If you are buying a Target Retirement Fund: You can’t buy anything else

Target Retirement Funds – function on the principle that you should invest in equity, while you are young, and move towards debt, as you get older.

Since such funds are – fund of funds, when you buy a Target Retirement Fund, you are effectively buying the funds that your Target Investment Fund invests in.

But, more than that; you are buying into the idea that your savings should be invested in a certain ratio of debt and equity.

If you buy that idea, and have decided that a particular fund offers you a good mix, then you have to invest all your savings with that fund.

If you don’t invest all your savings with that fund, then you skew your ratio of debt and equity from the one you believed: best for you.

And, if you skew that ratio, then you really don’t buy into the idea that a particular ratio is good for you.

The only exception to this is – when you knowingly buy a Target Retirement Fund that has a ratio, which you are not satisfied with. For example a fund that invests 80% in equity and 20% in debt, when you would like only 70% of your savings in equity. To correct that ratio – you need to buy additional debt funds, and balance your portfolio.

The question is – if you have to manage your asset allocation, after buying a Target Retirement Fund, does it really make sense to buy a fund – whose purpose is providing the right asset allocation, in the first place?

How hard is it to buy the funds that your – Target Retirement Fund – will own on your behalf, and then keep investing in those funds directly every year? It can’t be much more difficult than buying additional funds to balance your asset allocation.

If you have invested in a Target Retirement Fund, and have more money invested in other instruments, you might want to re-think that decision, and consider owning the funds that your Target Retirement fund owns on your behalf.

What is a money market mutual fund?

A money market mutual fund is a type of mutual fund that invests in ultra-safe or low risk securities. The objective of the fund is to preserve the capital of the fund, and it is rare to see the NAV of a money market mutual fund go below one. The NAV can go below one, if the securities do badly but it is quite rare to see that happen.

A Money Market Mutual fund is meant for people who wish to safeguard their capital, and park their short-term cash into a security that gives – steady but low returns.

It is also used by people who want to balance their portfolio and build in some safety. If you have a lot of stocks in your portfolio, then money market funds can balance your overall portfolio by providing capital protection.

Money Market Mutual Funds offer – securities of domestic and foreign issuers. They are securities that are inherently – high quality (low risk) short term securities that can have a fixed, floating or variable interest rate.

A money market mutual fund usually invests in the following type of assets:

1. US Government Securities

2. Securities that are issued by entities sponsored by the Congress, but not issued by the US Treasury. (Example – Fannie Mae)

3. Bank certificates of deposits

4. Banker’s Acceptance

5. Bank Time Deposits

6. Notes

7. Commercial Paper

8. Repurchase Agreements

List of Money Market Funds

There are different classes of money market funds, based on where they invest their funds. For example – a fund can invest its money in US T – Bills or in Municipal bonds.

Here is a list of some Money Market Mutual Funds:

  1. Fidelity Cash Reserves (FDRXX)
  2. Fidelity Money Market (SPRXX)
  3. Fidelity Institutional Money Market Portfolio – Class I (FMPXX)
  4. Fidelity Tax Free Money Market (FMOXX)
  5. Fidelity Tax Free Money Fund (FIMXX)
  6. Fidelity Institutional Tax Exempt Portfolio – Class I (FTCXX)
  7. Franklin California Tax Exempt Money Fund (FCLXX)
  8. Franklin Money Fund (FMFXX)
  9. Franklin New York Tax Exempt Money Fund (FRNXX)
  10. Franklin Tax Exempt Money Fund (FTMXX)

In addition – here is a list from Financial Week that contains – Top Money Market Funds.

Should I buy a 100 billion dollar Zimbabwe Bank Note?

Zimbabwe is going through one of the worst humanitarian crisis that the world has ever seen, and the economy has all, but collapsed.

The inflation rate exceeds 2 million percent per annum, and that means Zimbabwe is issuing some banknotes with – a very very high value. In fact you can pay – 15 USD ,and buy a – 100 billion dollar Zimbabwe – bank note from Ebay.

Would you buy a 100 billion dollar Zimbabwe banknote for 15 dollars?

I asked this question to a few friends, and they said – maybe four months ago; not now.

Which brings me to my next question –

Should we let the GDP contract?

To calculate GDP, one needs to sum up:

C + I + E + G

Consumption + Investments + Net Exports + Government Spending

By not buying a 100 billion dollar banknote, which has no utility whatsoever, you are in fact, contributing to the contraction of the economy. Since the – C – in the above equation reduces, as we spend less.

Ordinarily, what you don’t consume, you – Save, and the savings in your bank – ultimately form capital for entrepreneurs and businessmen, and translate into – Investments. So even if you consume less, it should eventually translate into Investments.

The key word here is – eventually. So while today the economy may contract, tomorrow the savings will help it to bounce back.

A lot of wasteful spending characterizes any boom, and during recessionary times – people are more thrifty and careful. That just goes to show that if an economy contracts – it contracts for a reason, and artificially propping it up will do more harm than good.

I don’t know the right answer to the question of allowing the GDP to contract, but I’ve always felt that – what is good for a person is good for the country, and if you use that train of thought; the answer is obvious.

What is a Target Retirement Fund?

A Target Retirement Fund is based on a simple principle – your portfolio should have more equity early on in your career, and more debt as you near – retirement. Based on this principle a – Target Retirement Fund changes its allocation of funds every year.

Target Retirement Fund is a Fund of Funds

A Target Retirement Fund is a fund of funds, which means – it only invests in other funds. You can choose which year you will retire, and select a Target Retirement Fund – that is close to your target retirement age. For example, if I wish to retire in the year 2045, I can choose the Vanguard Target Retirement 2045 Fund.

The Funds leans towards Equity Initially, and Debt – later on

A Target Retirement Fund will be heavily invested in Equity in the initial years of investment. For example – A fund that targets – 2045 retirement, can have as much as 90% of its funds invested in equity today.

However, that mix changes gradually as you near retirement. For example -  a fund may keep a 90:10 – Equity:Debt ratio, for about ten years, then reduce that ratio gradually every year. However, this ratio may never be totally flipped to 10:90, with a fund holding 90% debt and only 10% Equity.

There is no fixed rule though, and while some - Target Retirement Funds - may hold greater than 50% equity in them; even when you are a couple of years away from retirement, others may just hold 20% equity.

Target Retirement Funds Invest only in their own Family of Funds

A point that worth noting is that – a Vanguard Retirement Fund will only invest in other Vanguard Funds, and a Fidelity Fund will only invest in other Fidelity Funds.

Another interesting point that – The Oblivious Investor – makes is that – the Target Retirement Funds should not charge you – its own expenses, over and above the expenses of the funds it holds.

List of Target Retirement Funds

The major Target Retirement Funds are offered by

Has this concept been oversimplified?

I think that the Target Retirement Fund is an oversimplified product, and doesn’t offer much to an investor. All the fund does is: keep investing a steady percentage amount from equities to debt over a number of years.

If you have a decent idea of your expected annual savings, and your retirement goals – you are in a much better position to invest this money on Equity and Debt funds yourself.

Even if you are not an active investor, there are plenty of Index Funds that can help you invest in equities and money market funds. I don’t see the benefit of restricting yourself to one fund.

So bottomline is: you need to do a decent bit of analysis of where the Target Retirement Fund invests in order to make an informed decision. This again will be a tedious task for most investors, and this time can be better spent in analysing, and investing in other funds directly.

How does China Manipulate its Currency?

China’s currency manipulation remarks by Mr. Tim Geithner hit the front pages of all major newspapers last week. So let’s take a look at how China manipulates it currency.

To be fair to China, almost every country in the world manipulates its currency. In an ideal free market world – there would be no government intervention in the currency markets. However, there is hardly any Central Bank in the world that doesn’t intervene, when its currency starts to appreciate or depreciate beyond a certain price band.

Almost every Central Bank has a certain price band for its currency in its mind, and as soon as the currency goes beyond that band, governments start intervening in one way or the other.

This government intervention can be direct or indirect.

Buying Dollars to Keep the Dollar Price High

China has been interested in keeping the Yuan (Chinese Currency) undervalued relative to the US Dollar, and the easiest way (if you can afford it) to keep the Dollar price high, and the Yuan low is to buy dollars from the open market.

A country like China, which runs a huge Trade Surplus can afford to buy dollars in the open market to keep the demand for dollars high, and push the dollar price upwards relative to the Yuan. This keeps the Yuan undervalued.

Indirect Measures

There can be indirect interventions like putting a cap on the amount of foreign assets that locals can invest abroad. For example – India allows its residents to invest only up to $50,000 in foreign assets every year.

Other indirect measures can relate to taxation laws. For example – by allowing tax free repatriation of the Great Britain Pound – the British government can help boost inflow of Pounds in the country, and influence the exchange rate.

Why Does China Wish to Undervalue the Yuan?

China’s engine of growth is exports. The lower the value of the Yuan, the better it is for China’s exporters. Basically, if 1 Dollar buys 7 Yuans, and a exporter sells a Chinese Shirt for 10 dollars – he pockets 70 yuans. But if one Dollar was worth only 5 Yuans, the exporter would only be able to pocket 50 yuans.

By How Much is the Yuan Undervalued?

It is really impossible to tell by how much the Yuan has been undervalued, but estimates suggest that this range is between 15% – 40%.

A direct consequence of keeping the local currency undervalued is inflation, and since China faced rather high inflation rates in 2008 – it did plan to let its currency appreciate in 2008 (but that was before sub-prime).

How is the US Impacted?

It can be argued that the US is flooded with cheap imports from China not because China is really cost – competitive, but because China has artificially kept its currency undervalued. If the Yuan was allowed to appreciate – Chinese imports may no longer be cheap enough to compete with American produced goods.

On the other hand, it could really be that the Chinese are cost competitive, and it is really cheaper to produce goods in China than it is to produce them in US.

The truth probably lies somewhere in the middle.

US Stimulus Spending

The US runs huge trade deficits, and has plans for massive stimulus spending. The deficits mean that this stimulus spending can be done by either issuing more debt to foreign countries or printing more dollars.

If Mr. Geithner’s comments continue; they may aggravate China to such an extent that it stops showing up at the Treasury Bond auctions.

If that happens, then the US will have to resort to printing currency and quantitative easing on a scale that unleashes massive inflation.

It will be interesting to see how the situation unfolds, and how Mr. Geithner deals with China’s “Manipulation” – if and when he actually takes office.

Update: Tried to get rid of the “irritating” hyphens.

Interesting Reads – Jan 24, 2009

I think that one of the most disappointing things about the TARP, and the various other bailout plans – is the lack of effort; by those in power – to explain the rationale behind the bailouts.

Very few people realize – the full scale of repercussions – if huge banks like Citi are allowed to fail. The whole bailout process should have been a bailout of ordinary tax-payers; with bad bankers getting bailed out as a by-product of it. However that doesn’t seem to be the case at all.

Here is an excellent example of what I mean – this Wall Street Journal story talks about – goats getting jobless because of the bad bets Lehman made.

There is a whole lot of other interesting stuff that I read this week and I present a few of them here:

1. Do it yourself Debt Consolidation by Moolanomy: A very insightful article about debt consolidation, and how you can get in control of your debt.

2. Is Market Linked Certificates of Deposit good for you by Money Ning: Pros and Cons of this little known product.

3. Book Review: New Rules for Retirement by Canadian Capitalist: Canadian Capitalist reviews this book and has a book give-away on his website. It is only valid for Canadian residents though.

4. Dividend Yield for Major US Indexes by Dividend Growth Investor: A look at the indices which have the most – dividend paying stocks in the US.

5. Teaching Delayed Gratification Skills by My Wealth Builder: Delayed Gratification is a fancy term for saving now and spending later. My Wealth Builder has taken a very nice example of how he is teaching this to his four year old daughter.

6. Why 2008 was an awesome year for dividend investors by Dividend Guy Blog: This is the first time I hear someone talking about how great 2008 was.

7. Wondering what happened with oil prices by The Penny Daily: An interesting video about the speculation in oil prices and the resultant volatility. I have written about the topic oil speculation myself.

8.  Can Risk Tolerance Change by The Oblivious Investor: A short and sweet article about how risk tolerance is not something static, and changes with time.

9. Want to be a Millionaire, Ways to Become Rich by The Smarter Wallet: Tips to become a millionaire.

10. Setting up a Budget and Entertaining Friends: Vilkri talks about the evolutionary process, i.e. Setting up a Budget.

The Small Probability of a Very Big Loss

Microsoft announced layoffs today: the stock dropped about 11% in one day, and is about half of its 52 Week High Price.

It is not easy to get employed at Microsoft, and one can easily understand why. I am sure that a lot of Microsoft employees own Microsoft stock, and some of them must own quite a bit of it, as a percentage of their total assets.

I personally know a lot of people, who started investing in the stock market by buying their employer’s stock. People feel secure in their employer, and when starting off – on a risky investment such as stocks, prefer their own employer to other companies.

Buffet Insured a Billion Dollar Lottery

Several years ago – Warren Buffet’s – National Indemnity Insurance – insured – Grab.com’s – 1 billion dollar lottery prize money. The odds of someone winning a billion dollars were: 1 in 2.4 billion, and if someone won, the cash would be disbursed in a number of years (as opposed to lump-sum).

National Indemnity insured the prize, got its premium, and no one; won the billion dollar lottery.

National Indemnity entered in a transaction, which had a small probability of a very big loss. And they profited from it.

Get Laid – Off and Lose All your Savings

Unfortunately, for – the Microsoft employees, who invested in their employer’s stocks, and later got laid off, they also – entered in a transaction, which had a small probability of a very big loss, but they lost.

The difference between other shareholders of Microsoft, and laid-off employee shareholders of Microsoft – is the fact that the laid off employees will probably need to sell the stock at a big loss.

Other shareholders can look at their portfolio, curse their broker, and go on with their life; waiting for the market to turn. Their loss is just a notional loss. If you don’t sell your stock, then the loss is just notional – only on paper.

However, if you lose your job, and all your savings are in your company stock – first you lose your pay-check, and then you lose a substantial chunk of your savings. In extreme cases – you may be completely wiped out. (Enron – anyone?)

The worse thing is that, if you are working for a great company, which had to resort to lay-offs, the market situation must be quite dire, and you may not find another job that pays the same – for a long time.

Don’t buy  your employer’s stock

This particular risk is very hard to visualize, and only when it happens with someone you know – you comprehend the magnitude of it.

The Satyam Fiasco (India’s Enron) happened in the recent past, and I know a lot of people who lost their jobs and their savings, and I suspect the Microsoft lay-offs will have the same kind of impact (but a lesser magnitude) on a lot of people.

Everyone has a different risk tolerance, and everyone views risk differently. A lot of people who got employed in the IT Sector, after the dot com bust played out, have a completely different notion of job-security, than people who saw the dot com bust.

To me – a small probability of an event that can wipe off your life’s savings, is a risk that is simply not – worth taking.  Especially, when the trade-offs are not very clear. If I am a Microsoft employee, and think Microsoft is going to do extremely well, the question in this context is – will it do substantially better than Google, IBM or Intel? Is it worth taking this risk?

You might think – What if I invest in IBM, and IBM goes bust at the same time that Microsoft  lays me off?

It could very well happen, but the odds are lower.

But Buffet did it, didn’t he?

When I was discussing this idea with a friend – he cited the Buffet deal. However, the difference is that National Indemnity is an insurance company, and it is the job of insurance companies to get into such deals. They understood the risk that they were taking, and knew how to put a fair price on that deal.

Most investors, who have not seen lay-offs – probably do not understand this risk at all, hence don’t factor it in while making their investing decision.


We are going through one of the worst recessions most of us would live to see, and, whatever else it may be, it is a heck of a teacher. I don’t know whether this recession will give us the answer to the question of buying our employer’s stock. But, I would certainly think – that it has at least given us the ability to ask this question, and see the situation in a new light.

I have been thinking about this question for about a week now, and am really curious to know what others think, so please, do leave a comment.

What is a Bank Run?

A  bank-run occurs when a large number of depositors queue outside a bank, and ask for their money back. Normally, customers and depositors hear rumors about the bad state of their bank, and decide that it is a good idea to take their money out of the bank.

When a large number of people start withdrawing their money from the bank, the bank starts facing a liquidity crunch, and usually starts discouraging people from withdrawing their money.

When the bank discourages withdrawals – it lends credence to the rumors, and more and more people start to queue up. This increases the bank’s problems – a vicious cycle is triggered, and it eventually becomes a self-fulfilling prophecy.

Why does the bank discourage withdrawals?

It is common to call the depositors of the bank, its customers. However, if you have a savings account in a bank, and collect interest on it – how are you the customer? The bank doesn’t make any money off of you.

The bank makes its money by lending. So the money that you deposited to the bank has been lent out to corporates, entrepreneurs, sub-prime mortgage holders, and other people who need to pay off their credit card debt etc.

At any point in time – the bank may have less than 10% of its total deposits. In fact, if every person in a country decides to withdraw their money from the bank at the same time – nothing can stop the financial sector from getting destroyed.

There simply isn’t enough cash in the system to face such a situation.  And that is the reason banks discourage withdrawals.

How can Bank Runs be prevented?

Theoretically, the risk of a bank-run can only be eliminated completely if the maturity of the deposits are matched 100% to maturity of loans made out by the bank. In such a case, all the banks loans will mature at the same time, as their withdrawals become due. However, this is realistically not possible.

The two steps that are usually taken during during a bank run are:

1. The Government provides Liquidity to the Bank: If the bank-run is triggered just because of a rumour, and the bank is fundamentally healthy, then the Government should provide a bridge – loan to the bank to tide over the crisis. Once, the panic is settled and people are assured that their money is safe, the deposits will find their way back to the bank and everyone will be happy.

2. The Government Insures the Depositors: The second step is for the government to assure the investors that their deposits are protected, and in case – the bank defaults – the depositors will still be paid their money back. This will work like the FDIC in US.

Since, bank-runs are  a case of a crisis in confidence, the solutions lies in restoring the confidence of depositors, and assuring them that their money will be paid back.

How does a Leveraged ETF make money?

Leveraged ETFs are a relatively new species of rapidly growing ETFs, that have already crossed the $6 billion dollar mark – for assets under management.

Leveraged ETFs track an index, commodity, currency or sector, and target double or triple daily returns of the index. So, a 2X Leveraged ETF that tracks oil prices will gain 10%, if oil gains by 5% in a day. By their very nature, Leveraged ETFs provide daily returns, and are rebalanced every day. That means – a 2X Leveraged ETF will return 4% in a day – if the underlying index rises 2%, but it will not return 4% over a week, if the index rose 2% over the week. For an explanation of this visit this example of daily leveraged returns from a Leveraged ETF.

How does a Leveraged ETF make money?

While the functioning of each leveraged ETF will differ from another; at a high level – Leveraged ETFs invest in a mix of short-term fixed income investments (like US Treasuries, bank deposits, money market funds, repo agreements) and derivative options.

The cash and cash equivalents (like T – Bills) provide collateral for buying derivative instruments, which are then used to create an investment vehicle that returns twice or thrice the underlying asset.

The most common instruments that Leveraged ETFs invest in are:

1. Swap Agreements: A swap agreement is an agreement between two institutional parties that exchange returns for a particular period of time based on an underlying asset. For example, in an – Interest Rate Swap – two parties will agree upon a notional amount, one party will pay the other a fixed rate of interest, while receiving a – floating rate – pegged on something like LIBOR.

2. Forward Contracts: A – Forward Contract – is a contract between two parties – to carry out a transaction on an asset at a future date on a predetermined price.

3. Future Contracts: Futures are like Forwards, but the difference is that Futures are traded on a stock exchange and can be bought or sold at any given time. As opposed to Forwards which  can be executed only at a certain future date.

4. Options: Call and Put Options of the underlying asset are traded by Leveraged ETFs, in their regular dealing.

At any point in time, a Leveraged ETF holds a combination of these instruments, such that, they return twice or thrice the underlying asset in a day (based on the fund type).

Apart from the Options – the Beta of the other contracts has to be 1 or close to 1, so that the fund moves in tandem with the underlying asset. The Leveraged ETF constructs this combination of instruments every day, and trades it daily in order to be perfectly aligned with the goal of returning twice or thrice the index.

How to invest in Gold?

There has been a lot of discussion about Gold as an investment class and for people who are interested in buying – gold, there are several options.

Gold ETFs

You can invest in gold by buying gold ETFs. Here is a list of some Gold ETFs.

1. SPDR Gold Trust ETF (NYSE: GLD)



Gold Mutual Funds

There are a few mutual funds that invest in stock of precious mining companies, as well as in gold and silver directly. This link has a detailed list of Gold Mutual Funds.

Gold Stocks

Apart from these ETFs, the other way of investing in gold is to own gold mining and exploration stocks. Here is a list of certain gold related stocks:

1. Barrick Gold Corporation (NYSE: ABX)

2. Kinross Gold Corporation (NYSE: KGC)

3. Agnico Eagles Mines Ltd. (USA) (NYSE: AEM)

There are several other gold stocks that I have left out. The reason I left them out is that they were either penny stocks or their operating history was less than ten years.

Gold Coins

Buying gold directly is slightly more complicated than you may expect. This is because there are several different types of gold products, and different dealers offer them at different prices. Gold coins and Swiss Gold bars are common ways of buying gold directly.

Here is a list of popular gold coins:

1. American Gold Eagle Bullion Coins

2. Canadian Gold Maple Leaf

3.  Krugerrand Gold Coins

Swiss gold bars are also a very popular way of  buying gold directly. There are two popular type of Swiss gold bars:

1. Swiss Pamp Gold Bars

2. Credit Suisse Gold Bars

Gold coins and gold bars can be bought directly from the US Mint, and other gold dealers – both online and in stores.

Gold Stock and ETF – Derivatives

A slightly more sophisticated way of investing in gold is buying derivative options of gold mining stocks or gold ETFs. I have discussed one such option in a recent post about – buying out of money call options of gold stocks.

These are the most common ways of investing in gold and even other precious metals. I have deliberately left out Gold ETNs and Warrants that are issued by Gold companies. This is because they are more of a debt product, than a gold product.