The Big Flaw in 401(k) Reform

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For the 401(k) plan of the future to succeed we should offer professionally managed for all employees. Rather than plan participants choosing their own investment mix of funds a pensiion fund tyoe investment vehicle will work best. Individuals are ill prepared to manage their own retirement accounts.

Here’s what real reform would look like:

  • Every plan should be required to have a minimum of five risk adjusted, globally diversified portfolios (ranging from conservative to aggressive), consisting solely of low management fee stock and bond index funds. Employees would take a short risk capacity survey and select the portfolio suitable for them;
  • Investment advisers to 401(k) plans should be required to state in writing that they are “3(38) ERISA investment fiduciaries”, which means they can have no conflicts of interest. They would accept 100% of the liability for the selection and monitoring of the investment options in the plan. These advisers would be required to provide investment advice to all participants to be sure they have chosen a portfolio suitable for their investment objectives and capacity for risk.

These simple reforms would radically improve the expected returns of plan participants.

The underlying fallacy in current efforts at 401(k) plan reform is that employees are capable of making intelligent investment choices when presented with a dizzying array of mostly poor investment options. I recently spent time with a group of nurse anesthetists whose plan we advise. It never occurred to me to ask them to give me ten needles and five choices of anesthesia (some good and some dangerous) and let me handle their next patient.

Why do we assume employees can be skilled investment advisers? We need reform that makes the process of making investment selections in 401(k) plans foolproof. Current reform just doesn’t cut it.

Plan sponsors would benefit from these two proposals because this mirrors the old pension plan. The participants in their plan would improve results and reduce anxiety.

Please comment or call to discuss how this would affect your company no matter the size.

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Stern Advice: Companies shake up 401(k)plans, cut fees

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Plan sponsors are recognizing the need to understand the fees their plan is paying. Employees will begin to ask questions on fees when they learn what they are paying.

Employees may not see evidence of these changes until the spring of 2012. But here are some they may already be seeing, and what to do about them.– Controlling costs is paramount. Not every employee has access yet to those clear fee reports, but there are some ways to see what you are spending. Workers whose plans are covered by Brightscope can see that information on the Website. Workers can ask their human resources department for a bottom-line figure.

As much as 90 percent of 401(k) costs are in the investment management fees, reports David Huntley of HR Investment Consultants. That means the funds you choose have the biggest impact on what you pay. Typically, index funds charge less than actively managed funds. Even cheaper options could include institutional classes of funds or separate accounts that look like mutual fund portfolios but are created especially for retirement accounts.

— It’s not all about the cheapest. It’s good to go with the lowest-cost option that fits your objective. That means you shouldn’t keep all of your retirement account invested in an uber-cheap money market fund if you need stocks for the long term. But, once you’re choosing among similar stock funds, you’ll probably improve your retirement income by choosing the lower-cost one.

Fees matter and starting in 2012 plans will be required to disclose who gets paid what. A low cost globally diversified portfolio will allow participants to reach their financial goals with less stress. Studies suggest this will result in increased productivity.

Please comment or call to discuss how you can determine the fees your plan pays ahead of the regulations.

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Their Confidence Is Killing Your Returns II

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The marketing machine of the financial institutions over shadow thr the truth of investing. Dan Solin articulates what true investing is.

I often wonder why so many investors ignore the overwhelming data indicating that capturing market returns in a globally diversified portfolio of low management fee index funds in a suitable asset allocation is likely to outperform stock picking, manager picking and market timing — the daily grist of many brokers and advisors. If you have limited time for research on this subject, take a look at the “Standard & Poor‘s Indices Versus Active” reports, which you can find here.The answer to this riddle may have nothing to do with a battle over data, and everything to do with the perception of confidence. Don Moore, of Carnegie Mellon University, conducted research showing that we are inclined to accept advice from a confident source, even if the track record of that source is unworthy of our trust. Another study is even more troublesome. It found those receiving “expert” advice essentially “switched off” their brains (as measured by an MRI). The subjects would have been better off ignoring the advice of the “experts” and making their own decisions, but their brains went “dormant” when confronted with “expert” advice.

Keep this research in mind the next time you are exposed to the oh-so-confident opinions of financial experts. You would likely be better off independently looking at the data and making your own decision.

Be careful who you take your advice from.

Comments are welcome.

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Paying More in Fees Can Get You Less in Returns

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Expenses in mutual funds and insurance products can prove very costly to your long term financial goals. Remember the larger the organization the larger the paypoints involved. There is a cast for marketing, executives, managers….

The expense ratios of S&P 500 index funds range from very low to extremely high. For an egregious example of an indefensibly high expense ratio, consider the State Farm S&P 500 Index B (SNPBX). It has an expense ratio of 1.49%, and a deferred load of 5.00%. This fund has assets of $547 million.A small difference in expense ratios can have a dramatic effect on returns. Let’s assume an S&P 500 index fund and Vanguard’s both return 8% annually, before costs and you invest $10,000. A savings of only 1% annually on expenses would mean the lower cost fund would yield an additional $63,000 over forty years ($201,000 versus $138,000). That’s a big difference.

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The Free 401(k) and the Prohibited Transaction

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Regulation 408(b)2 regarding fee disclosure will end the free 401(k) for plan sponsors. Employees will be informed of what fees thet are paying and to whom. What questions will they ask when they realize their employer is paying anything for this benefit?

For many plans it is very common for the adviser to work one-on-one with participants and provide advice recommendations.  Let’s say that the adviser recommended an actively managed fund that pays revenue sharing, over an S&P 500 Index fund that does not.  While we all know there may be very valid reasons to do so, but ERISA is very clear that fiduciaries must act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them.

By recommending a fund that pays revenue sharing over a fund that does not, that adviser (acting in a fiduciary capacity) has just influenced their own compensation, or their firms, thus creating a prohibited transaction.  Therefore, what started out as a qualified financial professional providing assistance to a plan participant, ended up in creating a prohibited transaction for the plan.

In my experience, most plan sponsors do not realize the risk they are putting themselves and their plan in by entering into such arrangements.   This is where you can help them understand the inner-workings of the plan services and fee arrangements to help them from inadvertently creating a prohibited transaction.

Many plan sponsors are unexpectedly allowing the adviser to their plan to commit a prohibited transaction. This can and should be avoided, not only to protect the plan sponsor but also to protect the participant.

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

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Simple Investing for Troubled Times

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Actively managed funds are promoted because of the trading revenue they generate for the financial institutions. It does not matter whether the market is up or down the institutions make money on every trade. This strategy is not in your best interest.

Dump your actively managed fundsSeeking “alpha” is exciting. “Alpha” is the value a portfolio manager is supposed to add over its benchmark return. Since you can capture the return of a designated benchmark (net of transaction costs) by buying an index fund that tracks the index, purchasing actively managed funds makes no sense unless the portfolio manager is likely to deliver alpha. Here’s the rub, according to an exhaustive study, only 0.6 percent of managers produce alpha as a consequence of skill.

Don’t be fooled by pre-tax return data

Mutual funds report returns pre-tax. Most investors don’t understand the impact of taxes on their returns. The tax burden of individual investors varies depending on whether their accounts are tax deferred or after-tax accounts and the tax rate of their state of residence. Kritzman uses an example of a Massachusetts resident (admittedly a high tax state) who has a marginal tax rate of 35 percent. If this resident had a choice between an index fund with an expected return of 10 percent, a mutual fund with an expected return of 13.5 percent, and a hedge fund with an expected return of 19 percent, you would think selection of the hedge fund would be a no-brainer. You would be incorrect. At the end of a ten year period, after accounting for transaction costs, taxes, management and performance fees, the simulated return of the index fund was 8.27 percent, which beat the return of the mutual fund (7.82 percent) and the much hyped hedge fund (7.61 percent).

Here’s Kritzman’s conclusion: “It is very hard, if not impossible, to justify active management if your goal is to grow wealth. If, instead, you view active management as a source of entertainment, you may wish to consider less costly ways to amuse yourself.”

Study after study proves that active managers add no value to your portfolio. Investing for retirement is a long term process and a low cost, globally diversified portfolio, risk adjusted for you is the best option.

Please comment or call to discuss how this affects you.

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Morningstar Should Be Ashamed of Its 401(k) Plan

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If you would like a pension fund like plan for your employees do not follow the Morningstarmethod. Many studies prove that model risk adjusted portfolios far out perform employees choosing their own fund mix.

I feel sorry for Morningstar’s employees. The fund selections represent everything that is wrong with 401(k) plans in this country. Here are some suggestions for Morningstar’s committee. They reflect finance 101. It’s sad the committee is so clueless about them:Your Employees Need Portfolios, not funds.

Very few employees have the ability to put together a risk-adjusted portfolio from a selection of a large number of fund options. Instead of giving them twenty-three funds to choose from, why not offer globally diversified portfolios of stock and bond funds at different risk levels, ranging from conservative to aggressive?

Get rid of all your actively managed mutual funds.

How can you possibly justify having twenty-one actively managed funds and only two index funds as investment options in your plan? You create a lot of the mutual fund data, do you simply ignore it when it comes to the welfare of your employees?

The likelihood of your actively managed funds outperforming their benchmarks over a ten year period is statistically extremely small. Only about five percent of actively managed funds equal their benchmarks over a decade. It’s hard to believe your committee is using past performance as a benchmark. There is precious little data indicating that stellar performance persists. I assume you are familiar with the SEC mandated caveat that “past performance is no guarantee of future results.”

I’m sure your committee believes it’s doing something useful when it engages in the kind of analysis detailed in your article. It really is just wasting time, feeling important and populating your 401(k) plan with expensive funds likely to enrich mutual funds and reduce the returns of participants.

Success in saving for retirement, as well as all INVESTORS, is about managed portfolios not picking the right funds. We are saving for retirement not looking for the latest or hot investment.

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

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Six Things Your 401(k) Provider Doesn’t Want You to Know

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For an employerto attract and retain talented employees they will need to provide a more secure and worry free solution for retirement planning. Plan participants realize that they cannot do it themselves and will look to their employer for help. You can provide that help.

2. Actively managed mutual funds rarely beat the market and aren’t worth paying a premium onMost 401(k) plans are built with actively managed mutual funds with a goal to beat a benchmark market index (e.g. the S&P 500).   Beating the market sounds like a worthy goal, but unfortunately, few fund managers can demonstrate results of doing this consistently over any stretch of time (if ever).  Picking stocks is like predicting the weather – very hard to do with any real consistency.  Managers not only have to be very good, but they also have to find enough winners to overcome the costs of losers, research, personnel, and added trading costs common with actively managed funds to outperform an index.

One independent study recently evaluated the performance of 2,100 actively managed funds over a 31 year period and found that only 0.6% of fund managers had stock picking success.  How different is that from zero?

Demand index funds in your 401(k) plan.  You’ll likely be much better off.

3. They share none of the risk or fiduciary duty on your plan (but you sure do)

When you provide 401(k) benefits, you have the duty to run the plan in the best interest of your employees.  Part of those duties includes monitoring investment options made available and making changes as appropriate, providing guidance materials to members of the plan etc.  And while your rep and provider may have given you a list of funds to select from – and even suggested a few – it’s your responsibility.   The very investment expertise the rep is supposed to be providing is really fully on the employer.  Bad funds? Your problem.  Employee complaints? Your problem.  Employee lawsuit? You get the picture.

The 401(k) plan is the sole source of retirement for most Americans. We must begin to give it a higher degree of importance in our benefit packages. Many employees, both current and prospective are looking for security in their retirement plans.

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

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The Search for a Better 401(k) Plan

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Small company plans must have and deserve an excellent quality retirement plan to ensure all employees can successfully retire. This may mean joining a ‘mutual fund’ of retirement plans. For any company which does not have the time or expertise to properly run their plan this is an excellent option.

Still, anyone at a smaller company who would like to cut costs in half while also improving the investmentchoices, as he did, would be wise to consider the hurdles he had to clear and the obstacles in his way.So why are all the details so important? Most people starting their careers now will spend 45 years trying to save enough so they can stop working someday. But if the investment costs and fees inside your 401(k) or similar fund average, say, 1 percent of your assets each year instead of 0.25 percent, the difference can cost over $100,000 by the time those 45 years are up.

And that’s just the fees side. Most actively managed mutual funds, which try to pick investments that will do better than an index of similar securities, often don’t actually outperform that index over long periods of time. Even so, many employers, out of ignorance or blind faith, don’t provide a full menu of index funds in their retirement plans

Small company retirement plans have been historically much higher priced than larger employers. This can be avoided with the proper help.

Please comment or call to discuss how your plan can be improved.

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The Mutual Fund Industry Is A Huge Scam That Costs Investors Billions Of Dollars A Year

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The best financial advisorsadd value by developing a strategic investment portfolio for each client and keep the client focused on their long term goals. We must protect our future self from our current self. Discipline, with the right strategy, will lead to a successful retirement.

Specifically, year in year out, investors buy funds that have been given 4 and 5 stars by Morningstar and withdraw money from funds that have been given 1 and 2 stars. They do this despite the fact that even Morningstaradmits that the ratings aren’t predictive–that 4 and 5 star funds aren’t likely to do any better in the future than 1 and 2 star funds.What is predictive?


The lower the cost of a fund, the more likely it is to do well in the future (relative to other funds). The higher the cost, meanwhile, the less likely the fund is to do well.  This is one reason that index funds outperform “actively managed funds” (funds with managers paid to pick good stocks and sell bad ones) year after year: The manager’s salary is deducted from the fund’s returns, and most managers aren’t good enough to offset the cost of their salaries and their employer’s profits.

Why don’t financial advisors tell their clients these simple facts?

Because financial advisors like to believe (or pretend) that they can add more value than that–that their acumen and relationships and experience will allow them to select funds that do “better than average.” (Even though index funds do distinctly better than average.) And also because financial advisors are often incented (paid) to recommend certain funds over other funds–and the commissions on high-cost funds are generally higher than those on low-cost index funds.

The best solution for investors saving for retirement is a globally diversified portfolio with low cost funds. More specifically, a portfolio with the risk characteristics relevant to their age and time horizon.

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

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