Financial advice from a non-expert

Winston C. Yang

w i n s t o n       at              c s           dot          w i s c  dot          e d u

Created March 24, 2007

Modified March 25, 2007

 

I have read various financial books and web sites. They have numerical data, charts, quotes from famous investors, analogies, and advice. After a while, they seem to be saying the same things. Below, I have distilled the financial knowledge about mutual funds from my reading.

 

I am not a financial expert. For more details, seek a financial expert (especially the parts about traditional IRAs and retirement plans at work, which are my beliefs).

 

I created this web page by using the "Save as Web Page" option on Word X on a Mac. The outline below may have incorrect numberings in various browsers.

 

  1. Buy an index fund (also called a "passively-managed fund," as opposed to an "actively-managed fund").
    1. If possible, buy from Dimensional Fund Advisors (dfaus.com). (Disclosure: I own DFA funds.) To do this, you will have to contact a financial advisor; fill out a form on the DFA web site and they will email you about advisors in your area. Some financial advisors require a minimum investment of $100,000 or more. Some financial advisors may waive this minimum requirement.

                                                                               i.       DFA was founded by and employs eminent economists, some of which are from the University of Chicago and some of which are Nobel Prize winners.

                                                                                 ii.       DFA believes that markets are efficient and believes in a long-term (buy-and-hold) strategy. In contrast, other mutual fund companies might have short-term (market-timing) strategies.

                                                                                   iii.       DFA uses academic research to help them find promising stocks. In contrast, other mutual fund companies use news, company statements, and company visits to find promising stocks.

                                                                                   iv.       DFA uses index funds and uses their own indices. They do not slavishly follow popular indices like the S&P500, which are somewhat arbitrary.

                                                                                 v.       DFA does not advertise. If you want to invest with DFA, you must seek a financial advisor who has taken a training course at DFA. (DFA does not want financial advisors or clients of financial advisors who are short-term investors, because they might interfere with DFA's long-term strategy.)

                                                                                   vi.       There are no kickbacks between financial advisors and DFA. Financial advisors use DFA because they share DFA's beliefs about efficient markets and believe that DFA provides the best value for the financial advisors' clients.

    1. Vanguard, Fidelity, and other mutual fund companies also offer index funds. Vanguard pioneered index funds. (Disclosure: I have a Vanguard SIMPLE plan.)
  1. When buying a mutual fund, look for the following aspects.
    1. No front-end load, back-end load, or 12b-1 fees.

                                                                               i.       A front-end load (also called "class A shares") means that you pay a fee to enter the mutual fund.

                                                                                 ii.       A back-end load (also called "class B shares") means that you pay a fee to leave the mutual fund.

                                                                                   iii.       A 12b-1 fee (also called "class C shares"), named after a section in the law, means that you pay the mutual fund an annual fee so that they can advertise and attract more investors.

    1. Low expense ratio.
    2. Tax management.
    3. Low turnover.
  1. Also, when you buy a mutual fund, the following aspects might indicate a good fund.
    1. Long manager tenure (5 years, 10 years, or more), if the fund is not an index. (It is debatable whether managers add much value. In some studies, 66% to 98% of the mutual funds studied underperformed an index fund.)
    2. Past performance for a long period (10 years or more). (It is debatable whether past performance matters much. In one study, the top mutual funds for a few years did not perform well during the next few years.)
  2. Every year, max out your contributions to your Roth IRA (or traditional IRA).
    1. The deadline for contributing to a Roth IRA is the deadline for filing taxes (the first day on or after April 15 that is not a weekend and not a holiday).
    2. If you make too much, you are not eligible for a Roth IRA.
    3. If possible, invest in index funds.
  3. Every year, max out your contributions to your retirement plan at work (401k, 403b, SIMPLE, ...).
    1. If possible, invest in index funds.