Inflation Article

There are a lot in interesting articles out there with current finance topics, but here is one that I found.  See what you think, and how it makes you think about your investing for the next couple of years.

http://biz.yahoo.com/bizwk/080818/aug2008db20080815021990.html

Institutional Mutual Funds

In response to a comment today I would like to give a quick summary of Institutional Mutual funds and how they differ from “investor”, “retail” or “open” mutual funds.   What we will see is that the differences are quite small.  But, the differences instead highlight that the two types of funds are intended for different investors instead of a real difference in a fund.

For those who have not heard of institutional funds, lets take the following example, two investors.  One investor (investor A) is very wealthy and has 1,000,000 dollars to invest.  The second investor (investor B) is solidly in the middle class, and would like to invest 2,000 dollars.  As we have talked about before, mutual funds have an annual expense amount (fees that are paid to management company).  If both investors paid a 1% fee, Investor A would pay 10,000 dollars, while investor B would pay 20 dollars.  From a purely practical perspective, the management company has about the same overhead and administrative cost for both the investors, so investor A is paying a lot for the same service that investor B is paying 20 dollars.  So, instead, investor A would rather pay less, and probably shop around to find a better deal.  Now switching sides, a fund management company would rather have one person invest one million than 50,000 people invest 2,000.  So you give the big investor a little bit of a break (they are  still paying a lot if you charge them 0.8% instead of 1%), and you also encourage other big investors to invest with you.

These are the two main differences.  Institutional funds have higher minimum investment amounts (over 10,000 or 100,000), and slightly lower fees, while retail accounts have lower minimum investments (2,000 or less) and slightly higher fees.  The funds are invested in the same stock/ bonds, so there is no difference.

That said, many of you may have institutional funds and don’t even know it.  Many employer 401k plans utilize institutional funds (Each month they combine all the employees amounts and invest one large lump sum into the institutional fund). So be thankful that you are saving money on your fund fees.

Financial Links

There are many financial calculators out there in my opinion you have to know about the underlying assumptions for them to be of any use.  So, I have an idea, I am going to give you a link to the Harris Financial Group site that has more options of financial calculators than you probably have time. My wish would be that you would go to the site, use a few of the calculators, and then let me know the questions you have (eg. what pre-tax return do I expect on my IRA investments? or what is inflation?) As an added bonus, there is even a Financial IQ test. See below for the link.

http://www.harrisfinancialgroupinc.com/index.cfm?type=C&source=calc_hdr.cfm

Also, as long as I am submitting links. I found this interesting page (see below) on the Key Bank website, that has a lot of information on buying a house, the process and different types of mortgage products.  Hope that you enjoy.

https://www.key.com/html/MOL-10.html

Thanks for reading this moneyclamps post!

Conversational Finance

To kick off this topic, i would like to mention that there is one main target audience for this blog, that is “non-finance” people. That means that while many others may enjoy reading, i really want to reach those who have questions and who do not have formal instruction through a class of finance or have the opportunity to work in a finance/ money / investing field. An idea that was requested was a section called “conversational finance”. Similar to a class in Spanish or French by the same title, conversational finance will be for those who at a backyard barbecue or picnic or conversation at work want to follow or participate in a conversation that is taking place about investing or houses or debt. With the idea that you will at least be able to follow along if someone else is talking about any of these topics. That said, please give me questions or “theories” that you would like explained, and ill do my best.

Since i was at a barbecue this last weekend, i thought i would go ahead and throw out the first topic that came up… Housing. You may have noticed that its a popular topic these days, and let me give you some of the key players in the housing economy and the key drivers of the growth and decline cycle of the last several years.

Key Players:
Banks (those who actually loan the money)
Government (in charge of setting interest rates – see previous post on interest rates, and also federal oversight of the housing agencies and housing policies)
Housing Agencies (eg. Freddie Mac and Fannie Mae – federally chartered private organizations that create liquidity in the housing market by buying mortgages from banks)
MBS – or Mortgage Backed Securities (Investments that are purchased in a fashion similar to bonds, that receive cashflows [money or interest payments] from payments made on underlying loans)

So, not to be too complicated, let us stop there, but here is the quick cycle for a home buyer (we will call him Bob, and the flow of his mortgage loan).

Bob walks into his bank and wants to buy a house. He fills out the application and then the bank approves him for a loan, and then he goes and buys a house. Bob then every month pays his bank his mortgage payment. The bank may hold the title to Bob’s house, or sell it to Freddie Mac. If Freddie Mac buys the loan, then they pay Bob’s bank, and then Bob’s bank gives another loan (to Sue this time). Now, Freddie Mac by doing this over and over will get a lot of loans, and they are able to “pool them” [combine] and then sell the underlying cashflows (Bob is still paying every month), to investors. This investment structure is called a Mortgage Backed Security. So a mutual fund or pension fund will buy this MBS as an investment, and every month will receive some of the cash that is paid from Bob.

The risk is for the investor, that Bob does not pay his mortgage, but the real trouble happens when all of Bob’s friends and neighbors do not pay their mortgage, because there is a margin of safety in MBS transactions, and the problem today is that more and more of Bob’s neighbors are not paying their mortgages and the margin of safety on these investments is very low or does not exist anymore.