Understanding mutual funds is important if you want to learn how to become a financial advisor or an investment specialist. For example, you should begin by knowing how to determine actual fund costs. A mutual fund's total costs are measured differently, depending upon the study or expert cited. For example, a study reviewed the 100 largest domestic stock funds owned by defined contribution plans as of December 2007. The study found trading costs averaged 0.11% of assets annually in the quintile with the lowest costs and 1.99% of assets in the quintile with the highest cost, with a median of 0.66%.
A different study, updated in 2009, looked at thousands of U.S. stock funds and concluded the average trading costs to be 1.44% of total assets, with an average of 0.14% in the bottom quintile and 2.9% in the top. An expert in another study reported that "while some trading actually adds value, high trading costs overall tend to have a negative impact on performance. On average $1 in trading costs decreased net assets by 46 cents."
Market impact costs, and the resulting opportunity costs, are often the largest component of trading costs-as much as 1 ½ times brokerage (trading) commissions. These costs occur when a large trade changes the price of a security before the trade is completed. Similarly, opportunity costs occur when the impact of a trade inhibits a fund manager from filling an order on her terms, resulting in either a less-favorable price or fewer shares traded.
If you want to become an investment specialist you should know the seven "sins" of mutual funds. The first is known as "hugging the index" which is when managers charge active management fees but seek safety by being part of the herd by "closet indexing." The next "sin" is "racing the clock" where year-end trades to beef up a portfolio and keep management bonuses by taking on short-term risk; the next is known as "stalling the clock" near-end-of-the-year moves to clean up a portfolio to reduce risk and increase returns; "chasing performance"-higher than normal turnover coupled with inconsistent strategies in an effort to "get on the hot performance bandwagon;" "chasing yield"-increasing high-yield bond holdings to detriment of total returns; "baiting and switching"-fund names and/or objectives that do not correlate with the actual portfolio and "getting cold feet"-having excess cash when nervous about the market.
To learn how to become a financial advisor or an investment specialist, you should study the research about mutual funds and about passive versus active management. To become successful at active management, refer to the information and research on superior active management. For example, a 1995 study reviewed 17 large cap funds that outperformed the S&P 500 at least 37 out of 49 rolling 5-year periods. Common traits among these top-performing funds were:
[1] seasoned managers [2] consistent rather than headline returns [3] independent thinkers [4] using fundamental analysis for predominantly value funds [5] contrarian investing [6] conviction in judgment, as reflected in concentrated portfolios [7] long-term investment horizon and low turnover, and [8] managers listed by name instead of by management team or a long list of managers.
You can greatly improve your chances of having a successful career if you do the research and study examples.
Author Resource:
Cory Bowman is Director of Ops at the Institute of Business Finance. IBF has helped thousands of members of the financial services industry attain designations. For more information about IBF, how to become a financial advisor or investment specialist, visit http://www.icfs.com
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