mutual funds are required to distribute capital gains each year, which can lead to a nasty taxable surprise each December.
• You can take advantage of the larger tax deductions for charitable donations of appreciated stocks.  Since mutual funds distribute capital gains annually, your basis continues to rise.  When you donate shares of a mutual fund your basis is almost equal to the book value.  If you instead donate a stock that has appreciated 10x (lucky you), you can deduct the full 10x value, and never have to pay tax on the 9x gain.

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Tags: diversification, Fidelity, low cost stock transactions, mutual funds, Schwab, Vanguard

I’ve recently written a few posts about investing in 529 accounts.  The main conclusions so far are:

• 529 funds charge a program management fee in addition to the underlying investment expenses,
• the higher fees offset, and in some cases can negate, the savings from reduced taxes,
• the programs for states that offer tax-deductions for contributions tend to charge a higher program management fee, and
• comparing investment options is difficult because 529 funds are not publicly traded and there is not a standard reporting format or annual date for the fund’s performance calculation.

Managed funds tend to have a higher expense ratio than index funds.  Unless I can convince myself that a managed fund is worth the additional expense, index funds are a safer bet.

I’ve looked for, but not found a good managed 529 fund.  There may be one out there — if you know of one, please drop me a line.  Therefore, I’m left to choose from index funds.  This narrows down the choice, practically speaking,  to Fidelity or Vanguard, and through which state’s program?

Vanguard. Vanguard has terrific index funds with low expense ratios.  Almost half the states’ 529 programs offer Vanguard funds, but each state charges different program management fees.  We’ll look at a couple of options.

Vanguard direct. The Vanguard website directs you to the Vanguard funds as offered through the State of Nevada program.  If you purchase shares of Vanguard’s S&P 500 Index fund through the Nevada program, you will pay an expense ratio of 0.05% plus a program management fee of 0.39%.  According to a footnote at the bottom of the page, “Vanguard and Upromise have agreed to a specific formula for the allocation of the Program management fee.”  Upromise is a division of the SLM Corporation (“Sallie Mae”), which is better known for offering student loans.

Vanguard funds through Utah. The Utah program offers the same Vanguard funds but charges about half the program management fee, 0.22% vs. Nevada’s 0.39%.

Vanguard funds through Ohio. Ohio offers a similar set of Vanguard funds for a program management fee of 0.19% — about the same as Utah.

Vanguard funds through Pennsylvania. Just for fun, let’s look at one bad option.  Pennsylvania charges you 0.70% for the same Vanguard funds.

It may sound petty to whine about a 1/2 percent here or there, but over time it can really add up.   The table below shows the value of a $10,000 investment in a 529 plan for a newborn child using each of the states’ plans listed above by the time the child leaves for college, assuming a 6% annual return on investment.  You can see that Oscar from Ohio will have 9% more money than Penny from Pennsylvania, if Penny and Oscar each invest in their homestate’s plan.

Fidelity. Fidelity also has perfectly good index funds, charging low expense ratios.  At the Fidelity Website, Fidelity directs you to choose from one of its five state programs: Arizona, California, Massachusetts , Delaware, or New Hampshire.  All the Fidelity programs offer essentially the same investment options for the same program management fee of 0.15%.  The table below shows that an investment made through one of the Fidelity programs is equivalent to an investment made with Vanguard through either Utah or Ohio.

Summary: For low cost 529 index investing, good options include:

• Vanguard through Utah or Ohio, or
• Fidelity through Arizona, California, Massachusetts, Delaware or New Hampshire.

Disclaimer: The above analysis does not constitute an endorsement of Vanguard or Fidelity Funds, or their parent companies.  Read the program literature thoroughly before investing.  Investing in mutual funds involves risk and you can lose principal.

Disclosure: No investment in any company.

Image Credit: Nick Garrod at Flickr.

Carnivals: This post was included at this week’s Carnival of Personal Finance hosted at the Well-Heeled Blog.

Tags: 529 funds, Fidelity 529 funds, Vanguard 529 funds

Recently, I’ve written several posts about the fees charged by Qualified Tuition Plans, a.k.a  529′s.  To find a good program, start by looking for a low program management fee.  This is pure overhead charged by the investment company above and beyond the expenses of the underlying investments.  Fidelity charges a higher program management fee for its managed funds (0.20%) than its index funds (0.15%) — on top of the higher expense ratios for the managed fund.  We shouldn’t have to pay program management fees at all — brokerages don’t charge extra for IRA accounts.

However, fees don’t tell the whole story.  After all, you want your investment to pay a good return.  How do you compare plans?

Index Funds vs. Managed Funds

Index Funds hold investments that mimic a particular index.  Because you’re not paying for some brainiac to pick the winning companies, expenses are limited to trade execution so that the fund continually represents the index.  The largest funds are typically the most efficient.  Two of the largest S&P 500 index funds, the Vanguard 500 Index Fund (VFINX) with $93 billion under management and Fidelity’s  Spartan 500 Index (FUSEX) at $24 billion, charge a miserly 0.18% and 0.10%, respectively.

Managed funds maintain a stable of research analysts who comb the country (and sometimes the world) looking for the next Google.  It takes some hay to feed that stable, so they typically charge a much higher expense ratio.  Less than 1% is considered good, though some funds charge 2% or more.

Is the additional expense of a managed fund worth it?

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Tags: 529 funds, 529 program management fees, expense ratios, Fidelity 529 funds, FUSEX, index funds, managed funds, VFINX

Qualified Tuition Plans, commonly known as 529 Plans, are a great way to save for your child’s education.   Investment earnings are exempt from income tax if used for college expenses.  Unfortunately, there are often high management fees to pay on top of the expense ratios of the underlying investments.

For example, if you invest in the Aggressive Growth Portfolio in Idaho’s College Savings Program, you pay a total fee of 0.75% each year, of which 0.11% goes to the underlying mixture of Vanguard mutual funds.  The rest of the money (0.64%) goes to program management fees to Upromise and the State of Idaho.

Through the Idaho program, you pay more than five times the expense ratio for the privilege of having the money in a tax-advantaged account.

Why are there program management fees for 529′s?

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Tags: 529 plan, 529 tax deductions, funding education, investment fees