Mutual funds designed primarily to produce income are a much larger subject and group than one would suppose. Over time here I have covered money market funds, bond funds, oil and gas royalty funds among others. One of the basic secrets in evaluating income funds is to look at their costs passed on to us. When you are talking about 4% to 5% cash dividends, there is a dramatic difference between money funds which charge costs of less than 1/2% and those which charge over 1%. The math is, of course, quite clear and can represent a difference of 1% or more in your earnings. 1% may not sound like a lot, but 1% of a million dollars is $10,000 per year. The other factor in a low cost environment versus a high cost environment is safety. A fund with very low costs does not have to "reach" or hunt for the highest yield short term money market instruments in order to compete for your business. They can stick with the highest rated and historically reliable issuers and get paid a reasonable rate. The high cost fund managements may have to go to riskier issuers or go longer term. Without naming names in the"reach for yield" category (you can use a search engine to find them) there have recently been, and will possibly be more, money market funds which have had to be "rescued" by their backers in order to keep their price firmly cemented at $1 per share. These losers apparently got sucked into the "reach for yield" game and ended up in the sub-prime loan commercial paper debacle.
Even if you keep a lot of money in money market funds for safety, do not to go sleep. Look at the yields which are normally found in some daily and most Sunday newspapers or on internet sites. One site is:
http://www.money-rates.com/moneyfunds.htm Yields are sinking, of course, due to the Federal Reserve's cutting of the overnight inter bank rate (Fed Funds) from 5.25% to 4.25%. All other short term rates are adjusting to this large change according to their safety rating. Get in the habit of looking at the current rate of your money market fund and look up its annualized cost on its website or in its prospectus. If this cost is over 0.5% per year and it is paying out a higher than average yield to you, get suspicious of a possibly dangerous "reach for yield" which could cause problems for you. The yield to you plus the cost to you is what the money market fund is taking in on its investments. My personal favorite is Vanguard's Prime Money Market Fund which charges 0.24% annually for management and is paying 4.47% (annualized) for a total of 4.81% on their investments. There are money market funds which are currently paying more than 4.81% to their investors and charging far more annually than $0.24. So you need to know what they are investing in and for how long. The average maturity of the investments in money market funds cannot normally exceed 90 days.
This isn't rocket science, but I'm amazed that so few money market fund investors "know where their money is" in terms of interest rate paid to them, the annualized cost to them, and average maturity of the money fund holdings (0-90 days). The fourth factor is the "quality rating" of the holdings which you need to read about. Briefly, there should be a lot of Aaa and Aa issues and NOTHING with a B in the rating. Learn these four vital numbers for your fund, write them down with the date you looked and do it at least every month.
As of Friday the 3 month Treasury bill annualized rate was 3.09%, another number you should write down each time you check the interest rate, annualized cost, average maturity, and quality rating of your money market fund. That is quite a bit less than even the safest of money market funds, and even bearing in mind that with T bills you pay no state or local income taxes, so the markets are factoring in some nervousness about non-treasury money market instruments. That "nervousness" should at least make you aware and make you LOOK.
Another time I'll discuss standard income funds of longer maturities than money mark funds: short term (up to 1-2 years), intermediate term (2-7 years); and longer term (over 7 years). The same principles apply to such funds as to money market funds: know the yield, annualized cost, maturity, and quality rating. Also use a search engine and familiarize yourself with the concept of bond duration as it relates to bond maturity. These funds and money market funds traditionally have been managed in the sense of balancing the four factors to meet a specific maturity need (short, intermediate, or long term) and a specific type of bond (Treasury, GMNA, corporate, a mix of these, municipals, or foreign).
Another type of bond fund which has been growing in popularity and success over the past 25 years is the actively managed fund whose managers change their bond profiles just as stock mutual funds (other than indexed funds) do. You can think of traditional bond funds as indexed funds to a specific bond sector and the newer funds as actively managed, although even indexes require expert management.
Despite my admiration for Vanguard due to its very low costs (and ONLY because I use it for that reason, and I receive NO other benefit from them, or anyone else, whatsoever), I am not a fan of index funds. I believe there are managers of all kinds of stock and bond funds who are simply better than indexes. An index, after all, lumps the good, the bad, and the ugly together so that you don't miss what the market has to offer. Simply said, I want to invest with someone who has a record of picking the good and leaving out the ugly. You do not get a valid feel for who is very good by looking at who did best last year or even for the last three or five years! You really need to see AT LEAST ten years of total return charts (with all dividends reinvested) to see who is best through all kinds of markets. The stock market has certainly been "up and down and all around" in the past ten years, and bonds have bear markets too. I wouldn't judge a stock fund by how it did only in the past five years of a bull market, and the same goes for bond funds.
With internet access you can find such charts.
http://Finance.yahoo.com is one.
http://Moneycentral.msn.com/ is another.
http://Morningstar.com has some free features and others for subscription and is an excellent source.
http://FastTrack.net has the best total return mutual fund charts I know of, and you can look for free at some charts of specific fund companies for free or subscribe to their service as I do. I'll show you a five year FastTrack chart of six income funds, four of which I own and two (PAAIX and HSTRX) that I may buy soon, and a nearly 17 year chart of the four of them that have been in operation since mid 1991.
VWINX is Vanguard's Wellesley Income Fund, one of the earliest of the stock and bond balanced funds, about 30-35% in stocks and the rest in bonds, mostly corporate bonds of an intermediate maturity as a rule. VWINX currently pays 4.31% as a cash dividend plus capital gains and charges only 0.25% per year. VWIAX with a $100,000 purchase minimum pays 4.41% cash dividends plus capital gains and charges only 0.15% per year and is managed by legendary Wellington Capital. Look how it sailed through from 1999 to 2003. Being a value investor VWINX did worse in 1999 than in 2002! Steady, safe, simple, long term record.
RPSIX is T R Price's Spectrum Income Fund which is a mix of several Price Funds chosen by its managers to meet its goal of a steady, safe income producer. It's relative lack of volatility beats even VWINX as it has half or less the percentage of stocks, usually 18% or less and a wider (and therefore shorter) exposure to bond maturities. You pay for low volatility with a lower payoff, but RPSIX is currently paying 4.65% annualized cash dividend on a monthly basis plus capital gains.
BERIX is Berwyn Income Fund whch is similar to VWINX long term in overall yield. In contrast to VWINX, BERIX is tilted more toward small and mid caps in stocks and to preferred stocks and higher yield corporate bonds, when justified, as opposed to VWINX's solid mega-caps and high grade corporate bonds. Berwyn had cut back on high yield corporate bonds this year which served them well. BERIX is yielding 4.70% and charges 0.73%.
Last of the "oldies" is the king of the managed bond funds, LSBDX, also available in smaller minimums as LSBRX. You can see that VWINX, BERIX, and LSBDX tracked one another pretty closely until mid 2002. LSBDX took off as they are a "go anywhere" bond fund and so were into foreign sovereign bonds "early and often". The management has won the Morningstar Bond manager award of the year many times, beaten out this year only by Bill Gross. But LSBDX's returns are far greater every year. So for the excess yield, this is where I have been. If Dan Fuss and Kathleen Gaffney, there since the start in 1991, retire or leave I'll have second thoughts. They each also have a major part of their own wealth in the fund. This fund is currently yielding 6.16% and charges 0.67%. As you will see on the five year fund chart, LSBDX is beginning to slow down as they have trimmed their sails this year wisely and ahead of the credit crunch this past summer. They did very well in Canadian Treasuries this year, and I expect that if the recession truly develops this year, they will have been cutting back more to US Treasuries and outperform less than usual. Given their history and method I trust them to "get it right" unless at some point they do not.
PAAIX and HSTRX are income funds I have not mentioned before. If you invested through Vanguard and some other fund companies (perhaps Schwab?) which clear trades through Pershing, you can buy many of the PIMCO institution grade of funds for a minimum of $25,000 instead of $5,000,000. The "retail" versions are the same but with higher annual costs, supposedly to compensate for the extra cost of many smaller investor's traffic instead of fewer but much larger accounts. Rob Arnott does at PAAIX what the T R Price team does with RPSIX. He picks and actively changes which of many PIMCO managed funds are represented in PAAIX. Current trailing 12 month yield on PAAIX is 7.66% with a 0.86% cost, and with PASDX (retail) 7.09% and 1.46% cost. PAAIX/PASDX are more volatile than the others but may be worth the diversification for some. I am looking at it for possible purchase since I can get in for $25,000 through Vanguard and Pershing.
Last, but not necessarily least is, John Hussman's HSTRX. It is an eclectic income fund based upon the idea of beating inflation, at least judging by its holdings. Mostly they are fairly short but variable maturity TIPS (Treasury inflation-protected notes), a few high dividend stocks, and 10 to 20% in gold stocks. Both the TIPS and gold stocks are traded, with trading for the golds based on gold stock relative strength compared to gold bullion and other undisclosed factors I am sure.
HSTRX had a modest record from inception until the past 24 months since when it has taken off in relative terms. I told you earlier that short term records of three or five years really do not test the mettle or long term abilities of managers, and Hussman may certainly have merely been lucky to ride both TIPS and gold bull market spurts of the past two years. He has shown great skill in his long/short mid cap stock fund (HSGFX) using very conservative principles, and he is still relatively young for a successful independent manager. So I feel I may be seeing in Hussman someone like Dan Fuss and Kathleen Gaffney were in their approach before they really hit pay dirt in 2002. I would like to see how he does when gold pulls back and/or TIPS do if a deeper recession occurs than most people expect. Since I own gold I do not need Hussman to give me the exposure, but as I get older I may need to simplify further and allow others to do more of my work for me.
Start simple, get a few basic facts and some history, use your head, narrow it down, simplify further.
Recent Comments