Compass Asset Management Group

So, you think you’ve got this investing game down, right? You got 6% of your paycheck going right into your company 401(k) plan, invested in mutual funds. The plan is allocated to your Target Retirement Year or horizon (Target Date Funds) and it’s Auto Re-balanced 4 times/year!  Easy, peasey!

Well, yes. Investing in mutual funds can be an easy, inexpensive and low-risk way for investors to play the market. But despite the relative simplicity, mutual-fund investors are still making some costly mistakes that eat into their returns and may put their portfolios at risk..

1. Not Knowing What You Own

Suppose back in 1999, you had half of your retirement savings in a technology fund and the other half in a fund indexed to the Standard & Poor’s 500-stock index.  You were diversified, right? Not really.  What you didn’t realize was that roughly 30% of the S&P Index fund was exposed to the tech sector, putting the entire tech exposure at roughly 65%!  When the markets dropped, your portfolio would have fallen significantly MORE than the index!

This is called “overlap”.  To avoid unwittingly doubling down on a stock or getting over-exposed to a certain asset class, investors should know the investment style and holdings of their funds.

Carefully reading a fund’s prospectus is a good way to learn about a fund. To avoid overlap, investors also should be sure to consider the allocation of their entire portfolio before purchasing a new fund.   Call it a “Wellness check” for your Wealth.

2. Chasing Performance

While it may be tempting to buy the “hot fund” you heard about at a party or on TV, buying a fund solely based on past performance is more often than not, a bad idea.

Ever open your statement and wonder why that high flying fund of yesterday hadn’t done so well over the past year?  It’s probably the cyclical nature of markets. A fund might do well because it invests in a narrow niche that’s hot now, but should things change, that might cause the fund to under perform in the future.

In the case of an actively managed fund, the previous fund manager responsible for the great performance may have left the company.  While that may not be a “deal killer”, investors need to know if the fund’s performance was based on the individual in charge or on an investment process that’s been institutionalized at the fund company.

3. Underestimating The Impact of Fees

We can never state this enough.  Investors are often more concerned with macro factors, such as the state of the U.S. economy or the growth in certain emerging markets, and while that’s an informed investor, it’s not the whole story.  Pay close attention to fees when selecting a mutual fund.  To think that fees aren’t important is a mistake, as fees can take a big bite out of a fund’s return over time.

Example:

A $5,500  per year investment, earning 7% per year, compounded monthly over 30 years would be worth $580,581.

But figure in a mutual fund’s annualized fee of a 1.5% and the total drops to $431,318!  OUCH!  That’s almost $150,000 less!

Fees can especially eat into the returns of many bonds funds, which have experienced historically low yields over the past decade.

A fund’s prospectus must list the fund’s expense ratio. Investors can use websites such as Morningstar.com to see how a fund’s expenses compare to other funds in the same category.

4. Forgetting Taxes & Control

Many investors buy into a fund late in the year, shortly before the fund distributes to holders the net capital gains realized on sales of securities in the portfolio. That’s not something that the investor can control.  Therefore, when investing in mutual funds, it may be better to wait until after those payouts, to avoid owing tax before you have made any money on your investment in that fund.

Investors also often make the mistake of not tracking their cost basis in the fund when they elect to have their dividends reinvested to buy more shares. As a result, huge mistakes can occur as investors end up mistakenly reporting a much larger taxable gain when they sell the fund and thus pay taxes twice—once on the dividend income and then again when they sell the fund.  What’s worse is, we’ve seen this happen even with accountants involved.  Because accountants will not retro-actively calculate the cost basis of dividend reinvestment, many time simply the “Buy” amount and “Sell” amount is used on tax forms.

Be cautious of investing in a fund that tends to “churn” its stock portfolio in order to try to maximize returns because this may also generate large capital gains for investors. This can be a real problem if the fund isn’t held in a tax-deferred account such as a 401(k) or individual retirement account.

5. Taking Your Eye Off the Ball

Sometimes, investors tend to hold on too long. They may have a loyalty due to past performance and assume a fund will continue to perform well.

A better way to monitor a fund’s performance is by tracking your holdings in that fund with the comparable sector index.

It’s always a good habit for investors to have their eyes and ears poised to pick up signals that something at a fund or within fund management has changed and then to question what that is and why that is.  We suggest to read everything from the fund, check at least once a year that the same management is in place and set up alerts on the fund to keep apprised of any changes.

“Make the right choice, consult Compass Asset Management Group for advice & guidance that will change your life.”

For more information contact us at 845.563.0537 or Contact@CompassAMG.com

Please note that the content of this blog is not intended to provide tax advice and is only intended for the educational purpose of the reader.  Please consult your tax advisor for specifics regarding your circumstances.

Steven M DiGregorio is President of Compass Asset Management Group, LLC and an Investment Advisor Representative with Spire Wealth Management, LLC a Federally Registered Investment Advisory Firm.  Securities offered through an affiliated company Spire Securities, LLC a Registered Broker/Dealer and member FINRA/SIPC.

About Compass Asset Management Group

Our boutique-style firm has an investment philosophy is both prudent and value driven. We combine research from the largest firms on Wall Street with three decades of market experience to provide strategic, tactical and dynamic investment management.  Compass Asset Management Group, LLC delivers personalized financial planning, estate planning and investment management advice in a private setting with a high degree of sensitivity to your concerns and objectives. Our goal is to exceed yours expectations by listening closely, understanding deeply and communicating well through frequent, personal consultations entirely focused on your financial goals.