Chapter 10: Active Management vs. Passive Management

If a financial advisor’s value proposition is founded on their (or their firm’s) ability to consistently pick winning stocks, mutual funds or investment managers, or to time the market swings, it is highly unlikely that they will agree with what you will learn in this chapter. However, facts are facts.

Active management: Attempting to beat the risk-based returns of the broad market or a particular asset class, either through individual security selection or market timing. Any mutual fund, annuity, or separate account manager attempting to beat the market subscribes to active management. The term “active” does not necessarily mean that the manager is executing frequent buys and sells, although this is often the case.

Passive management: Attempting to match the risk-based returns of the broad market or a particular asset class by broad ownership of many or all stocks in the broad market or asset class. An example of a security relying upon passive management would be a no-load S&P 500 index fund.

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Chapter 9: Know Thyself

One of the most important things that any investor can do is identify their risk tolerance. You should understand how recent market activity may influence the way you feel toward the market, and consequently, your risk tolerance at any given time.
I have followed Jason Zweig for many years and have always found him to be a voice of reason. Your Money and Your Brain by Jason Zweig, Simon & Shuster, should be required reading for all investors. The following article appeared in the Wall Street Journal in February 2012. If you do not read Jason’s book, at least read this article.

The Intelligent Investor: This Is Your Brain on a Hot Streak by Jason Zweig

Past returns are no guarantee of future success. Just like smokers ignoring the Surgeon General’s warning on the side of cigarette packs, investors over-look the most obvious caution about the stock market at their peril.

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Chapter 8: Hidden Ongoing Commissions

When I was growing up, I spent summers working on the family farm, which grew cotton, soybeans and rice. There were many snakes in the rice fields. I learned quickly that the snake you can see is not the one that bites you. It is the same way with hidden commissions, also known as 12(b)-1 fees. If you own a mutual fund or variable annuity, you are most likely paying a 12(b)-1 fee, whether you realize it or not. A 12(b)-1 fee is an ongoing commission often amounting to 1.0 percent of the value of your investment annually.

Named after the 1980 legislation that created them, 12(b)-1 fees were intended as one-year relief for struggling mutual funds. Today, over 70 percent of mutual funds and many variable annuities charge these onerous fees, which cost investors well over $10 billion each year. They are collected by the mutual fund directly from fund assets, and paid to the brokerage firm that holds the fund. Also known as trailing commissions or “trails,” these fees can be charged for many years for mutual funds, variable annuities, or other products that impose them.

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Chapter 6: FEES MATTER
Too often, what makes big bucks for Wall Street makes
little sense for investors.

The miracle of compounding returns has been overwhelmed by the tyranny of compounding costs. ~ John C. Boyle, Founder, Vanguard

How long will it take for your money to double? The “Rule of 72” provides the answer: simply divide 72 by your compounded annual rate of return.

For example, if your investment return is 10 percent, it will take 7.2 years to double your money: 72/10. With an 8.0 percent return, it takes 9 years to double your money: 72/8 = 9.

Let’s examine the impact of fees on your returns. It is not uncommon for annual fees to exceed 2.0 percent for many financial products—variable annuities, mutual funds, and separately-managed accounts, for instance. Many products collect fees directly from the fund’s assets, so shareholders never see an invoice (Wall Street’s true genius) for charges such as management fees, administrative fees, and ongoing asset-based commissions known as 12(b)-1 fees. A 2.0 percent expense ratio (annual expenses/total assets) is a huge burden to overcome. Consider the illustration on the following page.

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