NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.

A nice place to learn about investment terms is Investopedia.  Here is there definition of an Index Fund.

A type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.

Good… but I’m not sure what they mean when they say, “… is said to provide…”.  An Index fund actually does these things.  Unless, you get a very specific type of index fund that focuses on a small market segment.  Let’s look at an S&P 500 Index Fund.

Broad Market Exposure

This index fund invests in 500 stocks.  500 different US companies.  This is very broad exposure.  If one of those 500 stocks goes to $0.00 in just one day it will only bring down your portfolio 0.2%.  The whole market can move more than that in a day.  You will never even notice the loss.  This also works on the upside, if one of those 500 stocks double it will only give you a 0.2% bump.  This broad market exposure effectively reduces your volatility.

Low Operating Expenses

If you are in a 401(k) or a 403(b) you may see index funds with expense ratios as low as 0.5% to 0.8%.  The average mutual fund has an expense ratio of around 1.6%.  The extra 1% savings could make a big difference over time.  If you go to Vanguard, you can get index funds with expense ratios lower than 0.2%.

Low Portfolio Turnover

If you are in a taxable account this can really pull down your performance.  If a stock is held for more than a year than you will only pay capital gains of 15%.  However, a stock sold in less than a year can be taxed as high as 35% – Ouch!  An S&P index fund may change only 2-4 % of the funds in a given year.  A managed fund can change 100% or more (sell twice) in one year.  Even if your managed fund beats the market you may get killed on taxes.

One of my investment rules…. By Index Funds whenever you can!

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In: Investing

Comments Off on How Did Your Portfolio Do In 2010?

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action. 

One of the thing I recommend to all investors is an annual review of your account.  However, you need to have reference points to compare it against.  Below is a short list of some investment averages and how they have done over the last 1,3,5 and 10 years.  These are just for a reference but can be a good guide to see how you are doing.

  1 Year Avg 3 Year Avg 5 Year Avg 10 Year Avg
Europe Stock Average 7.98 -8.44 3.47 6.24
Foreign Stock Average 11.97 -5.88 3.80 5.26
         
Short-Term Bond Average 4.22 3.52 3.92 3.94
Intermediate-Term Bond Average 7.64 5.83 5.45 5.55
Long-Term Bond Average 10.51 7.28 6.11 7.20
         
Large Growth Average 16.00 -2.04 3.01 0.69
Large Value Average 14.11 -3.42 1.62 3.50
Mid-Cap Growth Average 24.58 -0.48 4.70 3.28
Mid-Cap Value Average 21.74 1.07 3.88 7.37
Small Growth Average 26.95 0.60 4.28 4.28
Small Value Average 26.62 4.65 4.65 9.65

If you have a small cap mutual fund then you should have made around 26 -27% return in 2010.  If you only made 10% then either you don’t really have a small cap fund or it… er … um… sucks.  Some funds try hard to stick to one part of the market – others do not so it can be hard to tell.  If you aren’t sure how your funds did last year just send me an e-mail and I will look them up for you.  If you have more than $20,000 you should use multiple funds to balance your goal and reduce your volatility.

Below is a sample portfolio.  It is mostly stocks but has some bonds and some international investments as well.  The exact percentages don’t matter.  What is important is that the swings are not as big.  Look at the 1 year return of 16.32%.  Not as high as the small cap average but better than bonds, international and large cap.  A variety of funds can lower the volatility – so you can sleep at night.

  1 Year Avg 3 Year Avg 5 Year Avg 10 Year Avg
Sample Portfolio 16.32 1.07 4.55 5.88

I hope this helped and good luck in 2011.

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In: Investing

Comments Off on The Lottery As My Retirement Plan

NOTE: This post is part of an ongoing education series. This information is for educational purposes only. This information does not constitute investment advice. Please consult with your financial advisor before taking any action. For planning advice contact Polaris Financial Planning. 

Are you worried about saving enough for retirement?  Do you think that buying a lottery ticket is a good way to get to retirement?  Think again!  The lottery should never ever be thought of as a way to save for retirement.

If you want to have a little fun by spending a few dollars on a couple of tickets – go ahead.  But, most people have a hard time understanding the odds of winning.

I see the lottery is a regressive tax that is put in place by lazy politician that don’t want to make the needed effort to solve fiscal problems.  A regressive tax places a higher burden on those that can least afford it and in many cases least likely to understand it.

I am going to look at the Mega Millions lottery.

According their website it costs just $1.00 and here are the odds of winning.

Mega Millions index

The odds of winning “any prize” is 1 in 14.7!  So if you play 15 times ($15) you have a good chance of winning $1 and about 1 in 4 chance of winning an extra $2.  I would guess that most people don’t play the lottery to win $1 but, it can be enough of a reward to get you to keep “Playing”.  So, we will need to look at the odds of winning the big prizes.

The jackpot is tricky to analyze because the amount changes from week to week.  Today the prize is $91 Million if you are willing to wait 30 years for all of the money to be paid out and $56 million if you take it all today.  So if you bought every possible number combination or 258,890,850 tickets you would win $56,000,000.  A payback of about 21.6%.

Your odds of being hit by lightning in your life is about 1 in 12,000.  You are 21,574 times more likely to get hit by lightning then winning the Mega Millions with one ticket.  Well, people who don’t know the odds don’t just buy one ticket!

What happens if you buy more tickets?  I love to make extreme examples to show how ridiculous things are.  If you spend $100 per day from the age of 18 to the age of 67 in Mega Millions tickets. That would be around 1.788 million tickets (or $1,788,000).  Your odds of winning would be about 0.69%.  There is a 99.31% chance you get nothing (remember we are only talking about the jackpot).

If you invested that money each and every year and made 10% a year you would have over  $40,000,000.  So you could have over $40 million or you could have a less than 1% chance to win $56 million.