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March-14-12

Are mutual funds getting a bad rap?

It seems that mutual funds are getting a bad rap these days and exchange traded funds have been praised as the new “best” investment tool.

When we construct portfolios, we look for vehicles that fill a spot in the asset allocation we have identified for our client. The characteristics we look for are:

  • Broad diversification
  • Low cost
  • Low turnover and tax efficiency (especially for taxable accounts)
  • High liquidity
  • Transparency
  • Exposure to an investing factor we want to include in the portfolio (Factors we look for include the overall allocation between fixed income and equities, an equity tilt to small companies, an equity tilt to value companies, and exposure to stocks exhibiting momentum, when possible.)
  • Exposure to an asset class which is to be included in our portfolio.

If these characteristics are available, the structure as an ETF or mutual fund is not a material consideration. So don’t let the mutual fund tag deter you from considering it as a viable investment vehicle.

By: Kathleen Clough | 1 comments
March-13-12

Too Many Choices: Decision Paralysis

Research conducted by academics with the Graduate Business School of Columbia University and Department of Psychology of Stanford University1 shows that too much choice can lead to either “decision anxiety”, where people have a hard time making a decision, or “decision paralysis”, where indecision leads to no decision.

These conclusions were reached after a number of studies, one of which involved tasting booths at a supermarket. One booth had 6 types of jams available for tasting. Another had 24 flavours. While the majority of shoppers were drawn to the booth with the larger selection, those who visited the booth with only 6 jams were 10 times more likely to buy a jar of jam.

This seems counter-intuitive. Shouldn’t more choice result in more sales, as more people are able to find a product they want? It seems not – more choice resulted in fewer paying customers.

While we are not in the business of selling jam, the investment field is one that offers a lot of choice – thousands of mutual funds and hundreds of exchange traded funds are available, all vying for the attention of investors. In fact, I think back to the days when I was reluctant to become a licensed investment advisor. I had a major concern – how would I determine which of the thousands of mutual funds I would recommend to clients? It was only after defining a solid investment philosophy that I realized I could eliminate the majority of funds and narrow the pool to a few that fit the criteria defined by the philosophy.

Decision anxiety or paralysis around investment choices can be caused by the desire to make the perfect decision – something that is impossible to know in advance. If we focus on performance, we will likely be able to look back and find another investment that performed better than the one we chose. So agonizing over the perfect or best product is a non-starter. More importantly, investors should focus on the process and a bigger picture approach:

  • Ensure your portfolio is property aligned with your risk tolerance as well as your goals and time horizon. This means you must have a plan.
  • Rebalance regularly – portfolios get out of balance when one asset class performs differently than another and must be brought back into line.
  • Keep costs in check – high fees are very detrimental to investment returns.
  • Keep tax to a minimum – high tax can also be detrimental to investment returns.
  • Keep emotions in check – this can be a make or break issue when it comes to investing, regardless of the investment products chosen.

Focussing on these areas will prove infinitely more valuable and will provide a far superior real-life investment success, than spending countless hours trying to decide if Fund A will outperform Fund B next year.

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[1] “When Choice is Demotivating: Can One Desire Too Much of a Good Thing?”, Sheena S. Ivengar, Columbia University and Mark R. Lipper, Stanford University.  Journal of Personality and Social Psychology, 2000, Vol. 79, No. 6, 995-1006.

By: Kathleen Clough | 0 comments