In 2012: What Boomers Can Expect

"Time is free, but it's priceless. You can't own it, but you can use it. You can't keep it, but you can spend it. Once you've lost it you can never get it back." Harvey MacKay

One of the key elements in any financial transaction is time. If you want to retire, you must consider the amount of time. If you want to borrow, how long you have to pay it back can be translated into dollars and cents. Investing; timing they suggest can't be down but is important nonetheless.

If you are twenty, time is on your side. If you are thirty, there is time left. If you are forty, time is of the essence. If you are fifty, time is running out. If you are sixty, where has the time gone. And older than that, time is no longer on your side. It accompanies us through life like some dark passenger. It reflect back on us from the mirror. And when we look at our retirement plan, it stares at us without guilt or shame. Time is the truth.

When I first began writing these predictions, and I've been churning out these year end ditties for over a decade, many were laced with optimism, some with an urging that we learn the lesson and move forward armed with knowledge of past mistakes, and still others were exercises in reality. In 2012, we have some opportunities and some problems awaiting us, left on the table as we symbolically turn the calendar wiping out 2011. But it won't leave quietly.

So I have a few thoughts about what you can do - resolutions of sorts but not the drastic sort we make and break almost within hours of promising ourselves at midnight.

Increase your contribution I start with this obvious chant for two reasons: you aren't making a large enough contribution and two, I would be remiss in not telling you this right from the start. And I'm not just speaking to those with a 401(k).

There are the millions of you who are forced to (and because of that are not likely to) finance your own retirement through an individual retirement account. We lament at the worker who literally only has to sign up at his workplace and doesn't. And far too often, we say little about the person who has to sign-up (after finding a fund), commit with a fortitude that is somewhat lacking and to contribute some of their paycheck via direct deposit every week or month. That effort, it seems is a much more involved hurdle.

In 2012, the investment world will be little changed. It will roil and confuse and gyrate and possibly even nose dive - just as it has for decades. It will react to news - if not from Europe form China or even the presidential elections (which ironically tend to be excellent years to invest). This will have you second-guessing your investments. But this will only apply if you have no idea how much risk you can take.

Pay attention to diversification You may not be capable of rebalancing, the act of making sure that your investments are directed evenly across many investments. This is much harder than it seems. As long as you are involved - and that is YOU in capitals - the struggle to keep balance will not get any easier.

For the vast majority of us, mutual funds will be the investment vehicle of choice. These investments will see more movement towards fee reductions. Which is a good thing. Fees will and always have been a subtraction of gains. This makes an excellent argument for indexing.

Choosing six index funds across the following cross-sections of the markets will not solve the problem of rebalancing (some will do better than others) but it will provide diversification. Index the largest companies (an S&P 500 fund), a mid-cap fund (the next 400 companies in size), small-caps (the next 2000), an international fund (an index of the largest countries (those with established banking systems even if they are currently troubled and will continue to be so in 2012), an emerging market fund (after international funds, the most risky) and a bond index (one that covers as much fixed income as possible).

Some of you will wonder if exchange traded funds (ETF) wouldn't be just as good if not better than simple indexing. In 2012, ETFs will continue to drill down ever deeper into sectors of the markets that add risk along with the illusion of an index. ETFs will become more actively managed in 2012 offering you more risk at a lower cost. Cheap doesn't mean better. 2012 will be year of the ETF. If you are unsure what these investments are, consider this conversation I had with David Abner of Financial Impact Factor Radio recently to help explain what these investments are and how they work.

Focus on your financial well-being This refers to your credit score. It continues to impact your financial future and will become increasingly harder to ignore. A new credit rating service agency will add to the difficulty in 2012 and not only will the current scoring impact costs such as insurance, it will seek to trace the breadcrumbs of your financial life more thoroughly that the big three do.

There is little likelihood that the job market will increase as many of our returning troops will flood the marketplace, taking numerous jobs from your kids just out of college. Which means another year with your kids at home. The only answer to this problem is to continue to tighten down your budgets in 2012. As I mentioned earlier: "If you are forty, time is of the essence. If you are fifty, time is running out. If you are sixty, where has the time gone."

And you must do this understanding that inflation - not the reported number but the real number in your grocery bill - will still chip away at your wealth. This means you will move in two opposite directs in 2012: saving and investing more for your fleeting future (at least 6% but 10% would be best) and spending less in the present (easy of you don't use credit).

And the housing market will improve for those who have repaired any damaged credit or who have saved enough of a down payment to buy a house. people are still buying and selling. These people have found that while the market is not accessible to all, it is for those that have done right by their personal finances.

Do all of that this may not seem like a new year - but it will be a better year!

An Expert on ETFs

This past week, on the Financial Impact Factor with Paul Petillo, Dave Kittredge and Dave Ng we had David J. Abner. He is the Director for Institutional Sales and Trading at Wisdom Tree and the author of The ETF Handbook: How to Value and Trade Exchange Traded Funds (Wiley Finance) These funds, that trade like stocks have been coming to the forefront of the investment world for almost a decade. But even after all that time, their purpose isn't clearly understood, their benefits less so and the media, suggesting volatility has dampened our enthusiasm towards them. Mr. Abner discusses these products, what they are and why they are important. ETFs will begin showing up in your 401(k) as investor demand and plan administrator's fiduciary responsibility tightens. This increase exposure is good for the funds; but are the good for you?

Listen to internet radio with

Paul Petillo of Target2025.com/BlueCollarDollar.com

and Dave Kittredge and Dave Ng

of FinancialFootprint.com

on

The Financial Impact Factor

at Blog Talk Radio

ETFs: Are These Investments Needed in Your Retirement Plan?

Boomers are often faced with a decision that will be framed in such a way as to make it seem the only logical choice. As the mutual fund verses ETF debate begins to gain steam, some truths need to be considered.

Mark Twain suggested: "The reason we hold truth in such respect is because we have so little opportunity to get familiar with it." This will be the selling point for exchange traded funds: you will hear that they are less expensive, that they are better than the mutual funds - many of them indexed, and that you should own them in your 401(k).

They will suggest you overlook the cost of trading them, the fact that they tempt you to trade them more frequently than ou would a mutual fund and in doing so, allow you to follow the herd on any given day, a behavioral no-no for every investor. So what exactly is the attraction that they want us to see? Are mutual funds better or worse than ETFs?

The answer depends on who you are. If the sort of investor who believes that they can make small moves to harness big gains, then you should probably avoid the lure of ETFs. Exchange traded funds are mutual funds that can be traded just like stocks. They tend to have lower fees than their comparable cohort the mutual fund but the commissions that brokers charge for these trades tend to erase the advertised returns you might get.

If you are the sort of investor who buys to hold, then the surprising choice would be ETFs. Yet you will need to harness the inner trader in you that wants to succumb to the temptation to trade. This sounds easy. But in truth, is no easy feat.

So let's run some numbers comparing a total stock market ETF sold by Vanguard and a total stock market index sold by the same company. The ETF (trade as VTI) carries and expense of 0.07%. The mutual fund version of the same thing (bought as VTSMX) levies a 0.18% fee on investors. The former has no minimum investment,; the later wants $3,000 to begin. So we'll start there and propose a hopeful return over 10 years of 4%.

In the first calculated example, the investor made no additional contributions to the investment. Vanguard does suggest that they charge no brokerage fees but they do charge a $20 annual fee for the account. This might be much higher when accessing these funds through your 401(k) and there may be additional brokerage fees. So we'll assume a $10.00 brokerage fee - as I said, yours might be lower and in most cases, the brokerage charge is on both ends of the transaction.

Based on the above numbers, the ETF, once purchased and held begins to creep past, in terms of raw returns by the third year. By the 10th year, you will have saved about $19.41 in fees giving you a net gain for your ETF of $32.82. 

But begin adding to the security on a regular basis (say $200 a month) and the differences are much more notable. To add to the ETF in equal proportions over the same 10 year period would cost you $1021 in commission costs and with this money not working for you, the sacrifice in what each would be worth at the end of the 10-year investment period used in our example in addition to the trading cost would leave you with over $1200 less in the ETF account.

Inside a 401(k), where regular contributions rule the way you invest, ETFs can give the average investor less of an opportunity than proponents suggest they will. In a taxable account, bought without commissions such as Vanguard offers and purchased in large lump sums, ETFs slightly trump their mutual fund siblings.

Will you take the time to learn the truth about yourself before making the decision on which investment is better? You are the debate. 

Paul Petillo is the managing editor and founder of Target2025.com/BlueCollarDollar.com and a fellow Boomer.

The Next Investment Temptation is Three Years Old

Does being older and wiser and a Boomer make us smarter? We would like to think so. But in fact, we tend to be less patient with our investments even as we grow more conservative in which ones they are. We are worried that we won't have enough to live on - in light of our "extended lifetimes". So we look for a little risk, a little pizzazz in our investments. And the actively managed ETF might be something you are considering.

Investors are divided into two groups: those that see themselves as investors and those that use their 401(k) accounts to invest for their retirement. The latter group tends to refer to this activity as savings, a word that has long since distressed me for its inaccuracy. The other group, the ones who think they can invest, tend to fall prey to the next new thing or on the flip side, spend a great deal of time and money trying to mimic an index fund. This group wants to be their own mutual fund manager and does everything but charge the trailing fees that a mutual fund does.

So we have one group who "invests" and the other who "save".Both use essentially the same tools and with any luck, practice the same prudent practices. Tempting both groups is the ETF or exchange traded fund. When these we first introduced, about a $1 trillion worth of investments ago, they were heralded as the one thing investors needed to keep their assets where they could get to them, when they needed them.

Trading like stocks, you could buy an ETF in the morning, sell it if you wanted to at noon, and buy it back before the end of the day. This was a genius move on the part of Wall Street and began generating buckets of cash via trades. Mutual fund companies wanted a piece of the action and jumped in as well with ETFs that looked eerily similar to index funds they were already selling.

The cost of the trade was about the only thing you could toy with. So they eliminated that fee. But not to be allowing you to do something for free, they found another way to charge you. Back on January 6th, 2011, I wrote: "a Vanguard spokesman said the company believed “that the ability to attract and retain clients, particularly high-net-worth clients, will improve the bottom line and ultimately result in lower fund expense ratios.” The truth is that instead of charging for the trade, they charge you to hold the ETF in your account."

Now, three years into the first appearance of the actively managed ETF, we wonder if this will be as wildly popular as the indexed ETF (which has sliced and diced the market in such a way that no corner of the investment world is un-indexed and because of that, has added to the volatility in the marketplace, particularly at the close of trading). Perhaps but the wary investor and more than one "saver" should approach these tools with caution.

Does an actively managed ETF cost less than a actively managed mutual fund? The short answer is yes. Mutual funds bought outside of your 401(k) - where fees tend be lower and in some cases, different - have fees for distributions and marketing. While these fees are annoying and do take away from your returns, they are needed to attract new investors, pay for research into which stock is next on the buy or sell list and to pay for the services of the fund manager. Could they be lower? Yes. Have they dropped significantly? Over the last several years, yes. But what about their ETF counterpart?

Without many of those "trailing fees", actively managed ETFs are less expensive. But few people add in the cost of the trade when they think of purchasing an ETF and each time you buy or sell, this acts as a fee - albeit right up front.

Several other comparisons come to mind. The transparency of ETFs, which must disclose what they hold everyday seems on the surface like it would be a grand idea. But when it comes to this type of investment, transparency and rules for trading tend to make this a dangerous place. In an index fund or ETF, the investments mimic an index, set and left alone for a year, sometimes longer.

In an actively managed ETF, which discloses its holdings and must disclose its building or restructured portfolio almost as it executes the trade, it allows investors outside of the ETF to "front-run" the fund and buy at a cheaper price than the fund would pay. This is not good for the ETF manager if the stock they are buying is somewhat illiquid.

Taxes are another issue. Mutual funds tax you quarterly and yearly. Index ETFs tax you only when you trade them and because they don't turnover (trade their securities often) as much, the taxes, once levied are less. Actively managed ETFs only charge you taxes when you sell the fund but, because they trade often, the taxes you will pay will be higher than indexed ETFs.

Now there is little I can say that will dissuade you from buying an actively managed ETF once they become more widely available and have logged a track record (currently, they have less than three years under their belts). If you find them in your 401(k) and they are cheaper than actively managed mutual funds, they might be worth looking at if you are looking at adding some risk.

This investor tool is not going away. And it will add to some additional volatility as traders in these funds move around much more than those that hold individual stocks and/or mutual funds. And that can't be good no matter how you view who you are: and "investor" or a "saver".

Paul Petillo is the managing editor of Target2025.com/BlueCollarDollar.com and a fellow Boomer

A Boomer Look at Similar but Conflicting Investment Tools

There is a great deal of conversation going on about whether the ETF is a better than the mutual fund. Both have advantages and one, as you will find out, has more disadvantages than the other. Because we are basically discussing the approach to retirement, the concern among investors as to which would be better is relevant.

The argument is never clear. When we compare mutual funds to ETFs, we often miss the differences between the two in large part because we are discussing two different types of investments, how they should be used and what they are. Folks on the ETF side of the disagreement point out a variety of plus while conveniently leaving the minuses out of the conversation. People who argue for mutual funds are looking for something other than a simple index fund.

The Pluses of ETFs (with the minuses)
The tax benefits that are often touted by the ETF camp rely on the buy-and-hold strategy that index funds offer. It should be noted that when comparing these two investments, one should drop the vast majority of mutual funds from the argument and concentrate only on the index mutual fund.

With any investment, capital gains are a consideration. The only way these two can be compared on a tax basis is when there is a sale. While funds held outside of a 401(k) or other retirement account distribute capital gains on a regular basis, ETFs do so only when sold. An actively managed mutual fund (which is what numerous ETF supporters believe is a fair comparison) can generate a capital gains even if the fund losses money. Actively managed mutual funds shift the holdings in the fund during the course of the year and this does present the possibility that you will need to pay taxes on those transactions. But like index funds, ETFs only shift holdings when the index fund it tracks shifts holdings.

So in this argument, ETFs and index funds are similar in tax efficiency. But when ETFs are compared to actively managed funds, ETFs seem the better choice.

Are ETFs a more simple investment?
While you buy an ETF at a set price (which can also be done with index funds, the main difference is the when the price is fixed - in mutual funds it is at the four o'clock close; ETFs reprice throughout the day depending on how well the underlying portfolio has done) that price can gyrate wildly throughout the day. In fact, much of the last minute swings in the overall market are due to ETF positioning and may offer you a false picture of the underlying worth of the ETF.

Those for ETFs suggest that this one price, one trade principle makes these investments better. But the cost of that one trade can be much higher than the purchase of a mutual fund (actively managed or indexed) and that trade, which is whatever your brokerage account charges, is also a factor in the sale. If you add those two transaction to the cost and the fact that many mutual funds do not charge for the purchase of their shares, the argument about simplicity falls flat.

So in this argument, on the surface, ETFS seem less expensive but only as long as you buy and hold which is not what professionals do with this investment.

Perhaps ETFs are more cost-effective
Once again, ETFs cost you dollars to trade. While this is a fixed cost that can be calculated, mutual funds charge expenses against portfolio balances. This makes any mutual fund purchase, even index fund investments, subject to fee considerations. The lower the fee, the greater the cost-effectiveness. With ETFs, you do pay an underlying fee which when compared to index funds is often higher and you pay commissions on the purchase and sale.

One percent is one percent no matter who charges it but if you can buy one for nothing compared to the cost of a brokerage fee both in and out, the ETF argument runs into problems.

The ETF option
While there are numerous types of ETFs available there are also numerous types of mutual funds tracking essentially the same markets. Mutual funds offer sector investments just as ETFs do. Here ETFs are probably better. The simple reason is the ability to allow you to get in and out of a hot sector without any pain other than the cost of the trade. But for the vast majority of investors, their style is passive. They really want to do the research, make the decision and then let the money and the investment ride.

ETF investors crave action even if they do it under the guise of flexibility. They are essentially chasing the next hot corner of the market while mutual fund investors leave the pursuit up to the professional manager they hired.

So in this argument, ETFs play nicely to the investor who wants to move quickly in and out of a hot sector.

Are ETFs easier to transfer
Of course they are easier to transfer. Held in your brokerage account, the shares are yours to take wherever you want. Transferring assets in a mutual fund (index or actively managed) does require a bit of work and there may be a slight charge for the effort but this argument also falls flat. When moving a fund, those shares must be sold and there is a cost in doing so. But most mutual fund investors spend a great deal of time researching their investments (manager tenure, fees, performance and underlying holdings/investment style) and if they desire to move, it is because something has gone wrong with the fund. In this instance, moving a fund is worth the cost incurred. ETF investors move based on price value alone. And they move to another ETF.

So in this argument, the better research you do the more likely you are to buy an index fund and hold it or buy an actively managed fund and monitor it. Owning an ETF is always a temporary investment and the investor is always looking for another ETF to suit their needs.

Paul Petillo is the managing editor of BlueCollarDollar.com and a fellow Boomer