Let Someone Else Do It

Ben: I’ve had a decent chunk of cash invested in a mutual fund since I was 9 years old. At the time it seemed like a great idea, especially when my mom broke down the long term returns. However, I’ve been following this mutual fund for the past 8 years and its price has dropped significantly. I’m curious to know your views on mutual funds and financial advisors. Do you think I should find another, more reliable mutual fund? Keep my funds liquid? Or should I find a competent professional to manage my money for me? (Assume that I am not interested in managing my own portfolio)

A:If you need the money in less than five years, put it in a savings or money market account. It is best to let investments grow over a long period of time so that any minor downward fluctuations in price disappear. Assuming that you have no short-term need for the money, it is best to stay invested. How you are to stay invested is a more complicated matter. Since you are not interested in managing your own portfolio, you have three choices: an index fund, a mutual fund, or a professional manager/financial advisor. A mutual fund is an investment vehicle where the funds of many individuals are pooled and then managed by a professional investor for a fee. The track record of most mutual funds borders on the criminally negligent. An index fund is a mutual fund except that no attempt is made to beat the market. The fund manager buys every stock in the market or chosen index (S&P 500, Dow Jones Industrial, etc.). This way your returns will be the same as those of the market and your fees will be at a minimum. You can expect your long-term returns to be about 10% annually, if held for a significantly long period of time, because that is the general return on the stock-market as a whole. A professional manager is a business or an individual to whom you entrust your money for investment. Their fees can be either a percentage of assets under management, a percentage or profits, or some mix of both. The choice between the three is best determined by your financial acumen.

If you know little to nothing about valuing a business, stick with the various index funds. This will provide you the least amount of headaches and guarantee that you will receive the same return on your money as the market. Also, the fees tend to be lower than your other two choices.

If you know the difference between investing and speculation and can talk about P/E ratios and growth rates at least somewhat intelligently, then find a mutual fund. Look at a fund's investment philosophy. This can best be determined by its current and past holdings. If it claims to be a value fund, but its history shows rapid trading with no discernible pattern, find a more reliable fund. One of the keys to picking a good fund is to locate one with low turnover (buying and selling activity). Trading activity costs you money in the form of transaction fees. Also, look at returns in down years. If the market returns -10 percent, and the fund is up 20 percent that might be worth investigating. See how often the management changes. If there is a different person in charge of the fund every three years, keep looking. All of this information is available in the fund's promotional literature or on the web. If you cannot find it, call the company and ask. Always remember that you are trying to determine whether or not to trust these people with your money. Insist on taking every precaution and gather all the data necessary in order to make an informed decision.

Picking an individual manager or business to run your money can be tricky. This is a path you should only follow if you could manage your own portfolio at least somewhat intelligently. If you understand DCF to some degree, then you might be able to handle a private manager. If you are wondering what DCF stands for, forget about picking a private manager. Not only must you have knowledge of business valuation, but you must also be a fair judge of character. My family recently decided to pick a private manager for the bulk of our assets; so I am able to give an account of this process. The initial recommendation came from our accountant with whom we had worked for many years. My mother made an appointment with one of the managing partners of the firm in question and asked that I come with her since she knows nothing of common-stocks. I brushed up on the requirements for financial managers, went over all of my investing notes, looked over their promotional material, and compared their positions with their proclaimed philosophy. I found no red flags. I came up with a list of questions for the meeting. These ranged from everything to, "What would you do if a client's investing philosophy differed from yours and he asked you to take a more aggressive position than you felt comfortable?" to "What brought you into this business?". The meeting began with my mother and me on one side of the desk with the partner on the other side. We conversed until I ran out of questions. He explained every issue to the finest detail with my mother sitting in quiet confusion. There was no hesitation or rush. Every answer was clear and to my satisfaction. After the meeting, I told my mother that if I was to choose someone to manage my money, he would be the man. This experience led me to develop a qualitative criterion for selecting a manager. First, always meet the candidate in person and take note of the surroundings. You are looking for the fullest professionalism in dress and decoration. If something strikes you as questionable or suspicious, take note and investigate. Do not hesitate to ask about it; you are trying to decide whether or not to trust this person or organization with your money. Second, if the candidate in any way hurries you or denies you an answer to a reasonable question, strike him from the list. Third, find out what brought them into the business and how they think. You want to hear something along the lines of, "This is why I wake up in the morning." Look for passion; if you don't hear it, walk away. Finding good managers is extremely difficult. For every one manager of ability, there are at least two hundred who know less than you do. If you pay attention to the details and take your time, the return will be worth the effort.