Mutual Fund Upgrading

[Luhar]

Hi,
I am a fairly new mutual fund investor (I only invest in No-Load Funds in a Roth IRA, 34 years old, limited funds saved because I have a PhD) and was curious whether anyone has experience with using the "upgrading" strategy. In particular, I was wondering if there are any good books on the topic and how someone who saves relatively small amounts of money on a regular basis can use the strategy without incurring ridiculous transaction fees. For example, I have a Scottrade account (roth IRA) and save money in 50 - 500 dollar increments twice a month (it varies in that range depending on the month). It costs $17 to buy shares in a fund - unless it is a no-transaction fee fund (NTF). The NTF options are limited and therefore, to effectively upgrade I would need to evaluate the fee funds too. With my small monthly investments, the $17 fee makes up a healthy percentage (if I put 50 dollars in a fund, that's essentially a 66% fee). Naturally, I want to limit that percentage. Do people that use the upgrading strategy simply accept the fact that they are going to have to pay high transaction fees? Or do they spread their money across several investment institutions (i.e. Vanguard, Fidelity, Schwab....) to take advantage of each institutions NTF's?

I have read that index investing (especially through Vanguard) is the best way to save on expenses for long term retirement dollars. However, after doing some calculations I expect to need a 10% return on my retirement money to meet my goals. I don't think that's feasible in index funds.

I look forward to hearing your advice - thank you in advance!

[pb4uski]

Why don't you just move your Roth to a mutual fund company (I use Vanguard as do many of us here) where you can buy funds in such small increments at no cost?

You need to recalibrate your expectations on return. While a 100% equity portfolio has had an average return of 10% from 1926-2012, I expect future equity returns to be somewhat lower.

[braumeister]

+1

First point: You really don't need to pay anything in fees to add to a mutual fund if you choose the right place to do it.

Second: No offense, but it sounds like your assumptions might be a little off.
"needing" a 10% return has to be based on a very limited set of assumptions.

Instead, why not think in terms of either:
increasing your contributions
or
adjusting your goals.

As you're no doubt starting to realize, there are quite a lot of parameters to consider when looking at your retirement financing. But there are also quite a lot of good resources available to help.

[mickeyd]

Hey Luhar,
Welcome here.

"Upgrading" is a new term for me but I guess it refers to ditching a high fee fund and latching onto a low fee fund family like Vanguard.

Quote:

I was wondering if there are any good books on the topic and how someone who saves relatively small amounts of money on a regular basis can use the strategy without incurring ridiculous transaction fees.

Here is a link to the Bogleheads wiki that lists many excellent books on the subject. You may have read some of them, but they are all on topic.
Bogleheads • View topic - Books

[ERD50]

A $17 fee on a $50 deposit is an overwhelming wall to overcome. It's killing you, you are starting out four steps behind.

The market doesn't care what you 'need' - it will deliver what it delivers. If you think that's not feasible in index funds, what makes you think it is feasible in other investments?

I don't know what you mean by an 'upgrading' strategy.

-ERD50

[Luhar]

Thanks for all of the feedback. I really appreciate it. If anyone who's posted is still following I can try to address some of the comments that have been made.

1. I haven't actually paid $17 on a $50 investment. However, there are times when I only have $50 to save (every tiny amount adds up in the end). In these cases I put the money in a money market account until I have a larger amount to invest. The problem with this strategy is that I'm missing the opportunity to produce returns on the money that is in my money market. As you may have noticed, I'm trying to figure out what my investing method is going to be so I can get returns (or losses) on that money.

2. I would love to save more, but I already save about 20% of my net income. Student loans/groceries/gas take the rest.

3. I do realize my goal of 10% returns is lofty. I've been reading Paul Merriman's books and he suggests using a retirement calculator (yes, it is based on many assumptions, which need to be reassessed every year) to set a really rough retirement goal. He also suggests that your investing strategy should be based on your retirement goal (the next author I read will probably suggest something completely different).

4. Vanguard is beginning to sound like a much better deal. I'm obviously still learning here, but I thought "upgrading" was a more popular method of mutual fund investing than it really is.....#5 below follows up with this....I just wasn't sure if Vanguard would be conducive to this method since upgrading would require access to many fund families.

5. Upgrading is a more active form of mutual fund investing where you sell underperforming funds and replace them with better performers. The frequency of this depends on the investor. There is a company called FundX that does this. It is also described in the following link, which I realize is biased but I provide it only as a reference: Strategy for Picking Mutual Funds | Wealth & Retirement

6. I just got "The Bogleheads' Guide to Investing" and "Common Sense on Mutual Funds" by John Bogle. They seem to be very popular books that will give me some more sense of what method to follow.

Thanks Again.

[braumeister]

Quote:

Originally Posted by Luhar I just got "The Bogleheads' Guide to Investing" and "Common Sense on Mutual Funds" by John Bogle.

Well done!
You are most definitely on the right track now.

And even though it may seem a bit premature, given your age, you may find it useful to look at The Bogleheads' Guide to Retirement Planning

[Luhar]

That's good to hear.

[travelover]

Quote:

Originally Posted by Luhar .......... 5. Upgrading is a more active form of mutual fund investing where you sell underperforming funds and replace them with better performers. The frequency of this depends on the investor. There is a company called FundX that does this. It is also described in the following link, which I realize is biased but I provide it only as a reference: Strategy for Picking Mutual Funds | Wealth & Retirement............

When I was starting out I fell for this strategy, too. It is called chasing performance. It does make some people rich - the people selling this stuff, but not the investors. Read a few of the books recommended, hang out on Bogleheads forum and here a while and you will be a a good path.

[Animorph]

Quote:

Originally Posted by Luhar 5. Upgrading is a more active form of mutual fund investing where you sell underperforming funds and replace them with better performers. The frequency of this depends on the investor. There is a company called FundX that does this. It is also described in the following link, which I realize is biased but I provide it only as a reference: Strategy for Picking Mutual Funds | Wealth & Retirement

We call that "performance chasing"! You buy into the hot fund just in time to see it underperform, then repeat endlessly. A good way to severely underperform the market.

With index investing you are pretty much guaranteed to get the market return, minus expenses. You can't do much better than that as a beginner. If you are looking for a higher return, you can weight your asset allocation towards value, small-cap, and some satellite holdings like real estate and commodities, still within index funds. But you may or may not beat a total stock market index in the future. There is no magic.

If you want to work at it, you can try to select active funds that have beaten the indexes over the past 10 years or more. You have to compare each fund to its closest index, not an active emerging markets fund with the S&P 500 index. That gives you a hope of beating the index, but there's nothing close to a guarantee. A couple of lucky guesses, like no financial stocks in the last bear market, and a fund can look pretty good over 10 years. And out of 5000 funds, someone will get lucky. Start with a simple index fund portfolio and then you can get as complex as you want.

As for transaction fees, at least try to keep them below 1% of your transaction amount and a limited to once in and once out, not once a year. Even better, use only your NTF funds. You can use multiple brokerages or invest directly with many fund companies. Each has a different set of NTF funds or no-commission ETF's. Most of us on this forum will rail against financial advisor fees of 1% of assets per year. You don't want to give your 1% away just buying and selling your funds by yourself.

[Luhar]

Now I get it - financial institutions must have come up with the name "upgrading." It sounds better than "performance chasing."

I really appreciate all the great advice. I'll have to get in touch with Vanguard.

[Badger]

Quote:

Originally Posted by Luhar I really appreciate all the great advice. I'll have to get in touch with Vanguard.

Sounds like a good idea. They will be able to guide you to appropriote funds. However, be sure to read and educate yourself so you don't blindly accept anyones recommendations.

Some funds like Vanguard's Retirement Funds and others (maybe their index funds) only require $1k to open a Roth IRA. On taxable investment I think the minimum initial investment is $3k. I'm not sure what the minimum contribution is at the moment but I would imagine it would be within your ability. The fees are some of the lowest in the industry and there are no purchase or redemption fees.

Cheers!

[ERD50]

Quote:

Originally Posted by Luhar ... 5. Upgrading is a more active form of mutual fund investing where you sell underperforming funds and replace them with better performers. The frequency of this depends on the investor. There is a company called FundX that does this. It is also described in the following link, which I realize is biased but I provide it only as a reference: Strategy for Picking Mutual Funds | Wealth & Retirement ....

Ahhh, the "FUND-X" upgrading strategy! I did subscribe to their newsletter for a few years, probably back in the late 80's, early 90's? Like just about any strategy, it works OK sometimes, and not so OK other times.

Here's a link that will compare their mutual fund that uses the strategy to Wellesley and SPY:

PerfCharts - StockCharts.com - Free Charts

Run the slider back to the beginning, ~ NOV 2001, and you'll see that FUNDX does OK sometimes, and not so OK other times. Not too exciting.

-ERD50

[pb4uski]

Neat chart. Are the lines ignoring dividends or with dividends reinvested? If the former, is there a way to include reinvested dividends?

[Animorph]

Quote:

Originally Posted by pb4uski Neat chart. Are the lines ignoring dividends or with dividends reinvested? If the former, is there a way to include reinvested dividends?

The Perf Charts most often, but not always, include distributions. They can be especially iffy for recent distributions. Use at your own risk, but I don't know of anything like it that does better.