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Why bad funds stay in your 401(k)

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When you are dealing with actively managed mutual funds you will always have some bad funds in your portfolio. The thought that someone can predict which fund managers will beat the market seems attractive. The problem is the Wall Street bullies have convinced you that it can be done when in fact it cannot. The markets are random and unpredictable. You should invest accordingly, with the help of an investor coach.

Reach Skilled Volunteering
Reach Skilled Volunteering (Photo credit: Wikipedia)

Among funds whose trailing 3-year performance was in the lowest-ranking decile, “non-trustee” funds were almost three times as likely to be removed the following year (29.6%) as trustee funds (11.9%). Did the keeper funds reward their administrators’ faith by rebounding? Not in the short run: The researchers found that, on average, those trustee funds went on to underperform their benchmarks by 3.6% in the year after they survived the cut.What keeps slacker funds from getting expunged? As MarketWatch’s Ian Salisbury has reported, many trustee firms offer employers pre-packaged rosters of funds, an arrangement that can keep individual funds from getting closer scrutiny; the trustees also often cut employers a break on administrative costs if the employers let the trustees have more leeway in picking funds.

But there’s another factor in play: The bad funds don’t seem to bother employee-investors that much. Plan members, of course, could vote with their feet and leave these funds behind (ideally, in favor of index funds where underperformance would be less of an issue). But according to the NBER study, while 401(k) investors tend to chase good performance and pour money into hot funds, they’re less likely to pull their assets out of a poor performer—unless, of course, the trustees take it out of the plan. Evidently, inertia trumps disappointment.

via blogs.marketwatch.com

Most employers do not realize that they are accountable for the funds in their 401(k) plan. These same employers, mistakenly believe the person selling them the plan are accountable for the funds in the plan. To find an adviser willing to accept responsibility for fund choices, you must have them agree, in writing to serve as the ERISA 3(38) investment manager.

Please comment or call to discuss how this affects you and your emplyoees.

Posted via email from Curated 401k Plan Content

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Cramer Sees the Light (But Misses the Point)

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Unfortunately, Jim Cramer is what is wrong with the 401(k) industry, in that, investors can manage their own portfolio. Most, if not all, are unable to emotionally manage their portfolio efficiently. To succeed in reaching your retirement goals you must develop a prudent strategy and reamin disciplined. This may sound easy but we are unable to make the proper decisions during times of stress. We need a coach to keep us disciplined and focused on our long term goals.

The plan proposed the most complex highway interchange attempted in Ontario to that point. (Photo credit: Wikipedia)

I am no fan of Jim Cramer. I don’t find him entertaining, although I can understand why many people do. My gripe is that his antics harm investors by making it appear his opinion on the direction of the market, or his stock-picking skill, adds value. It doesn’t. There is no evidence that his track record is better than what you could expect from random chance. In a scathing blog, Henry Blodget stated: “It would be impossible to write a ‘Bad Advice’ column about investing without discussing Jim Cramer.” David Swensen, financial author and Chief Investment Officer of Yale University, opined that Cramer “exemplifies everything that’s wrong with the advice — and I put advice in quotation marks — that is given to individual investors.” According to a 2009 study by Barron’s, “[C]ramer’s recommendations underperform the market by most measures.”I was pleasantly surprised to read a blog by Bruno J. Navarro at CNBC summarizing an interview he did with Cramer about 401(k) plans. Cramer is quoted as opining that most 401(k) plans “stink” because of high fees and lousy returns. He notes the entire system feels like it was set up to “… benefit the financial services industry, not you.” With typical bluster, he states that “almost nobody else” expresses these views.

He is mostly correct. The 401(k) system in this country is a disgrace. It is rife with conflicts of interest, high costs and terrible investment choices. The primary beneficiaries are the mutual fund industry and the brokers and insurance companies who “advise” plan sponsors.

He is wrong that only he has this insight. I set forth similar views in my book, The Smartest 401(k) Book You’ll Ever Read, published in July, 2010. Cramer’s nemesis, Vanguard Group founder John Bogle, recently observed that the 401(k) system is “profoundly flawed.”

Here’s the point Cramer misses entirely. The core problem with 401(k) plans — as Cramer noted — is terrible investment choices. Most plans offer primarily high management fees, actively managed funds, where the fund manager attempts to beat a designated benchmark. These funds are likely to underperform low-cost index funds over the long term, reducing the returns of plan participants. Since brokers and insurance companies can incrementally increase their fees by offering the more expensive funds, they often minimize or eliminate index funds from the investment options.

Active fund managers tend to underperform because they engage in stock picking, notwithstanding the numerous academic studies demonstrating that attempting to find mispriced stocks does not work.

What advice does Cramer’s Mad Money show dispense? Stock picking advice. Recently, he selected stocks he believes will benefit from a deal to avoid the fiscal cliff. This is the same activity engaged in by managers of actively managed funds in an often unsuccessful effort to “beat the markets.”

The logic underlying Cramer’s sage advice concerning the indefensible state of the 401(k) plan industry, applies with equal or greater force to his musings about stock selection. I applaud Cramer for taking on the 401(k) industry. Now he should do investors a huge favor by either dispensing academically-based advice about the perils of market timing, stock picking and fund manager selection or go off the air. Either option would be of immense benefit to investors.

via huffingtonpost.com

If you follow this advice your 401(k) plan will become more of a pension fund like plan.

Please comment or call to discuss how your 401(k) plan can be improved.

Posted via email from Curated 401k Plan Content

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Big and Bigger Lies About Bond Fund Managers

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Many investors, left on their own, will avoid pain at all costs. This actually ends up meaning they will sell low and buy high. Just the opposite of what they should be doing. Most of us cannot manage our own portfolio because of our emotions. We must have a prudent process in place and remain disciplined.

Different risk and return of investment for th...
Different risk and return of investment for the different investors (Photo credit: Wikipedia)

In times of economic uncertainty, investors tend to flee to the perceived safety of bonds. Let’s ignore the fact that bouncing from stocks to bonds is a form of market timing. As an investment strategy, market timing has a dismal record.Unfortunately, many investors want the returns of stocks, with the reduced risk of bonds. Those that are looking just for a safe haven invest in “risk free” bonds, like Treasury Bills.Most often, investors looking for higher returns from their bond holdings invest in actively managed bond funds (where the fund manager attempts to beat a designated benchmark, like the Barclays Capital Aggregate Bond Index). They could invest in lower management fee bond index funds of comparable risk, but they believe an active bond manager has the investment skill likely to increase returns over the benchmark index, while taking no more risk. They are paying more for the services of the active fund manager and expect to be rewarded.

The big lie is that actively managed bond funds are likely to outperform index funds of comparable risk. The bigger lie is that actively managed bond fund managers have demonstrable investment skill, permitting them to beat their benchmark index, net of fees.

via huffingtonpost.com

Market timing does not work. Those that profess an ability to predict where the market is going are nothing more than confidence men. Investors will be best served by developing a prudent strategy with equities included and remain disciplined.

Please comment or call to discuss how this affects you and your financial future.

Posted via email from Curated 401k Plan Content

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The Big Lie Is a Cruel Hoax

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The Wall Street bullies have lead us to believe that there is someone out there who can predict the future. This belief is the main cause for poor performance by investors. Your financial future is at stake. Granted some will get lucky but the vast majority will suffer.

M42 at dusk
M42 at dusk (Photo credit: Highways Agency)

The perpetuation of the myth that you can pick outperforming actively managed funds through “research” is a cruel hoax. It makes ordinary investors feel inadequate when their efforts fail. Most don’t realize that extraordinary resources by researchers with advanced degrees in finance have been devoted to finding the magic bullet that would “beat the markets.” None have succeeded.The fruitless search for predictive factors of outperforming funds is harmful to your financial health. In a recent blog on Forbes, Richard Ferri calculated the probability of selecting a winning actively managed fund for different categories of stocks and bonds ranged from a low of 22 percent to a high of 32 percent.

Most investors hold a portfolio of mutual funds, and not just a single fund. Ferri reached some startling conclusions about the probability of a portfolio of all actively managed funds beating a comparable portfolio of all index funds. This statistic stood out: An actively managed portfolio consisting of five funds held for 20 years had only a 2 percent chance of beating a comparable portfolio of index funds. Ferri concludes that “[T]he evidence in favor of all index funds, all of the time, is irrefutable, overwhelming and important to all investors.”

Don’t be misled by statements indicating there is some way you can identify actively managed funds that will outperform their benchmarks prospectively. As one commentator noted, relying on past performance and hoping it will persist is “like driving forward while looking through the rear view mirror.”

via huffingtonpost.com

Trying to pick active managers that ‘beat’ the market is gambling and speculating with your money. Don’t do it.

Please comment or call to discuss how to improve your portfolio.

Posted via email from Curated 401k Plan Content

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5 Ways to Boost Your Company’s ROI on 401(k)s

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With the new fee disclosure rules requiring notifying employees of all fees in their plan by the end of August, 2012 plan sponsors need to take a proactive role. Remember 401(k) plan has become the sole source of retirement for most Americans. It requires and deserves your full due diligence. Plan sponsors must be certain that their plan is for the sole benefit of the plan participants and their beneficiaries.

Mutual Funds for Dummies ...U.S. Funds at War ...
Mutual Funds for Dummies ...U.S. Funds at War -- Too simple? (Monday, June 4, 2012) ... (Photo credit: marsmet545)

In addition to exposing the new fee data, the new 401(k) disclosures present an equally important opportunity for CEOs to understand if their plan truly makes sense–for their company and their people. Here’s what to look for:1. Determine your “all-in” cost.

There are two broad sets of ongoing fees that come with your 401(k). The biggest chunk is a fee that goes to the investment company managing the underlying portfolios–which is bundled up into what’s known as an expense ratio. The sneaky thing about annual expense ratios is that they never show up in a statement; they’re deducted from a fund’s gross assets. Investors see only their performance net of fees. Good news, though: Expense ratios are included in the new data disclosures, expressed as a percentage of assets. If your plan uses retail mutual funds, you can also find this data online for free at sites like Morningstar.

The second set of fees covers recordkeeping and other administrative costs. Combine the two, and you have what is known as the all-in cost.
 How does your “all in” stack up? A study last year conducted by Deloitte Consulting for the Investment Company Institute broke down median all-in fees by plan size. Though the overall median was 0.78%, the typical charge for plans with less than $1 million in assets was 1.41%. For plans that size, the lowest fees (at the 10th percentile) were 0.99%, and the higher end (90th percentile) was 1.83%. For plans with $1 million to $10 million, the median all in was 1.14%. At the 10th and 90th percentile, the medians were 0.80% and 1.60%, respectively. If your plan’s all in is at the higher end, time to start asking some questions.

2. Confirm you have low-cost index fund options.

There are two broad approaches to investing: Park your money in a mutual fund that’s built to track an established benchmark, such as the S&P 500 index for U.S. stocks or the Barclays Aggregate for U.S. bonds. The other approach is active investing, where there’s a manager or an investment team in charge of making all investing decisions–what to own, when to buy, sell, etc. 
I realize active sure sounds more compelling; hire some smart guy, and you will whip the index. If only. I’ll spare you the deep data dive and cut to the chase: The vast majority of actively managed funds underperforms index funds. Pick any time frame and any type of fund (stock or bond, domestic or foreign, etc.), and index funds do better.

My definition of a good 401(k) is one that includes index fund options. Moreover, they should be cheap index funds, ideally with an expense ratio of no more than 0.50%, and preferably lower. If you have index funds that charge 1% or more, that’s just too expensive for a passive investment strategy. I’d be asking some seriously sharp questions at that point.

3. Take inventory of your fund options.

More is not necessarily better in terms of the number of investment options your plan offers. Studies have shown that when there are too many choices, participants get confused or frustrated or just decide not to participate. If you really want to keep it simple–and simple, here, is incredibly smart and effective–I would make sure you have one broad U.S. stock index fund, one broad U.S. index fund, and a diversified international stock fund, preferably an index fund. That’s going to give your plan plenty of bang for the buck. If you also want to offer more specific funds, such as portfolios of small-cap stocks, emerging market portfolios, perhaps a TIPs fund, etc., that’s your call. But don’t go overboard with the number of options.

via inc.com

Plan sponsors should take a more proactive role in the management of the company sponsored retirement plan or seek professional fiduciary help. Many of the fiduciary functions can be outsourced, freeing up staff time and reducing liability.

Please comment or call to discuss how this would affect you and your company.

Posted via email from Curated 401k Plan Content

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Comparisons to Other Mutual Funds Can Be Misleading

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Marketing gimmicks in the financial services industry are rampant. Many investors are realizing that they cannot trust wall street as evidenced by the outflow of fund from actively managed funds and inflow to passively managed funds.The main street solution is to own equities, gloablly diversify and rebalance.

Mutual Fund Playas
Mutual Fund Playas (Photo credit: greggoconnell)

Since 100 percent of its retirement funds beat their 5-year Lipper average, investors could believe that T. Rowe Price has found a way to consistently “beat the market”. Is this accurate?Not if you understand how the use of benchmarks can be misleading.

Lipper mutual fund averages are benchmarks that measure the performance of funds in a given category against other funds in that category. The fact that all of the retirement funds managed by T. Rowe Price beat their Lipper averages means they were better than the average performance of the other funds measured by Lipper. While interesting, it tells you nothing about how those funds performed against their benchmark indexes.

Morningstar assigns a benchmark index to each mutual fund it rates. This is the index against which the performance of a given fund can be measured. These indexes are assigned by the Morningstar fund analyst team, based on its Morningstar category. It is the index the Morningstar analyst team believes is the most appropriate benchmark for the Morningstar category.

The performance of a fund against its appropriate index is a more accurate way to evaluate the performance of a mutual fund. Think of it this way. If the average 8th grader can run a 100 yard dash in 20 seconds and your child took 40 seconds, you might be concerned. However, if the only information you had was that your child was better than the average in his class (and the average in his class was 45 seconds), you might believe he was in great shape.

Using data from Morningstar (for example see here), Index Funds Advisors calculated the returns for the five-year period ending December 31, 2011 of the T. Rowe Price Retirement funds against their analyst assigned benchmark. This was the same period used by T. Rowe Price to measure performance against the Lipper average. We measured the performance of all 33 T. Rowe Price Retirement Funds. The results were surprising. None of them equaled (much less beat) their Morningstar analyst assigned benchmark. Underperformance ranged from 0.84 percent to 1.73 percent (annualized). Only twelve of these funds are available for direct purchase by individual investors.

via huffingtonpost.com

The marketing machine of the major mutual fund families are continuously looking for ways to peddle their funds. Most of these methods are misleading to investors. Armies of lawyers for these funds make sure the wording of the marketing pieces will get their firm into court.

Please comment or call to discuss.

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An Investor Protection Plan

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Does your brokerfollow the fiduciary standard or the suitability standard? Brokerage and insurance firms have been fighting the fiduciary standard with zeal. Why?

broker
broker (Photo credit: milo tobin)

Debunk Their “Expertise”A broker who loses a client to index funds typically responds with a dismissive statement indicating that he and his firm have the ability to select “market beating” fund managers. As discussed above, ask him to show you a peer reviewed article demonstrating the reliability of his methodology. In addition, ask him to provide you with a long term (10 years or more) analysis comparing the returns of the proprietary mutual funds of his firm (funds that have the name of the firm as part of the name of the fund) with their Morningstar assigned benchmark. After all, if they can pick superior managers, wouldn’t those managers be running their branded mutual funds? This is another report you are unlikely to receive.

There is an easier way to avoid becoming a victim. Don’t use any retail broker or adviser who tells you they have the ability to “beat the markets”.

via huffingtonpost.com

If your broker or agent really could beat the market why would they need you? Another question to ask yourself is, if the big brokerage firms really knew who was going to be the best fund manager why do they have over 100 managers?

Please comment or call to discuss how this affects you and your portfolio.

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The Greater Fool Theory and Investing

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Stock pickers success has nothing to do with skill and all to do with luck. To succeed in reaching your long term financial goals own the market, globally diversify and rebalance. The final piece is to remain disciplined to your strategy. The formal phrase is the investment policy statement. You will not know if you succeed unless you have a goal and a strategy. Remember predicting the future is for fools.

Image via Wikipedia

You are Picking StocksPicking stocks refers to both the practice of buying individual stocks because you believe they are mispriced, or purchasing actively managed stock mutual funds, where the fund manager attempts to beat a designated benchmark. If you are engaging in either of these activities, you are a participant in the GFT.

Individual and institutional stock pickers assume they can find mispriced (typically underpriced) stocks, hold them and sell them at a profit. If anyone could do this, you would think it would be Bruce Berkowitz, the much lauded manager of the Fairholme Fund. With much fanfare, on Jan. 12, 2010, Morningstar issued a press release naming him the “Domestic-Stock Fund Manager of the Decade.” It noted this was a new award recognizing fund managers who have achieved superior risk-adjusted results over the past 10 years and have an established record of serving shareholders well.”

How did the “Domestic Fund Manager of the Decade” perform in 2011? According to data provided by Morningstar Direct, his fund suffered a staggering loss of 32.4 percent!

Greater fools thought that Berkowitz had the Midas touch that would continue indefinitely. They assumed there would always be buyers at a higher price for stocks picked by him. They were wrong.

If you purchase any actively managed mutual fund, you are engaging in the GFT. One study (reported here) showed the Vanguard Index fund beat 75 percent of designated mutual funds before taxes for the period 1982-1991. The same study found that its after tax return beat 65 out of 71 mutual funds. When you buy these actively managed funds, you are the greater fool.

via huffingtonpost.com

Stock picking and over weight in gold are two big mistakes investors make. Many are driven by fear and media hype. The best strategy is a risk adjusted globally diversified portfolio. This takes out the guess work as well as the anxiety.

Please comment or call to discuss how this affects you.

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2011 Winners Can Make You a 2012 Loser

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No one can predict the future. Yet the financial institutions has convinced the public that they can beat the market. The best solution for investors is to own equities, globally diversify and rebalance. Any other strategy makes more money for Wall Street and less for Main Street.

Arends looked at the “most hated” stockswith the most analyst “sell” recommendations. The top 10 of these stocks underperformed the most “loved” stocks by less than 1%.The overwhelming evidence that no one can predict which asset classes (much less which stocks or mutual funds) will perform well in the future has not deterred the same “experts” from making predictions for 2012. I want to get in on the action so here are my predictions:

1. A majority of investors will continue to believe brokers have the ability to pick outperforming stocks and actively managed mutual funds and to provide guidance on “what is happening” in the market;

2. A minority of investors will cancel their retail brokerage accounts and invest in a globally diversified portfolio of low management fee index funds in an asset allocation appropriate for them.

3. Over time, the returns of the minority of investors described in #2 are likely to outperform those of the majority of investors described in #1.

4. The primary beneficiary of perpetuating the myth that retail brokers and financial pundits can predict the future will be those dispensing this advice. The victims will be those relying on it

via huffingtonpost.com

Process beats predictions over time. No one can consistently predict the future.

Please comment or call to discuss.

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U.S. 401(k) Disclosure Is Coming-What To Do In January

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Plan sponsors need to get a handle on this early. An independnent analysis will clarify what needs to be done, if anything. Indifference will result in increased fiduciary liability and many irate employees. Employers have the huge responsibility to help their employees successfully retire, whether they like it or not. The alternative would be to hand it over to the federal governement.

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Here are some practical recommendations for fiduciaries seeking to change their investments and feesbefore the disclosures become mandatory:

  • Know what your fund management fees are and make sure to investigate whether institutional class fund shares, which typically have lower fees, are available for your plan. David Hurley of Investment Consultants states in the article that investment management fees may represent as much as 90% of 401(k) costs.
  • Provide an investment menu with a manageable array of funds. It is not advisable to simply make all of the funds in a mutual fund family available to participants. There will be a mix of high and low performing funds in the platform offered and these may have different fee levels. Plan sponsors report that many participants are likely to be overwhelmed by too much choice. In addition, fiduciaries will have difficulty demonstrating that they fulfilled their fiduciary responsibilities to select appropriate funds if they do not review and winnow down fund family offerings.
  • Many fund families will let your plan use outside funds. Investigate their performance and fees.
  • Offer low-fee index funds as an option.
  • Consider whether your participants pay commissions, loads and other costs of investment. Transaction costs as well as your administrative and record-keeping costs may be negotiable. Fund sponsors often waive loads for 401(k) and pension accounts.
  • Consider undertaking a request for proposal from new service providers, if your provider’s fees are high, particularly if you haven’t done an RFP recently.
  • Consider hiring an outside adviser if your in-house expertise is limited.

However, it is also important to remember that fees are only one factor to consider in fulfilling fiduciary responsibilities. Performance and level of service should be weighed as well, and a fund with outstanding performance may be worth higher fees.

via pensionsbenefitslaw.com

This is great advice for all fiduciaries. Plan sponsors, big and small, need to be diligent when offering a retirement plan to their employees. This benefit will allow your employees to successfully retire if given the right tools.

Please comment or call to discuss how this affects your company retirement plan.

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