Posts Tagged ‘where to invest’

In an article published at Bloomberg.com on March 18, 2010, it was noted that bonds issued by financial services firms like JP Morgan and Credit Suisse in particular came with rates that were substantially higher than rates in the general market. What this means for mutual funds and growth funds in particular is that there is plenty of opportunity in the financial services sector. Let’s take a closer look.

The Bloomberg article in questions makes it quite clear that the debt sold by banks, brokers and insurers returned 0.81% compared to the broader market’s return of 0.48%. This is a premium of more than 80% over what the broader market dictates. Consider this for a minute as we explore another interesting comment that was made in the article in question.

Brian Machan, a money manager at Aviva was quoted as saying that very few people are “underweight” in financials. This means that mutual funds are heavily buying up this debt. They are doing it because it looks attractive. The reason it might look attractive is that the yield is expected to drop, thereby increasing the value of those bonds on the open market.

The flip-side is that the financial services firms issuing this debt find rates attractive. This means they expect rates to increase in the future, allowing them to finance debt at today’s currently low rates. All indications support a rising interest rate environment; if ever there was a time to issue corporate debt now be that time (to the benefit of the borrower, that is).

Now, getting back to the premium paid by these financial services firms. Consider why they might need to raise this type of capital. It is cheap. Plus it helps finance a whole lot of plans. These banks have something up their sleeve and it is just around the corner by the look of things.

As far as growth funds are concerned, the mutual funds that are bullish on financial services such as the Ivy Small Cap fund we wrote about already or the Dryden fund we bragged about earlier, send a strong message to the investment community: financial services stocks are expected to outperform. This sure seems to be supported by the level of debt they are confidently raising right about now.

Other growth funds that invest heavily in financial services stocks include the FBR Small Cap Financial fund which has a history of LOW risk and above average returns. Morningstar rates it as a 5-star fund! Like the Ivy Small Cap fund that we touted as our Top Small Cap Pick for 2010, the FBR fund has a large interest in Iberiabank and East West Bancorp, regional banks that stand to substantially benefit from a positive shift in the economy.

Regardless of what type of mutual fund you choose, ensure that your growth funds have at least some exposure to the financial services sector. Whether they are smaller, regional financial companies like those held in the IVY or FBR mutual funds or larger banks like JP Morgan and Credit Suisse, the indications are quite clear that these firms expect to reap the profits and rewards of an economic turnaround that is just waiting to happen.

It may seems obvious to some and it is definitely obvious once it is pointed out to investors, but where to invest in periods of economic expansion is definitely not in typical bond portfolios. Instead, value funds or mutual funds with a good blend of value and growth securities would be the most logical place to start. As an investment strategy, this is not an art or a learned skill; it simply makes sense once the description of an economic expansion is properly understood.

So what is an economic expansion?

According to Smart Money, which published a great article about the Yield Curve, and economic expansion typically occurs immediately after a recession. Now, we have to be careful about how we define a recession. Yes, it means for tough economic times and periods of cutting back and sacrifices. But economically, a recession is different than what people like you and I experience. Instead, a recession is categories by certain economic statistics, including among other things, several periods of consecutive negative growth. Once that trend is broken and other economic statistics line up, that recession is over. And strange things start to happen.

Like what?

For starters, yields on treasuries and bonds steepen. This means that the rate on a 3 month treasury bill more than 3% lower than the rate charged on a 30-year treasury bond. As of today (March 15, 2010, that spread is more like 4.47%), this certainly holds true according to data on bloomberg.com. And if the Yield Curve is at all accurate in everything it has suggested since the late 1970’s, then we are in a period where the economy is expected to start growing quickly in the near future.

What does that tell us about where to invest!

Before we get to that, consider what it tells us about where not to invest. Obviously, when rates are expected to increase (everything we hear today combined with the yield curve tell us as much), bonds are out of the question. This means lightening up on income-class securities and moving money into equity based securities.

But does that mean growth funds or value funds (or a blend of both).

At the Mutual Fund Site, we have suggested that some small cap funds are actually no brainers. We outline the reasons why in some detail, but let’s look at the most fundamental reasons why some small caps are a good starting point:

• Value. Yes, we said it. Small caps offer tremendous value right now. Why? Because they were beaten down the credit crisis of 2007 dragged through 2008 and into 2009. The fear was that small cap stocks would disappear off the face of the earth once they could not fund their operations through credit or they went broke trying to make payments on higher-rate capital. In many cases, this did not happen and the survivors stand to benefit. In our case, we like regional financial institutions because they have government stimulus and people’s returning to work (okay, in some cases where employment is over 20% like in some areas of California, this seems like a stretch, but things will improve even in these highly unemployed areas) on their side. Plus, many of these companies have been very profitable during the last few years… even with the world crumbling around them!
• Small caps are one of the first segments to record steeper profit growth. This could be a numbers game in some cases, but it could also be the result of smaller companies willing to take the risks that larger corporations are unable to take. Blame it on smaller boards, less restrictive financial covenants, etc., but smaller cap companies take risks where larger companies simply will not… and this often bodes well for them.
• Lastly, small cap securities are one of the first to experience a “pop” in security price when recessions are over. Look at Citigroup as an obvious example (although you cannot say they are small cap, their story is quite well known). When it became clear that they would survive after all, its share price popped on the news alone. All they had to say was they were going to survive! Imagine a company that had numbers to back this up! Small caps have those numbers.

Does that mean we recommend small cap stocks? If small cap stocks are where to invest, what does that say about less risky alternatives?

Well, we believe that value funds are where to invest. Because even larger cap securities (and many mutual funds hold them) offer tremendous value, even in today’s market. And this is where investors should be — in value funds or funds that invest in such securities. Is it too late? No, not if we believe what the yield curve is telling us. I mean, look at GE, one of the world’s largest and most-diversified conglomerates. In 2008, its stock price touched below $6.00. Talk about extreme value… now it trade at nearly $16 and it still has inherent value.

Of course, we advise clients to be careful when they look at value funds and make sure they are investing in something that meets their investment needs and risk tolerance.

When we have so many mutual funds to choose from, we often get lost in some of the irrelevant details. We seem to want to chase the next trend, the biggest or hottest sectors and so on. Bond funds, value funds, dividend funds; we talk about these specific investments right here on our site just as planner do with their clients. If we were looking at economic figures, we would call it micro-economics. But when it comes to investments and mutual funds in particular, taking a macro-economic approach might actually help tell us about where investors should steer their money.

If we look globally, for example, we see that the Japanese Yen has been taking a hit over the last week or so because of that country’s position on interest rates. Unlike the US where the economy is (finally) starting to grow and rates have increased (Fed Funds Rate) and are expected to continue to increase, Japan is looking to reduce rates so that people will borrow and therefore buy more. While this fiscal policy will devalue their currency, the implications for Japanese corporations, particularly those that export their goods, are actually very positive.

In fact, a devaluation in currency combined with increased foreign spending will have a turbocharging effect on Japanese companies that report their financial results in Yen. Not only will sales revenue increase, but if foreign dollars are being used to purchase goods, the currency conversion results in a forex gain on the financial statements.

This could be a bad thing in the long-term. As the Yen stabilizes and starts gaining in value again, the company may have forex losses which can offset or more-than-offset stable or even climbing revenues.

What this means for mutual fund investors that is that Japanese-heavy value mutual funds might be a safe bet for shorter-term gains. Why? Because the premise of a value mutual fund is that the securities held within the portfolio are undervalued. This can be based on any number of criteria, but are normally price-to-earnings, price-to-book (value), price-to-cash and so on and so forth. Ultimately, the fund manager will determine whether to include a security in his or her value fund, but the qualifying criteria will come down to one thing: the security is underpriced.

This security, mind you, can be equity or income based. Right now, investors would gain either way. Japanese bonds can very easily increase in value if rates start dropping. Japanese equities can also increase, but it could take more time before revenues start to increase and translate in to balance sheet strength.

Our next step is pick a value mutual fund that meets our specific investment objectives (with time and risk as the driving force behind such a decision).

Now this is a top-down investment approach. It is how the Mutual Fund Site comes across mutual fund recommendations. A financial planner and/or investment advisor will work this way as well. Except they do this by also understanding your goals and matching up your goals and beliefs as best as they can to the macro-economic situation.

A long-term investors who has a decent appetite for risk will be ill-served to keep all of his or her investments in domestic securities. It normally “fits” to incorporate foreign or global investments into the plan. It never (or it should never) involve finding a value fund and then justifying a reason why it makes sense.

With that in mind, buying any kind of mutual fund because of a recommendation is often the wrong approach. Taking a bottom-down, birds-eye approach to your investments always makes more sense.

As one of the BRIC nations (Brazil, Russia, India and China), China represents a huge opportunity for investors with nerves of steel and a risk tolerance that most people would love to have (particularly when it comes to alpha-male poker tourneys). When it comes to mutual funds, legendary manager Anthony Bolton has come out of retirement specifically to head up a brand new, China-based mutual fund for one of the leading fund companies in the world – Fidelity. So what does that tells us regular folks about the merits of China insofar as growth funds are concerned?

For starters, it confirms the global opinion that China certainly presents a huge investment opportunity. This is not simply a North American view (Bolton is, or was, based out of the UK and his track record from 1997 to 2007 with Fidelity’s Special Situations Fund speaks for itself). But investment field aside, all industries are a little nervous about China. Why? Because of what will happen as their economy grows.

See, as China’s economy continues to grow, the financial demographics of their population will shift. There will be a growing middle class, regardless of what naysayers might preach about the socialist possibilities of their government. There is already evidence of this as Chinese workers outsource their skills to the world through the internet and other legitimate venues. In addition, China is one of the world’s largest student’s of the English language. It is estimated by People Stream that as China becomes the world’s largest English-speaking nation, the market will increase by 300 million possible employees. Even at 1/2 of the salary (this is being generous) of North American employees, Chinese candidates present a huge cost savings for companies that need English-speaking individuals. (You can view their 5-minute YouTube presentation here). For the Chinese, this translates into a growing middle class with growing middle class wants and vices. Even if the naysayers are right and a “socialist” government controls Chinese markets when they cannot control the inflow of wealth, they may be able to control where that wealth is spent. Regardless of whether there is much control, a lot of that wealth will be spent in China, allowing Chinese companies to see a long road of prosperity ahead of them. And that is as of today! Not five years from now, but right now.

Some of the risks to investing in China are well-known already. They include poor transparency in terms of environmental controls. Poor transparency in terms of financial reporting. They include a currency that the government will not allow to fluctuate on the free market (it is pegged to another currency, the US dollar). These are all risks; an investor might find a great Chinese company one day only to find that it has not made a dime or was bankrupt or presented inaccurate financial records or was penalized for not having the right government contracts and so on and so forth. In other words, it could be gone within a matter of days… These are real risks with investment in China.

By holding a growth fund with a China focus, investors would hope that the mutual fund manager has done his or her due diligence. Some funds, however, will not do this properly, they will not visit the company or do more than analyze the figures. There could be more risk with funds with low assets under management than larger funds with enough of a capital base to fund such trips to China. The bottom line is that investors should approach these types of investments with a great deal of caution. They should understand the thinking behind the fund itself and should be comfortable with the management team. With such things out of the way, investors looking to enjoy long-term growth will surely be rewarded.

There are plenty of reasons why investors should steer away from mutual funds that invest in gold. While some mutual funds have performed well thanks to their gold holdings, there is a lot of concern among professional money managers that gold may have reached the end of the profit road.

It could be one of those situations where hindsight will tell us that the warnings signs were all to apparent. Here are some of them:

Consider the abundance of infomercials on television that ask people to send in their unused gold to be converted into “cash.” At these prices, many of these companies are able to turn a nice profit from all of that activity – in fact, they can even offer to pick up the tab on the courier expenses and insurance. The bottom line is that Gold is at a healthy, attractive price right now… if you are selling it.

…there are some fundamental reasons to steer clear of gold and gold funds

When it comes to investing in gold, one of the most active players are Exchange Traded Funds. Think about that. ETF’s, not central banks, not large financial institutions. What this tells us is that retail investors, who are investing in these ETF’s, are picking up Gold at prices that are so attractive that some of the largest countries in the world are offloading the metal at extremely lucrative prices. What Contrarian Profits.com points out is that when these investors decide to take a profit, the selling of gold by these exchange traded funds will push the price of gold down faster and farther than most expect.

And this makes a great deal of sense. Consider oil. The year was 2008, the month was July and oil touched $147.30, the highest it had ever seen. Since then, oil gradually fell (okay, that’s being polite: oil actually fell like a stone) to under $40 by November of that same year. This does no suggest that gold will suffer the same fate, but nobody expected crude oil to take such a drastic hit in such a short period of time. In fact, some analysts were calling for oil to hit $250 by the following summer (it never reached that).

Although they called crude oil the new “liquid gold” there are more than just rhetorical similarities between the two. First off, oil ran up as the economy reached its peak. Gold, on the other hand became a lot more overbought as the economy reached its trough and has begun to recover. For gold to remain in high demand, the economy needs to remain beaten down and all other inflation hedging investments lights currencies as well as other commodities become less attractive. Ultimately gold prices can be seen as highly sensitive and linked to the economic cycle.

Secondly, oil is a commodity, just as gold is. Just as oil supply is essentially limited and its production is controlled by OPEC, so too is gold supply controlled. In fact, gold production and supply is also shrinking. The point here is simply that arguments that gold will continues to see its prices climb in steady succession are unfounded and cannot be mistaken as fact, despite what some of the others are saying.

Essentially, the Mutual Fund Site believes that gold is expensive right now. We agree with Contrarian Profits that there are some fundamental reasons to steer clear of gold and gold funds that are heavily invested in the commodity, including some Gold ETFs. But because of this uncertainty, we also do not recommend taking a short position against the commodity either; it is best to sit this one out rather than endure a painful recovery process like those who, in the 1980’s bought Gold in the high $500’s and had to wait over fifteen (15) years for the prices to reach such highs again.

Recently, the Mutual Fund Site presented a post about the easiest and smartest investment strategy: investing regularly on an automated contribution plan. This investment strategy is also (or better) known as Dollar Cost Averaging and makes perfect sense when used with mutual funds, whether more-volatile funds that invest in small cap stocks, index funds, or even bond funds.

Aside from buying more units when the markets are down (and less units when the market is up), Dollar Cost Averaging strips the issue of “market timing” out of your investment strategy. This can be fairly important because virtually nobody can “time” the market with absolute accuracy. That means only luck and no amount of research can help an investor buy at the absolute lowest.

Likewise, even the unluckiest investor will have difficulty buying at the absolute highest, but we often feel that way – that we bought at the highest and now our investments are doomed to fail.

This is where Dollar Cost Averaging makes great sense. Not only because it takes the “guess” work and “luck” out of the situation, but because historically it errs on the up-side. That means that if you use dollar cost averaging, your returns are more likely going to resemble the returns of someone who has the great luck and skill to buy at the absolutely lowest days.

This may seem strange because one would think that, statistically, you are more likely to buy the “average” or median between the best and worst possible days to invest. This would be true in a flat market, but historically markets have risen. Therefore, in a 10-year rolling average, even the “worst” possible day will be the best day at some point.

In fact, a Canadian Financial institution actually ran these numbers based on their market, the S&P TSX index. In their illustration, if you were to invest at the absolute worst days over the period of 1989 through to 2009, your returns would still be positive at 5.42% annually. The absolute best days: 7.36%.

And by employing a Dollar Cost Averaging strategy and invested each month on the first business day of the month, your return would have been 6.38%, less than 1% lower than if you had invested at the absolute best time possible for the year but nearly 2% better than if you had invested on the absolute worst days.

Interesting that a simple, more-affordable strategy could yield such positive results. But again, when you look at the historically rising market, it makes sense. In a declining market, the rates above would probably be reversed, but ultimately, investing through an automated investment program (dollar cost averaging) allows you the benefits of not having to worry about the impossibility of market timing, especially when it comes those riskier mutual funds, like those investing in small cap stocks. The investment strategy, however, can be used with other types of investments as well, even those in declining market-value environment such as bond funds.

Give it some thought….

One of the reasons we like the Ivy Small Cap Value fund so much that we named it as one of our top mutual fund picks for 2010 is that it invests heavily in the right kind of financial services firms. The kind that have great value, even if they are consider small cap stocks or mid-cap stocks. We feel that as an investment strategy, these types of securities will allow the Ivy fund to not only outperform in pure growth areas but with its generous dividend it will also generate some decent income.

One of our reasons for liking the Ivy fund is that its underlying securities stand to benefit handsomely from a housing recovery, something we have already started to see according to a recent post over at Reuters about Homebuilder Confidence.

So why Ivy Small Cap Value and not something like the Fidelity Real Estate Income fund? After all, some of these real estate funds produce fairly substantial gains and income — Fidelity’s sure is one of them with a nice 4.8% yield and high returns compared to its peers, along with its “low” risk rating. But comparing Fidelity’s fund to Ivy’s is not a proper comparison. You cannot compare the two.

You cannot compare a real estate income fund to a small cap value fund.

For starters, funds like Fidelity’s are part of the income class. They invest in income-producing securities with roughly 50% of their total holdings in bonds. Of the 20% they hold in  stock, guess what 91% consists of? (Hint, we talk about about them a lot and suggest the difference between “good” and “bad” financial services firms to hold. Somewhat surprisingly, they seem to be holding the “bad” ones).

In comparison, the Ivy fund is equity driven. They have a purpose, with roughly 40% of their portfolio invested in the type of securities that will benefit from the same recovery from which a pure real estate fund (equity based) should.

So while the Fidelity Real Estate Income fund exists to produce income, Ivy Small Cap Value exists to generate long-term gains with income being a nice bonus. For people who are bullish on real estate, Ivy still makes better sense as an equity play because it stands to profit from the recovery. For the Fidelity fund to remain attractive, rates would have to continue dropping, which is still possible given how fixed mortgage rates continue to drop).

Ivy, however, does not need a housing recovery to remain a top-performing small cap stock fund. Why? Because the majority of its securities are already profitable. Remember, there is a difference between good and bad financial stocks; Ivy knows the difference because they hold the good ones. And those firms will only see their revenues increase when housing makes its come-back.This of course is one of the benefits to holding small cap stocks in a portfolio in the first place.

Would we recommend the Fidelity fund as an income play? Not now (besides, we prefer the Janus High Yield Fund as our preferred income fund for the year. Does that mean the Fidelity Real Estate Income fund is a bad one? Definitely not; it just does not make much sense as an investment strategy right now. And we feel our statement is fully backed up by the yield curve.

As an investment strategy, putting $12,000 into a mutual fund today versus spreading that $12,000 over the course of twelve months (or $1,000 per month) is statistically not such a smart move… well, unless of course you invest $12,000 per month or at some kind of regular interval. This has nothing to do with the mutual fund in question. Instead, investing regularly has its share of perks, in fact enough of them that investors would be silly not to take advantage of them from Day 1.

To illustrate just how powerful regular investments can be versus single, lump-sum investments, consider that even if a security value drops, you can still come out with a gain if you make your investment purchases on a regular basis.

To add credibility to our little illustration, we will look at S&P 500 values for 2009. Our first investor will invest $12,000 on the first business day of January while our second will invest $1,000 every month on the first business day of that month. By December 2nd, they will have both invested at total of $12,000.

As we can see from the chart below, the investor who invests every penny at once will be ahead by 19% on December while the investor who puts $1,000 aside every month is only marginally ahead of that investor at 20.57%. The difference of $200.10 hardly seems worth it in the end… or does it? Putting yourself in the shoes of the two investors might tell us a different story as we work our way from month to month.

Take look at the Investor #1 who goes “all-in” on January 2, 2009. How would this investor feel one month later on the first business day of February when that $12,000 investment is down 11.41%, a loss of nearly three thousand dollars. Would Investor #1 be getting sick to her stomach on the first business day of March when that investment is down 24.79% or a heart-stopping $2,974.63?

In comparison, after that first business day purchase in March 2009, Investor #2 would have put $3,000 away and lost just 13.3% or $398.86. In absolute terms, Investor #2 would probably feel a lot better than Investor #1 at this point. And any sinking feeling of loss would be gone for the rest of the year for Investor #2 by the time the first business day in April rolls around and he see his investments roughly at a break-even point (a 0.26% gain actually) while Investor #1 is still not eating or sleeping because they are still down nearly 13% or $1,554.67.

In fact, while Investor #2 watches his investment gain throughout the rest of the year (except in July, when they slip from being “up” 12.27% in June down to being “up” only 8.53% in July), Investor #1 has to wait two extra months before they break even again… and that victory is really short-lived because in July they will have seen their investment swing back into the red again. Talk about an emotional roller-coaster ride for Investor #1 — while Investor #2 recorded just 2 “down” periods for the year Investor #1 was in the red for 5 of the 12 periods, a little more than 40% of the time!

And what if either Investor had lost part or all of their regular income and needed to draw on their investment after 3 months? At that point, only Investor #2 showed a gain of any type meaning Investor #1 would have been cashing in at the absolute worst time possible.

Of course, in the end, Investor #2 actually ends up being $200.10 ahead of Investor #1, thanks entirely to their regular contributions allowing them to purchase more units. After understanding the probable emotional turbulence that Investor #1 experiences, the extra $200.10 seems like only a single piece of what is really much-larger bonuses — these being the reduced stress levels, the added units and the lower dollar-value losses when things turn South.

This is not magic. You can run the figures yourself using S&P 500 closing prices found at Yahoo! Finance. But remember: investing regularly in mutual funds really can make a big difference.

Illustration A (S&P 500 values; Invest One-Time vs. Invest Monthly)

Illustration A

It seems that any time positive news comes out about the state of the economy, growth funds and small-cap funds in particular get a nifty little boost in value. It stands to reason, of course, that as the markets react to such positive news, so too should mutual funds. But what mutual funds stand to benefit most? This is a question that a lot of investors, like those who want to know where to invest $20,000 or so, have.

Homebuilders
One area that gets a nice boost (or gets tanked) every month relates to the housing market. Since this sector was blamed for many of the problems relating to the latest recession (if it was not the bank’s imprudent lending practices, then it was housing for its hyper-inflated values and the subsequent flooding of inventory), it makes sense that housing stocks will be particularly, positively influenced by positive news for the sector.

For example, on February 2nd, positive news about housing  had the impact of bumping one particular housing company’s stock price by as much as 10% in the session. Other related shares got a nice boost of no less than 5%. A nice little return, wouldn’t you agree?

Risks
The risks with such big moves is twofold. First, this has the effect of increasing volatility for these types of shares, making them more difficult to trade individually. An investor needs to exercise displine to realize the gains he or she wants and not stay in too long; otherwise, they will record an immediate loss.

What Mutual Funds Own Such Stocks?
The best way to find the funds that invest in these types of sensitive shares is to visit Yahoo! Finance and search under the security’s Major Holder’s section. This gives a fairly accurate snapshot of what companies are owned by what mutual funds.

In the case of housing stocks, Vanguard has taken a fairly large interest in several of the housing stocks in its Small-Cap and Mid-Cap funds. It makes sense. Housing continues to be out of favor and these types of out-of-favor stocks are often what turn regular investors into astute investors.

As well, housing is one of those areas that will need to improve before the rest of the economy improves. That means that it is quite likely that the sector could receive a boost through some type of government incentive that sees people buying more and more houses and in the interest of keeping people employed (or hiring more people back), some of these incentives are likely to incent or at least benefit the homebuilders. Vanguard has taken an interesting approach (among others).

Does this suggest that mid- and small-cap mutual funds is where to invest $20,000 (getting back to that question)? Probably not for the whole $20,000. But 20-25% of an aggressive portfolio that can benefit from a mid- to long-term investment period, sure… no, absolutely. In fact, they can be expected to easily outperform growth funds held for that same period.

One of the most-common questions that investors ask themselves before deciding on where to invest is whether they should put their money in an ETF or in mutual funds. While both behave similarly and share many of the same characteristics as far as pooled investments go, they actually differ quite a bit. Ultimately, an ETF makes sense for investors who are able to dedicate some time to the management of their funds and a mutual fund investment makes sense for someone who wants as little involvement with their investments as possible.

Of course, the above statement should not be taken as gospel. In fact, mutual funds require some involvement as well, requiring something more like executive-level involvement whereas managing one’s ETF portfolio is more like a being a foreman, you will get your hands dirty pitching in but you don’t build the product from the ground up.

Mutual funds require executive-like, top-down management whereas ETFs require frequent, hands-on/foreman-style management on the part of the investor. Pick which works best for you.

Being a Foreman – ETF Investing

While managing an ETF portfolio will involve some hands-on involvement on the investor’s part, there are many benefits to investing in ETFs. Among these benefits include low management fees and extreme management styles. Whereas most mutual funds will hold straightforward, long investments (i.e. a buy and hold strategy with some derivative use), ETF’s can become increasingly complex, taking on short positions not only on stocks but currencies, commodities and so on.

For the most part, a foreman is in the trenches, putting in sweat and labor, getting the job done. Managing an ETF portfolio is very much like that. Know how to trade, know what to buy and what to sell, and know how to execute.

In fact, you can literally find an ETF to meet virtually any investment need you might have, including hedging your investments against currency volatility, hedging against potential downswings in a market where you are mostly holding for the long-term. In other words, ETF investments are a lot more exotic than mutual fund investments… in fact, they are often a lot more exotic than straightforward stock securities!

This does not necessarily make an ETF more dangerous or even risky than a straightforward mutual fund investment, but it certainly involves a lot more participation on the part of the investor. Itinvolves understanding the underlying securities and how they operate. A “bad” investment choice with an ETF will result in buying high and selling low (a common mistake we all make, even the professionals at times), incurring enough in brokerage fees to make the “discounted” management fees associated with ETFs make mutual fund management fees look like a giveaway.

Investors who do not pay attention to the way their ETF portfolio is behaving learn the hard way that they have gotten in over their head. This results in losses.

Of course, not all ETF portfolios need to have “the exotics” included in the plan. A buy-and-hold investor who might otherwise be a mutual fund investor can find an actively managed ETF that behaves like a tactical balanced fund (in fact, it is probably easier to find such an ETF than it is to find a mutual fund that behaves this way).

Executive Style Management – Mutual Funds

Contrary to the involvement needed to properly manage a profitable ETF portfolio, mutual funds require very little involvement on the investor’s part. Initially, of course, the investor needs to outline his investment plan and put together an investment management strategy, but beyond this the investor can review his or her mutual fund statements whenever they come in, make changes if needed, and move on with life, all within the span of half an hour.

An Executive studies the numbers and starts making calls when things don’t look right. For the mutual fund investor that can be a call to his or her financial planner. It can also mean firing people (like the planner) or filling a position with someone else (like switching from one fund company to another).

The downfall is that mutual funds come with higher management fees. As well, they are not traded on an exchange which makes them, for the most part, a lot less liquid than ETF investments. As well, due to the high level of regulations surrounding mutual funds, they are unable to properly hedge again risks, both real and perceived the way that an ETF can (and even if the actual ETF does not hedge against such risks, there is surely another ETF out there that, if purchase properly, will mitigate those risks).

So for investors who want to know where to invest — in an ETF or mutual fund? — the answer can be found in another question: What type of manager are you?

If one were to look at high return investments, there could be a couple of places one might look. Growth funds might be an obvious starting point, but is quite likely too generic a field to find something with true, high returns. In most cases, one will have to resort to specialized fields. Over the past three years, such a specialized field might have been gold and other resources. Just prior to the recession – agriculture. And prior to that – real estate. But Fidelity’s Select Medical Equipment and Systems has not only been one of the most steady mutual funds over the past 10 years but also one of the best high return investments.

As the name suggests, the Fidelity Select Medical Equipment and System mutual fund is a mutual fund focused on the medical equipment and systems arena. As far as growth funds go, however, this niche mutual fund has been a top performer among other growth funds, having tripled investors’ investments over the past 10 years. Compare this to the S&P 500 which has yet to return your original investment (as of January 28, 2010).

So that begs the question: what makes high this particular mutual fund so special

Well, with $1.3 Billion under management, the fund is quite large. However, it has not allowed its size to get to its head and holds a fairly tight portfolio of just under 60 securities, all of which are somehow related to the healthcare industry. In terms of investment style, the fund does not follow the others with just one or two choice deviations. In other words, it does not list list GE shares as a top holding. In fact, this top performing mutual fund is considered a mid-growth fund according to its investment style; its holdings are mid-cap and are considered growth investments (versus value investments). From a percentage-of-holdings viewpoint, though, the largest exposure is to large-cap securities; with a fairly substantial exposure to small-cap securities (roughly 10% of its total holdings) the overall investment style gets bumped downward into the mid-cap range.

The impact of this mutual fund’s investment style is that risk is marginally above average (yet is not considered high risk). This has no double allowed it to achieve above average returns over the past 3, 5, and 10 years. With the protection offered by large-cap holdings combined with the growth potential of small- and mid-cap securities, this fund has steadily outperformed the Index with the exception of one year… 2006.

The fund’s largest holding (at 14% of the portfolio, this is a big gamble) is Covidien PLC, a company that touches commercial, institutional and retail markets. Over the past year, it has added 33% to its stock price, itself a nice a return. Less than a week ago, Piper Jaffray upgraded its view on this stock to Outperform; the mean rating is a mildly strong buy… and that can explain why Fidelity has gotten in deep with this security.

Do these stats really qualify the Fidelity Medical Equipment and Systems fund as a one of the best high return investments on the market?

Well, that really depends. For investors looking to get an edge without having to take a scary amount of risk, then of course it does. With a fairly low Beta (0.76) and returns that outpace the market’s, this is one of those growth funds that makes achieving great investment returns look easy and stress-free.

But for investors who want continual mid- to high-double digit returns regardless of risk, then maybe this is not one of those high return investments. Can we suggest real estate funds? Commodity pools? A Gold bear-ETF? Even then, what are the risks and are they worth the potential returns?

See you can say just about anything that gives a 50% return is a great investment, but when you factor in risk and consistency, is it really?

That is where this fund differs and why we think it is one of the best high return investments for those with courage. High returns, marginally above average risk and a history that speaks for itself. If you’ve got $2,500 available to add diversification and a bit of specialization to your growth funds portfolio, consider the Fidelity Select Medical Equipment and Systems fund.

Okay, you have just three years and a hundred thousand dollars burning a hole in your pocket. Three measly years and you need to know where to invest that money so that, in three years when you need that investment, you know that you have not risked that money for the sake of return. Where do you invest it? What type of mutual funds, including ETF’s meet this requirement?

Three years as a time horizon is a tricky one. It is neither short-term nor long-term. Some may call it medium-term, but when you have just three asset classes from which to choose – cash, income, equities – how to do you find that best 3-year time horizon. Because let’s face it; based on the interest rate environment, many bond funds now have a 5-year time requirement. And high yield investments, due largely to their speculative nature really should be longer-term, even if they come with the probability today that they will benefit from rates in the next 12-36 months.

Based on the interest rate environment, many bond funds now have a 5-year time requirement…

And equity funds, well, even the most conservative come with a minimum time investment of 5 years. Anything short of that is just far too risky for the investor. Of course, luck can always prevail and provide the right return after just 3 years, but there is no guarantee of that. Suppose you invested in 2005… three years later would put you into 2008, arguably one of the worst years for the markets. You would have been (censored), kicking yourself.

Okay, and let’s say you invested in bonds at the same time. Short of a government bond fund that saw rates plummet while the US borrowed heavily and saw some rates so close to zero that brokers quoted them that way, you would have also been (censored), kicking yourself for ever thinking that bond funds were the safest and greatest thing since, well, sliced bread.

In 2005, the best 3-year investment would have been a 3-year term deposit… with a financial institution that did not go under. But remember, even people who invested in Citibank were nervous in 2007/2008, lining up to get access to their money. Remember that panic?

But that was the past, right? Today, things are different. Citi is still around, rates are at their lowest and some of the best performing mutual funds in 2009 were indeed bond and equity funds. It makes high yield investments look really lucrative right, especially after this very site announced that its top pick for 2010 was a high yield investment fund. But even the most aggressive financial planner would recommend a 5-year time horizon on a fund like that!

So what are your options when it comes to a 3-year maximum time horizon?

Cash Equivalent

You could look at a cash equivalent fund, but kiss any kind of return goodbye.

You could also look at a term deposit but consider than rates are likely to increase, so if you lock up your money, you will lose purchasing power.

Bond Funds

While bond funds will present marginally more risk, your short-term bond funds will allow fairly decent turnover within the fund, mitigating the risk of holding longer term funds. While rates of return will not come close to those expected in some of the riskier funds, the idea here is to get back what you invest.

Diversify

Perhaps your best bet with your $100,000 and 3-years, would be to diversify your holdings. This might look like 30% short-term bond funds, 30% cash equivalent or Treasuries, 25% Cash, and 15% term deposit. The strategy might involve using the cash and cash equivalent funds to gradually increase your short-term bond holdings or term deposit holdings based on the performance over the next 2 years so that at the end of 2 years, your portfolio might have 65% short-term bonds and 35% term deposits that mature in the year that you need the funds.

A riskier investor might be able to absorb the potential volatility and impact that a lower-risk equity fund can offer, but most financial planners will not even touch that one… leaving you to make your trades with a discount broker.

At any rate, realize that with 3 years your investment options will be limited. And while growth and returns will be low, your objective should be to virtually guarantee return of capital. Even the most educated fund manager would subscribe to such a strategy, ensuring that investment risk is only so high as the expected rate of return.

Education savings plans have increased in popularity over the past decade or so. As people have struggled with savings for their children’s education, so too have they struggled with where to invest the money they set aside every week, month or year. But interestingly, they struggle less when it comes to the mutual funds that are part of an education savings program than they do with their own savings and their retirement savings in particular. Since most people will start with smaller numbers when saving for a child’s education, the natural start is with mutual funds; balanced funds in particular.

It is not so much about knowing where to invest than it is about how to invest.

And this makes sense. Balanced funds offer tremendous growth opportunities in the mid- and long-terms. A balanced fund that takes a tactical approach to investment management will do its best to get a lead on the markets, whether it is in bonds or equities or a tactical approach to both. Ideally, however, tactically managed balance funds will provide active investment management, something that many people cannot enjoy with investment values of $100 per month.

More importantly however is that people who decide on balanced funds are more inclined to “sit” on them during periods where market values erode, such as what was seen up until 2009. This becomes a strategic approach, then, so that it is not so much about where to invest than it is about how to invest.

Unfortunately, many investors who witness the type of portfolio erosion that most investors witnessed from the end of 2007 through to the first quarter of 2009 get nervous. They hate to see the type of devaluation that they undoubtedly witnessed. And where their education savings are concerned, the time horizon for that investment may not be as long-term as, say, their retirement savings; Junior will be going to college in two years and cannot wait the fifteen years that I can wait to see that education savings plan recover.

So they pull the plug. They drop that terribly depreciated balanced fund and decide against all wisdom, all historical evidence and advice that where to invest is actually in income-producing securities. Not high yield investments, either because all companies are going the way of GM, Ford and Chrysler or because they have become turned off anything corporate altogether. So instead of those high yield investments, they choose government bonds or, worse yet, term deposits.

And we all know where those rates are. They are low, they provide so little income that the purchasing power erosion combined with rising tuition costs will have a negative compounding effect on the actual purchasing power of the original investment. In addition, as those government rates start to rise to compensate for inflationary pressures, the value of those bonds will decrease (of course, TD’s will retain their par value, but at virtually 0% interest, they provide next to no liquidity… there is no getting out until the maturity date).

So where is the true logic in bailing at what could be ultimate low in that balanced fund’s market value?

That’s the thing, there is no logic. Emotions overtake logic.

This past year has illustrated that history has a way of repeating itself. And of course, those who bailed at the ultimate low have seen that markets do recover.

Statistically, people who invest in education savings are more apt to sit tight. And this is a good thing, as history has proven time and again.

In regards to knowing where to invest in an education savings program, realize that Balanced funds clearly provide the best overall option, particularly for people with lower dollar figures to invest (which would probably be most people). Not only do many balanced funds provide enough of a tactical investment management approach, allowing the fund managers to shift from one asset class to another in times of market turmoil, but they are normally managed by the best and brightest — and most of us are nowhere near as intuitive as they when it comes to investing.

And for those with larger amounts to invest. Consider a strategic asset allocation model.

Because knowing where to invest is often secondary to knowing how to invest.

If you have the problem of not knowing where to invest $10,000, you have a problem that many people would love to have. But not knowing where to invest is not the true problem; it is a symptom of the problem of not knowing enough about investments and the optimal investment vehicles. While some people might understand the basics of mutual funds (they are pools of funds where hundreds, thousands, or even hundreds of thousand of investors write checks to these fund companies, who then take all of this collective money and purchase securities on the open markets and then return the gains, proportionately, to the people who invested in the funds), fewer yet understand the different asset classes — Equity, Income, and Cash/Cash Equivalents — and even fewer understand how the different funds operate in terms of investment management strategies.

Not knowing where to invest $10,000 is a great problem to have… but that is not the problem. The problem is investment knowledge.

The easiest way to understand investment management is by understanding how the following chart below works. Ultimately, there are three areas; red, blue, and yellow.

Asset Allocation Model

This chart illustrates the basis of asset allocation. Each color represents an asset class; equities, income and cash. Understanding your risk tolerance, investment objectives and time horizon will allow you to allocate part of your $10,000 to specific areas at specific, pre-determined ratios.

For example, if you have a medium risk tolerance with an investment objective of income and some growth, with a time horizon of five years, then you might consider an asset allocation model as follows: 25% Equities, 65% Fixed Income, and 10% Cash. In this chart, the Equities would be the Blue portion, Fixed Income would be Red, and Cash would be yellow.

The fundamentals of a strategic investment management suggest that all you need to do now is ensure that these assets stay within their limits (65% Income, 25% Equities, and 10% Cash) through period rebalancing.

So, where does that leave you when it comes time to invest $10,000? Depending on your level of investment knowledge and how well you know your stuff or how much you trust your financial advisor, then you could easily develop your own plan using a well-defined asset allocation model.

If you would rather not have much involvement with your investments, then you are probably best served by a Balanced Fund. This is a common choice for people who need a place to invest $10,000 and they need a little more time to educate themselves on the different investment options they have.

Why Balanced Funds? These types of mutual funds offer active investment management from top investment managers at a reasonable price. Most of these managers would not normally deal with people with less than $1,000,000 in investments… yet here you can access them with 1/100 of that amount.

Balanced Mutual Funds offer active management from investment industry leaders.

So where does that leave the average invest with his or her $10,000? Starting with a Balanced Fund that aligns with his or her investment objectives, risk tolerance and time horizon is ideal. While the fund operates on its own, the investor will be able to learn more about other investment options, if the desire is there. Of course, many investors will remain invested in Balanced Funds. In fact, many private bankers will use their institution’s balanced fund portfolio managers to manage their high-net worth clients’ funds. The only difference is that private bankers will deal with people who have extremely high net worth; balanced mutual funds will help people invest $10,000.

Ultimately, the question about where to invest $10,000 can be answered introspectively. If you have high investment knowledge, then mutual funds are probably not your ideal investment. If, however, you have moderate to no investment knowledge (like most people), then mutual funds work well. If you feel you need to learn more before making a permanent investment decision, then balanced mutual funds are the best place to invest $10,000 after all.