Karen Klein in recent press-media reports, has stated she's thinking of making "investments to make my money grow". This may be unwise given the current volatile, low demand environment - but just in case she intends to go forward here's an investment test to ascertain if she's truly ready to go that route - or (as I suggested) stick to immediate fixed annuities. The test is also useful for anyone else considering plowing money into the markets, now that the magic DOW is heading up toward 13,000 to perhaps stay.....or maybe crash 5,000.
TIME: 45 Minutes: NO GOOGLING!
1) What is a P/E ratio?
2) What is the maximum tolerable expense ratio, beyond which an investor shouldn’t invest in a mutual fund?
3)Distinguish between front and back loads.
4) Joe has $10,000 to invest and the fund is front loaded at 5%. How much is he really investing? How much must he gain the first year to reach break-even? How much must his fund earn to achieve a REAL 5% gain. (Assume the expense ratio is 2%)
5) Distinguish between bonds and bond funds?
6) How would you recognize collateral debt obligations (CDOs) in a bond fund? Interest only strips? Inverse floaters?
7) When investing in stocks, one of the worst tricks used by brokers or managers is collusion using ‘micro caps’ to keep their clients buying and selling stocks within a closed artificial market. (Source:‘License To Steal: The Secret World of Wall Street Brokers and the Systematic Plundering of the American Investor', page 211). Explain.
8) Small, individual investors in stocks are usually fleeced by brokers through “crossing”, “churning” and “parking”. Explain how each of these would work.
9) Why can’t you trust a “financial advisor” to really handle your money in YOUR best interest?
10) Why, if you do – is the ADV form Part II essential? What is an ADV form?
11) Hidden commissions using transactions between brokers is another way to fleece stock investors. (‘License to Steal’, p. 212). How exactly would it work, referencing two brokers you can call “A” and “B”? (E.g. what exactly would A and B each do to make it work, using any stock price you want)
12) Fund managers like derivatives because they can artificially inflate a fund's return numbers to attract more buyers. They are risky and unregulated devices. They are usually not specifically reported in any portfolio. How would you know if your investment has derivatives?
13) Joe and Mary Schmoe are within 6 years of desired retirement. They estimate they need at least a $300,000 nest egg along with their Social Security. In order to ramp up their savings they put $100,000 of their $200,000 so far saved into equity and bond funds in their 401ks. After three years, their total loss is $30,000. Assuming average 5% gains per year afterward, how long will it take them to make back their original investment? Assuming similar performance, how long will it take them to reach $300,000 in their nest egg? (Assume 15% capital gains taxes per year).
14) Distinguish between money market accounts and money market funds. Why are the latter always riskier?
15) Sally has $250,000 inheritance to invest. She doesn’t want to play the market directly, so opts for what she believes is a diversified portfolio of stock (equity) and bond funds. All the stock funds have derivatives. All the bond funds have either IOs, CDOs or inverse floaters. Despite her rigid attention to what she thought was “diversification” she loses $20,800 in the first year – half from the bond funds, and $40,900 the second year.
a)What should Sally do at this point?
b)Explain why her funds are not really diversified.
c) How can she ensure a relatively SAFE portfolio in a low demand environment without going to a financial advisor?
Marks allocation: 1-3, 5 and 9 (5 marks each), 4, 6- 8, 10, 12, 14 (10 marks each), 11 and 13 (15 marks each), 15 (20 marks)
Over 85% - Ready to invest or meet with financial planners ...without risking a life of catfood
70- 85%: You might be ready but be sure if you do you have the ADV form pt. 2 for the FA, and know what you're getting into.
50-70%: Stay out of the investment game and stick with safe fixed income devices.
Below 50%: You may want to ask a kindly relative to manage your money for you!