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

Bubble, Bubble, Trouble in Bonds?

Boomers should probably pay attention.  What is or better what could happen in the bond arena will impact not only what you know about your potential retirement wealth but whether your retirement wealth can withstand what may happen.

Personally, I don't like the term bubble.  It implies that once punctured, the pop is immediate.  But that's not how market bubbles usually react.  There is the slow hiss of the initial investors leaving somewhat quietly, who begin to see that things aren't going as planned.  This of course follows the big investors making statements that make sense, are largely ignored and then, suddenly embraced and the selling begins. The next to bail on the bubble is the individual investor who may have used that certain security as a parking place for their money or even as a short-term investment.

Following that, the retirement investors.

All the while the value of said bubble decreases. It doesn't "pop" as bubbles do but instead offers pain to those slow to react. The warnings are starting to surface at a more frequent pace and if this is a typical bubble scenario, those who went conservative after losing a great deal of their portfolio value in the last market debacle and began investing in bonds will be the last to react.  And be the worst hurt.

Many folks invest in bonds as part of an aging portfolio rebalancing.  In numerous cases, they do this via bond mutual funds and not the individual kind.  Unfortunately, this carries some additional risk.  Individual bonds have fixed maturity dates.  If held until that point, they will do exactly as they promised, paying you whatever the coupon book suggests.  That is, unless they default at some point.

Bond mutual funds, like all mutual funds are a basket of bonds with varying maturity dates.  Your reliance on the mutual fund manager to have a good mix, be wary of maturity dates and offer some considerations for the potential of default (when a bond is not bale to pay the value of the bond, which is essentially a loan).  But even more, the length of those bonds in the portfolio might be at risk as well.

Bonds have seen a lot of new fans.  Investors worried about not having enough to retire on, worried that the markets betrayed them in 2007-2008, and the concept that retirement as originally planned will need to be re-thought, even reconsidered, saw a great deal of rebalancing.  This "rebalancing may have been just as unbalanced as an equity heavy portfolio was - and what got them into trouble in the first place.

The old idea that your bond allotment match your age has found many investors poised to be disappointed, if, what the bond gurus are saying comes to pass.  And what they say is not good news. Bill Gross, the king of PIMCO sees trouble on the horizon. And yet, you hold on for more proof that the one man who probably knows everything there is to know about bonds is right. By then, it will be too late for many investors.

So why is he, and numerous other experts worried? There are several reasons, one of which I already mentioned: default. We hear numerous reports of how flush many businesses are with cash.  While there are quite a few with huge reserves, enough to worry the White House and economists alike, there are many more who simply must go to the bond markets to continue to finance their operations.  While this seems like a good idea on the surface, worries about the prolonged nature of the recession have also raised fears that many of these bonds will not be repaid.

Untangling this sort of mess in a mutual fund environment can be the most difficult.  And when investors catch wind of this possibility, fund mangers begin to sell to cover those departing the fund.  From there, its is a quick tumble towards the bottom for those remaining and the bond markets in general.
Inflation is also a concern.  This has been more or less benign of late.  Yet no one expects it to remain that way, new bond investors may not have the savvy to recognize the negative effect of this on their portfolio.  As inflation rises, the money involved in the bond - which is fixed in terms of how much is owed to you and the yield you expect - is worth less.  Not worthless, but not worth as much as you might assume it would be.

Ty A. Bernicke, writing in Forbes sees trouble on the horizon in the form of interest rates.  The Federal Reserve could hold rates low in the near term.  But don't expect it.  He writes: "There are three striking similarities between the 1940s economic landscape and today. The U.S. is experiencing an extremely low interest rate environment, our country is coming off a prolonged period of low inflation, and there are elevated concerns regarding defaults on bonds. The same three factors were present just prior to the beginning of the prolonged bear market in bonds from 1940 to 1980." In 1980, we began a bull market in bonds that has lasted until today.  There is evidence that this is beginning to unravel.

If that happens, we could be in for a long stretch of not much of anything.  beginning in 1940, and lasting for forty years, the "five-year government bonds averaged 3.38% per year" and "corporate bonds with maturity dates near 20 years averaged 2.8% per year".

There are only a couple of things you can do if you have invested heavily in bonds or bond funds.  Begin rebalancing now, lowering your exposure to these securities.  Some younger investors have far more than the traditional rule of thumb suggests (percentage of bonds equal to your age) and older folks should pay heed as well.  You could look towards the stocks that paid dividends consistently throughout the downturn.
Dividends paying mutual funds tend to be the most stable, spreading the investment over a wide swath of the top 100 or so companies that pay.  That's not to suggest that you couldn't buy the dividend paying stocks yourself, individually.

The only other thing might be to go short-term and look for the highest interest rate.  This will take a little bit of homework on your part.  But your investments will be somewhat safer, more liquid and not among the casualities that are bound to be tallied by this time next year.

Paul Petillo is the Managing Editor of BlueCollarDollar.com/Target2025.com and a fellow Boomer

Boomer Investors are Better Off?

Where you are in the retirement planning stage of life has more of an impact on your chances of recovering your pre-2007 portfolio values than you might think. Having enough to retire on is important. But some Baby Boomers had an added boost that may not be available to younger investors, even if they work longer and contribute more to your 401(k).

The old “time is on your side” adage often applied to the earliest investor may only be partially true. While time does play a role in how much you recover should your investments falter in a downturn, it may only do so because you have a longer contribution horizon.

The newer “I’ll just simply work longer” response many middle aged investors are reciting of late may not be enough either. The result of their longer careers will have a similar impact on their retirement portfolios that their younger cohorts will experience: more lifetime contributions.

None of these two previously mentioned groups, what the Center for Retirement Research at Boston University describes as the Gen Xers (30-year-olds) and the Late Boomers (40-years-old), will ever equal the earning power of the stock market that the Early Boomers received. This group of fifty-plus-year-old investors, had they been invested during the heyday, or what is referred to in the report as the “run-up from 1982-2000″, will have benefited greatly. In terms of real retirement, they are far better off because of those years than their younger cohorts may possibly ever be.

To read more of this article by Paul Petillo, managing editor of Target2025.com and a fellow Boomer, click here.