Are you biased?
Experts in the fields of behavioral finance and neuroeconomics have found that humans are susceptible to developing biases. A bias is a preconceived notion, preference, or tendency that, once adopted, is difficult to alter or overcome.
Here are some of the common biases we often see:
Mental anchoring is an attachment to past events, situations, numbers, ideas, explanations, or impressions, that tend to block thinking. The mind ignores other aspects of the situation, and particularly neglects new events (or a sounder analysis of the available information) that make the situation different from the past (or from the way we evaluated it in the past). This often leads to biased decisions. The investor’s mind often stays focused or stuck on a past price reference (his/her buying price for example, or sometimes a round price, or a past peak price, or some rigid / stubborn objective decided in the past…). He / she does not accept to sell an asset he / she owns if its current price is under that reference price, even if its future price prospect has been dwindling. Therefore he/she takes the risk of losing more money by keeping an asset that did not keep its promises.
Confirmation bias is a tendency for investors to look for and admit as relevant only information that confirm their prior beliefs, and/or to interpret whatever information in a sense that fits those preconceptions.
Recency bias is to give more importance to recent events than to older ones. It is a kind of mental myopia that focuses on the most recent information. A common example in asset markets is the expectation that some assets which have been fashionable until now will keep being popular in the near future.
Catastrophisizing Bias – Similar to Recency Bias. Extrapolating today’s bad news indefinitely into the future. “Things are terrible today, and will always be terrible. The stock market will NEVER recover.” “Gold is going to keep going up and up and up.”
Mental accounting/compartmentalizing bias – using separate criteria to value and to deal with your different economic assets, transactions, situations or expectations. The “house money” effect is a good example. People are usually rather cautious on the risk/return prospects when they invest their hard earned savings. But when they sell their winners for profits they view their profits as “house money” with which they can speculate.
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Mutual Fund Sales Charges, Fees, and Expenses
Key Points
- Know the Costs
- Glossary of Terms
- A Shares: The Front-End Load
- B Shares: The Back-End Load
- C Shares: The Level-Load Funds
- No-Load Funds
- Classifications of Shares
- Which Type of Fund Is Right for You?
- Points to Remember
With thousands of mutual funds to choose from, selecting the funds appropriate for your needs can be a challenge. Many investors choose to work with qualified financial advisors who can assist them in choosing funds to pursue their financial goals.
Before you begin making investment selections, you should review your situation. What is your investment goal? How long do you plan to keep your money invested? How comfortable are you with changes in the value of your investment over short and long periods? You should also familiarize yourself with the principles of asset allocation and diversification. And finally, before you invest in a mutual fund, carefully examine its performance, fees, and any sales charges.
Know the Costs
All funds have annual fees and expenses, which are used to compensate their professional managers and cover operating expenses. These fees may include a 12b-1 fee, which is collected to cover marketing and distribution costs and is periodically deducted from the fund’s earnings each year.
Some funds also apply a sales fee. These funds are known as “load” funds. The sales load, or fee, compensates the broker who helps you determine which fund is right for you (if you buy the fund from a broker or registered representative). If you are working with a fee-based financial advisor to select your investments, you may want to avoid buying shares that charge a front-end sales load unless the fund offers exceptional performance potential. When evaluating load funds, which charge either a front-end load (A shares), a back-end load (B shares), or a level load (C shares), consider your investment goals and time frame as they relate to how and when the fees are paid.
| Glossary of Terms |
| Contingent-Deferred Sales Charge (CDSC) — A fee that may be charged when a shareholder sells fund shares.
12b-1 Distribution Fee — An annual asset-based sales charge that is used to pay for sales-related expenses. Income Distribution — Payments to shareholders resulting from interest or dividend income earned by a fund’s portfolio. Service Fee — Payments by a fund for personal service to investors and/or for maintenance of shareholder accounts by the distributor or a financial representative. |
A Shares: The Front-End Load
Front-end loads are deducted from your initial investment, thereby reducing your immediate purchasing power. Investors in these shares are likely to have an extended time frame for their investment goals. These investors expect to remain in the fund for several years. If circumstances change, however, the shares can be redeemed at any time without additional charges.
One advantage of a front-end load is that it is based upon the fund’s net asset value at the time of purchase, and not on any appreciated value. In addition, some funds with front-end loads do not charge an annual 12b-1 fee. Investors should remember, however, that a front-end load could result in slower growth for your money than an investment in a level-load or back-end load fund.
B Shares: The Back-End Load
Back-end load funds typically charge what is known as a “contingent-deferred sales charge” if you sell your shares within 7 to 10 years of purchase. The sales charge may be collected on either the existing net asset value at the time you withdraw the funds or on the net asset value at the time of purchase, depending on the fund.
For many funds, the sales charge is reduced gradually over time, and after several years, no sales charge is collected. Of course, this declining fee schedule depends on the individual fund. Back-end load funds may be an appropriate choice for investors who intend to hold the investments for four to six years. But because these funds often charge a 12b-1 fee (as much as 1.00%), a fund with a lower 12b-1 fee may be a better choice for longer-term investors.
The advantages of a back-end load are that all of your money goes to work for you immediately, and if you hold the shares long enough you will not pay a sales charge.
C Shares: The Level-Load Funds
Level-load funds may collect a sales charge based on the net asset value each year, and some may also include a small front-end or back-end load. They can also charge a 12b-1 fee. These somewhat higher costs may result in lower income per share than income earned on Class A shares. Therefore, these funds may be appropriate for an investor with an investment time frame of less than five years.
No-Load Funds
“No-load” funds do not charge sales fees but may incur 12b-1 fees. The maximum 12b-1 fee a no-load fund can charge is 0.25%.
| Classifications of Shares | ||||
| Class A | Class B | Class C | No-Load | |
| Sales Charge | Sales charge is an up-front fee, typically 2.5% to 5.5% of NAV at time of purchase. | A contingent-deferred sales charge is collected when shares are redeemed, typically 5% of NAV declining to 0% after 6 to 8 years. The sales charge may be assessed on NAV existing at time of purchase or at time of redemption, depending on the fund. | Typically a sales charge of 1% to 2% of the NAV each year. | None |
| 12b-1 Fee | May be charged | May charge up to 0.75% annually of NAV. | 0% to 1.00% annually of NAV. | May not charge more than 0.25% annually. |
| Investment Advice Provided | Yes | Yes | Yes | No |
| Appropriate for | Long-term investment | Investment held 4 to 6 years; or longer if shares convert to Class A after that time. | A short-term investment of 5 years or less. | An investor who does not necessarily need the assistance of a broker or financial advisor in selecting investments. |
Which Type of Fund Is Right for You?
Because of their lower fees, no-load funds may seem most appealing at first glance. But before choosing these funds, consider your goals, your level of investment expertise, and how much time you can devote to making investment decisions. If you feel that you need assistance in selecting and investing in mutual funds, then load funds may be the more appropriate choice unless you are working with a fee-based financial planner. Before buying a fund that collects a sales charge, consider its performance record net of sales charges.
No matter what your decision, remember to evaluate your specific goals and personal investment style. With a long-term strategy, you’ll be more prepared to select the alternatives that can offer you the best value over time.
Points to Remember
- Before you invest in a mutual fund, consider the fund’s performance, fees, and any sales charges.
- All funds have annual fees and expenses.
- These fees may include a 12b-1 fee. In addition, funds may charge a sales fee, known as a load.
- Load funds are classified as either A shares, B shares, or C shares.
- A shares — front-end loads — means the sales charge is deducted from your up-front investment. This reduces the amount of money that goes to work for you. These funds are more appropriate for long-term investors.
- B shares — back-end loads — typically charge a contingent-deferred sales charge, usually at the time you withdraw the funds. These funds may charge a higher 12b-1 fee; therefore, they are more appropriate for an investor with an intermediate investment time frame.
- C shares — level loads — may collect a sales charge based on net asset value each year and may include a small front- or back-end load or a 12b-1 fee. These funds are more appropriate for time frames of less than five years.
- No-load funds do not charge a sales fee but may charge an annual 12b-1 fee of up to 0.25%.
- Before you invest in no-load funds because of their lower fees, consider if it would be more beneficial to you to take advantage of the assistance that a financial advisor can offer.
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© 2011 McGraw-Hill Financial Communications. All rights reserved.
August 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP®, a local member of FPA.
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Three Questions for Investors
1. Why do we need to Invest?
The “One Goal” everyone has is to achieve financial security – to save for a “rainy day” fund, to pay for kid’s college, secure retirement, down payment on a home, and to have enough money to live the lifestyle we desire.
The two biggest obstacles to achieving financial security throughout our lifetimes are inflation and taxes. (Others are self-inflicted – procrastination and spending habits)
2. What types of investments (securities) are available?
Two main categories:
a) Those that don’t generate returns above inflation: anything with fixed income (bonds, CDs, savings accounts, life insurance policies,etc).
b) Those that do*: stocks, real estate
*Precious metals, oil & gas provide inflation protection but generally with higher risks.
3. How do I effectively implement an investment plan?
Before implementing a plan, here’s a primer for beginning investors:
Understanding Diversification
No one has the ability to predict the future.
Past Performance is never a guarantee of future performance.
The best performing investments rarely are the same from year-to-year. Some years it’s government bonds, other years it’s emerging market stocks.
Buying just one stock or one market sector is a “hit or miss” strategy— win big or lose big. So we diversify across a variety of asset classes and market sectors to “be approximately right rather than precisely wrong.”
Understanding Risk
Stocks fluctuate. Small cap stocks fluctuate more than Large cap. International/emerging market stocks fluctuate more than US stocks.
Bonds fluctuate, but not as much as stocks.
CDs, savings accounts, checking accounts, life insurance cash values do not fluctuate.
Gold fluctuates a lot. In fact it fluctuates more than stocks.
“Standard deviation” is a measure of risk or fluctuation in an investment:
Over long periods of time Gold does not provide a higher return than stocks. Bloomberg’s gold index has a standard deviation of 19.6 since 1970, compared with a 15.4 standard deviation of the Standard & Poor’s 500. Between 1970 and 2006, the gold index earned 7.5% annually and the S&P 500 earned 11.3%.
Implementing an investment plan
“Buy Low/Sell High” (or Sell High then Buy Low) through Diversification and Rebalancing.
Picture a Pie Chart – all pieces of the pie (stocks, bonds, real estate, etc.) add up to 100%
Determine the appropriate mix of investments based on your personal financial situation, return requirements, risk tolerance, liquidity and income needs, time horizon, and goals. Each investment in the portfolio has its own set of “risk and return” characteristics such that each investment fluctuates more or less than the others.
Reasons to rebalance the portfolio:
New deposits
Withdrawals
Market Volatility causes the asset allocation to drift from its target.
Major changes in emotional risk tolerance, changes in marital status, children, change in income or expenses
Investing for Income in Retirement
Systematic Withdrawal Plan – schedule a monthly withdrawal from your account. “Dribble” the money out at a rate of 4-5% per year (widely accepted as a “safe withdrawal rate.”) Allow the portfolio to fluctuate. Rebalance as needed. Maintain appropriate cash levels. Allow dividends and interest payments to build up into cash.
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Consider Dividend-Paying Funds as a Source of Income
Key Points
Profitable companies traditionally have rewarded their shareholders one of two ways: by reinvesting corporate profits in the company with the long-term goal of increasing the stock price or by paying shareholders a regular dividend. While the stock price may or may not increase over the long term, dividends, typically paid quarterly, offer investors more immediate income. Many large, well-established companies historically have paid dividends.
Mutual funds that invest in dividend-paying stocks may enhance your portfolio in the following ways:
- A source of supplemental income. For investors with an appropriate risk tolerance, funds that pass along equity dividends offer another choice for potential income.
- A track record of strong returns. Past performance is no guarantee of future returns, but history shows that dividend-paying stocks have the potential to generate average annual returns that are higher than those generated by non-dividend payers.
- A potential cushion against market volatility. The prices of dividend-paying stocks historically may experience fewer ups and downs compared with equities that have not paid dividends. Dividends provide a regular return even when stock prices are in a slump.
Ask your investment advisor whether a dividend-producing fund provided by the is appropriate for your circumstances. As its name implies, an equity income fund may enable your portfolio to benefit from the best of both worlds: The long-term growth potential of stocks combined with a source of income.
Keep in mind, however, that a company’s track record of paying dividends in the past does not necessarily mean the company will remain profitable or continue to pay dividends in the future.
Because of the possibility of human or mechanical error by Financial Communications or its sources, neither Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.
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© 2011 McGraw-Hill Financial Communications. All rights reserved.
August 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Dan Federman, CFP®, a local member of FPA.
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Three Primary Areas of Planning
- Estate Planning – What happens at my passing?
- Incapacity Planning – What happens if I get hit by a bus but survive? Who will take care of my affairs?
- Lifecare Planning – What happens to me from retirement to end of life? How do I make sure I will get good care, preserve my resources and everything in between as I get older?
What is an Estate?
Estates only occur when you die. Either you have an estate plan or you don’t. If you don’t have a plan the state legislature and Governor will make a plan for you. Dying without a will is called dying “intestate.” The person in charge of the estate may be someone you’ve never met. The beneficiary may be someone you never intended. Or it may be someone you intended, but you may not have intended to give them this money while they were 18 years old.
What is a Will?
A will is a “testamentary” document. It does not have any effect until you die. The last one you revise is the one that counts. A will can be changed and amended at any time to reflect changes in your life status. As your life changes, your will need to be updated.
The will is a document that answers the following: “Who am I? Who is in charge when I pass? And Who Gets What?” The person in charge when I pass is called an Executor (male) or Executrix (female). This person is responsible for administrating the estate. You want someone who will do the work and make sure it gets done. You can choose successors as a back-up. The beneficiaries are the people who receive the money or assets. If you’re in someone else’s will, ideally you’re the beneficiary and not the executor.
“At my passing here’s who’s in charge and here’s who gets what.”
Special situations: Minor children, substance abuse, spendthrift. You can select a trustee to oversee the money to provide money to these beneficiaries in an effective manner so the money is not spent immediately.
Name a guardian to minor children in a will. Who will be the surrogate parents of my children? If you don’t designate a guardian, the court decides. The will governs all assets titled under your name.
Other asset registrations not governed by the will include:
- Joint Tenants with Rights of Survivorship and Tenants by the Entirety.
- Insurance Policies with beneficiaries.
- Banking accounts have Payable On Death.
- Brokerage Accounts have Transfer On Death.
- 401k’s, Retirement Plans have designated beneficiaries.
These are planning options that can be utilized to avoid Probate, which is the arm of the court that retitles assets when somebody passes. Some people prefer to bypass this administrative process. Another way to bypass probate is to set up a revocable living trust. By titling all my assets into the trust, no assets at my death are in my name.
Some planning techniques to pass assets at death:
Incorporate into will or trust named beneficiaries, special needs provisions, spendthrift provisions.
Letter of Intent – tangible items. Ex. mother’s china goes to my sister. Silver to the son. Etc.
Federal Estate Tax
Not applicable to most people. Current law (through 2012) – first $5 mill in assets per individual/spouse is not subject to estate tax.
Incapacity Planning
If something happens to me and I am unable to oversee my financial affairs, another individual needs authority to takeover my affairs. Guardianship is costly, cumbersome, and unnecessary if you draft a Financial Power of Attorney. The more specific and expansive they are the better they are. Ex. Ability to refinance or sell a home.
Healthcare Power of Attorney – non-terminal conditions. Headache to heart condition. Only in the event I cannot make an informed decision. Majority of medical decisions are covered. Name a person up to the task to make these decisions. Person should be comfortable with medical decisions and making decisions in general. This person will honor your desires and directives.
Advanced Medical Directive or Living Will – Permanent Vegetative State, Irreversible Coma, Terminal condition - two doctors examine me and must confirm in writing one of these three states. Want artificial life support or not. Personal preference. The person is there to enforce the decision someone has already made. Wishes are clear. Party is authorized. No confusion.
Lifecare Planning
What happens from retirement to end of life?
How will I use my resources?
If I need care, where do I get it and how do I pay for it?
Proactive planning vs. reactive crisis management.
Many people want to stay at home. Convenient, familiar.
Cost of care is lowest at home.
Adding ramps, safety bars, moving bedrooms to upstairs,etc.
Ex. Aunt Betty lived in house for 40 years. Slipped and fell and broker her hip. But has dementia so can’t follow directions and unable to do rehab. Moved into skilled nursing facility. Suddenly it’s a crisis. What happens to the house? Who pays for bills?
First – decide where I want to live.
Stay at home? Many people want to stay home. But some surviving spouses say it’s lonely and want social interaction. There are independent living (condos, developments,/ continuing care retirement communities).
Independent living - Leisure World –. I can do everything for myself, but I’m tired of cutting the lawn and tired of making meals.
Lowest cost care – have someone come in (min. 4 hours a day) 9am to 1pm. At home.
At some point this doesn’t work.
Next option is Assisted Living. ex. Sunrise. Live in a facility. Need assistance with taking meds. Or need assistance with activities of daily living. 24/7. skilled nursing care available. $3k to $5k per month. Goal is to get the best care in the least restrictive facility.
“Guide to Retirement Living” – every facility in the (DC/Metro) area. Costs. What is offered. Make sure the care is good.
Best care involves friends, family and advocates. For example, bring in Krispy Kremes to workers. Become friends w/the staff. Social Workers can help be advocates. Involvement of all parties helps ensure better care for your loved ones.
Stay at assisted living as long as possible.
Next level is skilled nursing care.
Nursing home is last option. Very costly. $80k to $110k per year on average. Can quickly deplete a lifetime of savings/resources. 24/7 nurses and doctors available.
How to pay?
Long-term care insurance – in the event I need care, this policy will pay for it.
This information is intended for educational purposes and is not intended to provide specific advice. Please consult your estate attorney or financial adviser to determine the appropriate level of planning for your personal situation.
To talk to a financial adviser at Ariba, call 1-800-808-7488 or visit www.aribaasset.com
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