Socially responsible mutual funds are an extreme example of asset gatherers using your values and neediness to turn you into a profit center for them. Socially responsible funds buy companies that they deem good corporate citizens or that follow certain religious or moral guidelines. They tend to avoid tobacco stocks, companies that discriminate or do not hire union workers, firearms and weapons manufacturers, and companies that pollute the environment.
While you are under the illusion your money is doing good, mutual fund companies operate on the hard fact that socially responsible fund investors do not trade funds and have low standards for investment return. These funds all buy the same stocks and produce the same mediocre returns, but their asset bases grow steadily. In recent years, socially responsible funds have been among the fastest growing asset gatherers. More importantly, your investment does not go directly to the company doing “good.” Your cash is used to buy shares from other stockholders who are tired of the company. A direct investment in a socially responsible enterprise or in a public offering of new shares is rare. When you discover that your money is enriching fund managers, not you or your causes, you may feel betrayed. If stocks are outside your comfort zone, you will feel better giving directly to the endeavor you support and investing the rest of your funds within your comfort zone.
Fund organizations run many funds. They call themselves fund “families.” Studies show that marketing, not high returns, increases funds under management over the long-term. The fund families send you newsletters and have Web sites. Every article is designed to encourage you to ignore the results you have gotten and buy more product. Your mailbox will also be stuffed with bulletins about new funds, account statements, proxy statements, and tax statements. The more money you have with the family, the higher the level of service and status you can achieve within the family. You can move up from ordinary to preferred to gold to platinum to admiralty. Switching funds within the fund group is convenient and quick. To switch from a rival fund, they will even do all the paperwork for you. But moving out of the family is discouraged. If you are dissatisfied with one of their funds, they hope your sense of loyalty and desire for convenience will cause you to buy another fund within the family. Retaining your mutual funds is their primary goal.
Some funds close to new investors. This gives existing investors the illusion that they own an exclusive product, which discourages them from selling. Some funds also impose penalties for early withdrawals. This keeps your money under management and creates a steady income stream for the und manager.
As with any good dysfunctional family, there are many secrets. You cannot find out what stocks your fund owns more than every six months, and then only 45 days after the six-month period ends. Nor can you get any information explaining why one manager was fired and another hired. Even mutual fund watchdogs such as Lipper and Morningstar cannot obtain this information. It is as if this is not your money but the family’s money.
If you have family abandonment issues, mutual fund investing will be troublesome. Seeking approval and support for your emotional deficiencies will cause you to stay with poor funds when better returns are available elsewhere. Severe depression could follow.
The personal change process is harder than the process described in this book. Outside help is necessary. You deserve to have a happy investment life just as you deserve to have a happy relationship. To achieve personal change, you can commit yourself to a codependence treatment program, see a psychiatrist, take prescribed medication, go to a trained psychologist or therapist, attend group psychotherapy, commit to Gamblers Anonymous, and enlist the support of family, friends, and work colleagues.
But you must get help. You cannot fix yourself. You cannot use a broken tool to fix a broken tool. The input of trained professionals and those who have recovered is absolutely necessary.
For most of you, however, Step 1 is the entryway to your comfort zone.
Unmanageability is a big issue with municipal bonds (munis). (Munis are bonds issued by states and local governments.) State and local government bonds are less secure than federal government bonds. The federal government can print money to pay bond interest and principal. With munis, defaults are possible, because state and local governments do not have the power to print money. Although defaults are rare, they occur. Many munis are secured by specific projects. If the project is bad, the muni could default.
Other munis are secured by a general fund. However, mismanagement of the general fund can endanger your muni. For example, the Orange County (California) general fund in 1993 and 1994 was run like a hedge fund. The fund manager invested in derivatives and leveraged up the fund just when interest rates rose dramatically, bankrupting the county. This type of mismanagement can lead to feelings of outrage among bondholders.
Munis are sometimes insured, but the insurer needs to be solid for the insurance to be any help. State and local governments sometimes establish a fund, known as a sinking fund, to be used to pay off specific bonds when they come due. These bonds are known as prerefunded bonds. Prerefunded bonds are more secure as long as the sinking fund is never attached.
Important as it is, the general ledger doesn’t exist in a vacuum, but interacts rather cleverly with other parts of a company’s accounting system. This occurs through a process called posting.
Posting is simply entering into the G/L a summary of posted directly to the general ledger include returns of merchandise, allowances from a supplier for credit, asset acquisitions, asset sales, investor capital contributions, loan drawdowns, and loans. These are called journal entries.
Transactions transactions recorded in the subledgers or journals, with a reference number. We’ll get further into the entire process later.
Some transactions are posted only to the general ledger and not to the subledgers. These transactions tend to be unusual. But proceed with caution. Items that should be entered in subledgers but are simply posted to the general ledger for the sake of convenience can throw the bookkeeping out of whack and unbalance your balance. That’s an error no accounting system can afford.
The general ledger exists for three main purposes: It serves as a summary of every transaction as recorded in the books of original entry; it’s the source document for all financial reports; and it offers an audit trail for tracking individual transactions, should that become necessary.
As the heart of the company’s financial body, the G/L records all transactions that occur within the company’s business activities. It also functions as the center of the firm’s books of original entry. When individual transactions are recorded anywhere within the subsidiary ledgers (subledgers), such as accounts payable or accounts receivable, they feed up to the G/L. (If a business is relatively small, there may not be any subledgers. However, even if you work in a company with such a simplified accounting system, it’s good to know how a more sophisticated system works.)
But the G/L is not a single document. Its content is augmented by receipts, journal entries, invoices—paperwork known as “source documents” that support the transactions recorded within. They all roll together, in fact, to form the company’s accounting system, with the G/L at its heart.
Why is it important for any manager not responsible for financial matters to understand general ledger processing? Well, why is it important for a salesperson to understand the nature, properties, and construction of the item he or she is selling? Financial management is a crucial part of your position. The more you know about what takes place on the accounting side of the fence, the better off you’ll be.
The next figure shows the same kind of relationship between the assets and liabilities accounts. If we add $100 to assets, the debits go up $100, and the credits go down $100. At the same time, in the liabilities account, debits go down $100 and credits go up $100.
The figure shows how an accountant would record four common transactions in terms of debits and credits:
The company borrows $8,000. Cash (an asset) is debited and Notes Payable (a liability) is credited.
The company sells $5,000 in merchandise on credit. Sales Income (an income account) is credited and Accounts Receivable (an asset) is debited.
The company pays its electricity bill of $200 immediately. Utilities Expense (an expense account) is debited and Cash (an asset) is credited.
The company sells some of its older computers for $1,500. Office Equipment (an asset) is credited and Cash (an asset) is debited.
Simple as it should be, the concept of debits and credits is a little like a Zen koan (a paradox). Terms are easily defined, but how they integrate into your balance sheet and income statement and the effect they have on your accounts… Well, that’s not so clearly understood without first understanding how liabilities and owners’ equity are treated in relation to assets. That may take a little getting used to.
As you now know, asset and liability accounts go together, as opposite sides of a balanced equation—with owners’ equity, of course. That’s why they make up the balance sheet, which shows the financial position of the company. In a similar way, income and expense accounts go together and make up the income statement, which shows what’s coming in and going out.
It’s really two simple systems that become a little complicated when they’re put together, because the double-entry system sometimes requires entries that may at first seem strange, because of the need to balance. It’s usually easy enough to understand how assets and liabilities are affected by a transaction, but it may be harder with the effect of a transaction on income and expense accounts.
So, we’ll provide a few examples to show it all makes sense, with a little effort.
One of the best ways to approach the opportunity cost of debt is to consider your interest rates as “potential rates of return.” In other words, if you had to choose between putting $100 per month toward a savings account paying 2% and a credit card charging you 15%, you should pay down the credit card. Even though you won’t earn the 2% annually on your $100, you avoided paying 15% on the same amount. For the savings account to make more sense, it’d have to have a higher interest rate than your credit card. In short, this means paying off a 15% credit card is roughly equivalent to earning 15% on your money!
One of the major advantages of loan workouts is that negotiations can be conducted in private. In some situations, the entire process can be resolved without any publicity, thereby avoiding uncertainty among customers and suppliers, and any consequent instability to the business. Even in cases where the disclosure of a company’s financial problems is unavoidable, for example to meet local stock exchange requirements for quoted companies, the parties involved are usually able to manage communication flows better outside a statutory process.
The participants in a loan workout are able to retain control over the transaction, rather than relinquishing it to the court. As a result, the final outcome more closely reflects the needs of the participants most affected by the company’s problems. The ability to control the process also results in flexibility. Provided the needs of the participants are met, the process (for example, the timetable) can be varied to respond to the prevailing circumstances. This is often impossible under a court-administered process.
The range of solutions possible, for example, the use of innovative financial instruments, is often greater under an out-of-court process. Less reliance on the legislation and judiciary can overcome many of the other shortcomings associated with statutory processes highlighted previously in this chapter. For example, transactions can usually be completed quicker, and with more focus on commercial issues. The fact that it is up to the participants to agree a financial restructuring and ensure the rescue of a company, rather than delegating that responsibility to a third party, can also engender greater ownership and commitment to the process.
