10/29/2003    

Mutual Fund Scams

Have any of you ever thought that a mutual fund is a safe way to invest?  Sure, we all have. The premise is so simple. Groups of people pool their money and reduce their risk by buying a large bunch of stocks together.  You could never buy all of those stocks, right?  Right, you couldn't.  But you wouldn't want to either!

The idea is so simple and sounds so safe and sound. But is it really?  Just recently the press has drawn attention to unethical practices in mutual funds.  Our safe and sure investment has come under attack.  It seems that big fund buyers have been allowed to trade the funds after-hours, and so have some of the fund managers for their private accounts! 

This is considered 'timing the market' and has been called unethical because most of the funds discourage or prohibit it for their customers.  Even most discount brokerage houses punish anyone who wants to buy a mutual fund through their ?Mutual Fund Marketplace? and get out of it prior to a 6-month holding period.  The punishment is a high fee.

Let me tell you about mutual funds.  I touched on them last week and promised to explain some of the terms I used. Mutual funds come in all shapes and sizes. There are stock funds, bond funds, gold funds, index funds, and money market funds.  They can be 'load' funds or 'no-loads.'  Then there are the hideous 'A' and 'B' funds sold by full service brokerage houses. 

If you are still with a full service brokerage, please do not be sucked into buying an 'A' or 'B' fund.  The 'A' funds have an upfront load (commission to the seller) of 5% to 8%  and the 'B' funds have a back end load.  The 'B' funds are usually pushed by the broker (who, by the way, is a salesman) as being more suitable and economical for you because,  if you stay in the fund for five years, you will pay NO commission.  However, do you really want to be in the same investment for 5 years?  Think about it.  Do you even want to stay in your house for the next five years?

To my surprise, after viewing a few prospectuses, I found that the 'B' funds have a higher ongoing management fees than the A funds!  Here's another reason for your kind broker to push a 'B' fund.  That's an extra percent or two a year the millionaire fund manager charges for ?managing? your fund and the broker gets a cut of it.  Some fund managers buy and sell often and have high turnovers and some buy and sell infrequently and have low turnovers.  However, the turnover does not affect the management fees as the following story will show: 

Here is an amusing but sad story from my own experience. A Solomon Smith Barney broker sold me their Aggressive Growth Stock Fund, 'B' fund.  The yearly management fee (hidden in the prospectus) was a whopping 2%.  This is not 2% of the gains, just 2% of what is invested, period. There was a nice list of the stocks in the fund on the broker's website and in the prospectus and the top 10 could be found on Morningstar.com.

By the way, I can mention the name of the brokerage because it has now been changed for some reason.  Could it be Jack Grubman, WorldCom, or maybe Global Crossing? .   

Well, anyway, every few months I looked at the list of stocks that were being managed for me in the fund. To my amazement, they never changed.  Quarter after quarter they stayed the same.  Well, I wasn't the only one to notice that my 2% management fee was being charged for the manager to do NOTHING.  Herb Greenberg on the Street.com noticed and wrote an article blasting the brokerage and their owner, Citigroup.  Instantly, the group of stocks changed.  The millionaire manager was FORCED to actually look at the stocks, weed out the bad ones, and replace them with some better ones, I assume.  I really don't if they were better because I dropped the fund and gladly paid the 5% back end load fee just to get out of it.

If you are interested in baskets of stocks, the best thing to do is buy an ETF or electronically traded fund. They generally are called I-shares for Indexes or Holders for industry sectors. You can get in and out whenever you want to with the click of your computer mouse because they trade just like stocks.  The most popular are the QQQ's and the SPYs, which represent the largest capitalization stocks in the Nasdaq and the S&P 500.  You can also buy Diamonds, (DIA?s) which represent the 30 Dow stocks.
In fact, you can buy over 100 different ETFs. 

Right now we at the Tactical Investor are in the ETF for Health Care, which has a symbol of IYH. (it is an industry holder)  We are also in the OIH, (another holder) which represents many stocks in the oil service industry.  These are contrarian intermediate to long term picks because they were extremely beaten down and oversold when Sol recommended them.

We like to buy low and sell high, and that is what we will do. When everyone else jumps in and pushes the stocks into the technically overbought range, we will exit with the ETFs we bought at bargain prices. 

Every woman likes a bargain, right?  I sure do.  If you stick with ETFs and a few good sector funds when warranted, you will be accomplishing the same thing as being in a mutual fund, but at a discount price. 
                   tacticaltracey@tacticalinvestor.com.