First Quarter Mutual Funds

Washington Post Staff Writer Brooke Masters was online Monday, April 7 at 11 a.m. ET to discuss mutual funds performance in the first quarter of 2006. She examined the issue in an article Sunday, part of a special report that included scorecards showing performance of the best , worst and biggest funds.

A transcript follows.

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Brooke Masters: Welcome everybody to our chat about the first quarter results for mutual funds and stocks. I'm Brooke Masters and I am based in the Washington Post's New York bureau where I cover Wall Street as well as white-collar crime and securities regulation.

A couple of caveats before we get started: I am a reporter not a certified financial planner and I cannot and do not give individualized investment advice. And as all the Wall Street documents say: past returns are no guarantee of future performance

As those of you who have received your Q1 statements already know, it was a fantastic quarter, particularly for international stocks and domestic small cap stocks. But there are definite clouds on the horizon, according to many analysts. So let's get started

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Vienna, VA: Thanks for a great feature focused on us young or new investors. I wish there was some more info for those of us who are ready to step beyond the 401k. If I wanted to invest in a mutual fund, I wouldn't really know who to call. I wouldn't know how much money I should start with. Are there investment companies that focus on a younger group? Ones who are willing to help someone invest a small amount 5k to 10k?

washingtonpost.com: Simple Steps To Begin Investing

Brooke Masters: With only a small amount of money to work with intially, you may do better with fee-only financial planner who charges either hourly or a set fee for a particular service, such as a coming up with a financial plan. Then you can implement the plan over time using no-load (no commission to those who don't speak Wall Street lingo) funds

While the price tags look scary, you know that you are getting their best advice rather than being steered to funds that pay high commissions.

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Providence, RI: I had 3 funds in the American Fund Family: Capital Income Builder (caibx), Am Funds Income A (amecx), and Bond fund of America (abndx) Bought them in July, and they all started to lose money right out of the gate. ABNDX was a real dog so I switched to Capital World Growth(cwgix) and eventually caught up.

Sold amecx and caibx at break even point early this year. When I got 1099 DIV I blew my stack. An additional $3000 income on my taxes from funds which had posted a net loss in 2005.

So infuriated me that I sold cwgix. (Broke even again.) Sort of a reverse pyhric victory: if it costs this much to lose how can I afford to win. The broker was clearly out to make her commission and that was it. She did nothing afterwards; I had to make all the decisions on what to sell and when.

With fees, dividends, and other carrying costs I don't see how anyone makes money on this trash.Also,with what I see as high volatility in the stock market the risks are too great. I'll stick with money markets and CD's unless you have some other advice.

Brooke Masters: I can't comment on the particular funds, but this has been a tough year for capital gains distributions. A lot of funds rebalanced which means they sold positions and distributed the gains to their investors for tax purposes. If you just got into the fund, you got whacked with the gains without actually seeing a real gain in your own investment. It's very frustrating.

A couple of possiblities:

1) invest as much as posssible within your IRA or 401K which do not have to pay taxes on distributions until you take out the money.

2) try tax-managed funds, which try to avoid this exact problem. (A caveat here--they can be very high fee and you should read the prospectus carefully)

3) tax free bond funds

4) index funds don't rebalance unless the index changes so the distributions are likely to be smaller.

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Fairfax,VA: I'm trying to get my 20-somthing niece and nephew saving for retirement with IRAs. Do you know of any (good, bad, indifferent) mutual funds that will accept $100 for an IRA mutual fund? I'm willing to kick in that much for each of them just to get them started. I started late, and started conservatively, and I regret it. I figure if I start, they will continue. Thanks.

Brooke Masters: I think you are going to have a hard time with just $100, unless they commit to making authomatic monthly deposits. H&R Block claims its Express IRA with a $300 minimum is one of the lowest around, but its investment performance has been less than stellar.

But I might troll the websites of the really low fee fund families like Vanguard and see what you can find.

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Danvers, Mass.: You write the average fund was up 3.7% this last quarter. Long run returns are 10.0% over the last 20 years. The S&P did 13.0%. Some smart people (Buffett among others) looking forward think stocks will do between 6 and 7 percent. If the same 3% difference in return prevails, the average fund may do 3 to 4 percent. Roughly half of all gross gains will go to fund managers and their helpers. If you give away half your income for the rest of your life, it's like giving away half your wealth right now. I'm wondering why this business is a good deal for investors.

Brooke Masters: I think you may be confusing annualized and quarterly returns. Make sure you compare apples to apples.

You are correct to be concerned about high fees however. All fund families must disclose their fees in the same form and the SEC has a great site that allows you to compare the impact of different fees (such as loads and annual expenses) on your returns.

http://www.sec.gov/investor/tools/mfcc/mfcc-int.htm

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Fairfax, Va.: You talked about gold stocks being the hottest of the hot. Is it too late to cash in?

Brooke Masters: Timing the market is really really tough. I've tried with my own money and generally failed.

I'm no expert, but the folks at Lipper who do a lot of research told me that the fantastic return on gold funds this quarter came almost entirely in January. (I'm doing this from memory but I think 19 of the 20 percent growth was in January) That would make me leery of piling in right now.

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Arlington, VA: Hi Brooke --

I have 35 years until retirement and want to open a Roth IRA later this year to supplement my 403(b) savings. I am considering mutual fund(s) as one investment vehicle for the account. Given my very long-term investing horizon, which types of funds are most appropriate? Many experts think that large cap growth stocks will make a comeback. Do you agree and is this option sensible for long-term investing?

Paul

Brooke Masters: In general, when you have a very long term investing horizon, it's probably best to spread your money around--some large cap, some small, a small amount of international. If you are using a broker, I would consider putting it all in the same fund family if you can find a decent selection because you may get "breakpoints"--commission discounts--once you cross a threshhold forall your investments combined, often around $50K.

As I said earlier, it might be worth investing in a financial plan from someone who is not getting paid by commission to give you some suggestions about how to distribute your investments (what percentage should be large vs. small vs. international.)

And again, watch those fees. They really add up over the long term

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Arlington VA: Thanks for taking my question! Is there any advantage at all to investing in funds that charge loads or higher management fees? It seems that with returns so much lower lately than the historical average that fees are a really important factor to consider now a days.

Brooke Masters: The main reason to pay a load is that you feel you need advice and would rather pay your broker a commission than pay a fee to a planner. Also some brokers would say that they have access to better funds--make sure you do your own research on this one. Just because they like the fund doesn't mean you will.

As for managed funds, in good times it's great to have an index fund. In bad times, a good managed fund can sometimes protect you from losses. It's finding the good ones that can be tricky.

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Washington, DC: Why are utility stocks and sector funds not a good buy when interest rates are rising?

Brooke Masters: Utilities generally carry a lot of debt because they have heavy capital expenditures (building and repairing all those power plants and transmission lines ain't cheap). If they have to pay more to borrow, they will likely have smaller profits.

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Arlington, Va.: I often hear the complaint that a three-month window is not long enough to adequately guage fund performance. I know the information is available in the scorecards you published, but have you considered yearly wrapups?

Thanks

Brooke Masters: We do year end wrap ups. It seemed kind of redundant to talk about the last 12 months when we talked about 9 of the 12 months involved in our January report.

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Annapolis, MD: This wannabe investor in mutual funds has been studying the highly-informative "Scorecard" on p. F15 of Sunday's Post (thanks for that) and have identified several possibilities. What's an easy way for a novice to determine costs/fees (load?)of a given fund that would reduce some of the glorious returns depicted? Any other "Mutual 101" info I should know? Many thanks

Brooke Masters: Every fund has to report its fees in the same standardized table in its prospectus. (Thank you SEC)

I know you don't want to read the whole thing (who does?) but get one prospectus, leaf through it until you get to the key tables and then get comparison tables for every other fund you are interested in. You can then use the mutual fund calculator I mentioned earlier to compare the impact of different kinds of fees.

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Alexandria, VA: Brooke, thanks for taking questions. I hope this one is sufficiently on-topic.

I think I've got retirement planning figured out (401(k), plus pension), and short-term cash (I've got a good three+ month buffer), but what to do about everything else? I've got some surplus that I 'know' I should invest but I can't say exactly what I'll use it for (house upgrade, family assistance, dream vacation?).

Are mutual funds a good way to save for unknown purposes with uncertain time frames?

Thanks...

Brooke Masters: Mutual funds can be a good relatively short term investment. Just make sure you are wary of Class B shares which have a high load that shrinks over time--if you might need the money soon, you don't get the benefit of the gradually shrinking fees.

The NASD has an investor alert on this subject as well as other good investor tools at

http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&nodeId=13

What I like about them is they do regular investor alerts about products that are either bad or being sold to the wrong people, so you can page through a couple of years of alerts to make sure that you aren't being talked into an inappropriate product

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Washington, D.C.: I have my 401K going and maxed-out.

I have a Roth-IRA going and maxed-out.

I'm building an emergency savings.

I want to invest more, but what now?

What's the best way for a common person to start investing in stocks and bonds?

Brooke Masters: Generally the next stop is mutual funds, because they allow you to own part of a large basket of stocks or bonds and therefore spread your risk.

Some people are becoming fans of Exchange Traded Funds which are also baskets of stocks but instead of being priced once a day like mutual funds, they float throughout the day. They can carry lower fees.

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Hedged06: To Washington D.C.

"Why are utility stocks and sector funds not a good buy when interest rates are rising?"

Actually in addtion to what you said because utilities pay high dividends, they tend to be low growth. So when rates were a 1% or say 2.5% the dividend payments look great. With Fed Funds at 4.75% the present value of dividend streams is less attractive since you have a higher discount rate.

Sector funds is too broad a term. There is not necessarily a correlation, though higher interest rates tend to erode all equity values, or investment for that matter. A sector can be steel, oil, agriculture, Pacific Rim etc....

Brooke Masters: Good clarification on the question of sectors as well as good additional issues with utility stocks...I assumed the question was refering to the utility sector but others may have made the same assumption that this poster did.

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Washington DC: Based on what analysts are predicting, is this going to be another good year for international funds?

Brooke Masters: I got really varied answers when I asked analysts about international stocks. Some see a great year, others are concerned particularly about the third and fourth quarter for the same inflationary issues that may impact US stocks

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Laurel, Md.: What does it mean that inflation-sympathetic sectors (metals, energy, real estate) were the best performers while the Treasury yield curve is almost flat (3mo = 4.5%; 10yr=5.0%)?

Brooke Masters: I wish I knew.

The yield curve was even inverted toward the end of last year, with long term bonds paying LOWER yields than short term. Many analysts said that might pressage a recession but it didn't happen this past quarter.

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Laurel: The best and worst-performing lists are made up of the usual suspects -- small caps, metals, emergining markets.

But the fourth-worst performer is a government bond fund. Government bonds haven't done a lot so far this year, how can someone screw up such a stable investment so badly?

Brooke Masters: Sorry for the delay I was just looking to see if I saw anything in the trade publications that suggested an answer to this question. No luck.

I suppose they could have made a really bad bet on the Fed's plans re: raising rates, but it does look very odd.

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Vienna, VA: I plan to sit down with my bank's investment counselor in a few days. This is the first time I've ever invested. I'm a little nervous since I don't know what to expect. Are there certain questions I should ask? When it comes to the bank's billing, how can I tell if they are being fair?

Brooke Masters: The first thing to remember is that he or she is in this business to make money for him or herself. So you should not be shy about asking how he or she is being compensated. Many times, s/he makes money if you do, but not always.

For example, if he or she recommends the XYZ index fund that tracks the Standard & Poors 500 index, READ THE FEE CHART. Then compare it to the fee chart for S&P 500 fund of a company that is known to have low fees, like Vanguard. If XYZ has a lot higher fees, you need to start asking questions

Also, do not buy products you do not understand. Several years before I took this job, I bought a variable annuity life insurance policy. It's a perfectly good investment for someone trying to build up a tax-free estate to pass on to their kids. However, I had two kids in preschool and my main concern was making sure they would eat if I died and trying to save for their college education. In retrospect, I might have done better with cheaper term life insurance plus a low fee 529 college savings plan.

But I was embarassed to admit that I didn't understand what I was buying and I didn't really understand what all the charts meant.

So now I have the 529 plan plus the variable annuity life insurance, but paying the high commission on the life insurance probably slowed my savings down.

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Washington, DC: I use mutual funds that use leverage to achieve 200% to 150% of the returns of other indices. No recommendation required but do you think that will spread to other mutual fund managers?

Brooke Masters: leverage is a very controversial issue. Some people worry that with all of the the highly leveraged hedge funds out there, we could be in for a market crack up if there's an unexpected economic shift.

Certainly the practice is proliferating in the hedge fund world. I'm less clear whether it is here to stay in mutual funds

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Regarding load v. no-load funds: It also has to do with length of investment. Let's pick a fund I'm in: American Funds Washington Mutual Investor. The prospectus is online at http://www.americanfunds.com/pdf/mfgepr-901_wmifp.pdf

If you look on page 5 (or page 7 in the Acrobat window), you will see that the Class A shares (the load shares) have annual fund operating expenses (deducted from share price) of 0.61%. The class B and C shares of expenses of 1.38% and 1.46%, respective.

To get the Class A shares, you have a maximum load fee of 5.75% (less if you have money in American Funds or purchase alot of it - see page 20) but you are "saving" 0.77% - 0.85% in expenses each year depending on the class of shares.

If you are investing for the long haul (10+ years), you are better off paying the load fee and having the reduced expenses each and every year. If you are only investing for a short time, the no-load class is the way to go.

Basically, read the prospectus and look a the purchase, annual, and redemption fees.

Brooke Masters: This is where the SEC mutual fund calculator comes in really handy. You can plug all the fees and loads in, put in your investment horizon and it tells you which one is a better deal feewise for you (assuming the two funds have the same returns)

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Bowie: Since the subject of holding cash came up...

My neighborhood bank (acutally a branch of a very large national one) offers less than 1% on savings accounts. Which is why I use an on-line bank that pays 4%.

T-bills were paying about 1% a couple of years ago, even when anyone could get 2% from INGDirect.

Is there any indication that competition from on-line banks is driving up the shortest-term rates, even among Treasuries?

Brooke Masters: I have had the same experience with online vs. local banks. I have not heard anyone connecting on-line banks to short term T bill rates, but I'll ask about it the next time I talk to the bond analyst types.

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Brooke Masters: Folks,

I've got to get back to reporting now, but I really enjoyed this chat. I hope you'll all come back the next time we talk about investing.

Please please remember to take all of these comments with a grain of salt. An investment that is great for one person is completely inappropriate for another. Don't let anyone push you into "the next great thing" without doing your homework.

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