Stock
 A stock (or equity) is ownership in an organization. The
ownership is represented by holding shares of the company. If the company
is successful, the stockholder may benefit in two ways. The first is by
receiving a dividend. Additionally, the stock may rise in price if demand
for the company rises. Conversely, if demand falls, the stock price will
fall, causing a stockholder to lose money. A stockholder takes risk
because their initial investment could be lost if the company goes down in
value or even possibly bankrupt.
Bond
A bond (or fixed-income security) is simply an IOU. The
organization issuing the debt typically promises to pay back the money
borrowed plus interest at a specified period of time. The bond may be
backed by collateral (secured bond) or only backed by the full faith of
the issuer (un-secured bond). Interest rates vary by the quality of the
issuer. Independent rating companies such as Standard & Poor and Moody's
rank organizations based on their financial strength. Lower graded bonds
pay higher interest rates while higher grade bonds typically pay lower
rates.
Mutual Fund
A mutual fund is a pool of assets from individual investors
that are managed by an investment company. Each fund defines a stated
objective to which it must invest its assets. (i.e. an international
stock fund must invest it's assets in equities outside the United States.)
All shareholders are treated equally and share in the gains or losses of
the fund on a per share basis.
Investors in a mutual fund benefit by many factors including:
Professional Money Management
Having your money managed by portfolio counselors and analysts who
spend the time, effort and research on finding the best investment ideas
provides significant resources to the average investor. This is their
full-time job; they are not practicing with your money. This is important
for the long-term investor. Diversification
Most mutual funds hold many different stocks or bonds (depending on the
objective of the fund) from multiple industries. It is not unusual to see
a fund with more than 100 different holdings or securities. Over the
long-term this typically helps reduce the volatility of an investor's
portfolio. Economies of Scale
A mutual fund typically purchases securities in such a large quantity that
it is able to buy such securities more cost effectively than individual
investors. Institutional trades have more "buying power" than trades made
by the general public.
Load vs. No-load
The debate over load and no load mutual funds has been around for more
than a quarter century. An investor must first understand that there are
two types of charges possible with a mutual fund investment. The first is
a front or back-end load and the second is the annual expense ratio. To
understand the difference between these two types of funds we feel it
important to reveal the total cost of owning a mutual fund.
A front-load fund charges an upfront commission, while a no-load fund does
not. A back-end load is only charged on amounts withdrawn (subject to
conditions of the fund and length of ownership).
An expense ratio is the annual fee charged to manage the mutual fund.
Often times the annual expense ratio of a load fund is less than that of
their no-load counterparts. Although these fees are fully disclosed in
the funds prospectus, they often times go unnoticed because they are
deducted from the funds performance each and every year. To complicate
matters even further, most fund families have introduce C shares which are
considered level loads, in order to offer a similar pricing structure as
the no-load families.
It is our strong opinion that it is much more important to consider the cost
of owning a fund over time than the cost to purchase the fund
initially.
In all the above mentioned text we have discussed fees only and have not
even considered performance. The cost to own a fund should be reasonable,
but should be only one of the factors used when considering an
investment.
Wrap Accounts
Wrap accounts have become increasing popular over the last decade. The
concept allows a shareholder to own and trade multiple securities for a
flat annual fee, typically 1-2%. In the case of a mutual fund wrap
account, the wrap fee is in addition to the mutual fund expense ratios.
Our concern lies in the total annual costs of managing a shareholder's account. High fees impede a portfolio's ability to provide strong long-term results. As stated before, a shareholder's total fees must be reasonable.
Active vs. Passive Management
Passive management relies on the efficient market theory. The theory
believes that it is very difficult to outperform the markets. Therefore,
a passive (or index) fund attempts to "be" the market, minus a small
management fee. The fee can be small because the fund does not require
research, or even human involvement. A computer model can easily
replicate the holdings of a particular index, and purchase those holdings
in the correct proportional amounts.
Active management attempts, through research and available market data, to
purchase quality holdings and avoid the biggest losers. The goals of
actively managed funds may be to outperform the market, have solid
performance with less risk, or both. They rely on quality managers,
analysts, and research to accomplish these goals.
At WWK, we are strong proponents of active management and are dedicated to
researching and monitoring the funds that we believe have the best chance
to accomplish the goals of strong performance and risk management. We do
this through our Investment Selection Process. Click here to learn
more.
Variable Annuity
 A variable annuity is a long-term financial vehicle designed for
retirement purposes. In essence, a variable annuity is a contractual
agreement in which payment(s) is/are made to an insurance company, which
agrees to pay out an income or a lump sum amount at a later date.
Investments in variable annuities are placed into subaccounts which are
similar in many ways to mutual funds (i.e. the returns are variable).
Although they are both professionally managed investment accounts,
shareholders of a variable annuity purchase units instead of shares.
Investments in variable annuities will fluctuate and values upon
redemption may be less than the original amount invested.
One of the most important features of a variable annuity is the ability to
defer taxes on the growth or earnings of your investment. These contracts
are typically used with non-qualified money. This benefit was more
beneficial under the tax laws prior to the enactment of the Economic
Growth Tax Reconciliation Relief Act (EGTRRA) which lowered the taxes on
long-term dividends and capital gains. However, many of these tax breaks
are set to expire on December 31, 2010, unless extended by Congress. If
these tax breaks are repealed, variable annuities may again become a more
attractive tax shelter.
Because variable annuities are offered by insurance companies most
contracts offer some form of guaranteed death benefit. These benefits
provide a minimum payout for the heirs of the variable annuity contract.
Bear in mind that the guarantee to make such payment is based upon the
claims-paying ability of the issuing insurance company and that variable
annuities are not guaranteed by FDIC or any other government agency and
are not deposits or other obligations of, or guaranteed or endorsed by any
bank or savings association.
Recently, there have been a number of changes in the rules surrounding
pension plans and the liabilities they can have on a company. As a result,
many companies have eliminated their plans. This has increased the demand
for the "living benefits" offered through variable annuities. Due to the
many different features that variable annuities offer, it is imperative to
understand ALL of the costs and limitations associated with your variable
annuity contract. There are contract limitations, fees, and charges
associated with variable annuities, which include, but are not limited to:
mortality and expense risk charges, sales and surrender charges,
administrative fees, and charges for optional benefits. Early withdrawals
may be subject to surrender charges, and taxed as ordinary income and, in
addition, if taken prior to age 59 1/2 an additional 10% federal income tax
penalty may apply. Withdrawals reduce annuity contract benefits and
values. Costs and contract flexibility vary widely from one insurance
company to another!
Risk
The definition of risk is different to many people. While some may
believe risk is simply the possibility of loss, others may look at it as
the fluctuation or volatility of a security. Another risk that many
people fail to consider is inflationary risk. This risk is that a dollar
will not have as much buying power in the future. There are many
measurements of risk including Beta and Standard Deviation. Morningstar
defines them as the following:
Beta
A measure of a fund's sensitivity to market movements. The beta of
the market is 1.00 by definition. A beta of 1.10 shows that the fund has
performed 10% better than its benchmark index in up markets and 10% worse
in down markets, assuming all other factors remain constant. Conversely, a
beta of 0.85 indicates that the fund's excess return is expected to
perform 15% worse than the market's excess return during up markets and
15% better during down markets.
Standard Deviation
Standard deviation is the statistical measurement of
dispersion about an average, which depicts how widely a stock or
portfolio's returns varied over a certain period of time. Investors use
the standard deviation of historical performance to try to predict the
range of returns that is most likely for a given investment. When a stock
or portfolio has a high standard deviation, the predicted range of
performance is wide, implying greater volatility.
Recommended Reading
Material:
Investment Basics
 The Wealthy Barber: Everyone's Commonsense Guide to Becoming Financially Independent (David Chilton)
Two for the Money: Financial Success for the Sandwich Generation (Jonathan and David Murray)
The Best Way to Save for College: A Complete Guide to 529 Plans (Joseph F. Hurley, CPA)
The Millionaire Next Door: The Surprising Secrets of America's Wealthy (William Danko)
Investment Greats
Capital: The Story of Long-Term Investment Excellence (Charles D. Ellis)
The Bond King: Investment Secrets from PIMCO's Bill Gross (Timothy Middleton)
Historic Market Events
And Then the Roof Caved In: How Wall Street's Greed and Stupidity Brought Capitalism to Its Knees (David Faber)
When Markets Collide: Investment Strategies for the Age of Global Economic Change (Mohamed El-Erian)
When Genius Failed: The Rise and Fall of Long-term Capital Management (Roger Lowenstein)
Enjoyable
Wooden: A Lifetime of Observations and Reflections On and Off the Court (Coach John Wooden)
From Glory Days: Successful Transitions of Professional Detroit Athletes (Kurt A. David)
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