Don’t Let Confusion Weaken Your Asset Strategy
Nashville, TN (PRWEB) July 30, 2013 -- For the common investor, placing assets wisely can be frustrating because there are so many options available. There are over 8,000 mutual funds to choose from, so investors can become overwhelmed in a hurry, explains Paul Winkler on his radio program (June 18, 2013). Paul is the president and founder of Paul Winkler, Inc., a registered investment advisory firm located in Nashville, Tennessee.
With such an overload of choices, there is the temptation to flock to an answer that seems to get around the complicated and confusing options. The stacks of possibilities can leave one wishing for an easy, seemingly affirming, solution: “What if I could buy three cheap mutual funds and be done forever?” an investor might wish. One fund would capture the return of the entire U.S. stock market, another would take up the international markets and a third fund would bring in the whole bond market. Such an investment plan is what many are advocating as an answer to the complexities of investing today, Winkler says. But, he cautions, there are hidden traps to this seemingly ideal investment solution.
To understand what the traps are, Winkler says that an investor needs to understand how these total market index funds are designed. They should also heed investment research from the past 60-plus years, which demonstrates that such big funds can miss the sweet spots of the stock market.
Total market index funds are typically “cap-weighted.” In plain English, that means that most of the money in the funds goes into the largest companies (based on their market capitalization).
If an investor chooses a mutual fund investing in the entire U.S. stock market, Winkler explains, “[they] might own over 3,000 stocks, but most of the money goes into shares of companies like Apple, Exxon, GE, Chevron, IBM, and other massive American firms.
“That may sound good to some investors: ‘Great, I own the most successful U.S. companies. Now I can sleep easy,’” he imagines an investor saying. The problem, he says, is that in the long term, “concentrating too much money in any one area of the market can lead to less desirable results.”
Winkler offers a poignant case against the reliance on these funds: From 1966 to 1982, the S&P 500, a familiar cap-weighted index, had an annualized return of nothing – yes, zero percent – per year, with inflation considered. What’s more, from 2000 to 2012, the index actually lost 0.7 percent per year due to inflation.
“Those are long stretches of time to go without returns, especially if you depend on your investments for income,” says Winkler. “What is important to understand is that different areas of the market, which are not well-represented by these funds, did quite well during the same periods in history. Smaller companies, which only make up a tiny fraction of the holdings of total market funds, can be the real game- savers when large stocks go through their inevitable seasons of drought.
“We need to recognize, as investors, that the biggest and most important companies of today will likely become the ‘has-beens’ of tomorrow, due to changes in technology and competition.”
Something else that proves problematic is the periods when interest rates increase. Winkler mentions that for 30-plus years, long-term interest rates have been on a downward trend.
“At some point this trend will come to an end, and reverse,” he explains. “The outcome can be market declines and a drop in longer term bond prices.”
A redeeming feature of total stock market funds is that their managers do not use certain strategies that Winkler sees as ineffective. That is, they do not cherry-pick stocks or try to time the market. Winkler says that studies often show that those strategies provide comparatively lower results in the long run.
The goal of buying into a broad mix of mutual funds is to reduce the overall risk of investing. Winkler advises that buying total stock market funds without investing in other kinds of funds rarely results in the level of diversification that an investor should strive for.
“Owning more funds, and those that give exposure to broad areas of the market, such as small companies, value asset classes and [funds with] better international representation, is often the ticket to greater success in investing,” states Winkler.
About Paul Winkler of Paul Winkler, Inc.:
Paul Winkler, QFP, ChFC®, RFC, CLU, LUTCF, CASL, AAMS, is president and founder of Paul Winkler, Inc., a registered investment advisory firm located in Goodlettsville, Tennessee. Paul has been in the financial services industry since 1989, and has been published extensively in industry and mass media publications. In addition to being the host of the long-running radio program, “Investor Coaching Show,” on WWTN-FM, often Paul has been a guest on nationwide radio and television programs.
Paul's unique approach to the world of investing and financial planning stems from his strong belief that the traditional approach to the discipline is often driven by promoting financial products rather than by sound investment philosophies. Paul is the author of the book, Above the Maddening Crowd, which is endorsed by many financial teachers and university professors around the country.
(PW, JO)
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