As a mutual fund investor, you've probably heard it said more than once that you should always consult a mutual fund's offer document before handing over your money. It's no secret, however, that the size of this document and the type of information inside can be hard to tackle. But don't be too overwhelmed. Here is a guide to what an offer document is, why it is important and what items should be central to your considerations.
What Is a Mutual Fund offer document?
A mutual fund offer document is a document detailing the investment objectives and strategies of a particular fund or group of funds, as well as the finer points of the fund's past performance, managers and financial information. You can obtain these documents directly from fund companies through mail, email or phone. You can also get them from a financial planner or advisor. Many fund companies also provide PDF versions of their prospectuses on their websites.
Knowing What to Look For
An offer document is a legally binding contract between the fund itself and the investor. It's easy to get lost in all the legal jargon and miss the information that matters most to you, so here is an outline of sections to which you should pay special attention. Note that the way in which a fund's offer document information is organized may vary from fund to fund; however, by law, all offer documents must contain the following important sections:
Investment Objectives
These are the fund's financial goals, which are reflected in the types of securities chosen to achieve those goals. Types of investment objectives include long-term capital growth, stable income, high total return, etc. Fund companies cannot change these objectives unless investors of the fund consent to the changes through a vote.
It is important to determine whether the fund's goals match your own investment goals. For example, a fund with an above-average capital growth objective would probably not be a good fit for an 89-year-old widow who needs regular income from investments to cover day-to-day expenses.
Investment Strategies
This part of the offer document explains the way in which a fund allocates and manages its resources to achieve its investment objectives. Aspects considered when designing such a strategy include setting goals for net asset value, determining asset allocation, investment restrictions (such as only investing in a certain industry) and deciding whether (and how) derivatives may be used.
A fund's investment strategy, like its goals, should be in sync with your investment style. For example, although a small cap fund and a large cap equity fund are both aiming for long-term capital appreciation, they are both using very different strategies to reach this goal. Before choosing one type of fund over another, make sure you consider why investing in any one of these asset types is right for you. Otherwise, you might be in for some surprises!
Risks of Investing in the Fund
Because investors have varying degrees of risk tolerance, the risk section of an offer document is very important. It details the risks associated with a particular fund, such as credit risk, interest rate risk, market risk, etc.
To get the most out of this section, you should be familiar with what distinguishes the different kinds of risk, why they are associated with particular funds, and how they fit into the balance of risk in your overall portfolio. For example, if a fund invests a large portion of its assets into foreign securities, you need to understand that this may pose significant foreign-exchange and country risk - but you also need to determine whether this kind of risk works with other types of risk in your portfolio in satisfying your tolerance.
Past Performance
This section shows you the fund's track record, but do remember the common disclaimer that "past performance is not an indication of future performance". Read the historical performance of the fund critically and make sure to take into account both long- and short-term performance. Also, make sure the benchmark chosen by the fund is appropriate. For example, using the performance of a bond market as a benchmark for an equity fund is useless. In addition, keep in mind that many of the returns presented in historical data don't account for tax, or some funds calculate an after-tax return with a rate that may be higher or lower than your own. Be sure to look at any fine print in these sections, as they should say whether or not taxes have been taken into account.
Distribution Policy
The dividends a fund pays its investors come from realized capital gains, dividends, interest or other income stemming from the securities and investing activities of the fund. The distribution policy tells you how these payments are made.
Fees and Expenses
This section is extremely important to consider because fees and expenses will eat into your total investment return from the fund. Here you will find information on any back or front-end loads and the management expense ratio. Because these compromise your return regardless of the fund's performance.
Fund Management
Here you can discover how long your fund manager has been managing your fund. Watch out for the fund that has been in operation significantly longer than the fund manager has been managing it. The performance of such a fund can be credited not to the present manager, but to the previous ones. If the current manager has been managing the fund for only a short period of time, look into his or her past performance with other funds with similar investment goals and strategies. You can then get a better gauge of his or her talent and investment style.
Conclusion
After reading the sections of the prospectus outlined above, you will have a good idea of how the fund functions and what risks it may pose. Most importantly, you'll be able to determine whether it is right for you. If you need more information beyond what the prospectus provides, you can consult the fund's annual report, which is available directly from the fund company or through a financial professional.
Saturday, February 16, 2008
Monday, February 4, 2008
RISK PLANNING FOR RETIREMENT
When it comes to risk planning in investments, especially in retirement, take care not to go about it the wrong way. Don't make the mistake of establishing unrealistic return goals and forcing yourself into an asset allocation and risk profile that is inappropriate for your situation. Your assets are finite and can only provide a certain amount of money on a sustainable basis. Reaching too far for return in retirement can be a cataclysmic experience if you get your timing wrong and are unprepared for the financial consequences. As such, your risk profile is of the foremost consideration in your retirement planning. Because no advice is appropriate for all investors, this process requires both objective and subjective analysis of your own situation. Let me show you how to determine how much risk your retirement portfolio can tolerate.
Take a Look at Expenses
The first step in this process is to determine your spending rate on an annual basis. The calculation is a simple division of your annual spending needs into your total portfolio value. For example, if you have a Rs.1 crore portfolio and plan on spending 500,000 per year, you have a 5% rate of spending (500000/10000000). So what does your spending rate tell you?
One way to view your spending rate is to gauge for the lifespan of your portfolio. More specifically, the higher the spending rate is, the shorter the lifespan of your assets, and vice versa. Assuming proper portfolio diversification, a 4-5% spending rate is generally considered sustainable over the long term while still protecting, if not enhancing, your real spending power. To illustrate, consider the fact that the average spending rate is 4.6% to last your portfolio infinitely. So, if you can live on a 4-5% spending rate, then you're in pretty good shape and can sustain a moderate to high risk tolerance in your portfolio.
The problem is that most people probably haven't saved enough money to live on a 4-5% rate of spending by retirement. Still, this knowledge is a very valuable general rule in your investment planning because it allows you to use your spending rate as an easily understood guidepost for risk tolerance. For example, if you have a spending rate of 10%, you know for sure that your portfolio's lifespan could be relatively short if you hit a protracted bear market. Therefore, you would need to invest in a very conservative manner to minimize fluctuations in portfolio volatility, lest your spending rate force you to sell large positions in a down market. Conversely, if you only have a 1% spending rate, your risk tolerance would be virtually limitless, as would your potential for portfolio growth.
As such, the key point here is to understand the potential effects of normal spending on your risk tolerance, which carries over into asset allocation and diversification considerations.
A spending rate of 500000 per year during a bear market would create an unrecoverable loss in real spending power. This illustrates the need for diversification for a retiree, who will almost certainly be pulling from a portfolio on a regular basis. Again, the higher your spending rate, the more exposed you are to fluctuations in market value and the lower your risk tolerance, which is why diversification is so important in your retirement planning.
So, once you've determined your spending rate, sit down with your financial advisor and begin the process of sorting out the risk of various asset allocations while taking into consideration your spending needs. Any reputable financial services firm will have asset allocation, risk management and financial planning software that can assist you in this process. Nonetheless, there are a few key points you want to keep in mind during these sorts of discussions.
Metrics to Think About:
• What is the expected annual standard deviation of monthly returns?
Standard deviation is probably the most important statistic because it will tell you the likely fluctuations in your portfolio's market value from year to year. For example, if you have an asset allocation that will fluctuate plus/minus 15% every year and you have a 10% spending rate, then you're taking on too much risk.
• What is the probability of taking a large loss in a given year, say 10%, 15% or more?
This is another very important statistic and essentially represents your total money at risk to achieve a given rate of return. For example, if your portfolio is expected to make 10% over the long term, but is placing 25% of your assets at risk in a given year, and you have a 10% spending rate, then you're probably taking more risk than you can tolerate.
• What is the expected rate of return for a given asset allocation?
This is important to know because your asset allocation should produce a rate of return that will pay for your spending needs, protect against inflation and maybe even grow your portfolio. However, as mentioned before, don't let your return goal back you into an inappropriate risk profile. Start by discussing your spending needs and associated risk tolerance, and then try to eek out the best asset allocation given those constraints.
It is an unfortunate reality that most people don't save enough to cover their retirement needs on an indefinite basis. Furthermore, this leads a lot of people to reach for return to make up that difference, implicitly ignoring their risk profile, which is primarily driven by spending needs.
Conclusion
Keep in mind that in retirement, your risk tolerance is driven primarily by spending needs as opposed to your psychological tolerance for fluctuations in market value. Trading only according to your psychological tolerance for risk is a luxury of being young. The fact of the matter is that unless you are in a position to live on a 4-5% spending rate in retirement, your portfolio will have a finite lifespan and accepting that reality is key to your financial planning. Just remember, high spending rates mean low levels of risk tolerance and low spending rates means high levels of risk tolerance.
Take a Look at Expenses
The first step in this process is to determine your spending rate on an annual basis. The calculation is a simple division of your annual spending needs into your total portfolio value. For example, if you have a Rs.1 crore portfolio and plan on spending 500,000 per year, you have a 5% rate of spending (500000/10000000). So what does your spending rate tell you?
One way to view your spending rate is to gauge for the lifespan of your portfolio. More specifically, the higher the spending rate is, the shorter the lifespan of your assets, and vice versa. Assuming proper portfolio diversification, a 4-5% spending rate is generally considered sustainable over the long term while still protecting, if not enhancing, your real spending power. To illustrate, consider the fact that the average spending rate is 4.6% to last your portfolio infinitely. So, if you can live on a 4-5% spending rate, then you're in pretty good shape and can sustain a moderate to high risk tolerance in your portfolio.
The problem is that most people probably haven't saved enough money to live on a 4-5% rate of spending by retirement. Still, this knowledge is a very valuable general rule in your investment planning because it allows you to use your spending rate as an easily understood guidepost for risk tolerance. For example, if you have a spending rate of 10%, you know for sure that your portfolio's lifespan could be relatively short if you hit a protracted bear market. Therefore, you would need to invest in a very conservative manner to minimize fluctuations in portfolio volatility, lest your spending rate force you to sell large positions in a down market. Conversely, if you only have a 1% spending rate, your risk tolerance would be virtually limitless, as would your potential for portfolio growth.
As such, the key point here is to understand the potential effects of normal spending on your risk tolerance, which carries over into asset allocation and diversification considerations.
A spending rate of 500000 per year during a bear market would create an unrecoverable loss in real spending power. This illustrates the need for diversification for a retiree, who will almost certainly be pulling from a portfolio on a regular basis. Again, the higher your spending rate, the more exposed you are to fluctuations in market value and the lower your risk tolerance, which is why diversification is so important in your retirement planning.
So, once you've determined your spending rate, sit down with your financial advisor and begin the process of sorting out the risk of various asset allocations while taking into consideration your spending needs. Any reputable financial services firm will have asset allocation, risk management and financial planning software that can assist you in this process. Nonetheless, there are a few key points you want to keep in mind during these sorts of discussions.
Metrics to Think About:
• What is the expected annual standard deviation of monthly returns?
Standard deviation is probably the most important statistic because it will tell you the likely fluctuations in your portfolio's market value from year to year. For example, if you have an asset allocation that will fluctuate plus/minus 15% every year and you have a 10% spending rate, then you're taking on too much risk.
• What is the probability of taking a large loss in a given year, say 10%, 15% or more?
This is another very important statistic and essentially represents your total money at risk to achieve a given rate of return. For example, if your portfolio is expected to make 10% over the long term, but is placing 25% of your assets at risk in a given year, and you have a 10% spending rate, then you're probably taking more risk than you can tolerate.
• What is the expected rate of return for a given asset allocation?
This is important to know because your asset allocation should produce a rate of return that will pay for your spending needs, protect against inflation and maybe even grow your portfolio. However, as mentioned before, don't let your return goal back you into an inappropriate risk profile. Start by discussing your spending needs and associated risk tolerance, and then try to eek out the best asset allocation given those constraints.
It is an unfortunate reality that most people don't save enough to cover their retirement needs on an indefinite basis. Furthermore, this leads a lot of people to reach for return to make up that difference, implicitly ignoring their risk profile, which is primarily driven by spending needs.
Conclusion
Keep in mind that in retirement, your risk tolerance is driven primarily by spending needs as opposed to your psychological tolerance for fluctuations in market value. Trading only according to your psychological tolerance for risk is a luxury of being young. The fact of the matter is that unless you are in a position to live on a 4-5% spending rate in retirement, your portfolio will have a finite lifespan and accepting that reality is key to your financial planning. Just remember, high spending rates mean low levels of risk tolerance and low spending rates means high levels of risk tolerance.
Friday, February 1, 2008
HOME BUILDERS STOCKS ARE ON THE MOVE
As the ice begins to break up, investors may be tempted to dip a toe into the frigid sector - just to test if the worst is over and there is finally profit to be made again. In this article we'll explore signals that capitulation is in full swing and examine if now is the time for contrarian investors to dive in.
Since the low in the fourth trading week of January, the Dow Jones U.S. Home Construction Index (DJUSHB) rallied 40%, as of the close on Thursday. Technical analysts know the recent pop means descending resistance of the relevant downtrend has been breached. However, technicals are lagging indicators and are simply a visual map of market action, based on underlying fundamentals. While the chart of the DJUSHB shows a breach of the relevant downtrend, what's really happening is a fundamentals-related shift within the sector.
It's Darkest Before the Dawn
Last Thursday, the Associated Press reported that existing home sales fell by 13% for the year, according to the National Association of Realtors. Talk about dismal. If that‘s not enough, total U.S. median home prices dropped on an annual basis for the first time since the 1968.
Here's the rub, when there's no end in sight and the whole market starts abandoning the sector, it's usually the time to start buying. Then again, those who've been on board with homebuilder stocks over the past few days already know this.
Stimulus Plan Good For Homebuilders Too
President Bush is attempting to implement an economic stimulus plan in which subprime mortgage rates will be frozen for five years. What this means is that those who are in way over their heads can relax a little…at least for a moment. At the end of the day, the government is doing everything possible to dig out subprime borrowers. And housing stocks are benefiting…at least the ones with solid fundamentals.
There was a rumor that Warren Buffett was thinking about buying Pulte Homes (NYSE:PHM), though not much has surfaced in the way of real news. However, the company is trading with an ungodly low price-to-sales of about 0.30 and a laughingly cheap price-to-book of 0.65. The fact is, the company has taken so many charges over the past year that its freefall has driven the stock into fundamental attractiveness.
What's vital to know right now, though, is that even though the company looks quite appetizing at current levels, there really isn't any evidence that consumers are sure to begin borrowing again. It's hard not to think that new homeowners won't resurface, especially with the recent economic stimulus freezing ARMs, providing tax rebates…and of course the Fed's recent rate cut. But the market is good a bucking trends, and therefore if a total rebound is expected too early in the game, investors could find themselves pounded again.
The Bottom Line
What it comes down to is common sense. While fundamentals of several homebuilders, including Ryland Homes (NYSE:RYL) and Tol Brothers (NYSE:TOL) seem enticing, those seeking to establish positions based on the recent turnaround may want to ease in ever so slightly, because we may end up finding these homebuilders' foundations to be in even worse shape than expected.
Since the low in the fourth trading week of January, the Dow Jones U.S. Home Construction Index (DJUSHB) rallied 40%, as of the close on Thursday. Technical analysts know the recent pop means descending resistance of the relevant downtrend has been breached. However, technicals are lagging indicators and are simply a visual map of market action, based on underlying fundamentals. While the chart of the DJUSHB shows a breach of the relevant downtrend, what's really happening is a fundamentals-related shift within the sector.
It's Darkest Before the Dawn
Last Thursday, the Associated Press reported that existing home sales fell by 13% for the year, according to the National Association of Realtors. Talk about dismal. If that‘s not enough, total U.S. median home prices dropped on an annual basis for the first time since the 1968.
Here's the rub, when there's no end in sight and the whole market starts abandoning the sector, it's usually the time to start buying. Then again, those who've been on board with homebuilder stocks over the past few days already know this.
Stimulus Plan Good For Homebuilders Too
President Bush is attempting to implement an economic stimulus plan in which subprime mortgage rates will be frozen for five years. What this means is that those who are in way over their heads can relax a little…at least for a moment. At the end of the day, the government is doing everything possible to dig out subprime borrowers. And housing stocks are benefiting…at least the ones with solid fundamentals.
There was a rumor that Warren Buffett was thinking about buying Pulte Homes (NYSE:PHM), though not much has surfaced in the way of real news. However, the company is trading with an ungodly low price-to-sales of about 0.30 and a laughingly cheap price-to-book of 0.65. The fact is, the company has taken so many charges over the past year that its freefall has driven the stock into fundamental attractiveness.
What's vital to know right now, though, is that even though the company looks quite appetizing at current levels, there really isn't any evidence that consumers are sure to begin borrowing again. It's hard not to think that new homeowners won't resurface, especially with the recent economic stimulus freezing ARMs, providing tax rebates…and of course the Fed's recent rate cut. But the market is good a bucking trends, and therefore if a total rebound is expected too early in the game, investors could find themselves pounded again.
The Bottom Line
What it comes down to is common sense. While fundamentals of several homebuilders, including Ryland Homes (NYSE:RYL) and Tol Brothers (NYSE:TOL) seem enticing, those seeking to establish positions based on the recent turnaround may want to ease in ever so slightly, because we may end up finding these homebuilders' foundations to be in even worse shape than expected.
Subscribe to:
Posts (Atom)