Chapter 16: Separately-Managed Accounts

Separate accounts—also known as separately-managed accounts or “separates”—are segregated individual accounts with one or more investment managers. Unlike mutual funds, your investment is not co-mingled. Many investment managers participate in the separate account programs offered through major brokerage firms and other institutions.

It is expensive to access investment managers through a brokerage firm. A brokerage firm directs your money to one or more investment managers who manage a separate account for you. The investment manager charges an ongoing management fee, perhaps 0.75 percent. Then the brokerage firm charges what is known as a “wrap fee,” which is an ongoing fee that is wrapped around the investment manager’s fee (the folks who you are already paying to actually manage your money). The brokerage firm collects both fees each quarter, pays the investment manager, and keeps the rest.

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Chapter 15: Actively-Managed Mutual Funds

As we learned in Chapter 6, investment fees can make a huge difference in your long-term success. Management fees, sales charges and administrative fees are strong headwinds for all shareholders to overcome.

Actively-managed mutual funds may have annual expenses of 2.0 percent or more. This does not include friction costs—any commissions as well as price slippage—incurred when large buyers or sellers move a stock up or down when buying or selling stock.

However, if you read a fund’s prospectus, you are more unlikely to see the true annual expenses because such friction costs are not included. Also, you will not see an estimate of the short-term capital gains liability that you face from the “turnover,” or frequent buying and selling of securities in the fund’s portfolio. The following illustration depicts the annual turnover experienced in various categories of mutual funds.

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SECTION 5 INDEX FUNDS

Chapter 12: Index Funds

An index fund is a bundle of stocks. The stocks that the fund holds are the same stocks, with the same weightings (percentages) as the stocks represented in a particular index, such as the S&P 500 index. You cannot own an index. You can own the same stocks as the index—an index fund.

The only time a stock in an index fund is bought or sold is when the publisher of the index makes a change in its lineup. For instance, if the S&P 500 expels ABC Company and replaces it with XYZ Company, then any index fund tracking the S&P 500 will do the same thing. This is mutual fund investing in its simplest form.
Index funds are said to be “passively-managed” because there is really not much to manage, which is why the costs are so low. As it turns out, more intense managing does not equate to more money for mutual fund shareholders, only more money for Wall Street.
Index funds do not buy or sell stocks often because changes to the underlying index do not often occur. This keeps capital gains tax liability low. The index fund avoids the expense associated with a lot of buying and selling—such as high-priced analysts, costly research, and the expense of conducting numerous transactions. The savings enable these funds to compete very effectively with mutual funds that are trying to beat the market.

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Chapter 11:The Importance of Proper Asset Allocation

The way in which you allocate your assets among asset classes, such as stocks, bonds, and cash will have the greatest impact on your investment results. Studies show that up to 88 percent of the variation in returns is explained by one’s asset allocation, not by individual security selection, fund selection or market timing.

What Is Asset Allocation?

Asset allocation is the process of combining asset classes such as stocks, bonds, and cash in a portfolio in order to meet your goals.

A financial advisor, whether a retail broker or independent investment advisor, can add value by helping you make the important decision about how to allocate your investment assets. Essentially, asset allocation is the concept of proper diversification—not putting too many eggs in too few baskets, and of seeking the most efficient balance of the perceived risk and expected return.

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