Archives For April 2010

Update on My Thumb Saga

April 30, 2010


I cut my thumb on December 22 of last year.

YESTERDAY I got a letter from Aetna informing me that they had received my appeal and decided to reverse their previous decision and will pay the bill.


Sadly, it took FOUR MONTHS to get this resolved.

The other sad thing is that it cost over $2,000 for four stitches. That’s just nuts! I was there about two hours and saw the doctor for maybe 30 minutes. Why the hell did it cost $2,000? I could understand $500. But $2,000?!?

I think it boils down to the fact that like colleges and universities, there are no incentives to keep costs low in health care.

Anyway, I’m glad my bill was paid. I just wish it didn’t cost so much in the first place. Health care costs are totally out of whack.

Since I have been on the topic of mutual funds, I thought it would be interesting to look at the difference between an A-Share mutual fund and a c-share mutual fund. Since I already have the data from my other posts, I’ll use American Funds Investment Company of America to make my comparison.

For those of you not familiar, an a-share mutual fund is a front-load mutual fund. That means when you purchase an a-share, a percentage (usually around 5%) of your purchase goes to pay the front-load. The more money you invest, the smaller the front-load is as a percentage (called breakpoints). For instance, ICA’s maximum load is 5.75%. But, if you invest $100,000, your load is reduced to 4.5%. A-share mutual funds also charge a 12b-1 fee (also called a trail) that is used to compensate the broker. The 12b-1 fee for the ICA a-share is .23% per year.

A c-share is much different. There is no front-load but in order to compensate the broker, the fund charges a higher 12b-1 fee. In the case of the ICA c-share, the 12b-1 fee is 1%. This 1% is charged for as long as you own the fund. There also are no breakpoints for investing more money in the fund.

As you can probably imagine, the c-share ends up being more expensive to own over the long-run. But, that doesn’t necessarily make it a bad product. Why?

Well, when a broker is making 1% per year, there is an incentive for him (or her) to take care of the client. As their c-share business grows, there’s also less pressure for the broker to have to find new clients. Contrast that to an a-share that pays a big commission up-front. As soon as the broker earns that commission, they have to either pursue more money through that client or they have to go out and find more clients so they can earn more up-front commissions. There’s not nearly as much incentive to take care of the existing client. Sure, not all brokers work this way but some do and it is a risk of purchasing an a-share mutual fund.

So, let’s look at a numbers comparison of ICA’s a-shares and c-shares. The ICA c-shares have only been around since 2001. I like to look at round numbers so I began the comparison on December 31, 2001 through December 31, 2009. I assumed that the 12b-1 fees (I divided the annual 12b-1 fee by 4) were charged on a quarterly basis based on the account value on the last day of each quarter. Here are the results I got:

It’s not a lot of difference but keep in mind that this was for only 7 year’s worth of data. The gap will grow with time (assuming all else stays equal). Most brokers I knew NEVER sold c-shares because they needed the big up-front commission and didn’t want to take the risk of the client leaving before they could make up the lost up-front commission in trailing commissions.

My post from yesterday raised some eyebrows and ruffled some feathers. I suppose I used a bit too much glamour when I used the word “smoked” in the title. I tend to do that sometimes when I want to draw attention to a post.

Some questions were raised about my methods:

Why did I choose a 10-year period? Well, I wanted to compare American Funds’ Investment Company of America with Vanguard’s S&P 500 Index Fund. My source for daily data is Yahoo! Quotes. Their data only went back to the mid-to-late 1990s. Since I was calculating the reinvestment of dividends on my own, I wanted to have daily data.

Did I “data mine?” No, I did not. I did not search for a mutual fund that would support my position (because I did not have a position). I would have posted the results REGARDLESS of the outcome. As I stated in my previous post, I chose American Funds’ ICA because I was familiar with them and knew that they had been around a very long time.


Since I didn’t have daily data going further back than the mid-1990s, I decided to switch to annual data provided in the ICA’s Annual Report and data that I have for the S&P 500 Index*. Here is a year-by-year comparison (you can click on the graphic to see a bigger version):

Those figures do not include a sales load. They also do not include a management fee for the S&P. So, to get a little more accurate picture, I assumed a $1,000 investment in each and deducted the maximum up-front sales charge of 5.75% for ICA. Then, I calculated the returns for the last 5, 10, 20, 30, and 40 years. Here are the results:

Remember, these numbers DO NOT include any sort of management expense for the S&P Index, which favors the index. Another thing to note is that looking at the data, I’m sure there were rolling periods in which the index beat ICA.

These figures all go to hell if you look at dollar-cost averaging since each investment in ICA would take a haircut. It would be hard for ICA to overcome that obstacle. That’s why I would ONLY consider a load mutual fund if I was investing a lump sum.
*Although I refer to it as the S&P 500 Index, the index was composed of 90 stocks prior to 1957.

I learned about American Funds during my PaineWebber days. A few of the brokers (though not enough in my opinion) used American Funds for their clients’ portfolios. One of the funds I liked from American Funds was the Investment Company of America. Yes, it had a front-load. But, the annual management expenses were quite low compared to other funds. I also liked the team approach to investing.

After I left PaineWebber, I quit following American Funds until the other day when I came across some old fund literature I had kept (yeah, I’m a recovering pack rat). Their numbers looked pretty solid so I decided to look them up to see how ICA performed over the last 10 years. Turns out they did pretty well considering what we went through over the last ten years. I decided to compare ICA’s performance with Vanguard’s S&P 500 Index Fund.

I assumed the following:

• a $100,000 lump sum investment placed on December 31, 1999 and held through December 31, 2009.

• a 4.5% front load on the ICA shares.

• the funds were held in an IRA so taxes were not an issue.

• all dividends were reinvested.

Here is the chart of the comparison:

The value of the ICA (Class A) shares (after the 4.5% front load) was $122,257 at the end of 2009 while the value of the Vanguard S&P 500 Index Fund shares was $90,165. That’s a $32,000 difference. Had the ICA shares not had the front load, the end value would have been over $128,000.

Now, the numbers would have been totally different had you used a different share class. I’ll rerun the numbers using the C-Shares, which do not have an upfront load but carry a 1.46% management fee compared to .66% for the A-Shares. Unfortunately, it can’t be an exact comparison because the C-Shares haven’t been around as long. I’ll use the last five years as a comparison.

The numbers also would have looked much different under a dollar-cost-averaging scenario since every purchase of the ICA shares would have been subject to the sales load.

Also, it’s important to note that not all load mutual funds are created equal. American Funds has a great reputation of holding costs down. Not all mutual funds take the same approach that American Funds does. I just wish their funds didn’t levy sales loads.

I came across this article this morning: 7 Courses That Will Help You in the Real World

This is no-brainer stuff:

• Accounting – this was my favorite class in high school (not so much in college when I had a teacher I could barely understand).

• Technology – if you’re not familiar with technology, what have you been doing?

• Public Speaking – consider joining Toastmasters.

• Writing – one thing facebook has shown me is that that lots of people do not know how to write.

• Marketing – one of the more interesting classes I took in college.

• Sales – we’re all salespeople.

• Management – another of my favorite courses in college. Fortunately, there are TONS of excellent management books available. I recommend reading 2 or 3 management books a year.

Basically, it’s a general business degree.

This week I have been trying to take a long-term look at our finances by peering into the abyss that is retirement when we are 65-years old. It’s a scary undertaking because there are so many unknowns.

In order to look at these numbers, I had to establish some parameters:

• Desired annual income: $100,000 ($222,000 at age 65). We could do with less but we are comfortable with this amount. Some of our bills will be gone (mortgage) but others will pop up (healthcare). I’d rather be safe than sorry so I’m estimating a higher income amount.

• The latest Social Security statement says that our monthly benefit at age 62 is around $2,500, which is not adjusted for inflation. I adjusted the amount for an inflation rate of 3% and came up with $5,700, which I then halved due to the uncertainty with the social security program. That gave me an annual figure of around $34,000.

• My wife has a pension plan. The latest statement says that she could expect a monthly benefit of $2,117 at age 65. I’m not too familiar with this plan but I assume that this number will increase over the years. However, to be conservative, I’ll stick with the $2,117 amount ($25,000 per year).

• That leaves $163,000 per year that must be funded via retirement plans (401(k) and IRAs). At a 4% withdrawal rate, the amount of capital needed to fund $163,000 in income is roughly $4,000,000. That’s a lot of money but it also assumes that the principal doesn’t diminish over the years.

• At our current pace (assuming a 9% rate of return), we should have more than enough to meet that goal. If I assume a 7% rate of return, we’ll have a significant shortfall. But, these numbers are misleading in that they do not reflect raises or profit sharing that goes into the 401(k) on an annual basis.

Yes, there are things to consider. For instance, I used a 3% inflation rate. If inflation runs 4% to 5%, my numbers will change dramatically. Social security could be phased out for those who are deemed “wealthy” by the government’s standards, which would be bad news considering how much money my wife and I have paid into the system already at this point in our lives. But, those things could be offset by saving more money and using principal throughout retirement.

I’ll run some more scenarios in the future to show you what I’m talking about.

I read this letter to the editor in today’s Wall Street Journal:

“In ‘George W. Bush’s 2010 Tax Miracle” (op-ed April 15), Donald L. Luskin suggests that many wealthy owners of IRAs and other tax-deferred retirement accounts will convert their accounts to Roth IRAs ‘in exchange for freedom from taxes forever after on principal, income and gains.’

“Should anyone be so naive to think that this administration won’t later change the rules and begin to tax all gains on Roth IRAs for those families making above $250,000 per year?”

That’s been one of my concerns too. Not so much that Obama would change the rules but that the rules would be changed at some point in the future. Things the government could do to jack things up:

• Force people to include Roth IRA withdrawals in their income in calculating the tax on Social Security benefits.

• Force people to take RMDs from their Roth IRAs.

• Tax withdrawals for people over certain income thresholds.

I know, I know. I sound like a conspiracy theorist. But, don’t think for a minute that the government won’t change the rules. They’ve done it in the past and they’ll do it again in the future. Anytime they see someone supposedly using the system to their advantage, they’ll figure out a way to close the “loophole.”