Diligence by Who? You or Your Financial Advisor?

In 2001, the Securities and Exchange Commission (SEC) adopted a new rule to supposedly prohibit mutual fund names that may mislead investors about a fund’s investments and risks. The rule required a fund with a name suggesting that the fund focuses on a particular type of investment (e.g., “stocks” or “bonds”) to invest at least 80% of its assets accordingly. Previously, funds were subject to a 65% investment requirement.

This rule resulted in many funds changing their names, changing their investments, or both. In general, things are better now than they were before the 2001 rule. However, today’s mutual fund names and categories can still be confusing and/or misleading.

Blurred Boundaries

For example, let’s look at names that connote where the fund buys its investments. These names usually contain words like “Domestic,” “International,” “Global,” and “World.” Imagine a Domestic Large-Cap fund, whose name suggests it buys large, U.S. companies. But if the fund owns mostly companies in the S&P 500 Index, those companies might be generating up to 50% of their revenues outside of the U.S. The large multinational firm might be based in the U.S. but do business in countries all around the world. The opposite may be true of funds with “Global” or “World” in their name; those companies based in foreign countries may be deriving some or all of their revenue from dealings with the U.S.

Undefined Jargon

Another confusing category of funds is called “smart beta”. Investopedia defines Beta this way1:

“Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of an asset based on its beta and expected market returns.”

Got that? Let’s assume you totally understand beta and CAPM. So, what is “smart” beta? If beta is a measure of volatility, then a reasonable person might assume that “smart beta” is a more intelligent measure of volatility, right? Let’s see if the definition of smart beta contains the word “volatility.”

Investopedia defines smart beta this way2:

The goal of smart beta is to obtain alpha, lower risk or increase diversification at a cost lower than traditional active management and marginally higher than straight index investing. It seeks the best construction of an optimally diversified portfolio. In effect, smart beta is a combination of efficient-market hypothesis and value investing. Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization-based indices. Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way. The increased popularity of smart beta is linked to a desire for portfolio risk management and diversification along factor dimensions, as well as seeking to enhance risk-adjusted returns above cap-weighted indices.

Hmm. Not a single mention of volatility. Are you confused yet?

Growth, Aggressive Growth, Capital Appreciation, Equity Income

Growth sounds good, but how is it different from capital appreciation? Don’t they mean the same thing? Does aggressive mean faster, riskier, meaner, or something else? Equity income funds are supposed to be stocks that pay dividends, right? So, what category do you think the Dividend Growth Small & Mid-Cap Fund3 is? It has both “dividend” and “growth” in its name, but are they separate or together? Does the fund invest in companies whose dividends are growing, or does it invest in growth companies that also pay dividends? An investor would need to read the fund’s prospectus to find out for sure. I’m sure all good investors thoroughly read those prospectuses from cover to cover.

Reporting Problem

The SEC requires mutual funds to report complete lists of their holdings on a quarterly basis. So, the manager of the hypothetical Blah-Blah Domestic Large Cap Fund could buy a bunch of foreign small-cap stocks on January 1 and hold them until March 28. Then, the manager could sell them and replace them with domestic large-cap stocks, and report on March 31 that the fund was properly holding domestic large cap stocks as required. On April 1, the manager could buy back the foreign small cap stocks and repeat that process every quarter.

Conclusion

Mutual fund names and categories are more informative than they used to be, but they can still be quite confusing or misleading. Investors (and advisors) need to do their due diligence, fully read those prospectuses, and closely follow the actions of the fund managers. Is your advisor recommending mutual funds? Are they confident of what’s really in those funds? Are you? If you have any questions about the mutual funds in your portfolio, email me at steve.hartel@trilogyfs.com and I if I can’t answer your question, I will find someone who can.

1. https://www.investopedia.com/terms/b/beta.asp
2. https://www.investopedia.com/terms/s/smart-beta.asp

The pandemic’s economic disruption altered people’s views on a wide range of money topics—from the feeling of financial insecurity to the extra burden of debt, to how best to protect their loved ones, physically and financially. People’s interest in life insurance—knowing they have a need for it—was heightened during the pandemic and remains so, as people take a closer look at their financial security and well-being. The 2023 Insurance Barometer Study, by Life Happens and LIMRA, shows this trend is prevalent among the younger generations, as well as with single mothers.

Single Moms Need the Industry’s Help

Fewer women own life insurance than men, 49% vs. 55% respectively. And that number is even starker for single moms: Just 2 of 5 single mothers (40%) own life insurance. That said, 6 in 10 single moms (59%) know they have a life insurance need gap—meaning they need coverage or more of it (vs. 41% of all adults) equaling about 5 million households. And 4 in 10 (38%) say they intend to buy coverage this year. With 7.9 million single-mom households, according to the U.S. Census Bureau, there is a dire need for single moms to
purchase life insurance, or more of it.

The primary reason single moms own life insurance (63%) is the same as the general population: to cover burial costs. However, only 26% say they have it to replace lost income. And more than half (51%) say they are “extremely concerned” about leaving dependents in a difficult financial situation if they died prematurely, vs. 29% of the general population.

That’s not the only area of financial concern. In fact, single moms have increased levels of concern over a wide range of financial issues—often double-digits—over the general population.
• Having money for a comfortable retirement: 58% vs. 44%
• Saving for an emergency fund: 56% vs. 38%
• Paying monthly bills: 50% vs. 32%
• Ability to afford college: 40% vs. 22%

Owning life insurance makes people feel more financially secure: 69% of life insurance owners feel secure vs. 49% who don’t own. For single moms, this is 52% of owners feel secure vs. 30% who don’t own. The good news is that while only a third of single moms (35%) work with a financial advisor currently, more than half without one are looking for an advisor (52%) to help them navigate their finances.

Desire and Need Are on the Rise

Gen Z is growing up—they’re adults now who are in the weeds of financial responsibilities and stresses. Half of Gen Z is now 18-26 years old, which means 19 million young adults are ready for life insurance, most of whom are non-owners; and Millennials, at 27 to 42, are well into their careers and starting families. The study took a look at life insurance ownership among different age groups and found that half of all adults (52%) own life insurance, with 40% of Gen Z adults and 48% of Millennials currently owning it.

As Gen Z starts hitting life milestones such as finding a partner, buying a home and having children, half (49%) say
they either need to get life insurance or increase their coverage. And Millennials are not far behind, with 47% saying so. And they are ready to take action: 44% of Gen Z adults and 50% of Millennials say they intend to buy life insurance this year.

They also want to purchase it where they have become comfortable—online—and that goes for all generations. In 2011, 64% of people said they preferred to buy life insurance in person; by 2020, just 41% felt this way. In 2023, it dropped to 29%.

Education Is Key for Gen Z

There is work to do on educating people about ownership: 42% of all adults say they’re only somewhat or not at all knowledgeable about life insurance.
A quarter of Gen Z and Millennials say that not knowing how much or what kind of life insurance to buy stops them from getting coverage. And 37% of Gen Z and 27% of Millennials say
they “haven’t gotten around to it.”

Across generations, cost is cited as the top reason for not getting life insurance. But only a quarter (24%) of people correctly estimated the true cost of a policy for a healthy 30- year-old, which is around $200 a year.* More than half of Gen Z adults (55%) and 38% of Millennials thought it would be $1,000 or more.

With the current climate adding financial uncertainties to Gen Z and Millennials, including layoffs and inflation, it is imperative that the two age groups learn how to protect their loved ones financially. Education around finances in general, inclusive of life insurance, will be extremely beneficial, particularly for Millennials, who cite the highest overall level of financial concern (39%).