Anatomy of a Fund
Part I of the book, the first three chapters, discusses the structure, purpose and economics of mutual funds. In the event readers are not sure what a mutual fund is, Birdthistle notes that it is a financial tool that gathers money from different investors and that combined pool of money is used to buy a portfolio of stock, bond, and other financial investments. And of course, the purpose is to achieve positive returns.
With respect to structure, Birdthistle makes an important point investors would be wise to understand: “A mutual fund … is an equity arrangement. That is, fund investors are shareholders, not creditors nor account holders; they hold stock, not debt. The consequences of this legal status are important, primarily because they permit substantial – even total – loss in the investment.” The final chapter in the first part looks at the economics of mutual funds. Though Birdthistle goes into great detail over the chapter’s 18 pages, the information he hopes to convey is pretty straight forward: investors have to be aware of how advisers are paid because how someone is compensated often impacts how they will behave with respect to fund management.
Diseases and Disorders
The first chapter, Diseases and Disorders, in Part II continues the discussion of fees, specifically the magnitude of fees, the impact of competition in the mutual fund industry on fees, and a detailed discussion of 12b-1 fees, the costs associated with annual marketing or distribution on a mutual fund.
The chapter on fees is followed by chapters on soft dollars, fair valuation, late trading, market timing, and selective disclosure. Although brief, at six pages, the Selective Disclosure chapter was among the most interesting to me. As the name suggests, information that is material to a fund’s performance is not necessarily shared – or shared in a timely manner – with the public at large. It is selectively shared, often with preferred clients, such as hedge funds, but not regular investors. In essence it is a form of insider trading; a disorder indeed!
The third part of the book is likely the most relevant and interesting to readers of this blog. Like each of the other chapters, the first chapter – 401(k) and Individual Retirement Accounts – in Part III starts with a quote:
“The 401(k) is a way for both your government and your employer to disown you, and to leave your life savings to be raided by the financial-services industry and its plethora of hidden and individual fees.”
~ Felix Salmon, “The Systemic Plight of Labor,” 2013
The takeaway from that quote will probably differ for each reader. My takeaway (and the reason I run this blog), and I believe the reason Birdthistle wrote, and included it in this book, is because the financial services industry, our (American) approach to retirement planning, and the primary tool for most Americans – the 401(k) plan – are each flawed; and therefore, the only way most can hope to find financial success, is to be aware of those flaws and construct a plan that will work within that existing framework.
Over the four chapters in this part – one for each topic – Birdthistle does a nice job of providing detailed information (e.g. tax treatments, risk tolerance, fees, flexibility, etc.), on the aforementioned 401(k) and individual retirement accounts, target-date funds, exchange-treaded funds, and money market funds.
This final part is comprised of a single chapter, A Healthier Use of Mutual Funds, which provides the author’s prescription for how we treat the ailment, how we save. Before delving into the prescriptions, Birdthistle smartly notes the impediments, the financial literacy of the citizenry and the structural imbalances in the system.
To address financial literacy, Birdthistle suggests we turn to utilizing a licensing system, somewhat akin to the requirement that new drivers must be tested and licensed prior to operating a motor vehicle. For certain investments, Birdthistle proposes a modest licensing regime. To obtain the license, individual investors would be required to take lessons and pass a test. That is certainly an approach that is different from anything else I have heard.
Birdthistle suggests two actions to address the structural imbalances: increase the bargaining power of individuals by pooling their economic strength and perform greater enforcement. With respect to pooling economic strength, Birdthistle proposes we allow individuals to invest in the Thrift Savings Plan (TSP), the federal government equivalent to the 401(k) and a program I have championed on the pages of this blog (here [see comments section] and here) in the past. While I won’t go into the detailed structure of the TSP, Birdthistle accurately notes its success can be tied to its modesty, prudence, and low (.029%) fees.
With respect to greater enforcement, the prescription is very straight forward and obvious. Some regulations governing mutual funds should be revised and a greater effort should be made to enforce those revised and existing regulations.
Those that are serious about retirement planning will find a lot to like about this book; I know I did. Birdthistle does a nice job of describing the purpose, structure and economics of mutual funds, the most prevalent investment vehicle for most Americans; identifying the various types of funds; identifying the diseases and disorders that afflict the mutual fund industry; and suggesting viable cures.
The book is available at Amazon in Kindle and Hardcover version, $14.39 and $33.15 respectively.
The Giveaway – simply leave a comment to be entered – will end, and the winner selected, at 12:00 p.m. (EDT) on Sunday, August 7th.