The following is an excerpt from

Big Picture Retirement Planning

Les Goldstein, M.B.A.

Personal Financial Strategies, Inc. PARK RIDGE, ILLINOIS

Copyright © 2018 by Les Goldstein.

The following content is for non-commercial educational use only. All rights reserved. No part of this publication may be reproduced, distributed or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other non-commercial uses permitted by copyright law. For permission requests, write to the publisher at the address below.
Les Goldstein/Personal Financial Strategies, Inc.
626 Busse Highway
Park Ridge, IL 60068
Book layout ©2013
Big Picture Retirement Planning/ Les Goldstein. —1st ed.
ISBN 978-0-0000000-0-0


Mutual Funds & Exchange Traded-Funds

I do not hate mutual funds. I simply don’t like them very much and believe that other investment tools can often be more appropriate. As always, there are caveats and exceptions. For example, in your 401(k) you may not be able to avoid them.

So, to begin this chapter, now is the time to learn more about your mutual funds. Here are some questions to ask yourself:

  1. What are the top 10 holdings inside my mutual funds? How often do the top 10 holdings change?
  2. What are the written investment objectives of my current mutual funds? Are these objectives in line with my goals?
  3. Are my mutual funds managed by one manager (per fund prospectus) or by a team of portfolio managers?
  4. If my mutual fund is managed by one manager, how long has he or she been in charge?
  5. Is my mutual fund a passive, buy-and-hold strategy, or is it actively traded?
  6. What are the internal operating expenses of my mutual funds, including trading costs? The higher the cost, the more difficult it is for you to prosper.

I believe that most investors simply don’t know the answers to more than 1 or 2 of these 6 questions. I also am confident when I state that most investors do not review the prospectuses before investing in their mutual funds. Why do I believe this? Because, unfortunately, people are typically not willing to put in the effort to find the answers to these questions. Even if you did find the answers in the beginning, what’s inside your mutual funds can change all the time.

Now, let’s talk about costs for a moment or two. Based on all the research we have done around the real costs of owning mutual funds, from literally hundreds and hundreds of cases we have analyzed, we typically see that, in many cases, the stated costs of owning a particular mutual fund are frequently lower than the actual costs. Every investment has a cost associated with it, and it is important to know how much it costs you to own your mutual funds.

Why can the published costs differ from the actual costs of your mutual funds’ management? One reason can be trading costs. Morningstar, as well as the fund’s prospectus, does not know what the trading costs are going to be for implementing that mutual fund manager’s strategy. In some cases, we have seen the actual costs exceeding the stated costs by 400 percent or more. Every ex-ra penny that you spend without a real economic benefit is wast-ed money. Here’s an example of a mutual fund cost analysis we completed for a new client towards the end of 2017. This chart is provided as an example only. Your results and research may vary.



This is a chart of the mutual funds owned by one of our clients, prior to our reallocation of his portfolio. The annual expenses, as measured by Morningstar, were 0.46 percent. Very competitive, by our standards. When we reviewed the mutual funds on, we determined that the annual expenses were actually 0.92 percent, exactly double the published costs. This client was paying $19,454.63 in annual operating expenses to own these mutual funds. He was not getting any support or guidance from his financial advisor. Costs matter, and the more money you keep in your pocket by keeping fees low, the better.

One of the questions that seeks to answer is, what is last year’s cost of ownership? This is defined by Personal Fund as management fee + distribution fee + transaction costs + taxes. Personal Fund uses the most recent 12 months of Lipper (a widely read and respected independent securities industry analyst) data to calculate management fees, distribution fees, and transaction costs. You will enter your own federal and state income tax information. For a complete review of all the formulas that Personal Fund uses, please visit and click on the “Glossary” tab on the website.

A March 2, 2013, Barron’s article entitled “The Hidden Cost of Doing Business” reviews three “invisible” costs as factors in eroding mutual fund returns. These three costs are:

  1. Commissions paid to buy and sell
  2. Trading costs, which include the “bid-ask” (price to buy, price to sell) spread
  3. The impact of mutual funds buying or selling big blocks of shares

According to this same article, commissions are the only part of the expense ratio that are itemized in a mutual fund’s prospectus.

Here are some more questions to ask yourself about your mutual funds:

Is my actively managed mutual fund similar to any particular stock market index or exchange traded fund? When possible and appropriate, compare and contrast passive index funds and exchange traded funds to mutual funds.

What kind of mutual funds do I own: large cap, mid-cap, small cap (stock)? Some mutual funds experience what we call style slippage. That is, a mutual fund may have started out as a small company growth fund, but, due to the success of the investments inside the mutual fund, it is now a medium-size company growth fund. Over time, the diversification you thought you had by investing in mutual funds with different company size objectives is now a portfolio of mutual funds that are very similar. The more similarity, the more potential for loss when times are bad.

Domestic or international? We believe that owning international stock investment mutual funds is not worth the risk. If you invest in mutual funds that are invested in large US company shares, such as companies that are members of the S&P 500, many of these companies will have international operations, and you can avoid the risk of foreign currency fluctuations and potentially less-than-accurate emerging markets accounting.

Do you own stock mutual funds that are sector-specific? Some examples of sector-specific mutual funds are health care, technology, even water or oil and gas. Sector-based mutual funds may have more growth potential if you are in the right sector at the right time, but they also may have more risk due to the narrow focus of investment.

Now, let’s shift our attention to bonds and bond mutual funds. As defined earlier in this book, a bond is a debt instrument either of a government or a municipality or a corporation. Basically, a bond is a promise to pay. You are making a loan to a specific entity. Let’s use XYZ Corporation as an example. XYZ Corporation is a highly rated, AAA public corporation with a very strong balance sheet and income statement. If XYZ Corporation wants to expand, the company can either issue more stock or sell bonds to the public. Since the company doesn’t want to make each share of stock less valuable through dilution, the company decides to sell bonds.

Let’s say the company believes they will need $100,000,000 to finance the growth of their operations. The company believes it will need use of the money for 10 years. For these reasons, XYZ Corporation decides to issue $100,000,000 of 10-year bonds at a 6 percent per year coupon rate, paid semiannually. At the end of 10 years, the bond matures and you will be repaid your principal. Of course, corporate bonds are not guaranteed by the issuing corporation and you can lose money.

Now for some questions and answers.

  1. What is a better investment for you, XYZ Corporation stock or their bonds? The answer is, it depends. What are you looking for? Are you looking for regular and hopefully dependable income? Or, are you looking for growth potential of your investment? In general, bonds are structured to deliver income, typically twice a year. Stocks are designed for growth potential and tend to pay a lower dividend than the coupon payments offered from bonds of the same company.
  2. What is a more risky investment, the stock or the bond of the same company? Both stocks and bonds change in value on a daily basis. Bonds are also subject to interest rate risk. That is, when interest rates rise, the value of an already issued bond falls. When interest rates fall, the value of an already issued bond increases. In general, you will receive the amount you invested back upon the maturity of the bond. That is, if you invested $10,000 in a bond and everything goes smoothly, you’ll receive interest in the form of coupon payments twice a year. And when the bond matures, you’ll receive your $10,000 initial investment back.

It is reasonable to state that bonds issued by XYZ Corporation are a more secure investment than common stock issued by the same company. Here’s why. In the event of the bankruptcy of a public company, bondholders are paid before stockholders. Here is the order of payments in the event of the bankruptcy of a company.

Last: common stockholders
Next to last: preferred stockholders
Before them: bond owners
Before them: secured creditors

First and foremost: the IRS. The IRS always occupies the first position when it comes to getting paid back. Surprise, surprise!

Let’s talk a little bit more about bonds. Bonds can be issued by large, medium, or small companies. In general, the smaller the company, the greater the risk. Bond funds that are named high yield funds invest in smaller companies, startup companies, or emerging markets. High yield bond funds have also been called junk bond funds in the past. This may not be an accurate definition, as high yield bond funds as a group have outperformed other bond funds over the last 25 years. From 1971 through 2010, the median historical default of high yield bonds has been less than 2 percent.

In addition to the historical moderate default rate of less than 2 percent from 1978 through 2010, the spread between the yield to maturity on high yield bonds vs. 10-year treasuries has always been positive. At least for the 42-year period measured in the accompanying chart, high yield bonds outperformed 10-year treasuries in 30 of the 42 years measured. Of course, high yield bonds are much more risky than 10-year treasury securities. Treasury securities are backed by the full faith and credit of Uncle Sam. High yield bonds have no guarantees at all. If you choose the wrong individual high yield bond, you can lose all of your money!

Annual Returns, Yields, and Spreads on 10-Yr Treasury and High-Yield Bonds

Source: Defaults and Returns in the High-Yield Bond Market: Third-Quarter 2013 Review, Journal of Financial Management, Markets and Institutions, Edward I. Altman, Brenda J. Kuehne


PFS Pearl of Wisdom: Except under very specific client-requested circumstances, we do not invest in bonds. Why? First of all, if you hold the bond to maturity and get your money back at that time, you’ve actually lost the buying power of your principal investment due to inflation. Second, the income from an individual bond is structured to be steady and not increase over time. So the income doesn’t keep up with inflation, either. Where suitable and appropriate, we consider using certain fixed index and variable annuities and income-oriented non-traded real estate investment trusts (non-traded REITs) over individual bonds and bond mutual funds. Why?

  1. The income distributions have the potential to increase over time.
  2. There is the potential for capital appreciation with annuities and real estate. If you hold a bond to maturity, there is no capital appreciation potential.

As always, there are risks to annuity and real estate investing. We believe the rewards can be worth the risks. The rewards can include reliable retirement cash flows, long-term growth potential, and safety of principal if the annuity owned is a fixed interest rate or fixed index annuity. The risks can include principal loss, illiquidity, and the internal operating expenses of annuities and non-traded REITs that may drag down your potential income and growth.

Let’s take a look at what we learned in this chapter.

  1. You probably do not know what is owned inside your mutual funds.
  2. Even if you do read the prospectus, you are reading old news. Prospectuses report on what has happened in the past and are not a way to gauge future activity.
  3. Adding assets that have low and negative correlation to the stock market may help to lower the overall risk of your comprehensive investment portfolio.
  4. Cost without benefit is a waste. Know the internal operating costs of your accounts and determine if a similar and less-expensive choice is available.
  5. As an asset class, bonds typically referred to as junk bonds have had a historic 2 percent default rate and have performed in a manner similar to that of common stocks. As always, prior performance does not guarantee future results.


Source: Acciavatti, Peter, and Nelson Jantzen, CFA “ JPM High-Yield and Lev-eraged Loan Morning Intelligence,” December 5, 2016

Mutual Funds vs. Exchange Traded Funds

To me, mutual funds are an investment tool of the past, not the future. We will discuss exchange traded funds (ETFs) next, and you can determine for yourself if ETFs make more sense for you.
People have been investing in mutual funds since 1927. Exchange traded funds have been in existence for about 20 years but have become popular with the retail public only recently. So let’s spend some time defining exchange traded funds. What is an ETF?

Here are some general characteristics and a comparison to mutual funds:

  1. ETFs are stocks and are typically traded on national stock exchanges.
  2. ETFs have daily liquidity and can be bought or sold on any open trading day.
  3. One share of a specific ETF can represent an entire industry or sector.
  4. Many ETFs are passive, not actively managed.
  5. With passive ETFs, you, not the mutual fund manager, control the sell decision.
  6. With passive ETFs, you, not the mutual fund manager, control the tax ramifications. This is because you control the sell decision.

To give you a better idea of what you can invest in with exchange traded funds, here are some examples:

SPY is also known as the “Spider.” SPY invests in S&P 500 companies.
PHO is an ETF that invests in companies in the business of water.
BRIC is an ETF that invests in companies in Brazil, Russia, India, and China.

One of the benefits of investing in exchange traded funds instead of individual common stocks is that you do not have to research individual companies to build your investment portfolio. Instead of investing in mutual funds, where the holdings may change based upon the trading activity of the manager, you simply identify sectors you want to invest in and invest in the entire sector. Another benefit is that with ETFs, you can set what is known as a trailing stop loss order below your initial investment price. Then, when the ETF increases in value, the trailing stop loss order also moves up. This strategy is designed to attempt to lock in gains and help to lessen downside risk at the same time. As always, there are no guarantees and substantial losses can occur.

Here’s an example of ETFs and a trailing stop loss order: You bought 100 shares of the ETF SPY at $210 per share. Because you wanted to limit your risk on the downside, you set an initial trailing stop loss order at $178.50, 15 percent below your entry price. Now, let’s say that SPY grew in value to $225 per share. Your 15 percent trailing stop loss order would now be at $191.25, 15 percent below the new, current SPY price. In the event that the stock market corrected down to a point where SPY fell to $191.25, your trailing stop loss order will become a market order and hopefully will be filled at a price equal to or close to $191.25. So trailing stops can be a good downside protection tool. They are not available on mutual funds, only on stocks, including ETFs.

It is important to understand that a trailing stop loss order becomes a market order prior to execution. In a rapidly falling stock market, you may not get filled on your stop loss order at your desired price. As always, investing is not as simple as it may seem at first!

Important Disclosures For This Chapter

It is important to understand that everyone’s situation is unique and not all strategies and methods mentioned in this book may be appropriate or suitable for every individual. We suggest that you consult fully with your financial, tax, and legal advisors on pursuing a strategy that is uniquely tailored to your particular needs.
Mutual funds and ETFs are sold by prospectus only. Investors should carefully consider objectives, risks, charges, and expenses before investing. The contract prospectus and the underlying fund prospectus contain this and other important information.Investors should read the prospectus carefully before investing. For a copy of the prospectus, contact your financial advisor.
Passive-style investing in index funds or index ETFs does not guarantee your investment success or failure. All investments involve the risk of potential investment losses, and no strategy can assure a profit. All indexes are unmanaged, and an investor cannot invest directly in an index. Past performance does not guarantee future results.
Specific-sector investing, for example, into health care, technology, or international exchange traded funds or mutual funds, can be subject to different and greater risks than more diversified investments. Declines in the value of these specific sectors due to economic conditions, new technology, currency devaluations, and more all present potential risks to real estate investments.
Bonds are considered fixed income securities and, if sold or redeemed prior to maturity, may be subject to an additional gain or loss. Bonds are subject to interest rate risk. Bond prices generally fall when interest rates rise. High-yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Bonds involve the risks of price fluctuation and the issuer’s credit quality. Carefully review all available information on the specific bonds and bond mutual funds and bond ETFs before you invest. Bond mutual funds and bond ETFs are offered by prospectus only. Review the provided prospectuses before investing. Not guaranteed; you can lose money.
REITs are sold by prospectus only. Investors should carefully consider objectives, risks, charges, and expenses before investing. The contract prospectus and the underlying fund prospectus contain this and other important information. Investors should read the prospectus carefully before investing. For a copy of the prospectus, contact your financial advisor.Annuity contracts and life insurance policies are guaranteed as to payment of principal and interest by the issuing insurance company.
Equity indexed annuities are long-term investments subject to possible surrender charges and 10 percent IRS early withdrawal penalty prior to age 59½. Current minimum return, principal value, and prior earnings guaranteed by the issuing insurance company are subject to their claims-paying ability and contract provisions.
Variable annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax, and, if taken prior to age 59½, a 10 percent federal tax penalty may apply. Withdrawals will reduce the living benefits, death benefits, and account values. Early withdrawals may be subject to withdrawal charges. An investment in the securities underlying a variable annuity involves investment risk, including possible loss of principal. The contract, when redeemed, may be worth more or less than the original investment. Optional riders have limitations and come at an additional cost through the purchase of a variable annuity contract. Guarantees are backed by the claims-paying ability of the issuer.
Variable annuities are sold by prospectus only. Investors should carefully consider objectives, risks, charges, and expenses before investing. The contract prospectus and the underlying fund prospectus contain this and other important information. Investors should read the prospectus carefully before investing. For a copy of the prospectus, contact your financial advisor.