Of course we are looking for fair. We want our financial professionals to play that way, act in our best interest, employ solid fiduciary standards and look out for the little guy. We want transparency. We want things to be cheap, even the complicated stuff and above all, we hand over flowing fist profits from every investment. We want to outlive our money and have buckets of legacy cash to leave our heirs. We want to be rich.
If everyone were fair, this is how it would turn out. But everyone and everything life throws our way is far from it. In fact, I’d be willing to bet that you haven’t remarked, either out loud or under your breath that you got a fair deal in the past week. But I’d be more likely to win a wager when I suggest that you probably at least once over the last week, thought that somehow something just wasn’t fair.
And no one is looking for fair deal from anything coming from Wall Street. In fact, I suspect that you are probably looking for something as simple as a profit that isn’t taxed too much, isn’t negatively impacted by too much inflation and that after all of that, wasn’t waylaid along the way by fees. Most of us are kind of naive when it comes to investing even if the vast majority of us use mutual funds to gain access to those potential profits.
Mutual Funds are enormously complicated investment tools that are often simplified to the following: You and other like minded investors hire a manager – who is financially savvy – and this person(s) then buys investments based upon whatever the fund is designed to do.
You have no doubt bought a mutual fund as part of your 401(k). Individual Retirement Accounts (IRA) are usually filled with mutual funds. They’re diverse, they can be tied to an index or they can invest around the world. They can be in stocks, bonds, commodities or a combination of some or all of these. They can be called exchange traded funds trading (ETF) just like stocks. The combinations seem endless. With every new whim that is uncovered, a mutual fund or something just like it sprouts in the fertile ground of that investment desire.
So how do you judge fair when the price of what you are paying for is so complicated that few outside of those actually in the industry know how it is done? The price you pay for a mutual fund on any given day is based on the net asset value or NAV. It is set based on what appears to be innumerable equations based on what the fund invests in. In the US with funds based here in the states, the NAV is determined by the fund accountant. It involves calculating not only what cash the fund actually has – a projection is the best way to describe it – and then this person tallies the day’s trading activity. They then subtract expenses and distributions and do all of this within two hours of the 4pm close on the NYSE.
But suppose you have bonds or there are bonds in your fund (balanced, fixed income and target date funds are examples of funds that hold bonds either in some minority position or as a whole)? These bonds are priced using a matrix pricing. According to Fidelity, matrix pricing is “a method of fair valuing bonds that applies analytic methods to historical prices to produce an estimated price. This price is not necessarily the price you paid for the bond, nor is it the price you could receive if you sold it.” There’s that word fair!
Suppose you have added risk to holdings of mutual funds and purchased something in the small cap sector? Pricing these stocks, which are often lightly traded and any sudden interest in a company of interest could send the stock soaring – which is why mutual fund manager say they need to keep their strategies close. But those stocks are not easy to price because of their illiquid-ness, a term used for not a whole lot of shares available for purchase on any single day. So to price these stocks in a mutual fund, an average is used, most often between the bid and the ask price.
Either way, the price you pay will be the next day’s NAV. But foreign markets don’t have the same closing time. Time zones are a problem for mutual funds investing in foreign companies trading on foreign exchanges. How do you get a fair value?
In many instances, the gap is closed with the estimate of a futures contract, a prediction by some traders where a markets might go and the actual close of that particular market. Other issues impact this “fair valuation” and none of them give comfort to the investor that simply asks why?
Perhaps instead of fair we are looking for equitable, something akin to a fair shake. We know that things will cost us money. Tell us. Even in the world of index funds, the difference in cost and style can be just as dumbfounding as they are in the world of the non-index funds, the actively traded variety.
We’re OK with knowing since the vast majority of us still don’t know whether we are saving for retirement, as so many suggest we are, or investing for retirement, which is what it is. We ignore risk when there are times when it is feasible to embrace simply because we don’t know what it will cost. There is no shame in telling us.
That’s not to say that there haven’t been improvements over the years which have driven down costs for all of us. behavioural financial people are slicing and dicing our every motive, poking and prodding at our every emotion or lack of it and putting what remains under the microscope. And from those watchful stares we find out that we aren’t very good at it and haven’t been for a long time.
But we should invest and do so with one open eye. The other eye should always be looking for the fairest deal. Because a fair deal is something we can wrap ourselves around. And unless we have one, we’ll never feel comfortable enough to invest more.
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