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Investing in Treasury securities

Dr. Don,
U. S. Treasuries. I don't know anything about them. Where can I get information?
Karl Capital

Karl,
The Bureau of Public Debt has a primer on Treasury securities on its Web site. You'll learn all about what is considered to be the safest investment on the planet. You can also learn about investing in U.S. Savings Bonds.

Mutual fund returns

Dr. Don,
How do I find out how actively managed my mutual funds are since I understand that the cost of managing and buying/selling my share in any mutual fund will lower the "real" return on my investment?
TK Oh

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Dear TK,
You've brought up some important points about investing in mutual funds, but you've mixed them all together. Here's how I would have you look at these concerns.

All mutual funds have annual expenses. These expenses are typically a combination of management and marketing fees. The fund manager is paid a percentage for managing the fund's investments and even a no-load mutual fund can charge annual fees for marketing the fund. The marketing fees are called 12b-1 fees and are separate from any sales loads (commissions) charged by a mutual fund. (No-load funds are called that because they don't charge a sales load.) Small funds and specialty funds typically have higher annual expense ratios than large funds, index funds, or funds investing in large capitalization stocks.

A fund manager is being paid to make trading decisions on the investments in the fund. Even an index fund will have turnover as changes to the index necessitate changes in the mutual fund, but high turnover can be bad on two fronts. A mutual fund is required to pass through the gains (losses) and income that the fund realizes in a year. Since capital gains (losses) aren't realized until a stock is sold, a fund with high turnover is more likely to generate a tax liability in the current year than a fund with low turnover. So tax efficiency is one consideration when looking at a mutual fund's turnover ratio. A second concern is that a fund with high turnover isn't taking a long enough view when making investments. The commissions paid by the mutual fund when trading stocks in the fund aren't something that you need to be concerned about.

To show how these factors can differ between mutual funds, I've chosen two mutual funds and compared them on the basis of annual expense ratio, tax efficiency, turnover, and sales loads. While the comparison wasn't random, there's no implied recommendation of one fund vs. another in the comparison.

According to Morningstar, the Vanguard Index 500 fund (VFINX) has an annual expense ratio of 0.18 percent, a tax efficiency ratio of 90.99 percent, turnover of 9 percent, and is a no-load mutual fund. In contrast, AXP Blue Chip Advantage A (IBLUX) has an annual expense ratio of 0.83 percent, a tax efficiency ratio of 43.40 percent, a turnover ratio of 81 percent, and clients pay a front-end sales load of 5.75 percent.

To be fair, the Vanguard Index 500 is both an index fund and one of the world's largest mutual funds. It will have a low turnover because it is an index fund. Sales loads are a common method of compensating financial advisers for their services, and investors that depend on a financial adviser when making investment decisions should be aware that they are paying for that service through a sales load.

There are dozens of sites that you can use to review mutual funds. Morningstar.com and TheStreet.com are the two sites that I use to review mutual funds before going on to read a fund's prospectus.

If I'm looking for a foreign stock fund, a sector fund, a small-cap or mid-cap fund, I realize that the annual expense ratios are going to be higher than for an index fund or large cap fund. On the other hand, if I'm having trouble deciding between two funds, I'll always choose the one with the lower expense ratios. A mutual fund's tax efficiency is much more important in taxable accounts than it is in tax-advantaged or tax-deferred retirement accounts such as Roth IRAs, traditional IRAs and 401(k)s.

Be aware of the commissions and expenses that you pay to invest in mutual funds, but don't let them be your only concern when investing. What the fund invests in, its stated objectives and how the investment relates to your other investments is important, too.

-- Posted: July 6, 2001

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