Financial Tips for Soldiers

Part II



                In my last article I strongly advocated that soldiers should adopt 2 financial strategies that consisted of consistently maintaining a 10% investing plan and a 10% emergency fund.  I also advocated using direct deposit to fund these plans.  In this article I will discuss what investments are ideal for investing and emergency plans.  As I do this, I will focus on young soldiers who probably lack knowledge about investing.  With this in mind let’s start with the basics.

Risk and Return:

                Before you invest in anything you must keep in mind the relationship between risk and return. (*Note: Return means the profit or money you will receive by investing.)  Historically speaking, the more risk you take as an investor the more return you will receive OVER THE LONG RUN.  With this being said, there are no guarantees in the short run, and you always risk losing money.  Likewise, if you risk little you typically don’t receive much money.  So what’s the best risk strategy?  It all depends on YOUR risk tolerance.  If you are willing to accept large losses in the pursuit of larger earnings you have a high risk tolerance.  If you never want to experience any losses you are risk adverse.  Bottom line, you need to be comfortable with the risk level of your investments, but ideally you don’t fall into one extreme or the other.  As a young inexperienced investor you probably want to be somewhere in the middle.  Based on my life’s experiences this is a good place for beginners to start.  Keep in mind that young investors have less money, but they tend to be willing to risk more money.  On the other hand, the old and established risk less because they have children going to college, or they face retirement issues.  In both cases the young and old tend to invest wisely based on the long run, and this is what investing is all about.  Most likely, your risk level will be based on your age, wealth and expectations.  

                Historically, equity investments such as stocks tend to outperform debt investments such as bonds.  Therefore, stocks tend to be more risky than short term bonds.  Keep in mind that both types of investments could cause you to make or lose money, but stocks would be more risky.  With this in mind, my advice for young soldiers is to take baby steps in the beginning.  Slowly test the waters and find the right investment for you

What is a stock or bond? 

                If you buy a stock you are buying a share of a business.  You are buying a company’s future profits or losses.  If you buy a bond you are buying a debt, loan or an “I owe you” from a government agency or company in the private sector.  People purchase these debt instruments so they can profit from interest payments.  This doesn’t mean you can’t lose money on bonds.  Like stocks, bond prices are constantly moving up and down based on demand.  Yes, if you hold a bond until maturity (until the loan is paid off) you will receive all that’s due to you, but if you choose to sell it before maturity you may receive less money than when you originally purchased the bond.  As a young soldier with little or no investing experience, this information may sound very confusing.  If this is the case, you should stay away from these types of investments.  Take your time, read about stocks and bonds, and expand your knowledge about investing before you take any risks with your money.  There are better investing opportunities for young soldiers who are just starting out.


Mutual Funds:

                Wouldn’t it be nice if someone with experience was willing to invest your money for you?  Well, that’s exactly what a mutual fund manager does for a living.  If you are an inexperienced investor and you want to receive a nice return, it might be wise to start with mutual or index funds.  This is what I meant when I suggested that you should avoid directly buying stocks and bonds at first.  Let the experts work for you while you are learning the basics of investing

                Maybe you are asking yourself; “How do I know if a fund manager really is an expert?  Who can I trust with my money?  How can I make money without being ripped off?”  These are all the right questions you should be asking yourself, and I will try to provide you with the information you will need to make an informed investing decision.  Read all of the information I’m presenting before you jump to any conclusions or finalize your opinions.



What you need to know about mutual funds:

                Before you invest in a mutual fund you really need to know certain facts.  I will discuss these facts in detail as I progress into this article.  For the time being focus on these key points.

-          What type of mutual fund are you looking at? 

-          How risky is the fund?

-          Who are the managers running the mutual fund?

-          How long have the managers operated the fund?

-          What are the fund’s 3, 5 and 10 year track records?

-          How does the fund’s track record compare against benchmarks such as the S&P 500, Wilshire 5000 or Barclay’s bond indexes?

-          Does the fund have any loads?

-          What is the fund’s operational expense?

-          Are there any other expenses you should be aware about?

-          Should you invest in a mutual fund or simply focus on index funds?


Fund Types:

                Before you purchase a mutual fund you should understand what type of fund is being offered.  Is it a stock fund, bond fund or does the fund invest in both?  Does it invest in domestic or foreign assets?  If it’s a stock fund does it invest in large or small companies?  If it’s a bond fund does it invest in short, midrange or long term debt?  Is the fund composed of corporate or government bonds?  Exactly how risky is the mutual fund you are looking at?  You can find the answer to these questions by receiving an information prospectus from the company offering the fund.  You should also gather facts from outside sources such as Morning Star, Kiplinger’s Magazine and Money Magazine.  All 3 of these sources offer a wealth of information about mutual funds.


Mutual Fund Managers:    

                Mutual funds can have one or more managers.  How many managers a fund has really doesn’t matter, but the manager or management team must have a proven track record.  Track records that are long and successful reflect highly on the investment unless a manager leaves the fund.  Once a new manager takes over a fund the track record is no longer relevant.


Track Records and Benchmarks:

                As I have already stated a mutual fund’s track record provides you with good insight into the fund’s management, but you need to know how to determine good performance.  To do this you should compare the fund’s returns against its benchmark. Mutual funds that invest in medium or large companies tend to be compared against the Standard & Poor’s 500 Index or S&P 500.  The S&P 500 is a group of the 500 largest companies in the United States.  Mutual funds that largely invests in smaller companies tends to be compared against the Wilshire 5000 which consists of the top 5000 US companies.  If a mutual fund can meet or beat the returns of its benchmark for 3 years or longer it will considered to be one of the best performing mutual funds on the market.  Always remember the longer the track record the better information it provides.  3 years is a decent indicator, but 5 years is better.  5 years is a good indicator, but 10 years is much better.  Never purchase a mutual fund based on a 1 or 2 year performance.  As a young investor you would be wise to look at mutual funds with at least a 5-year track record.  If a fund has a 5-year track record, and it has consistently outperformed its benchmark this could be a good investment, but there is other information you need to know before you act.



                Before you purchase a mutual fund you need to know all of the expense that are involved.  One of the most painful expenses are loads.  Loads are fees mutual fund managers require you to pay for their services.  Some funds require a “frontend load” where you pay a fee upfront.  Other funds require a “rear end load” where you pay a fee when you sell your shares.  Then there are some greedy funds that require that you pay both.  These loads or fees are based on a percentage of your investment.  Some say loads that are in the 1 to 3% range are reasonable, but I completely disagreeThere are many “No Load Funds” with outstanding track records.  In other words, there are many mutual funds that don’t have any loads at all.  These are the mutual funds you should be looking at regardless of what anyone tells you.


Operation Expense:

                Both load and no load funds have an operational expense.  There’s no way of getting around this expense, but you don’t have to overpay.  To understand what is a reasonable operation expense compare the figure against the industry average for your type of fund.  Once again, you can find this information in various medians such as Kiplinger’s, Money Magazine or Morning Star.  As a rough rule of thumb, 1% or less is a good figure.  Global or international funds tend to have higher expenses, so 3% or less is considered reasonable for these funds.  Once again, compare operational expenses to find the best bargains.  (*Note: Financial companies such as Fidelity and Vanguard have an outstanding reputation for offering no load funds with low operation expenses.)


     Other Expenses:

                When you purchase a mutual fund you want to avoid all fees and expenses to the best of your ability. Therefore, you should avoid any unnecessary expenses such as the 12B-1 fee.  Keep in mind that companies can legally call their financial products a “no load fund” and still require you to pay a 12B-1 fee for marketing purposes.  Also be aware that some companies may require you to hold a mutual fund for a certain period before you can sell it.  If you sell the fund prematurely you could face a fee of 1% or higher.  Be sure you get all the facts before you buy any financial investment.


Other Facts:

                Many mutual funds require a minimum investment.  The minimum investment could be $250 or significantly more.  In other cases, a mutual fund may not have any minimum investment requirements.  That’s why it’s wise to look at a company’s “family of funds.”  Most financial companies that sell mutual funds offer many different types with many different requirements.  Ideally you want to find a company that offers many no load options with good track records.  This gives you the option to roll your money into different mutual funds without the need to sell your investment outright.  Keep in mind that you may need to pay taxes when you sell your mutual fund, but you may be able to avoid this expense if you merely roll it over into another investment within the same company.  It also reduces many paperwork hassles.    


Connecting the Dots:

                As a young inexperienced investor you ideally want to do the following when purchasing a mutual fund.

-          Regularly read financial medians such as Kiplinger’s, Money or Morning Star.  These information sources list many facts about mutual funds so you can do a comparison.

-          Invest in no load mutual funds that have a 5-year track record or longer.

-          Ensure the fund consistently outperforms its industry’s benchmark.

-          Ensure the track record you are looking at has maintained the same management team.

-          Only invest in no load mutual funds that don’t have any hidden expenses such as 12B-1 fees. 

-          Always ensure your operation expense is reasonable.

-          Try to find companies that offer a wide range of no load funds.  Fidelity and Vanguard are 2 possible options, but keep in mind that there are many other opportunities.

-          Always invest based on your risk tolerance.  If you are willing to tolerate possible losses in the short run with the hope of gaining larger profits in the long run, then you should be looking at stock funds.  If you want to avoid any potential losses then look at money market funds or short term bond funds.  These are lower risk investments.

-          Last piece of advice, keep in mind that high risk tends to offer better returns or more profitability in the long run.  Since my message is targeted at young soldiers, and your 10% investment fund is a long term plan, it’s ideally suited for a stock fund or a comparable index fund.  On the other hand, emergencies pop up on a regular basis.  Therefore, your 10% emergency plan may be better suited for a short term bond fund, money market fund or a comparable index fund.  Once again, always invest your money based on your risk tolerance.

If you find my information on mutual funds interesting gather more information from different sources.  Personally I learned about mutual funds by reading articles in Kiplinger and Money Magazine.  I never read a book on this subject, but I’m sure you can find one on line.  If you find a book or article that discusses how to invest in mutual funds by Peter Lynch you should read it.  Peter Lynch is one of the most successful mutual fund managers of all times.


Index Funds: 

                Earlier I stated if you chose to invest in mutual funds buy those that consistently beat benchmarks such as the S&P 500 or Wilshire 5000.  When I said this I didn’t mention that most mutual funds can’t achieve this lofty goal.  Over a 5 or 10 year period, most mutual funds fall short of their benchmark.  Now that I have brought up this critical point you may be asking yourself how can anyone be sure their mutual fund will meet or beat its benchmark?  Maybe you are wishing you could be guaranteed that you will always achieve this goal.  Well guess what?  You can be guaranteed that your return will match the benchmark you desire!  All you need to do is to invest in an index fund.  There is nothing stopping you from investing in an S&P 500 index fund, Wilshire 5000 index fund or any of Barclay’s index funds for bonds.

                At this point you may asking yourself “So what’s the catch?  If the key to investing is to meet or beat a certain index, then why doesn’t every investor simply buy index funds?”  That’s a good question, and the answer typically hinges on overly high expectations or greed.  The simple truth is that most investors are not satisfied with the 7 or 8% return index funds typically offer over the long run.  Many consider this type of return to be boring or dismal, and they want a double digit return.  Some are not satisfied unless they can earn 20% or more annually, and index funds are not capable of doing this on a consistent basis.  I should also point out that NO investment is capable of guaranteeing a consistent double digit return, but many dream of striking it big.  Perhaps the people I’m describing are not really of the investing class, and they have more in common with gamblers.  With this in mind, consider these facts:

-          The S&P Indices Versus Active Funds Scorecard (SPIVA) shows that, with few exceptions, index funds have dominated their actively managed counterparts. As one example, over the past year, the S&P Composite 1500 beat 89.84 percent of all actively managed domestic stock funds. Over the past three and five years, those numbers were 73.24 percent and 67.72 percent, respectively. This holds true for both stock and bond funds. "Over the last five years, the majority of active equity and bond managers in most categories lagged comparable benchmarks," the report notes. Indeed, for bond funds, the "five-year data is unequivocal." Take, for instance, actively managed long government bond funds. Over the past five years, 93.62 percent of them trailed the Barclays Long Government index.  There are, of course, some exceptions to the general trend of outperformance. Take, for instance, large-cap value funds. Over the past five years, more than 60 percent of active funds in that category beat the S&P 500 Value index. But if you look at just the past year, that number drops to just over 27 percent.  (*Source Note:  News & World Report)


-          In a recent article titled Index Fund Portfolio Reign Superior, the author created 10,000 portfolios using actively-managed U.S. large cap funds, international large cap funds, and intermediate-term municipal bond funds. These portfolios were compared over five years to an all index fund portfolio using the same allocation to the three asset classes. The figures show that portfolios using actively-managed funds beat the all index fund portfolio only 18 percent of the time.  (*Source Note:  Forbes)



-          Other important facts to keep in mind, index funds typically don’t have any loads or 12B-1 fees.  If someone claims they do, look to buy your index funds from another company.


-          Index funds have lower operating expenses than actively managed mutual funds.


-          Most of the larger financial institutions such as Fidelity and Vanguard offer a wide variety of inexpensive index funds.


-          Since my message is targeted at young soldiers with little or no investing experience, it’s obvious that soldiers should start with index funds before investing in mutual funds or investing directly in stocks and bonds.


-          Once again, chose the right index fund that’s compatible with your risk tolerance.



                Perhaps I confused you by starting my conversation with stocks and bonds, progressing to mutual funds and then ending by recommending index funds.  The reason why I chose this approach was to offer you some options.  I didn’t want to come across as a salesman who wishes to steer you in a specific direction.  I want you to make your own investment decisions based on your own risk tolerance. 

Now that I have fully presented my advice, you should have less problems determining what investment is best for you.  If you still have questions do your homework.  Read periodicals such as Kiplinger’s or Money Magazine, or go on line to sites such as Morning Star.  Gather as much information as possible from unbiased sources before you invest your hard earned money, and avoid salesmen that work on a commission.  Once again, take baby steps and test the waters slowly, but keep in mind that you need to start somewhere.  Perhaps index funds offer you a good starting point, and later I will explain why income real estate may be the place you want to end. 


For quick reference here are links to my prior posts on Financial Tips for soldiers:

-          Part I

-          Part II

-          Part III 

-          Part IV

-          Part V


*Important Note:  I am not a financial analysis or broker.  I DON’T have the credentials to provide you with professional advice.  As I have stated before, I’m merely giving you enough information to whet your appetite, and I only wish to point you in the right direction.  Do not act on any of the financial advice I have provided until you have performed sufficient research.  This article by itself does NOT provide enough information to make a well informed decision.        


William G. McKinney

Bradley’s Military Enterprises