Answers and Guides from Top Financial Advisors

As for the "how" you need to open a Margin account with your broker. The broker will likely ask you to affirm that you have some amount of investment experience and tolerance for risk. You will also need sufficient collateral (investment balance) with that broker.

Hi Elliot, you asked about the difference between A and B shares.

An easy way to understand the difference between A and B shares in funds is simply that both will charge a commission to compensate the broker. A shares charge it in front and pay the broker. B shares won't charge you the entire commission in front. Instead, they will amortize that commission over four or five years, so you might pay, for example, 1% more per year for five years instead of 5% in front. Since the fund company is paying the broker in advance, the surrender charge is the unpaid commission which declines each year by around 1% until the entire commission has been covered. If the investor leaves early, the remaining commission is collected as a 'surrender charge'; and, as Alan stated, the B shares then convert to A shares to reflect the fact they are no longer collecting the commissions from the investor since all have been collected and paid.

If you're working with a broker, A or B shares provide compensation. If you are investing on your own, your friend is right that you probably shouldn't be paying for help you're not receiving.

I do agree with the comments made by Eve and Alan above. I'd be looking at the no-loads and ETFs but switching may have consequences worth evaluating.

Hi Ryan, It's important to remember that a mutual fund is an investment company. You are buying shares of the investment company, not of their stock holdings. They receive and `pool' the money of their shareholders and invest in the markets. So, in essence, you're buying shares of a company that invests in the stock market.... a distinction many individual investors don't realize.

Hi Caroline, Julian is right: There are always `experts' on each side of the question; that's what makes a market. Warren Buffet has stated, more than once, that he's never met anyone who could predict the stock market. The truth is everything fluctuates: Stocks, bonds, real estate, gold, collectibles - and all the while interest rates, inflation rates, all fluctuate as well. The only thing that doesn't fluctuate: We keep getting older. I wouldn't spend time worrying about the market. I'd be learning how to manage the various 'markets'. How you do that depends on your age, what stage of your financial life you're in, and your goals. I'm sure you can talk to a few advisors that are local to you and get some help. By the time you've talked to a few, you'll get a feel for who's thinking long-term, like you, and who's trying to sell you on 'performance' - always a red flag. Good luck!

Paul and Jeffrey are right.

It depends on why you're seeking diversification. Risk mitigation?

Something many individual investors don't think about is exactly what risk they're trying to protect against. You can mitigate business risk (the risk that one stock will suffer due to business issues)through diversification; but, what many don't realize is that you can't diversify away market risk.

That may sound counter to what you've heard; but when you think about it, it becomes clear. For example, if you buy a mutual fund that invests in only one sector, you may have risk that's greater than the broad market. If you add funds in other sectors, you can possibly reduce your risk somewhat; but if you purchased a fund that was diversified throughout the entire market, you likely wouldn't be reducing market risk, you'd be replicating it!

So, the more diversified your fund is, the more likely you'll be replicating market risk, rather than reducing it. Risk reduction might better be accomplished by allocating assets across multiple asset classes - stocks, bonds, commodities, real estate, and cash - all of which can be done via fund investing. Then it's not a matter of being too diversified, as much as being properly diversified, as Jeffrey says. Good luck!

Savita, Your question about long and short positions is timely, because today you will find many investments, even mutual funds, that have long-short positions. Many of these investments are managed by very experienced and capable managers, but understand that even in the most capable hands, these long-short positions have risks.

Most investors are familiar with long positions. We buy a stock or a mutual fund and watch it to go up (or down). This is a long position. If we buy the stock or mutual fund for $50 the stock may go up or down. Worst case scenario, the company goes bankrupt, the stock goes to zero, and we lose or $50 investment.

Short positions, on the other hand are less familiar to most investors. When we sell a stock short, we are selling a stock that we don’t own. If we sell a stock for $50 and the stock goes to zero, we can make $50 (we are omitting some of the market rules and additional costs relative to short selling for purposes of illustration). If the stock goes up, say to $200, we can lose $200, because at some point we will be required to buy the stock for delivery to the purchaser. As you can see, the risk of loss as a short position, unlike a long position – which is 100% of our investment) is theoretically unlimited.

To illustrate the concept of net positions (your original question – which you probably never thought I would get to), lets construct a 130/30 portfolio, that is a portfolio that is 130% long, and 30% short. How is that possible? We have $10,000 to invest. We sell short a stock or basket of stocks worth $3,000. Now we have $13,000 ($10,000 our original amount and $3,000 from our short sale). We by a stock, or basket of stocks in the normal way in the amount of $13,000 Long. So, for our $10,000 original investment, we have a portfolio that is 130% long ($13,000) and 30% short ($3,000). Many salespeople for funds that have such a portfolio would tell you have a net 100% portfolio. That is true.

But here is the rub, and this is what you are not often told (except in the bowels of the Prospectus), this kind of portfolio has 160% exposure. If we buy a stock long we (or the fund manager) are betting the stock will go up. If we sell a stock or basket of stocks short, in essence we (or the fund manager) are betting the stock will go down. If we are right we make money of both bets. If the stock we bought long go down and the stocks we sold short go up? If we are wrong on both bets we can lose serious amounts of money, much more than a dull, stodgy long position.

We would call this a form of leverage, and there are all sorts of ways to create hedges or increase risk, such as: individual securities, ETFs, mutual funds, futures, options, or forward contracts (to name a few).

Yes and no.

If mutual fund managers believe they can beat the market, yes a fund can be too big/diversified. Active managers who try to beat the market close their funds from time to time because they cannot invest without making an unfavorable impact (make prices rise too much before completing the entire purchase). If they believe they can beat the market, they do not want to be diversified because their stock choices theoretically will outperform the rest of the market.

On the other hand if fund managers believe they cannot consistently beat the market, then they will manage funds passively such as indexing. A larger fund will spread management costs over more investors thereby reducing the cost for each investor so they can not be too big.

What are the practical implications of this ambiguity? Actively managed funds have higher costs. Whether their performance recoups those costs over the long term is the question. For most sectors, over long periods, passively managed funds outperform. For actively managed funds who outperform, ask whether it was due to skill or luck. If skill, can you identify the fund manager before the outperformance? Hope this helps.

It is not specific to IPOs. Long means the bank owns shares on account. Short means the bank has BORROWED shares and sold them in the market (i.e. they have to buy them back at some point to sloce the gap). "Net" is the difference between the two - i.e. to be net short is to OWE the market shares of a stock.

This is a generic answer for net long and net short. Long means an entity owns the stock, say a 100 shares. If another division within the entity sells 50 shares short (shares they do not own but have to borrow), the overall entity is net long 50 shares (100 owned less 50 sold short). If instead 200 shares were sold short, the overall entity would be net short 100 shares (100 owned less 200 sold short).

Elliott,

Robert Harper's answer is terrific, and explains the B-Share issue well. There is a lot of information that we don't have which an advisor would need to help guide you. Some important factors on deciding where to invest these funds, once you get past the 8 year issue, are:

-Your age and cash flow needs. If you are young and don't intend to touch this money for 7-10 years, you may want to be more aggressive building a portfolio of index ETF's and/or actively manged mutual funds. If you are going to be relying on this portfolio for income you may want to build an income generating portfolio.

-Your tax situation. Will this investment be subject to long-term capital gains, was it a pass through, or was the cost basis established (stepped-up) at the date of death. As Mr. Harper pointed out, after 8 years this may be convertible to an A-Share with no tax consequences, so this has to factored into the analysis.

After you consider these issues, It may be useful for you to look at Morningstar's analysis of the fund. You may find you can find a less expensive alternative asset allocation mutual fund that has had as good or a better track record. Vanguard may be a good place to look. Or if there are enough assets you my be able to build your own diversified portfolio using ETF's and/or mutual funds.

Elliot,

You own the Principal SAM Flexible Income fund. It is a fund of funds and as you noted has a high expense ratio. The Principal Prospectus has the following quote: “Class B shares have higher annual expenses than Class A shares because they are subject to distribution fees for the first eight years. After the eighth year, Class B shares convert automatically to Class A shares of the same Fund, typically without income tax impact.” Also in the prospectus is the following statement. “You may speak with a Client Relations Specialist by calling 1-800-222-5852, between 7:00 a.m. and 7:00 p.m. Central Time on any day that the NYSE is open.” So you can call with your account number and find out how long the fund has been owned. If it has more than 8 years the fund should have already converted to an A share. If it has been less than eight years you will pay an extra fee to get out of the fund. Even the A share the fund carries a .25% 12b-1 or distribution fee included in the 1.29% total expense ratio. If your real concern is cost stick with no load index mutual funds. ETF’s may be slightly less expensive but you will be subject to the bid ask spread when you buy and sell and may also have to pay a transaction fee.

Keep in mind since SBUPX is a B share fund that you may be subject to a back end load (contigent deferred sales charge CDSC) that typically lasts about 5 years from the date of purchase on a typcial B share fund. The custodian would know if there is a charge. Most B share will automatically convert to A shares after this period is up. The reason the expenses are higher in a B share than an A share is that you are paying and extra 1% 12b-1 fee to cover the commission fronted the broker. Once it's an A share, that will go away. Even this fund's A share counterpart has very high expenses at 1.29%. I do like ETFs, but you need to undertand the consequences of switching first.