I’ve been getting letters from the American Association of Individual Investors (AAII) for years now, and another one arrived yesterday. Their stated goal is to “assist individuals in becoming effective managers of their own assets through programs of education, information and research.” In big print on the front of the envelope, they declare that they are a 501(c)(3) non-profit “education” organization.

But after reading their pitch about investing in little-known small-cap stocks and their claims of earning 6% a year more than the averages, I just got the feeling that this was another stock tip newsletter. Keep in mind that if someone could beat the market by just 2% a year consistently, they’d be very rich folks.

From previous research on charities, I know that a lot of “non-profits” have top executives making a lot of money. On the extreme end, there are shell charities that are basically really good-paying jobs that hide behind helping veterans or orphans. Of course, there are many situations where an executive can justify their salary, especially if the organization’s administrative and salary costs are a small percentage of donations and most revenue goes directly into the community.

Usually non-profits have to file an IRS Form 990 that is similar to an annual report, and this document is legally required to be open for inspection by the public. Let’s take a look at the 2009 AAII Form 990 from Guidestar.org.

In 2009, AAII declared revenue of $5.8 million, mostly from annual membership dues and subscriptions to their stock newsletters. That $29 a year adds up! Out of that, the salaries of the employees took up $3.1 million, over 50% of the revenue. The top 5 employees get paid a total of over $1.3 million a year. The top two officers both paid themselves approximately $450,000 each in 2009. Here are the exact numbers from a snippet:

$1.1 million was spent on marketing costs of printing and mailing all those letters, and the organization actually lost $1.6 million for the year. I wish I could start a non-profit that actually didn’t make any profit, but yet still paid me and my buddy both nearly $500k a year!

Finally, let’s take a look at their performance claims. According to the site HenryWirth.com, AAII appears to use the shady tactic of only releasing performance numbers after they know they beat their desired benchmarks. (If it doesn’t, it’s swept under the rug.) After the Hulbert Financial Digest monitored their true performance based on public, replicable stock picks, the newsletter was found to have subpar returns over the last 8 years. It lagged the Wilshire 5000 index by over 2% a year, and lagged the Vanguard Small Cap Index by over 7% a year.

I know there are some happy AAII members out there. Teaching individuals to invest independently seems like a good idea, although promoting unrealistic returns is sketchy in my book. Mostly, I find the fact that they are using non-profit status to increase their own wealth very irksome. I think AAII should be run as a for-profit business, and then they can charge whatever they want and pay themselves whatever they want. If you are happy with how this non-profit enjoys their tax-exempt status and how they spend most of their revenue on themselves, then by all means keep on sending in your money. I’ll pass.

Inside a recent Vanguard article was a nice graphic of the current glide path for all Vanguard Target Retirement funds, which shows how the fund’s asset allocation will change over time. The fund will automatically rebalance towards these allocations, even if market returns shift things.

First, you’ll notice that the Target Retirement Year of any specific fund assumes that you will retire at age 65. Nothing really changes from ages 25 to 40, and then from 40 onwards there is a gradual transition. According to the article, the changes will continue to change for 7 years after the Target Retirement Year with a final mix of 30% stocks and 70% bonds/cash. However, the graph above seems to indicate even less stocks past age 72. Either way, this means a fund will stick around even well after the retirement date has passed, like with the Vanguard Target Retirement 2010 Fund.

Knowing the glide path helps you decide if you want to make some slight adjustments you can make when buying one of these all-in-one funds:

• The Target Date assumes that you will retire at age 65. If you plan on retiring earlier or later than that, you can simply choose a different Target year. Keep in mind that your Social Security benefits will also adjust according to when elect to start receiving payments. When you do, that will provide a regular, inflation-adjusted income stream in addition to any income for retirement account withdrawals.
• The Target Date assumes a generic risk tolerance level. If you want a more aggressive or conservative asset allocation over time, again, simply choose a different Target year. This will shift your glide path above accordingly.

If you’re buying one of these things, you’re doing it for the low costs, ease of use, and even perhaps how it keeps you from fiddling too much. These funds are especially great if the great majority of your retirement savings are in tax-deferred accounts like 401ks and IRAs, which is probably true for many investors that are just starting out. Otherwise, you may decide that you want to separate asset classes according to their tax treatment by the government.

Money market funds always seek to maintain a published stable net asset value (NAV) of $1.00. If it drops even to $0.99, known as “breaking the buck”, people start to panic. Funds are allowed us book values and then round to the nearest penny ($0.995 becomes $1.00), so small fluctuations can be hidden from investors. On January 31st, the SEC started requiring money market funds to disclose their “shadow” NAV, which is the value of their holding at actual market prices out to four decimals places (i.e. $0.9995 or $1.0003). However, you only get to see them with a 60-day lag and by looking through SEC filings.

Shadow NAV Definition

The net asset value per share most recently calculated using available market quotations (or an appropriate substitute that reflects current market conditions), including the value of any capital support agreement, to the nearest hundredth of a cent.

How Do I Find The Shadow NAV For a Specific Fund?
These shadow NAVs are not widely publicized, although if a major money market fund had an abnormally low one, the financial media would probably pick up on it. To find the latest shadow NAV for a specific fund:

• Visit the SEC EDGAR Search page and enter the ticker symbol.
• Filter the big list of results by entering “N-MFP” under Filing Type.
• The highest result should be the most recent N-MFP filing. Click on the “Documents” button, followed by clicking on the red link for “primary_doc.html”.
• Scroll down to “Item 18. Shadow Price of the Series” for your fund.

As an example, here is the latest N-MFP filing for the Fidelity Cash Reserves Fund (FDRXX) with a Shadow NAV of $1.0003 as of 1/31/11.

What Is A Dangerously Low Shadow NAV?
[Read more…]

Inside this Wall Street Journal article about the recent phenomenon of brokers offering commission-free ETFs, portfolio manager Rick Ferri constructed some sample portfolios from the available offerings of Fidelity, Schwab, TD Ameritrade, and Vanguard.

In this Bogleheads thread, Ferri clarifies that these portfolio are not necessarily complete sample portfolios, just what you might be able to build given what was available. Still, a potentially helpful exercise.

The portfolios I provided for today’s Wall Street Journal article were created under a strict WSJ mandate. I was to take only the free trade ETFs available at each firm and form as similar as possible portfolios across all platforms. Since each platforms is different with many asset class choices being very limited, the portfolios contained only a very basic asset allocation. An ETF/index fund portfolio would hold more asset classes without the WSJ constraints.

Discount stock broker Firstrade.com announced that they will join other brokers in offering a limited number of free ETFs to be traded with no commission. You must hold them for 30 days. If you sell an eligible ETF within 30 days of purchase, their regular $6.95 online commission fee will apply. Here’s the current list of 10 ETFs:

Stocks
iShares S&P 500 Index Fund (IVV)
Vanguard Small Cap Growth ETF (VBK)
iShares S&P MidCap 400 Index Fund (IJH)
Vanguard Dividend Appreciation ETF (VIG)
Vanguard Emerging Markets ETF (VWO)
iShares FTSE/Xinhua China 25 Index Fund (FXI)

Bonds
Vanguard Short Term Bond ETF (BSV)
Vanguard Intermediate Term Bond ETF (BIV)
Vanguard Long Term Bond ETF (BLV)

Commodities Futures
PowerShares DB Commodity Index Tracking Fund (DBC)

The list manages to cover most of the basic asset classes, although it’s missing a certain continent called Europe. I’m sure they figure nobody cares about those old and boring countries anyway, especially if you could invest in China again… even though the Emerging Market ETF is already 18% China.

Update: As of late 2012 Scottrade announced that they would liquidate their FocusShares ETFs.

Scottrade bought FocusShares as a subsidiary and has joined the free ETF landscape. They introduced 15 new low-cost Focus Morningstar ETFs which passively track several major broad indices. Discount brokerage Scottrade will allow account holders to trade them commission-free without any holding limits or additional requirements. You don’t need a certain balance, and you could trade as little as one share at a time. Here’s a list of the ETFs:

Focus Morningstar US Market Index ETF (FMU)
Focus Morningstar Large Cap Index ETF (FLG)
Focus Morningstar Mid Cap Index ETF (FMM)
Focus Morningstar Small Cap Index ETF (FOS)
Focus Morningstar Basic Materials Index ETF (FBM)
Focus Morningstar Communication Services Index ETF (FCQ)
Focus Morningstar Consumer Cyclical Index ETF (FCL)
Focus Morningstar Consumer Defensive Index ETF (FCD)
Focus Morningstar Energy Index ETF (FEG)
Focus Morningstar Financial Services Index ETF (FFL)
Focus Morningstar Healthcare Index ETF (FHC)
Focus Morningstar Industrials Index ETF (FIL)
Focus Morningstar Real Estate Index ETF (FRL)
Focus Morningstar Technology Index ETF (FTQ)
Focus Morningstar Utilities Index ETF (FUI)

Tracking Indexes
It’s a bit annoying that all these guys track a proprietary index from Morningstar. For example, the US Market Index ETF tracks the Morningstar® US Market Index, the Large Cap Index ETF tracks the Morningstar® Large Cap Index, and so on. I know they probably end up very close to other broad indexes, but it makes performance comparisons more difficult. Perhaps they really wanted the Morningstar brand on them, or maybe the licensing fees are a lot cheaper than MSCI or S&P charges? Maybe both.

Expense Ratios
One of the major attractions of these new ETFs are their super-low expense ratios. In most cases, they are the cheapest in their sector, even lower than Vanguard. The US Market Index ETF charges a mere 0.05% annually. They provide a ETF expense comparison chart.

However, Vanguard’s structure has them offering ETFs “at cost”, which means that employees are getting paid, but there are no profits going off to eagerly waiting shareholders. Vanguard’s US Market Index ETF (VTI) is huge with nearly $20 billion in assets, and they are charging 0.07%. There is absolutely no way Scottrade & Focus are making money on these things at 0.06%, somebody is subsidizing the heck out of them and will be losing money for a while. If these don’t do very well, then they will either shut them down or raise expense ratios in the future.

Would I Buy Them?
First, competition is good, and I’m happy that people are realizing that costs do matter. If you really wanted exposure to these areas and already have a Scottrade account, this does makes them very convenient. You can open an account with just $500, and there are no minimums or maintenance fees. I can see how Scottrade-affiliated financial advisors would like them, as it lower costs for clients already committed to the platform, and they can rebalance without commissions.

There are similar free ETF offerings from Fidelity, Schwab, and TD Ameritrade

If you are an individual investor buying ETFs as a long-term holding, my preference would be to open an account at Vanguard, buy their ETFs with no commission as well (or mutual funds), and be able to feel confident that your costs will always remain reasonable. They also have a much wider selection, including international stocks and bond funds. FocusShares already shut down all their ETFs once back in 2008 already. Are these added risks worth $2 a year for every $10,000 invested?

More coverage: IndexUniverse, WSJ.

The SEC has officially recommended that anyone that provides personalized investment advice to retail consumers should be subject to a fiduciary standard of conduct. Put simply, this means that anyone under the “financial adviser/money manager” umbrella has to be legally required to put your interests ahead of their own. Currently, many people providing advice are simply salespeople with fancy titles. As you might expect, big Wall Street firms are pouring millions toward lobbying efforts to stop it.

Tara Siegel Bernard of the NY Times writes in her Will You Be My Fiduciary? blog post about one CFP who’s started circulating his own Fiduciary Pledge. The idea is to get your investment planner/portfolio manager to sign it. Sounds like a good test to me.

The Fiduciary Pledge

I, the undersigned, pledge to exercise my best efforts to always act in good faith and in the best interests of my client, _______, and will act as a fiduciary. I will provide written disclosure, in advance, of any conflicts of interest, which could reasonably compromise the impartiality of my advice. Moreover, in advance, I will disclose any and all fees I will receive as a result of this transaction and I will disclose any and all fees I pay to others for referring this client transaction to me. This pledge covers all services provided.

X________________________________

Date______________________________

Ron A. Rhoades writes an RIABiz article outlining how applying the SEC recommendation could alter the financial landscape for clients, leading to reduced fees for individual investors (and thus higher returns and bigger nest eggs) and more difficult justifications for creating “sh***y investments”.

Because fiduciary advisors operate under a fiduciary standard of due care, and because fees and costs of investment products do matter, closer scrutiny of the “total fees and costs” of pooled investment vehicles and other financial products would occur. As a result, portfolio turnover within funds would decline dramatically, and even greater pressure would be brought to bear on other aspects of the fees and costs of pooled investment vehicles. However, true fiduciaries would not have to choose the lowest cost product; rather, they would justify, as part of their due diligence process, why each fee and cost was worthwhile for the investor client to incur.

Not everyone wants to manage their own investments. But if you are paying someone for help, I would agree that they should be a fiduciary at a bare minimum.