ETF Index Mutual Fund

I have found that an index fund holds a collection of stocks and bonds that mirror the behavior of what ever is being indexed; in this case and exchange traded fund (ETF) following the S&P 500 index. Any increase in the S&P 500 after buying in, is a profit. Any decrease is a loss. Funds left in the cash managed account (CMA) and not invested earn nothing.

The ups and downs of each of the 500 companies is averaged to produce the current value of a share in the index fund. This guaranties that we will neither get the highest gain nor the highest loss.

Bank of America was “forced” to buy Merrill Lynch by federal authorities at the start of the Great Recession. Their on line stock trading is now done under the name of Merrill Edge. I am part way through an over 30-page document on setting up an account to follow the S&P 500 (we do not have green cards or passports).

Now to summarize the costs of using an index fund in relation to CDs. We need to pick a comparable time span. We have experienced few deaths here at Provision Living at Columbia memory care. Several residents have made repeated visits to the hospital and then returned about as good as before. Our unpredictable life span is not a very good factor.

I have already compared CDs designed for one to five year spans and an annuity set for 10 years in prior posts. The contracts are very clear on what we expect in return from what we have saved or invested (about 2% interest at best).

Merrill Edge marketing suggests that we need to consider, at a minimum, a 15 year horizon. Also, “Past performance is no predictor of future performance”; in the short term. The ever-increasing value of the stock market is a valid predictor of the future (but not the bumps along the way). This emphasis on long term has always intrigued me. [It is a key part of marketing and paid advising.]

I know it is based on the effect of compounding interest, but even the past 15 years of compounding is still subject to a decline tomorrow. It is tomorrow (when we may need the money) and the next few years that we must be concerned about; not the past.

To make sense out of the stock market means we must have other funds (CDs, or cash) to have the ability to wait out the recovery. CD interest rates have yet to recover after a decade, but the stock market is doing great, and always has; with enough time. 

[I did not include our annuity with the CDs above, as the marketing of annuities is also questionable. They do not protect us from large unexpected expenses. In fact, they make it worse if the annuity has left us with not enough funds to pay for large unexpected events.]

There is then justification to balance interest rates (that are manipulated by government agencies) with stock prices in an open market. [I-Bond rates are fixed to inflation rates. Years ago we had one that paid over six percent interest. They are now paying 2.76% with a three-month penalty at one year and no penalty after five years. The purchase limit is $5,000 per person per year.]

We need a means of waiting out the next down turn in the stock market, to get involved with it. One way I have found is to invest within our living revocable trust. If the market does go south, and we do not want to take the loss, the trust can continue for a time after our deaths and be managed by the trustee (unless we go broke prior to our deaths).

To put money into the stock market, we need a broker, Merrill Edge in our case. We transfer the funds from our bank account to an investment cash management (CMA) account. We then pay $6.95 per each order to buy S&P 500 index shares. There are nine flavors to choose from; large, mid, and small cap by value, blend, and growth; that range in price today between $69 to $236. We also pay $6.95 per each order to sell shares.

Our trading cost for putting $10,000 one year, with no change in the share values would be $13.90. A 0.01 to 0.03 charge per $1,000 is also levied each time (0.03 * 10 = $0.30). We are now at $14.20.

There is no minimum requirement and no monthly or annual fees with a self-directed account. A guided investment account is 0.45% a year ($45). A select managed account is 0.85% a year ($85). A full service account, as in the old days before the Internet, costs many times more.

The market must go up to pay for all of this, unless only the self-directed account is used. Then $14.20 would be a charge of 0.142%  (0.071% after two years and etc). An average increase in the stock market of 7% (1950-2009) would easily cover this ($700); and a return that is much higher than 2% CDs.

So, a mature CD pays at best about 2% after 5 years. An I-Bond pays 2.76% after 5 years. The ETF on the S&P 500, on average, pays about 6% with immediate access to the funds, if we are willing to wait out a multi-year recovery period or accept a credit card equivalent charge of about 20%.

BUT the loss on CDs, by our own selection, is only on the interest. The loss on the ETF, by chance, is on the entire POT! That is, about 20% x $40 ($8 a year from choosing a 3-year over a 5-year CD) vs 20% x $10,000 ($2,000 any year) with the ETF.

On the topside earned interest is about $40, certain from the CD, vs just 1% (out of an average of 6%) increase on the S&P 500 ETF would be 1% x $10,000 ($100). The stock market is at an all time high. In 10 years it can be expected to be higher.

Day trading and active management of a fund is now a questionable way of investing (unless you are very lucky). Robot management is now coming.

Over 40 years ago this was funny. Each person used the same trading software on his new desktop computer. The market took a fall when many of their computers said, “Sell”, all at the same time. That ended my interest in the stock market. Instead we bought a house.

Every trade requires a buyer and a seller. In general, to make the market work, it needs uneducated, uninformed or unlucky sellers to drop the market beyond “normal” variations from many unknown causes. These unknown causes make it impossible to predict short term events,

I can now understand the pricing structure of safe, limited access CDs, and immediate direct access to stock (highly variable), and to bundled stock, (low variable) ETF funds. The Internet and competition make all of this easy to do and inexpensive.

(I only need to fill out the eight-page application, call a phone number, transfer the funds from a checking account to the cash management account, and order a trade to buy the S&P 500 ETF flavor(s) of my choice at $1,000 per month; I think.

Any free advice or experiences that apply to this are welcome. The I-Bond window will still be open between April 14 and April 29 to give us the choice between the old or new rates..