A Roadmap for Investing Your Money

In a past posting, I argued that investing money in mutual funds was a massive mistake, given the immense fees that funds and fund managers charge, and that those excessive fees erode returns over time substantially. In this post, I want to pursue this argument and offer low cost alternatives that capture the same effects as mutual funds while further clarifying the case against mutual funds.

A mutual fund is simply a basket of stocks that a fund manager selects. Its that simple. There isn't inherent magic associated with owning a mutual fund and if the value of the stocks in that basket decline, you lose money. Fund managers are paid generally a percentage of the amount of assets they manage. Typically, a fund might have 20-40 stocks in it, depending on the appetite of the manager at the helm. The concept of the mutual fund was a brilliant tool in years gone by for the average investor to gain exposure to multiple stocks without incurring the fees of buying each one individually through a broker.

The advent of the internet and technology, however, have greatly changed the opportunities afforded to the average investor and I urge you to rethink your portfolio if you are one of the millions who own mutual funds. The main aspects of trading in today's climate are: where do you trade (which brokerage firm) and what do you own in those accounts.

Instead of owning mutual funds (and therefore paying unnecessary fees for the fund manager's salary), I recommend purchasing similar ETF's (exchange traded funds) that hold almost identical baskets of stocks with much lower fees. For example, rather than purchasing a mutual fund that mimics the S&P500, purchase the S&P ETF just like buying a single stock (ticket symbol SPX).

If you want to buy gold, no need to go to Fort Knox: buy the ticker symbol GLD which tracks the exact price of gold.

DIG: Oil up
DUG: Oil down
FXI: China
IIF: India
EEB: Brazil, Russia, India, China (aka BRIC countries)
GLD: Gold
SLV: Silver
SLX: Steel
NRG: Natural Gas
HHH: Internet stocks

There are ETF's for almost any industry such as telecom, home builders, financials, consumer staples, commodities and many more. A great place to start is:

www.ishares.com

Along the left side of that page is a list of the major categories you can chose from to learn more. Click on one of the ETF offerings and it will show you the major holdings in that ETF, which is how you can compare and find similar ETF's to your current mutual funds.

Online brokerage firms are NOT created equal:

50 years ago, one would have to call a broker to buy a stock, pay a huge fee, and then repeat that process to sell that stock (or a portion there of). Mutual funds came along and allowed people to buy the fund, gain exposure to that basket of stocks, and add or subtract to their holdings at set times. Presently, there are a plethora of discount online firms that have greatly lowered the costs to make a trade, as noted in the June 2008 issue of Smart Money magazine. You may note that Charles Schwabb, Etrade, and others tout their 'low fees' ranging from $10-15 per trade with Scottrade being as low as $7/trade.

I recommend, however, using:

www.foliofn.com

They only charge $3/trade which is roughly 80% less expensive than Schwabb for the exact same service. More importantly however, for an annual fee of ~$300, one can instead do unlimited trading in their 'window' system, which basically means that all trades placed before 11am or 2pm are free. That annual fee may seem daunting but consider that with Schwabb that would only afford you 20 trades a year!

At Foliofn, you can build your own folios of stocks and ETF's, and add or subtract funds from the folio virtually as much as you like, avoiding the immense fees associated with traditional brokers and mutual funds. They also offer preset folios that you can chose from, that include baskets of stocks, just like many mutual funds, WITHOUT the excessive fees!

My suggestion is to open an account with foliofn, choose preset folios you like or create your own filled with ETF's that include the stocks you want from sectors, industries, or geographies.

Remember to diversify. I recommend a newsletter called 'The Oxford Club'. They suggest following a strict asset allocation formula: in simple terms this means owning x percent US stocks, x percent foreign stocks, x percent gold, x percent bonds, and so on. They also make and track stock recommendations and adhere to firm rules: always use a 25% trailstop. PLEASE learn from my mistakes: although I have soundly beat the market in the past 3-5 years soundly (more than double, in fact), my returns suffered because I was not mechanical. By this I mean, always SELL a stock if it drops 25% from its last high. Do not be emotional and say "I know the stock will rebound".

Minimizing losses and high fees will maximize your returns in the long run.

Good luck in taking control of your assets and please let me know if I can be helpful in any way.