With Europe back in the news and Thursday’s wait-and-see attitude concerning the number of jobs generated in March—which turned out to be disappointing—the Dow suffered its worst decline in 2012, losing 1.2% last week. The U.S. only created 120,000 non-farm jobs (contrary to an expected 203,000), which resulted in both equity futures and bond yields to fall. Thankfully, the equity markets were closed on Friday, and the recent negative economic news has led to more speculation that the Fed may reconsider a new round of quantitative easing.
As we enter earnings season, there isn’t much wiggle room. The market is at its highest level in some time, and earnings have fundamentally peaked. Consequently, if the big guns miss their top-line numbers, expect the market to decline further. Frankly, as I’m writing this update, I wish I had a larger cash position, because when market risk appears to exceed potential reward, it is prudent to reduce exposure to “risk on” securities.
Investment managers are always looking to indicators such as “oscillators” to determine whether the market is ready to take a breather. Stocks like Chipotle (CMG) and other high flyers can serve as straightforward and fairly accurate leading indicators. This year, big growth names such as Apple, which still managed to rise 3.94% last week, have basically maintained their annual highs. However, if the high flyers shows signs of weakening, tighten your seat belt (and no, I still have not pulled the trigger on Apple…yet).
So, in a nutshell, remain cautious. In fact, since the market is only slightly off recent highs, there is still time to protect year-to-date gains. For those of you who have generated over a 10% return in VB, VBG, RFG, IJH, DIA, SPY, VIG, DVY and DTN, book some profits. Also, be aware that narrow sectors are typically more volatile during corrections.
When we look to place cash back to work in equities or fixed income products, an important consideration is the actual cost of owning securities. For example, when purchasing a mutual fund, exchange traded fund, or the services offered by an investment advisor, you must account for the following fees: load or sales load, 12b-1 fees, expense ratio, redemption fees, transaction costs, and advisory fees. Here is a brief description of those expenses:
Sales Load: A commission shared by a broker and the brokerage firm. The broker will typically receive anywhere from (approximately) 40% to 85% of the total commission.
Transaction or Trading Costs: The actual cost of buying and selling stocks and ETFs. When using a broker to execute a trade, a commission may be imbedded in the trading costs.
12b-1 Fee: An annual marketing fee either paid to a selling broker or used by mutual fund companies to cover the costs of participating in a “no transaction fee” networks, such as those offered through Schwab and Fidelity. Both load and no-load funds may impose a 12b-1 fee.
Expense Ratio: The total cost of operating the fund. Investors pay this fee in the form of a percentage of invested assets in the fund. An expense ratio includes fund management fees, operating expenses, and 12b-1 fees. Mutual fund companies are not required to include transaction or trading costs as a component of the expense ratio. You may use a fund’s turnover rate (how often a manager is buying and selling securities within the fund) as a general guide to potential transaction costs within the fund, which will ultimately impact a fund’s total return.
Redemption Fee: A fee charged by mutual fund companies to discourage investors from pulling out of a fund after a short period of time. Always be aware of the redemption fee policy prior to purchasing a mutual fund.
Advisory Fee: A flat rate or variable fee based on account size charged by an investment advisor for managing a portfolio. The fee is over and above mutual fund expenses and potential transaction costs. Annual advisory fees typically range from a low of around 0.5% to over 1.5% of assets under management. Fees are usually paid quarterly and may be calculated based on initial balance, average daily balance, or quarterly ending balance.
Here is an example of the impact that all of these fees can have: if you are invested in a portfolio of no-load mutual funds with 50% in equity and 50% in fixed income with an expense ratio of 1%, managed by an investment manager charging 1% (assuming broad equity market indexes generate a 10% return and fixed income a 6% return), you should expect to post a 6% return after fees.
This scenario does not take into consideration that the fund managers and investment advisor may outperform (or underperform) market indexes.