Mutual Funds For Dummies - Eric Tyson

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14).

      Gold, silver, currencies, and the like

      Whenever bad things happen, especially inflation, credit crises, and international conflicts, some investors seek out gold, silver, and other precious metals. Over the short term, these commodities may produce hefty returns, but their long-term record is more problematic. Over the very long-term, gold has kept investors just up with the rate of inflation — eking out an annualized return that is 0.5 percent per year above the rate of inflation. See Chapter 14 for all the details and how you can diversify your portfolio by using specialty funds investing in this sector.

      With the proliferation of cryptocurrencies, I must briefly discuss investing in currencies. There are very few funds that invest in currencies, and they all have pretty dismal or, at best, mediocre long-term track records. This makes sense because currencies — which are essentially keeping your money in cash — are poor investments. Over the long term, for example, the purchasing power of holding the U.S. dollar declines at a rate of about 1.5 percent per year.

      Will cryptocurrencies be any different? By financial market standards, their track record is quite short. Believers point to the crazy price increases enjoyed by select cryptocurrencies (such as Bitcoin and Ethereum) in the marketplace of now more than 17,500 cryptocurrencies, and more are coming quickly.

      The explosion of cryptocurrencies is in itself revealing. Crypto creators come up with an idea for how to promote a new crypto, and by getting in on the ground floor, they hope to reap large profits if others buy in and hopefully drive up the price.

      Annuities

      Annuities are investment products with some tax and insurance twists. They behave like savings accounts, except that they should give you slightly higher yields, and insurance companies back them. As with other types of retirement accounts, the money you put into an annuity compounds without taxation until withdrawal. However, unlike most other types of retirement accounts — 401(k)s, SEP-IRAs — an annuity gives you no upfront tax deductions for your contributions.

      Annuities also charge relatively high fees. That’s why it makes sense to consider contributing to an annuity after you fully fund the tax-deductible retirement accounts that are available to you. The best annuities available today are distributed by no-load (commission-free; see Chapter 7 for more on load and no-load funds) fund companies. For more information about the best annuities and situations for which annuities may be appropriate, be sure to read Chapter 15.

      Life insurance

      Some insurance agents love to sell cash-value life insurance. That’s because these policies — usually known as universal, whole, or variable life policies — combine life insurance protection with an account that has a cash value. They generate big commissions for the agents who sell them.

      

Cash-value life insurance isn’t a good investment vehicle. First, you should be saving and investing through tax-deductible retirement savings plans, such as 401(k)s, SEP-IRAs, and IRAs. Contributions to a cash-value life insurance plan provide you no upfront tax benefit. Second, you can earn better investment returns through efficiently managed funds that you invest in outside of a life policy.

      The only reason to consider cash-value life insurance is that the proceeds paid to your beneficiaries can be free of estate taxes. Especially in light of recent years’ tax law changes, you need to have a substantial estate at your death to benefit from this feature. For tax year 2022, the federal estate tax-free limit is $12.06 million. Married couples can pass along double these estate tax–free amounts (note that states often have lower limits and bypass trusts may be necessary to double these amounts at the state level). And, by giving away money to your heirs while you’re still alive, you can protect even more of your nest egg from the federal estate taxes. (Term life insurance is best for the vast majority of people. Consult the latest edition of my book Personal Finance For Dummies [Wiley], which has all sorts of good stuff on insurance and other important personal finance issues.)

      

Don’t fall prey to life insurance agents and their sales pitches. You shouldn’t use life insurance as an investment, especially if you haven’t exhausted your ability to contribute to retirement accounts. (Even if you’ve exhausted contributing to retirement accounts, you can do better than cash-value life insurance by choosing tax-friendly funds and/or variable annuities that use mutual funds; see Chapters 11 through 15 for the details.)

      Limited partnerships

      

Avoid limited partnerships (LPs) sold directly through brokers and financial planners. They are inferior investment vehicles. That’s not to say that no one has ever made money on them, but LPs are so burdened with high sales commissions and investment-depleting management fees that you can do better with other vehicles.

      LPs invest in real estate and a variety of businesses. They pitch that you can get in on the ground floor of a new investment opportunity and make big money. Usually, they also tell you that while your investment is growing at 20 percent or more per year, you’ll get handsome dividends of 8 percent or so per year. It sounds too good to be true because it is.

Many of the yields on LPs have turned out to be bogus. In some cases, partnerships propped up their yields by paying back investors’ principal (original investment), without telling them, of course. The other hook with LPs is tax benefits. Those few loopholes that did exist in the tax code for LPs have largely been closed. The other problems with LPs overwhelm any small tax advantage, anyway.

      The investment salesperson who sells LPs stands to earn a commission of up to 10 percent or more. That means that only 90 cents (or less) per dollar that you put into an LP actually gets invested. Each year, LPs typically siphon off 2 percent or more of your money for management and other expenses. Efficient, no-load mutual funds, in contrast, put 100 percent of your capital to work (thanks to no commissions) and charge 1 percent per year or less in operating fees.

      Most LPs have little or no incentive to control costs. In fact, they may have a conflict of interest that leads them to charge more to enrich the managing partners. And, unlike mutual funds and exchange-traded funds, in LPs you can’t vote with your feet. If the partnership is poorly run and expensive, you’re stuck. That’s why LPs are called illiquid — you can’t withdraw your money until the partnership is liquidated, typically seven to ten years after you buy in. (If you want to sell out to a third party in the interim, you have to sell at a huge discount. Don’t bother unless you’re totally desperate for cash.)

      

The only thing limited about an LP is its ability to make you money. If you want to make investments that earn you healthy returns, stick with stocks (using mutual funds), real estate, or your own business.

      If you reviewed the beginning of this chapter, you have the fundamental building blocks of the investing world. Of course, as the title of this book suggests, I focus on a convenient and efficient way to put

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