Budgeting

Many people just “wing it” with their finances and spend money as they feel the need/desire to. Financially speaking, that is the equivalent of trying to drive through the rain without windshield wipers. Without clear visibility, you can’t really see the road ahead. Start by making a list of your expenses, and it should include all your expenses, not just reoccurring monthly bills. Factor in costs like food, gas, parking, etc. While you can’t plan for every single expense, you can account for most of them. Set reasonable limits on personal expenses and stick to them. The first step in managing your debt is to know exactly where your money is going every month.   

Your budget doesn’t have to be a complicated spreadsheet. Even just a pencil and paper list of your income and expenses is sufficient. If you have trouble figuring out what appropriate amounts to budget for certain things, then track your spending for a month and keep your receipts. By looking at your shopping habits, you can figure out if your budget goals are realistic or not.

Tackling the Cable Bill

According to debtconsolidation.com, the average monthly cost for pay-tv was $86 in 2011. Within the next two years, that number is expected to rise to $123 per month. Don’t make the mistake of just looking at the total due on your cable bill and paying it without asking any questions. Pay attention to each line item on the bill and make sure that you know exactly what you’re paying for.

Scrutinize your bill and don’t be afraid to call the service provider and question charges that you don’t understand. There is a very good chance that you may be paying for services that you don’t even know you have. If you don’t watch television a lot, you should also consider ditching cable and explore streaming video options online. Many networks now make full episodes of popular shows available online for free.

Next Up: The Phone

While some people find cell phones to be an economical alternative to traditional landlines, many people feel they need both. The question you should ask yourself is should you break up with your landline? Most cell phone plans offer free long distance and you can easily find plans with unlimited minutes. Voice over Internet Protocol (VoIP) has become an increasingly popular alternative to traditional phone lines, but do you get enough use out of it to justify the extra $30 or more per month expense?

If you do decide that you have legitimate reasons to have a landline, then examine your phone bill the same way you should look at your cable bill. Are you paying extra charges for directory assistance? Is there a service contract tied to the plan that you really don’t need? Telephone companies are staffed by humans, and humans inevitably make mistakes. Don’t just assume that your bill is always correct because it might not be.

Paper or Plastic

While it is true that you can’t always pay cash for everything, that doesn’t mean you should resort to credit cards either. The typical credit card purchase costs 112% than using cash or a debit card, possibly even more if you have a tendency to make minimum payments and let your balances accrue interest. Make it a general rule that if you don’t have the extra money in your bank account to make a purchase, then you wait until you can afford it.

Don’t confuse “want” purchases with “need” purchases. You need food. You need to a place to live. You don’t need the latest iPhone. Sure, it would be great to have, but not if you have to go into debt to get it. It is perfectly normal to feel a little envious when your friends have the latest and greatest, but keeping up with the Joneses is a sure fire way to get into debt over your head. A little patience can be a huge step towards stopping overspending.

Utility Bills

Last, but certainly not least, “going green” isn’t just good for the environment, it is good for your bank account as well. Don’t leave televisions on when nobody is watching them. Turn off lights when you leave a room. Keep your rooms at a comfortable temperature, but don’t get carried away running the heater or air conditioners. Don’t keep devices such as your cell phone plugged in after they are already charged. As simple as these tips sound, they can be big money savers.

Outside of your rent or mortgage, utility bills are likely the second biggest chunk of your household budget. While you may not like having to remind your family members that things like electricity and water cost money, it is a necessary “evil” and the effort will be well worth it. Electric and water providers usually show usage amounts on your monthly bill. Track your usage each month and make it a point to reduce that amount gradually each month.

Living la vida frugal isn’t always easy. Admittedly, it can be a bit frustrating. The best way to relieve the pressure of tightening your finances is to go ahead and splurge occasionally, but make it a planned expense. Put aside a little money in your budget so that you can treat yourself to a night out once a week or save up for a vacation. You don’t have to deprive yourself of everything, just save your money for meaningful uses instead of wasting it needlessly.

About the Author: Tony Standin is a personal finance specialist with a passion for helping others learn to live healthier financial lives through budgeting, credit repair, and frugal living.

Save For Rainy Days

Give Up A Bad Habit

People enjoy habits because they make life easier and require less thought. It is time to ask yourself what habit have you created that is costing you money every week? Which one can you manage to live without? If you are eating lunch out 5 times a week, you could be spending $200 a month ($2,400 a year) on this luxury. Cut down to 2 times a week and you can save up to $1,440 a year.

Save The Change

Create a place to empty out all the change you accumulate each day. Save the change plus the lowest bill in your wallet. Make this a habit for a month. See how long you can do it and add up the amount you have saved. To build real wealth, put that money in a money market savings account or mutual fund. The longer you leave it alone, the more it will grow.

Spend Less Than You Earn

There is no way to build wealth unless you spend less than you earn. To meet this goal, you may have to increase your income, just to start saving the amount of money you need. Evaluate what you need to adjust in your life to make this possible and then do it.

Learn From The Best Finance Books

Dave Ramsey’s Total Money Makeover will teach you how to get rid of debt and build wealth. It is nice to learn from someone who has seen both poverty and wealth.

Ilyce R. Glink, wrote a book called, “50 Simple Things You Can Do To Improve Your Personal Finances.” Her first suggestion involves preparing a place in your home for handling your personal finance tasks. Getting organized like this really helps. She also offers many new ideas about saving money. She covers topics like taxes, credit reports, planning for retirement and budgeting. For a short read, this book is worth the current price of $2.89.

Learning Online

Since 2008, the number of people that said they have learned about personal finance on the internet has grown from 4% to 12%. While everything you read on the Internet is not guaranteed to be true, there are reliable sources for you to use without hesitation. Bankrate.com has a trusted reputation and provides you with current mortgage rates, housing trends and retirement information.

Although many people report that they don’t feel that they have enough of a savings account, there are many solutions to that problem. Start today by using these personal finance tips from Coolchecks.net.

Good Cash and Credit Management Practices

Managing cash and credit is a skill that can be beneficial for a lifetime. People sometimes fail to realize that credit card companies are in the business of making money off people who can’t do basic math or don’t project into the future how much their purchases will really cost. They bank on human nature to be lackadaisical with their payments.

Some Americans have adopted credit card usage as a “way of life.” Credit cards have been singled out as one of the most perilous consumer financial products and frequently leads to over indebtedness. Using credit cards to pay for unexpected difficulties is one of the biggest problems.

Managing Expenditures Adequately

Being able to keep your living expenses well below your income level is ideally the best strategy to take. Your entire financial success depends on being able to do this. This allows you to build up an adequate savings to handle unforeseen emergencies and helps you stay out of thinking that your best solution is to use a line of credit to pay your debts. It also allows you to build up savings for investment purposes. If you find that you aren’t in this position, then it is time to think about alternate ways to bring in income.

Income and Asset Protection

Insurance is one way to protect your assets. Car insurance minimizes losses from car accidents. Home insurance minimizes losses from accidents as well. Life insurance can protect your children in the event of your death. Using insurance to protect you from losses is wise, but be sure to do research into the details of each policy and carefully examine the risks you are taking.

Investing Wisely

No one wants to lose money so investing wisely is a skill worth learning. Because money can return a positive rate of return over time, it is best to start saving early in life. A $10,000 investment can grow to $57,430 in 30 years at 6% interest.

Preparing for Retirement and Estate Planning

You really need to start planning for retirement at the beginning of your earning career. Many folks put this off until it really is too late to do anything about. Starting at an early age, the time value of money can really work for your benefit.

Achieving financial success is a life time goal, but takes daily effort. The more effort you input, the more you will enjoy rewards.

Becoming active in savings for future consumption is a habit everyone needs to get into. According to the book “Personal Finance,” by E. Thomas Garman, from the Virginia Polytechnic Institute and State University, lifetime financial goals generally cover 1.) Maximizing Earnings and Wealth 2.) Practicing Efficient Consumption 3.) Finding Life Satisfaction 4.) Reaching Financial Security 5.) Accumulating Wealth for Retirement and an Estate.

Maximizing Earnings and Wealth

Having an abundance of money and valuable assets requires one fundamental principal: spending less than you earn. Budgeting and planning for this is a top priority. Another goal then needs to be focused on maximizing your earnings. You can accomplish that through employment, entrepreneurship and/or investing. How you do this is entirely up to you and unique to your particular interests and passions.

Practicing Efficient Consumption

We use money either for consuming or saving. Efficient consumption comes from practicing good financial skills, like keeping good financial records, avoiding impulse spending, using credit wisely and keeping living expenses down. Failing to do this is often a result of carelessly spending money on non-essentials and ignoring monthly obligations.

Finding Life Satisfaction

Your satisfaction with life may come from being debt free, owning a home, going on vacations, educating your children, living well in retirement and leaving an inheritance for your children. All of these goals can be achieved through a variety of career paths and every day investment decisions. Financial success offers you a better quality of life whether you want to live well or give your money away.

Reaching Financial Security

Financial security is not about having earned a specific amount of money. It is more in the comfortable feeling you gain when your resources will adequately fill any needs you might have and most of your wants. Free from doubt, anxiety or fear about money is a wonderful place to be. You will need to have a career with potential, an adequate emergency fund, investments an estate plan and a will. Setting short term and long term goals is absolutely essential to achieving financial security.

Accumulating Wealth for Retirement and an Estate

Many financial goals are set to make sure that retirement is a time of life that is comfortable and enjoyable. Seeing this goal as a young adult is really a precious gift. The value of time in savings and investing is really priceless. Anyone who can see that from the start of their careers is on the right course to achieving financial security.

Reason #1 – Lacking Belief

The mindset of a person that is struggling financially is negative. Plain and simply, they do not believe they have the power to change their lives. They then convince themselves that nothing is going to help so why look for help.

Reason #2 – Firm Belief They Are Doing Everything Right

Along with lacking belief, people think that there is nothing more they could possible do. To avoid feeling even worse about themselves, they then avoid learning more.

Reason #3 – They See No Reward In Learning New Strategies

People respond well when given rewards. If they feel they are failing already, then reading more makes them feel worse. There is no reward in their mind for learning new strategies.

Reason #4 – Lack of Establishing A Habit Of Reading

In the book, “The Power of Habit” by Charles Duhigg, award-winning New York Times business reporter, we learn that in order to establish a daily habit, people need to experience a reward. To establish a habit, the desired activity needs to be repeated regularly and occur subconsciously. So the habit of reading may not be one of the goals of someone having financial difficulty.

Reason #5 – A Desire To Feel Smart

Human beings seem to get an internal reward that feels good if they are given a task to do that challenges them and makes them feel “smart.” This intrinsic reward sets the stage for many life decisions. People having financial difficulty are struggling on so many levels, that they actually need more experiences that validate their need to feel smart. Reading about personal finance reminds them that they are lacking in this area and creates a negative reward.

So now that we know why people avoid reading personal finance articles, how do personal finance writers get more readers for their articles? We will respond to that question by referring to the top reasons people avoid this behavior. Here are five suggestions to get writers past the objections people use.

Solution # 1 – Provide Examples of Success

To combat the lack of belief obstacle, let’s provide some examples of people who fought through their challenges and came out winning. Dave Ramsey, a popular personal finance writer, had a portfolio worth $4 million dollars by the age of 26. He purchased real estate with money borrowed from one bank and that bank sold their holdings to another bank. The Tax Reform Act of 1986 ended up affecting one of his creditors who called a real estate loan due in 90 days. The only relief he could get was to declare bankruptcy. From that point on, he was determined to help other people with their finances and encourages people to get to the debt free stage and stay that way. He has enjoyed financial success because of his struggles.

Solution # 2 – Provide A Disruption In Thinking

To help people who think that they are doing everything right, they need to experience a “disruption” in their thinking patterns. An interesting study of a product that most people have now heard of, Proctor and Gamble’s air deodorizer Fabreeze, proved that people don’t often smell bad odors in their own houses. Why? Because they become so used to odors in their own homes that they were no longer offensive. They couldn’t smell it. What marketers did when they discovered that was to find a new reward for using the product. They studied women (lots of women) who cleaned their houses. After the cleaning was done, women smiled as they looked at their work. So the marketing department focused on this particular reward: The completion of the task and the finishing touches that a spray of Fabreeze could provide. Their product started hitting record sales levels. Remind people of what they could be experiencing with added attention to personal finance.

Solution # 3 – Help People See The Rewards Of Saving

Saving money is the toughest challenge we face. Whether rich or poor, saving money is mandatory. Without that chunk of money, people have no ability to make large purchases or to have a cushion to rely on for emergencies. Savings that are automatic and a predetermined percentage of monthly income seems to work for a lot of people.

Solution #4 – Develop Habits of Reading About Personal Finance

Personal finance can be dull, boring or even put some people to sleep. Why? Because people want to think they are doing their best or that they already know it all. They are not looking for the next hill to climb. Find someone who is a good mentor and then follow their strategies.

Solution #5 – Help People Feel Smart

Recognize all the decisions that helped them get this far in life. Help them plan new strategies and dump ones they have been burned on. There are always horror stories about people who make decent money, yet have no savings or find themselves spending more than they make. Just hearing some of these stories can be motivational or at least entertaining.

Changing your thinking patterns and setting new goals can put you one step closer to living a richer life. Start today by doing one small thing differently. Your success is up to you.

1 – Know the Stocks You Own

Most investors believe their 401(k) plan is well-diversified.  Let’s say that we invest half of a retirement savings account in a Tech fund and the other half in a fund that is tied to the S&P 500.  Without looking at the actual stocks being purchased, it can be easy to miss the fact that as much as 30% of an S&P 500 fund might include tech stocks.  Then, if we look at the total exposure to tech stocks, the percentages could potentially exceed 60% for a single industry.  

Needless to say, this is how how a diversified portfolio operates, and excessive exposure to a single sector leaves investors vulnerable to price swings for that industry. If this hypothetical example was seen prior to the 1999 dotcom bubble, this investor would have unnecessarily encountered substantial losses.  These problems could have been avoided by simply knowing the stocks that are part of your chosen fund.

2 – Don’t Chase a Fund’s Past Performance

Another common mistake can be seen when investors get caught up in the hype of the next “hot mutual fund.”  It can be very tempting to act on advice from a friend or a persuasive commercial but basing an investment decision on a fund’s past performance is usually unwise.  This is because markets are cyclical in nature and so a fund investing in a profitable niche now could easily underperform later on.  

There are also many examples where a fund does well under one manager and then performs poorly if that manager leaves the firm. For this reason, it is important to know if the fund strategy was the creation of a single manager or is part of a larger, institutionalized investment process that will be repeated in the future.

3 – Be Aware of Fees

Investors tend to focus on macroeconomic factors (such as the state of the labor market or the national economy as a whole), and instead ignore the fees associated with a particular mutual fund.  This potentially costly mistake can have a major impact on the returns investors are able to capture over time.  For example, let’s say we invest $5,000 each year in an S&P index fund over a 30-year period.  During this time, the investment would total over $400,000.  But if the fund’s fees came to 1.5% each year, that total investment would fall to less than $300,000. This amazing difference is the result of compounding investment.

Fees can have a particularly strong impact on bond funds, which tend to produce lower yields on an historical basis.  Investors should look at the fund prospectus (to see the associated expense ratio), and read Morningstar.com to compare the funds expenses to others in a similar investment category.

4 – Don’t Forget the Effect of Taxes

In many cases, investors will buy into a fund during the later part of the year, as the fund makes net capital gains distributions to clients. But if you wait until those payouts have completed, you can avoid tax obligations before you have made any real returns on your investments.

A common mistake is seen when investors fail to track the cost basis for the fund when choosing to reinvest their dividend payouts into additional share purchases.  This creates problems as investors likely make mistakes reporting larger taxable gains when selling the fund – essentially, paying taxes twice (taxes on the dividend income and on the gains made selling the fund).  Other mistakes are seen in funds that aggressively manage the stock portfolio as a means for maximizing returns.  Problems here occur when the fund is not held in an account that is not tax-deferred, such as a 401(k).

5 – Keep Your Investment Focus

Many investors hold onto their positions longer than they should.  This is because many think that outcomes that occurred in the past will happen again in the future (see Tip 2).  A smarter way to monitor fund performance is to establish a target for your holdings position that is appropriate for the expectations in that specific sector.  When your target limit is reached for that fund holding, sell some (or all) of your holdings and take your profits.  Targets like these can take some of the emotion out of the investment process.  This is important for making rational decisions that can ultimately protect your savings.

Conclusion:  Do Your Homework and Watch the Performance of Your Fund

Since mutual fund investments are widely regarded as a simple (or even automatic), it is important for investors to maintain focus, watch the changes seen in portfolio allocation and to ask questions when gains performance is not meeting your expectations.  Has something changed with the fund’s strategy?  Have previously successful managers left the company and are no longer guiding strategy?   These are important events that could mean it is time to look for other options.

Here, we looked at 5 simple tips for new investors to follow when managing their savings investments.  It is always important to read the materials that are provided by the fund, do your own research (on sites like Morningstar.com), and to consider selling your shares when unexpected changes are made within the fund.  At least once each year, you should check to see that the same management team is in place and look at the changes that are being made in the underlying stock selections.

One of the most often-discussed aspects of mutual funds is the fact that they tend to produce poor performances relative to the S&P 500 when things are judged on a pre-tax basis.  And, in many cases, these comparisons become even less favorable when looking at mutual funds on an after-tax basis.  Money managers tend to under-perform relative to Index funds because Index funds will hold investments for the long term.  This becomes important when investors are looking to minimize the expenses that are created when stock investments are bought and then sold on a short-term basis.

When we look at the capital gains distributions in Index funds and compare these to those generated by money managers, significant lessons can be learned.  These lessons essentially tell us that low turnover rates (a small number of trade transactions) and minimal cash balances (in funds that remain almost fully invested) can help investors to capture enhanced returns relative to other investment options.

Advantages of Index Funds

To be sure, index fund managers have an advantage that is not possessed by money managers.  The S&P 500 500 index is constructed by the Standard & Poor’s editorial board, so all these fund managers need to do is look at the stock weightings in the S&P 500 and distribute the managed money according to those weightings.  Selling stock holdings is an even easier process, as these index managers only need to sell shares when the makeup of the index is updated.  Typically, the S&P 500 will see 10 to 15 stock changes each year, and these tend to come from bankruptcies, mergers, acquisitions, or heavy corporate distress.  When we compare these changes to the number of “buys and sells” conducted yearly in the average mutual fund, 10 to 15 is a very small number.

If capital distributions that can be found in the Vanguard Index Trust 500 show 15 cents in short-term capital gains over a given year, 40 cents in long-term capital gains, and the Vanguard Index Trust 500 closes that year with a net asset value (NAV) of $90 per share, it becomes easy to see that the relatively low taxes (likely around 55 cents) do little to diminish the returns in either of these funds.  It should also be remembered, however, that an investor would take on additional tax consequences if shares of the fund were sold.

Lowering Your Tax Liabilities by Keeping Your Money Invested

Most new investors, however, are looking to create wealth over larger time horizons and to use the benefits of compounding returns to their highest advantage.  Looking at things on an after-tax basis, investors can create more value in their investments when keeping money invested (i.e. not cashing-in your shares).  So, while paying high fees can diminish your returns, handing over money in taxes (for fund shares that didn’t need to be sold) can have the same negative effect.

As another example, assume that Vanguard’s Windsor fund creates short-term gain distributions of 85 cents and a long-term distribution equal to $2.  If the fund possesses a NAV equal to $17 at the end of the year, Windsor will generate 6.5 times the tax burden (per share) while showing a NAV that is 81% lower.  If Windsor creates returns of 20% for the year (and the S&P 500 generates returns of 30% for the same period), most of Windsor’s returns will be taxed as capital gains distributions.  This can reduce those returns by as much as 15% to 35%.  (Here the exact reduction will depend on the tax bracket of the investor.)

The troubling reality is that a majority of mutual fund providers choose not to highlight after-tax returns.  They say that this is because individual tax situations are different, but if after-tax returns were highlighted, the performance differences between your typical mutual fund and in the S&P 500 would become much larger and more difficult to ignore.  Another benefit gained when using a predetermined investment plan (which includes less frequent share sales) is that this reduces the amount of money you have stored in low yield cash holdings.  It is possible for index funds to have more than 98% of its cash invested in market assets, but mutual funds will typically have much larger amounts of cash on hand (i.e. not actively invested).  So if your money is in a mutual fund, and only 90% or your cash is invested, it becomes more difficult to beat the returns posted by the index fund because of the smaller amounts of money actively invested.

All of these factors create some combined negatives, because money managers must outperform the index so that they can make up for increased expenses and because they are never fully invested with all available cash resources.  So, if money managers do beat the market (or simply break even) on a pre-tax basis, any value gains made for individual investors might be depleted with capital gains distributions which make a large percentage of these gains taxable.

Lessons for Individual Investors

So, when individual investors want to make their own financial decisions, the lessons here should be very clear: The best approach for generating larger, long-term returns is through maximizing money that is actively invested in the market and in adhering to the rules of tax efficiency. When the effects of taxation are calculated, outperformance margins that many short-term investors believe they have captured are significantly diminished.

Typically, the argument of these short term investors is that you will have to sell your shares at some point. But the reality shows us that when money compounds over longer time frames (as gains are reinvested, rather than cashed out), the lower tax rates for long-term shareholders create after-tax benefits that can be substantial. This does not even factor-in the possibility of owning stocks with dividend yields, which allow you to capture a rising income – gained through simple stock ownership. In some cases, it will be possible to live on your dividend income and leave your invested equity untouched (and without additional tax liabilities).

These are the reasons why S&P 500 Index investments are tough competition when compared to managed money accounts. When we understand why the S&P 500 index fund is often a preferable investment vehicle, it is possible to understand how to invest and keep expenses low. When investors minimize tax burdens and maximize the amount of money that is actively invested in the market, returns for the typical S&P 500 index fund far surpass those generated by professionally managed money. As an investor, your goal is to replicate this approach as closely as possible, as this will generate strong returns on an after-tax basis that are above and beyond what is typically seen in the market averages.

Amongst the many financial investments options available, hedge funds are making prominent waves. This is one kind of investment tool that is offered only to a group of investors who comply with specific requirements. When looking to invest, you are required to fill out a lengthy application form that details all of your assets and they must be $1 million or $5 million in investments. Hedge fund managers often make risky investments like derivatives or betting on currency moves. Initial investing has a $500,000 starting point and goes up from there.

Hedge funds are specifically open to those people that have sound investment capabilities. Investors, who are eligible for being a part of hedge funds, are given freedom from various stringent regulations such as short selling of funds, derivatives, funds’ leveraging, liquidity of funds, fee, charges etc. Hedge funds offer the high-profile investors the ability to generate staggering earnings ranging in millions of dollars. A hedge fund is a sought after investment option that dominates the top rung of the investment circles that also include trading of debts and derivatives.

The first investment of hedge funds was made by Alfred W. Jones in the year 1949. This first investor was a financial journalist and believed in the theory of empowerment of individual assets via the process of market performance. A. W. Jones tested this theory and diversified his financial portfolio by buying those assets that would fetch attractive prices; and such assets that would have under-valued prices. In the end, the movement of the price causes some losses however they get absorbed by the surplus gains made when the prices were going stronger and sturdier. The main objective behind inception of hedge funds was to mitigate its chances of meeting losses and thus empower the management of investments to become free of any kind of commercial restrains.

It is often difficult to invest in hedge funds because of the fact that you need significant assets and because there are rules about advertising hedge funds.

Ray Dalio, Owner Bridgewater Associates. Most successful hedge fund firm in the world.

What are hedge funds?

If you have ever wondered about what hedge funds are and why their managers seem to be in  the news and occasionally headed to jail, you will find a simple explanation here. Written especially for our Coolchecks.net consumers, we hope this helps you gain a better understanding of hedge funds.

Hedge funds are private entities that collect monetary funds from more than one source (individuals or groups) and then invest those funds into diverse financial portfolios.  Hedge funds are designed as an investment vehicle that is structured as a company or partnership. The average person will not be able to invest in this type of investment vehicle. Find out why below.

History

The creation of hedge funds began somewhere in the 1920′s. Today, the global hedge fund industry has net assets of $2.13 trillion (reported in April of 2012).  Many of them are created in offshore financial centers to avoid adverse tax consequences. The Cayman Islands has 34% of the world’s hedge funds.

Only wealthy investors are allowed to invest and are screened closely by the SEC. Most often institutions (61%), foundations, universities or people with exceptional wealth are allowed to invest in hedge funds. Some funds have a net asset value in the billions.

Hedge funds can also be compared to mutual funds but with a slight difference. Mutual funds call for investments from various sources but within the same financial portfolio. Conversely, if you are fortunate enough to be able to invest with hedge funds there are many choices for investors where they can choose any financial portfolio; invest for long term as well as short term; leverage their financial standing; trade in simple to complex stock derivatives; and invest in side pockets ( a type of hedge fund).

Hedge Fund Managers

The managers of hedge funds derive income by the means of a performance-fee and a management-fee. While the management-fee falls within the range of 1 percent to 4 percent of yearly invested funds, the performance-fee falls within the range of 10 percent to 50 percent of yearly return of the invested funds. Steadfast regulation is followed in the case of performance-fund where these charges are collected solely on the net profits after deduction of last year’s losses. Top Hedge fund managers earn enormous sums of money per year. Some reach the $4 billion mark. For the top 25 hedge fund managers, the average salary in 2011 was $576 million.

Investment Configuration

The basic structure of hedge funds is configured in limited partnerships where the fund manager acts like a general partner and every investor is akin to limited partners. Administrators and subordinate analysts work under the manager and take care of the operational funds and analyze the selections of the investment portfolio. More people can also be used to find prospective investors.

Investment Directive

There are comparatively simpler and lesser directives involved in hedge funds because they have such stringent prerequisites. Due to this reason, the rules and regulations are lenient and moderate. However, the participating investors are supposed to abide to rules laid by the SEC and its associated acts. One prominent regulation concerns the funds’ marketing. The SEC disallows explicit advertising in order to seek investors. This regulation also demands complete scrutiny of its comprehensive marketing materials.

World’s Most Successful Hedge Funds

The world’s most successful hedge fund manager is Ray Dalio (born 1949) who owns and manages the Hedge Fund firm, Bridgewater Associates, the world’s most successful hedge fund firm.  Dalio is often referred to as the Steve Jobs of investing. He began his career at the age of 12, investing $300 in Northeast Airlines which later merged with another company and tripled his investment. Currently, he is advising people to look at what is happening in the world around you and try to stay one step ahead of it.

Investing In Mutual Funds

Do you know how to measure your mutual fund performance? Are your personal finances allowing you to start using your savings as another way to earn money?

To most, assessing the true performance seems like a complicated task.  Many advertisements tout certain funds as having 5-star ratings or as being the “best choice” for American investors.  But how exactly are these performance ratings determined?  Can these ratings be trusted?  What exactly do we mean when we say a mutual fund generated a return of 20% and does this give us the true picture of a fund’s performance?

It can be very easy to get caught up in the hype of the media advertisements attached to many mutual funds, so making the best choice in a mutual fund investment requires a solid understanding of how performance should be measured.  Here, we will look at how to measure the relative performances of mutual funds so that we can properly assess the claims made in their advertisements.

Using the Morningstar Style Box

The first step in accurately assessing a fund’s past performance is to look at the Morningstar Style box, which divides mutual funds by market capitalization (small, medium and large) and by its investment objective (value, growth, and blend).  The box has 9 sections and can be seen in the graphic below:

This configuration allows you to place your chosen fund its correct category (one box on the “tic tac toe” spectrum).  This is helpful because it will allow you to compare total performance (rates of return) with funds of a similar size and investment approach.  Typically, investors make these comparisons over 3, 5, and 10 year time horizons (allowing you to smooth out short term fluctuations in the market).  Of course, performance comparisons can also be made relative to a benchmark index like the S&P 500, but the more specific performance comparisons (to those funds in a similar Morningstar category) tend to be more useful.

Separating Your Fund from the Market as a Whole

When looking to make an assessment of the market as a whole, the S&P 500 can be a useful benchmark for determining broad economic performance.  But in order to have a meaningful idea of your fund’s true merits, it must be compared to its peers those within the same style box category.

For example, roughly 90% of the available mutual funds underperformed the S&P 500 in 1998.  Index funds tied to the S&P 500 fall into the “blend” and “large cap” fund categories (which suggests that the S&P 500 has limited exposure to value and growth stocks).  In this year, as most mutual funds offered weaker returns than investments in the S&P 500, a majority of the similarly categorized “large cap” and “growth” funds actually beat the S&P 500 index.  From this, should we surmise that the managers of these funds put forward an exceptional performance?  Not exactly.

In 1998, growth funds with large market caps generated average returns of about 35% (which was about 8% better than what was seen in the S&P 500).  But some funds (such as the Vanguard Growth Index fund) generated returns above 42% for the year.  So, when some funds advertise the performance as “market leading” because they beat the S&P 500 benchmark, the first question to ask is whether or not the fund falls into the “large cap” and “growth” categories.  If this is true, you should not be as impressed by these results as you would be if the fund fell into one other categories (which would be a more impressive feat).  This is because the assets in that fund should have had no problem beating the S&P that year.

Matching Comparable Funds

There are some names that are well known in the fund community (such as Vanguard) that aim to provide access to index funds which fall into many of the Morningstar style boxes (Vanguard funds fall into 7 of these 9 categories).  So, when looking for funds to use as a measured standard of performance, these funds provide a good starting point.

Morningstar.com allows you to search for your fund using its name or ticker symbol.  You will then see a wide selection of informational articles related to the fund.  This will include its style box categories, yearly performance relative to the S&P 500 (for assessment against the broader market), and performance comparisons to funds that are more directly related to your fund of choice.   A quick internet search of this type can allow investors to assess the relative performance for mutual funds before making any share purchases.

SmartMoney’s Comparison Tools

Other sites, like SmartMoney.com, will allow you to compare funds through time periods of 1, 3, or 5 years.  These types of sites allow you to monitor how the funds in your 401(k) plan are performing when compared with a similarly positioned index fund.  The Vanguard funds make these comparisons particularly convenient and the following list shows which funds are comparable for each style box category.  You can use the ticker search at SmartMoney.com to look for these match-ups:

• Small Cap Funds: Vanguard Small Cap Index Inv (NAESX) compares to the Russell 2000 Index
• Mid Cap Funds: Shelton S&P Midcap Index (SPMIX) compares to the S&P Mid Cap 400 Index
• Large Cap Funds (Value):  Vanguard Value Index (VIVAX) compares to the BARRA/S&P Value Index
• Large Cap Funds (Growth):  Vanguard Growth Index (VIGRX) compares with the BARRA/S&P Growth Index
• Large Cap Funds (Blend):  Vanguard 500 Index (VFINX) compares to the S&P 500 Index

In addition to this, Vanguard has addressed other style box categories with a value fund in the small cap category (VISVX), as well as a mid cap index fund (VIMSX).  But since these are recent additions to the market, there is not enough of a historical record to allow for a meaningful analysis.  Instead, when looking at mid cap funds, other options include the California Investment Trust S&P Midcap Fund (SPMIX).  When looking at small cap funds in the growth or value category, investors can compare the chosen fund with those in the blend index funds with small market capitalization.  One example is the Vanguard’s Small Cap Index Fund (NAESX).

Conclusion:  Market Returns and Performance Ratings are Only Meaningful When Compared to Their Peers

Making a comparison of the annual returns generated by your chosen fund to those generated by a similarly positioned index or index fund will allow you to accurately assess the track record and measure its performance on a relative basis.  In many cases, these performances are less than impressive, despite what the fund’s marketing team might suggest in advertisements.  In other cases, a fund will outperform its peers (and its associated index), so an investor’s main task is to identify a fund that consistently outperforms relative to its competition.