7/30/2014 8:45 PM ET|
3 reasons investors have it good
With more choices, falling fees and lower tax rates, today's individual investors enjoy many advantages compared to just 20 years ago.
The markets have had a rough ride in the past two decades. But in many ways, investors have never had it so good.
The 1997 Asian currency crisis, the 1998 Russian debt default, the bursting of the tech-stock bubble starting in 2000, the housing-market collapse that began in 2006 and the 2008-2009 financial crisis all rattled the nerves of investors and hurt their portfolios. The stocks in the S&P 500 ($INX) generated an average return of just 4 percent annually, including dividends, between Dec. 31, 1999, when markets were booming, and last Thursday's close.
But something surprising happened along the way: The financial world became a much kinder place for U.S. investors, thanks to legislation and competition that have led to a growing array of investment choices, falling investment costs and tumbling tax rates. Investors also are blessed with access to better technology and more information than they had before.
Indeed, from today's perspective, the 1980s seem almost quaint. Investors subscribed to monthly newsletters, just to find out how their mutual funds were performing. They often called their brokers simply to get share-price quotes. Buying or selling a fund just before the 4 p.m. market close was nerve-racking, because of long wait times on fund-company phone lines.
By contrast, the investing landscape now offers many advantages to individual investors, though there also are potential pitfalls. Here is how to make the most of the innovations.
Today, individual investors can build portfolios that would have been the envy of many institutional investors two decades ago. Much of the credit goes to two developments.
First, in 1993, State Street (STT) introduced the first U.S. exchange-traded index fund. While mutual funds can only be traded once a day and are purchased directly from the fund company involved, ETFs are listed on the stock market and can be bought and sold throughout the trading day.
The fund, known as SPDR S&P 500 ETF (SPY), seeks to mimic the performance of the S&P 500 and charges an annual fee of 0.09 percent, or $9 for every $10,000 invested. Other popular ETFs also track broad market indexes and charge far less than most actively managed mutual funds.
The funds have rapidly gained popularity and could soon hit $2 trillion in assets -- almost as many investor dollars as there are in index mutual funds, calculates Chicago-based investment researcher Morningstar.
"ETFs have got people to focus their attention on costs and on indexing," says Rick Ferri, founder of Portfolio Solutions, an investment manager based in Troy, Michigan. "It's been a very good development in the industry, even if you don't use ETFs."
What's more, the wide array of ETFs allows investors to fine-tune their portfolios. The number of ETFs reached 1,332 at the end of 2013, up from 119 in 2003, according to the Investment Company Institute, a trade group.
For example, academic studies have lately emphasized the potential return advantage from overweighting "value stocks," low-volatility shares and stocks with momentum.
ETFs are available that mimic all these strategies, such as Vanguard Small-Cap Value ETF (VBR), which charges 0.09 percent, iShares MSCI All Country World Minimum Volatility ETF (ACWV), at 0.2 percent, and iShares MSCI USA Momentum Factor ETF (MTUM), at 0.15 percent.
Investors also can buy ETFs that track a number of individual countries and industry sectors. In addition, ETFs have opened up the world of alternative investments to ordinary investors. According to ETF.com, the eighth-largest ETF is the $34 billion SPDR Gold Shares (GLD), which tracks the price of gold bullion.
But be warned: The proliferation of ETFs may mean there are more ways to diversify, but it also means there are more ways to get into financial trouble.
While index funds were originally designed for patient investors looking to capture the market's long-run return at low cost, it seems many are using ETFs to trade in and out of narrow market sectors -- a side effect of the fact that ETFs can be bought and sold so easily during the trading day.
Some ETFs are highly volatile, such as ProShares Ultra S&P 500 (SSO), which charges 0.9 percent a year and aims to deliver double the daily return of the S&P 500 by using derivatives to leverage the market's performance.
"People are buying things they don't really understand, like the leveraged ETFs," notes Minneapolis financial planner Ross Levin. "There's a lot more ways to shoot yourself in the foot."
The second major development that has given investors more choice came in 1997, when the Treasury introduced a new type of government bond that delivers returns linked to the inflation rate. Suddenly, investors could buy an investment that was backed by the federal government and also offered protection against rising consumer prices. Those twin virtues make Treasury inflation-protected securities, or TIPS, perhaps the safest long-term investment available.
In recent years, investors have shown a growing appetite for TIPS. As of June 30, $1 trillion of TIPS were held by the public, up from $532 billion five years ago, and they now account for about 8 percent of all marketable Treasury securities.
Unfortunately, yields today are miserably low, with 10-year TIPS maturing in January 2025 recently yielding a tiny 0.3 percentage point more than inflation. Still, for home buyers, college savers and retirees who want to guarantee that the purchasing power of their money won't shrink in the years ahead, TIPS -- or, alternatively, Series I savings bonds, which also offer inflation protection -- can be a one-stop solution.
As investors increasingly shun actively managed mutual funds and instead put their money in market-tracking index mutual funds and ETFs, their investment costs have fallen sharply.
Do-it-yourself investors aren't the only beneficiaries. Many financial advisers, who at one time scorned index funds as guaranteeing mediocre performance, have embraced ETFs. One reason: They would rather cut fund costs than lower their own fees. For example, even if advisers are charging 1 percent a year, the total cost to their clients might be just 1.2 percent, if they put them in low-cost ETFs.
All this has helped drive down costs for fund investors. If you calculate an average that is weighted by the amount of money investors have in each fund, they paid 0.73 percent in fund expenses in 2013 for all stock-mutual funds and ETFs, according to Morningstar. That is down from 1 percent in 2003. Meanwhile, bond investors paid an average 0.6 percent last year, down from 0.74 percent a decade earlier.
By favoring low-expense funds, investors can tilt the odds in their favor and keep more of whatever the markets deliver. The savings can be substantial, particularly as the benefits compound over decades.
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VIDEO ON MSN MONEY
Investors might have to good, but the government has it better.
Just remember the government, whether the Democrats or Republicans are in the majority, love to see investors make profits. Profits mean more taxes.
Unfortunately when someone makes a nice profit, let's say $20,000, the government and rightfully so, gets the taxes on $20,000 of income. If that same investor losses $20,000 the next year, the government allows a deduction of only $3,000 of the loss. The remaining $17,000 will be carried forward and used up at $3,000 per year
An even harder set of rules apply if you win money on the lottery or at the casino. In one year, they tax you on your winnings, but when you give back part or all of your winnings the next year, you cannot deduct any losses. Certain states, like NY, have an even harsher rule on gambling winnings - your winnings on Friday cannot be fully offset by your losses on Saturday under certain circumstances.
The government is your partner when you make money, but they don't want to know you when you lose money.
I think it is better for the brokers, not the investors!
Years ago an investor could call a broker, get advise and buy or sell stocks for a commission on each trade. Nowadays the broker wants to manage your portfolio for an annual percentage based upon assets in the account. Fees average around 1% a year.
The broker that gave advice and got compensated by a transaction commission is a thing of the past. How can things be better for investors when they are either paying high management fees or left to manage their own portfolios without professional advice.
ON THE FLOOR AT THE STOCK MARKET.
The Vanguard S&P 500 Index Mutual Fund charges 0.05% and there are no fees to buy and sell shares. Why would you recommend an ETF that charges more?
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Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
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