feb 2015

FINANCE
BONDS AND
MUTUAL FUNDS
What are they and
how are they rated?
By Warren Marmorstein, CPA
Before making any investment, know to what extent you are willing
to risk loss. If the answer is “none,” stay away from stocks,
bonds, and mutual funds. All three can lose money. The risk adverse
investor should limit himself to banks, fixed annuities, and/or a
fixed investment inside of a life insurance policy. Each is principal
protected, government guaranteed and insured.
Other factors to consider before investing include an understanding
of whether the investment is for growth or income, taxable or
tax free, its liquidity, earnings potential, solvency of the issuer, and
fees.
Working with an independent advisor, not
captive to the house brand, will generally
result in more objectivity to find the fund best
suited for you.
Bonds are issued by governments and corporations. We lend
money to be returned at maturity, with interest along the way.
Bonds come in many varieties, such as taxable or tax free, domestic
or foreign, investment grade or junk, fixed or floating interest rates.
The promise to return our money is only as good as the credit worthiness
of the issuer. To assist in this understanding most bonds
have ratings. Higher rated bonds pay less interest, lower rated
bonds pay more interest. Assess your risk/reward tolerance before
deciding what quality bond to buy.
The major rating agencies are Moody’s, Standard and Poor’s, and
Fitch. At Standard and Poor’s, the highest rated bond is “AAA” vs.
the lowest rated bond being “C”. Bonds rated BB and below are
considered “junk”. If you’re buying bonds based solely on interest
rates, you’re heading toward disaster. Many brokers “sell” bonds
promoting high interest with no commentary about safety. Does it
really matter how high the interest rate is if the issuer defaults? If
your broker doesn’t talk about risk, consult another advisor.
Buying bonds without knowing your tax bracket is a mistake.
Paying a small amount of tax on a taxable bond with higher interest
vs. a tax free bond is often a better net of tax result. If you don’t
know your tax bracket, consult a CPA.
Bond owners must stay alert to the “formula” that as interest rates
increase, selling your bond prior to maturity may result in a loss.
Future interest rates are likely going up, so consider selling bonds
now.
Mutual Funds are a diverse portfolio of securities in a single investment.
Before buying any fund, evaluate its historical performance
against both the index which the fund is trying to outperform
and against the performance of other funds of the same style.
For the ‘do it yourself ’ investor not capable of the above, reference
Morningstar, a rating agency, that provides a one to five star
opinion on the fund you are considering. Consult a professional if
needed.
Mutual funds are generally sold in three classes: Class A (front
load), Class B (back load) and No Load; each differs by how fees
are charged. If your broker made this selection for you, ensure it
was in your best interest. No Load DOES NOT mean no cost. In
fact, No Load generally has the highest 12b-1 fee. Select a fund
based on its performance, also known as “net of fees.” Fund selection
based on lowest fee without regard to net of fee performance
makes little sense.
Many companies sell their own brand. Examples include national
brokerage firms and families like Fidelity and Vanguard. Working
with an independent advisor, not captive to the house brand, will
generally result in more objectivity to find the fund best suited for
you.
An Alternative - Certain investment types (other than stocks,
bonds, and mutual funds) offer the earnings potential of the
market WITH full principal protection. Bank depositors get the
principal protection they want with the opportunity for higher
interest. Market investors will get the earnings opportunity they
want with safety of principal. P
Warren Marmorstein, a 30-year CPA and financial advisor,
is independent of brand and a member of FINRA/SIPC.
www.MarmorsteinWealthManagment.com or
www.MarmorsteinFinancialGroup.com.
the PARKLANDER 107