GROUPIRA Learning Center

Education, strategies, and tools for our Members to invest better for whatever comes next in life.

Does Your Investment Strategy Work for You?

A common frustration of the financial services industry is the use of jargon that confuses people. An investor’s “asset allocation strategy,” is one example of financial services industry jargon. In simple terms, an asset allocation strategy answers the question: How do I invest my account balance? There are good and bad asset allocation strategies. The best strategies accomplish two things:

  • diversify investments, to reduce risk
  • provide suitable investment return potential, relative to your personal situation

Risk means the possibility of losing principal -- the amount you invest. Every investment has risk. Even keeping money in a bank account has risk. How? If your bank fails, and the U.S. Government does not guarantee your entire account balance, you may lose your money.

However, not taking suitable risk can be just as bad. Why? Over time, money loses purchasing power because the costs of goods and services generally rises. This effect is known as inflation. We see inflation everywhere. Inflation is why a can of Coca-Cola cost $0.05 in 1950 and about $1.00 today. If your investment returns exceed inflation, then your purchasing power increases over time.

There are many ways to measure inflation, but a good estimate is the U.S. Consumer Price Index. Historically, the average annual change in the U.S. Consumer Price Index has been slightly more than 3%. This means that if a can of Coca-Cola cost $1.00 today, we could reasonably expect it to cost $1.03 one year from now.

Investments with greater risk tend to provide greater investment return potential. Equity investments (ex. stocks and stock funds) provide the greatest return potential, but also carry the greatest risk. Fixed income investments (ex. bonds and bond funds) are generally less risky than stocks, but do not tend to provide as much investment return potential. Cash equivalents, such as money market funds, are generally the least risky asset class, but also provide the least opportunity for investment returns.

Investors with asset allocations weighted toward riskier investments are said to have a more aggressive asset allocation strategy. Conversely, investors with asset allocations weighted toward less risky investments are said to have a more conservative asset allocation strategy. Investors with a relatively even split of higher risk and lower risk asset allocations are said to have a balanced asset allocation strategy. As an example, below is one investor's asset allocation strategy.

Asset Class

Years to Retirement

40+

40 to 20

20 to 10

10 to 5

5 to 0

Equity Investments (Stocks and Real Estate)

100%

80%

60%

40%

20%

Fixed Income Investments (Bonds)

0%

20%

35%

50%

65%

Cash Equivalents (Money Market)

0%

0%

5%

10%

15%

Total

100%

100%

100%

100%

100%

Notice the asset allocation change from an aggressive asset allocation strategy to a conservative asset allocation strategy as the investor approaches retirement. Generally, investors closer to retirement should take less risk with their asset allocation strategy because they have less time to recoup potential investment losses. Likewise, investors further from retirement can assume more risk for potentially greater returns.

Knowing your retirement horizon is important before developing your personal asset allocation strategy. In addition, you should always consider investment objectives, risks, charges, and expenses before investing. If you would like to learn more or review your specific situation, our IRA Consultants are happy to assist.

Wall Street Does Not Want You to Know This About Mutual Funds

One of the mutual fund industry’s dirty little secrets is that mutual funds with identical names, identical fund managers, and identical investment objectives are not identical. This is a lesson in the murky world of mutual fund share classes.

Mutual funds can be sold in different share classes, where the principal difference among share classes are the fees and expense the fund will charge you. In fact, it is common for a mutual fund to have some share classes that cost 100% or more than other competitively priced share classes. Imagine buying a car at your local auto dealer and the sales agent tells you that two cars of identical make, model, condition, and options were priced at $20,000 and $40,000 respectively. What would be your reaction? Sadly, this is exactly what is happening in the mutual fund business. More on that in a minute, but first a little background on mutual funds.

Mutual funds are collective pools of money, managed by professional investment managers. The investment manager makes all investment decisions. In fact, the only decision investors make is which investment manager they hire or fire. Investors hire managers by purchasing mutual fund shares. Investors fire managers by redeeming their mutual fund shares. When a mutual fund is purchased, the investor’s money is transferred into the mutual fund pool. Once in the pool, investment managers are in control and decide what to buy or sell (stocks, bonds, commodities, etc.). When you fire an investment manager by redeeming your shares, the mutual fund company returns to you the proceeds.

Investment managers do not manage money for charity — they do so for a fee. This fee is known as the mutual fund expense ratio. The expense ratio is expressed as a percentage and reflects the mutual fund’s annual charge to investors. Mutual funds generally calculate their fees daily, so a fund with an expense ratio of 2.00% may charge (2.00% / 365) against an investor’s balance each day.

Now let’s consider the effect of different share classes by looking at a real world example — the PIMCO Total Return Fund. As of this writing, the PIMCO Total Return Fund is among the largest mutual funds in the world. In fact, you may own this mutual fund in your Individual Retirement Account or 401k plan. The PIMCO Total Return Fund is offered in a range of share classes:

  • Share Class A (PTTAX) – Expense Ratio: 0.85%, Minimum Initial Purchase: $1,000
  • Share Class C (PTTCX) – Expense Ratio: 1.60%, Minimum Initial Purchase: $1,000
  • Share Class D (PTTDX) – Expense Ratio: 0.75%, Minimum Initial Purchase: $1,000
  • Share Class P (PTTPX) – Expense Ratio: 0.56%, Minimum Initial Purchase: $1 Million
  • Share Class R (PTRRX) – Expense Ratio: 1.10%, Minimum Initial Purchase: None
  • Share Class Admin (PTRAX) – Expense Ratio: 0.71%, Minimum Initial Purchase: $1 Million
  • Share Class Instl (PTTRX) – Expense Ratio: 0.46%, Minimum Initial Purchase: $1 Million

The mutual fund objectives and the investment manager are identical, but the expenses vary significantly among the share classes. Another significant difference among the share classes is the minimum initial purchase. Mutual fund companies often reward large investors with more favorably priced share classes because they are purchasing in bulk. It is similar to Costco selling bulk products for less than you pay at convenience stores.

What investors do not always know is that a better priced share class may be available. The savings to investors can be significant, especially when considering that mutual funds are often purchased in retirement accounts with a buy-and-hold investment strategy. Investors should do their homework before purchasing mutual funds, lest they risk spending more than necessary. If you would like to learn more or review your specific situation, our IRA Consultants are happy to assist.