Green Investing or Investing in Green – How to Invest in an Environmental IRA

For an increasing number of investors, “doing good” with their investments is as important as doing well. Tapping into this new environmentally conscious market, more not-for-profit organizations are teaming up with money managers to create a new line of impact investments. Here are some examples:
 Green Century Funds at [[|Green Century Funds]];
 Aquinas Funds at [[|Aquinas Funds]]; and
 Calvert at [[|Calvert]]
Caution: before you pick any, use a resource to evaluate and compare, such as Kiplinger’s Finance at [[|Kiplinger’s Finance on investing]].
While there is no “green IRA”, you can pick a mutual fund, such as the ones mentioned above, or select stocks yourself in within your IRA or Roth IRA – for more, see [[|Financial literacy millennials received poor marks but they can fix that]] That is, when you contribute cash to your IRA, it sits in a money market account, doing little until you invest it. If you want to invest in environmentally conscious companies, you can, as follows:

1. Select type of IRA: Before opening and IRA, decide whether a Roth IRA or a traditional IRA suits your needs (see the Financial Literacy post).
2. Open an IRA: Opening an IRA has never been easier. You can contact a financial institution, by phone or online, that offers IRAs, usually a bank, brokerage or mutual fund company. Do your research and be sure the broker offers a self-directed IRA, so you can pick your investment options. Also, be mindful of fees charged for trades, that is the buying and selling of stocks or funds. You want a discount broker. Finally, name beneficiaries in case something happens to you.
3. Choose your Investments: Your IRA can be made of stocks, mutual funds or a mixture. In choosing stocks, experts such as Jennifer Schonberger of The Motley Fool, suggest that you focus on particular countries as you make green stock or mutual fund selections for your IRA. She notes that China is an innovator in green technology, though it is also known as one of the world’s biggest polluters.
4. Fund your Account: Make a plan to fund your account and stick to it! Starting early and contributing regularly can have an enormous impact your account’s value due to tax-free compounding of returns (see “Save 10% of Income” at [[Financial literacy millennials received poor marks but they can fix that|Savec 10% of Income]] )

As with any stock market investing, your Green IRA may show you a roller coaster ride of value swings; however, if you have a long-term horizon, the significant growth potential should out-weigh this volatility risk. Also, if you pick a loser, you can always sell your investment (tax-free) and invest in another. Good luck!

P.S. – you can always decide to invest well, this is both easier and yields better returns, and then donate to environmental groups.

Faults of the Individual Investor to Avoid (Reasons for Impartial Advice)

Individual investors historically act as a contrary indicator. That is, looking at recent events, they assume that a market going up will continue to go up, or that a falling market will continue to fall. The individual investor fixates on the past, as if it will continue, rather than gauging the future. With this perspective, the behavior of the individual investor is to buy at the peak and sell at the trough, hence making them a contrary indicator to what will really occur. Countering this behavior takes substantial discipline, experience and information, and usually a good advisor.

A good advisor should add value through asset allocation and fund selection, but foremost by guiding you to counter bad investment behaviors. You need to stay invested when you fear a fall and sell when you are convinced of sure upswings. Advisors need to provide value-added guidance that will:
(1) avoid giving any serious weight to short-term indicators;
(2) avoid trying to pick “winners”;
(3) closely examine expenses, as high costs result in much lower net returns;
(4) investigate riskier classes as a component of a good overall asset allocation (e.g., emerging markets);
(5) look for funds that stick to their own goals, rather than trying to match any index, as such discipline pass off over time;
(6) take a contrarian view at times because too often a fund doing well at a given time will ultimately revert to the mean of all funds; and
(7) be clear with clients on the risks being taken (that is, measure the risks for say a bond differently than stocks).
All these are ways in which advisors increase the chance that you achieve good investment returns over time.

Recent history provides a good example. With the crash in 2008, we spoke to many clients and started a flow of e-mail updates and strategy suggestions. This became our newsletter on our web site. The key advice was that, if you have a good allocation, and good investments, stick to your long-term plan, do not sell. Those of our clients who followed the advice returned to their pre-crash peak values by last year, something none of us thought would be possible so soon. However, those that sold were selling as investments declined in value. Moreover, they had no clear signal in mind as to when to reinvest. That meant that most missed the rise of greater than 11% in the beginning of 2009. That upswing can never be regained. Therefore, they sold at a low point and were forced to buy back in at a higher point.

How could those that stayed invested be back to their peak when most indices have not returned to their all-time highs? A well-managed portfolio, employing good asset allocation, will not drop as much so it will have less to recover to be “whole.” Therefore, it could regain its peak value more easily, and with less risk. Again, this points to all that we have published before on the need for asset allocation analysis and diversification within each investment type as well as among investment types. It also makes clear how important not losing capital is: losing 50% requires a 100% gain to recover, while losing 25% takes only a 33% gain.

Good investing will lead you to avoid the behaviors that constitute what Carl Richards dubbed the “Behavior Gap” (April/May issue of Morningstar Advisor), meaning the gap between investment returns and investor returns. Simply opting for index funds is not a quick fix that works. Instead, individual investors require guidance. They can have the best possible investment approach “only to blow it up completely with one big behavioral mistake at the wrong time.” He goes on to write that all approaches are tested over time, so the advisor’s role is one of helping “rid the world of negative behavioral alpha, to close the Behavior Gap.”

In another article, he writes that “ … if 83% of mutual fund investors are getting advice from advisors and are doing poorly, maybe we advisors are part of the problem. (See First, Do No Harm by Carl Richards 02-10-11) To state the opposite side, “Still the trend seems clear. Investors who were inclined to invest for the long term were likely to have better returns. A look at how the markets have worked during the past 10 years illustrates why that is. We had two bear markets and two dramatic rallies. Those who sold equities in the bear market missed out on the rally and therefore nearly all would have been better off riding out the bear market.” (Inside the Vanguard Science Project Vanguard’s more-patient shareholders outperformed the rest. by Russel Kinnel 05-05-11)

Investors doing all the work with no advisors have access to good tools, such as E-Z Planner for retirement planning, but that can be dangerous. Again, the risk of bad input, generating bad outcomes, comes from the same issues of perspective and bad investment behavior. With an objective source to counter your own bias or “bad investment behavior,” this can be avoided. For example, in addition to the investment issues reviewed above, most individuals understate spending. “Oh, yes, we did buy [something] last year, but that was a one-time event.” Each year will have “one-time” events. Building a good plan takes some means by which tough questions like cash flow and investment risk are addressed. Otherwise, the best software will produce results with erroneous conclusions.

You need terrific discipline or good advice to resist psychology of risk aversion and the urge to use recent events as a gauge for what will occur next. Otherwise, your investor returns will fail to match investment returns over time.

Having said that, what is the Next Step:
First, review how your portfolio performed in recent times, did you react from fear and leave your strategy or hold on?
Second, review your portfolio; does it fit your risk tolerance and financial goals?
Third, take a second look at your portfolio, but from a contrary perspective; did your answer on risks match the actual investments made? (For example, someone claiming worry about the economy should not be 80% in US stocks.)
Finally, check to see if the portfolio, with any on-going savings, will be sufficient to achieve your financial goals. If you are not certain, then advice from an objective source could make a substantial, and very important, difference.

Need help? Contact us!

Investments: the right fund does not have to be a winner

When building your portfolio, what criteria do you use to select the component investments? With the recent market dive, and then the surge this year, how do you know what works?

The Moringstar article reprinted below responds to the idea some investors have of trying to find The Best fund or manager by saying: “But the real question is why even try. Investing is about identifying options that help fulfill goals, not about finding that lone fund that is superior to all others. Splitting hairs in a quest for one be-all-and-end-all fund has diminishing returns and often can do more harm than good”

This is why financial planners and investment advisors build a portfolio to meet long-term goals. Much of the return generated over time comes from your asset allocation, not the specific fund selection. Having a winner in one year may mean having a loser in another. It is better to have good, steady performance over time in order to meet your goals.

Here is an example of how the goal drives the fund selection: We all know that money market funds have very low yields now, so it is tempting to use short-term bond funds as an alternative. However, if the money is for a big purchase, such as a car, or for college tuition, the risk of a loss even in a short-term bond fund is too great – the goal says stick with the money market fund.

Let me know if have questions on investment selection and portfolio construction.



Seek the Right Fund, Not the ‘Best’ Fund

by Eric Jacobson | 01-14-10

With such extreme returns over the past couple of years it’s worth reiterating some basic tenets of fund evaluation that can be overlooked when the market is zooming back and forth.

The Highest Return Does Not the Best Manager Make
During short time periods, some funds stand out with such remarkable gains that those returns alone appear to be proof positive of a manager’s superior talent. However, there are plenty of reasons such numbers don’t guarantee superior management. The most obvious and important is that single periods are reflective of factors that may not be repeated the next time around. Many funds with outstanding 2009 returns could serve as an example. One of the clearest is the closed-end Eaton Vance New York Muni EVY, now appearing prominently on 2009 leaders’ lists. This fund’s NAV went up 62% in 2009 while its market price soared an incredible 94%. But the firm’s own executives say those gains were largely the flip side of a harrowing 48% 2008 loss–one of its category’s worst declines–that was in part due to the same portfolio leverage that fueled it in 2009. Therefore, only by evaluating the fund’s performance over a much longer period of time could one reasonably evaluate its managers’ true abilities. Just as important: Banking on this fund to again produce anything close to the kind of returns it earned in 2009 would be a mistake.

Longer Periods Can Prove Arbitrary and Thus Misleading
Is a single calendar year any more relevant to judging the skill of an investor than a period of a different length? Are one-, three-, and five-year trailing periods any more valid than those covering two-, four-, and six-year returns? The investment industry uses the first set of specific periods out of convention and convenience, and for the purposes of comparison they have some utility. But short periods can easily cause unusual distortions even in longer-term performance numbers; a fund’s history of trailing returns can shoot up or crumble in the face of a severe short-term gain or loss. For this reason, looking only at a few select periods doesn’t fully reflect the investor experience over time. We see the effects of this problem every so often whenever the debate over indexing versus active management heats up. At any given time historical returns may confirm what everyone knows, which is that indexing beats active management–except during all those times when the opposite is proved.

The best assessment of a manager or strategy has to involve looking at multiple periods over time, sometimes slicing them up to better understand the effects of market moves, and to include as many as possible. Rolling returns are good for this purpose and provide insights unavailable in trailing or calendar-based periods.

Certainty Is Elusive
There’s a clear desire for many of us to come to final conclusions that one fund or style is demonstrably and conclusively better than another. That’s understandable, because that search is almost always undertaken when preparing to make an investment decision. For such an important task, it makes perfect sense to seek out conclusive proof that the decision you’re about to make is the right one.

But while one can do a pretty good job of narrowing down a big universe of investment choices to a handful of good options–ideally sifting out most of the truly bad and many of the mediocre ones–identifying the “best” fund of any particular kind is a lot more difficult.

Aside from the time-period factors, there’s a fundamental issue that in the mutual fund world, in particular, there’s a surprising variety of differences when it comes to the actual investment mandates and parameters of funds. Even two with almost identical names in the same category may have quite different management styles. On the equity side, for example, we often see this most starkly among value funds. A fairly conventional one might define its approach primarily in terms of selecting stocks that are demonstrably cheaper by some measures than, say, the average name in the S&P 500. Another might be a much “deeper” value player, though, or even one that focuses on companies in distressed situations.

The differences among bond funds might be less obvious, but two otherwise conventional intermediate-term bond funds can have very similar mandates, use the same benchmark, and still differ meaningfully. One that pursues a so-called core-plus strategy (a tag common to the institutional market), for example, might do so by including as much as 15% or 25% in high-yield bonds. Another might do so by focusing a similarly sized bucket on high-quality, non dollar bonds. And yet others might reserve a bucket eligible for either and perhaps even throw in some emerging-markets debt.

One can reduce lists of funds down to a handful of demonstrably very good managers yet find it almost impossible to conclusively determine that one is objectively “better” than the others given the variations in their styles.

But the real question is why even try. Investing is about identifying options that help fulfill goals, not about finding that lone fund that is superior to all others. Splitting hairs in a quest for one be-all-and-end-all fund has diminishing returns and often can do more harm than good.

Eric Jacobson is a mutual fund analyst with Morningstar.

Let us know if you have questions or comments. Thanks,


Lessons on portfolio construction and investment planning

The Morningstar article on mutual fund selection suggests that fund selection is not nearly as important as knowing your goals, picking your allocation appropriately and being aware of the lessons of history

You can expand this approach to selection of managers or narrow it to selection of specific stocks. Either way, the goal should drive the investment selection and you should have a strategy that fits.

If you want to discuss this more, let me know.



Two Things to Consider Before Picking Funds

by John Coumarianos | 01-05-10

Is a Morningstar mutual fund analyst really telling you that other issues are more important to consider than deciding which mutual fund to own? Yes.

Many investors spend too much time thinking about individual mutual funds and too little time thinking about more important investment questions such as their goals and overall asset allocation. Two such issues should take precedence over the consideration of specific funds. Only after you’ve addressed them should you begin thinking about which funds are appropriate.

Know Your Goal

Before coming to Morningstar I worked as a financial advisor, and I was amazed by how many clients just “wanted to make money” but couldn’t articulate a specific goal for the money they were investing.

My clients weren’t completely off base. Having and making more money is clearly better than having and making less, or losing money. But people have specific financial goals to meet. Some of the most common are paying for their kids’ college educations, owning a home, and providing for retirement. A simple desire to have and make more money without thinking about its specific purpose can get you into a heap of trouble.

A big challenge is that different goals require different time horizons. An area offering the potential for high gains can be the right choice in some cases but not others. In retrospect, a high-yield bond or emerging-markets fund clearly would have been great to own in 2009, as the Merrill Lynch High Yield Master II Index and the MSCI Emerging Markets Index have gained 57% and 77%, respectively, for the year to date through Dec. 28. But they wouldn’t have been appropriate places for money that an investor planned to use to buy a home in the middle of 2010 or for the entire allocation of Junior’s college fund, out of which the first tuition payment is due next September. Big near-term losses are just too common in these asset classes. For example, if one had to meet those goals in 2008 or early 2009, the results could have been catastrophic; those same indexes plummeted 26% and 53%, respectively, in 2008. And there was no guarantee that those asset classes would bounce back so well in 2009.

The appropriate place for money that you’ll spend within two years is in cash–a money-market fund or a certificate of deposit. For a time horizon of two to three years, you can consider a conservative short-term bond fund or an ultrashort bond fund. Anything else is too risky. Then you must be prepared to see the return on that investment lag many other choices. In fact, it’s virtually guaranteed that some asset class or sector funds will dramatically outperform that money-market account safeguarding next year’s tuition payment or down payment for a house. Learn to live with the fact that returns on short-term money may look weak next to alternatives.

In short, getting the best possible returns on that money isn’t the point; protecting it from loss is more important. Certainty comes at a price.

Understand Market History

Over the long haul, stocks have been better performers than money markets and short-term bond funds, but they’re no panacea. Knowing market history can help you build a successful long-term portfolio that neither overdoses on stocks nor avoids them altogether.

Stocks have returned about 10% annually for nearly a century, but they can go through extended periods of very poor performance. For example, the S&P 500 Index has posted a cumulative loss of 8% for this decade through Dec. 28, 2009, while the BarCap US Aggregate Bond Index has posted a more pleasing 85% return over that time. Additionally, stocks produced virtually no return from the period beginning in the mid-1960s through the early 1980s. Use this grim knowledge to set and temper your expectations.

The immediate future is unclear. It’s encouraging that stocks are not as expensive now as they were at the start of this decade, when many top companies were trading at P/E ratios of 30 or more. Still, it’s difficult to know whether the market’s current valuation is artificially inflated or depressed because it’s not clear if underlying corporate earnings are representative of future levels.

Because uncertainties like this almost always exist, Benjamin Graham thought a 50/50 stock/bond portfolio was a reasonable choice for most people’s long-term money. Vanguard founder Jack Bogle, by contrast, prefers the formula indicating that your stock exposure should be 100 minus your age. Others ratchet Bogle’s formula up to 110 minus your age for stock exposure. It doesn’t matter too much which of these you use but that you pick one and stay with it, rebalancing diligently as the markets take your prearranged allocation out of whack.

Knowing what stocks have returned over the longer haul, and knowing that they can disappoint over multidecade periods, can also help you keep saving appropriately. Don’t count on a roaring stock market to bail you out of not having saved enough for retirement or another major financial goal. Then, if the next decade for stocks turns out to be a great one, that will be icing on the cake.

John Coumarianos is a mutual fund analyst with Morningstar.

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