The Big, Fat, Retire Early Lie
Maybe I just watch too much TV, or maybe my eyes open wide whenever I hear questionable financial promises (Ponzi-dar?). Whatever the reason, I can't seem to escape the latest multi-million dollar ad campaign by one of America's largest financial services companies.
The ad starts with a dismal scenario visited upon a baby boomer: relocate or lose your job. Fortunately for the boomer, a brief consultation with a financial expert using sophisticated modeling software showed how early retirement was entirely doable. Goodbye cubicle, I'm going fly fishing, or whatever other boomer financial fantasy (retirement porn) is being used to hustle investment advice.
Not only did the brilliant financial services professional solve this person's dilemma, but, as the advertisement goes on to say, the early retiring boomer's boss called the same professional, wondering if he could retire early too.
The likely problem with the early retirement scenario? It's based on modeling using optimistic investment returns.
In a recent Wall Street Journal article about early retirement, an eerily similar scenario to the one teased in the advertisement is highlighted. Only the real world example uses real world market returns.:
Between 1994 and 2002, brokers from the Charlotte, N.C., branch of Citigroup Global Markets held more than 40 seminars and hundreds of individual meetings with BellSouth workers to show them how they could take early retirement. Central to the brokers' pitch was that the employees could expect to earn 12% a year from their investments and could withdraw about 9% a year from their accounts, according to the NASD complaint.
"You should be able to expect 12%," one broker told a couple, according to the NASD. "That is not guaranteed....We may do 15, may do 18 or 20. But good times, bad times, I think that we would do 12%."
What the workers were not told about was the risk they were taking by cashing out of their pensions, which provided guaranteed payouts, and putting the money in the stock market, where returns would fluctuate. The brokers' materials didn't mention that 12% returns were above the stock market's average returns over the long term -- 10.7% a year over the last 50 years, according to Standard & Poor's.
In addition, NASD said brokers didn't adequately disclose that customers would pay annual fees of 2% to 3% -- and as a result, workers would actually have to earn 14% to 15% on their investments to hit the promises made by the brokers.
When the stock market turned south, the brokers held a series of conference calls to try to hold onto accounts opened by BellSouth early retirees, the NASD said. During these calls, the brokers made various predictions that the markets would soon rebound. One prediction: the Dow Jones Industrial Average would rise to 20000 or 21000 by 2006. (The Dow is now around 13400.) In the end, more than 200 BellSouth employees saw their original investments decline by about $12.2 million, according to the NASD."
These early retirement clients may be fly fishing - but it may be because they can't afford to buy food.
We tend to take the opposite approach as those selling financial services - expect a below historical market return on your investments to make sure you're not broke at 75. If the market in fact delivers double digit returns, great, buy a boat. In the meantime, plan on working and saving more.
Of course, that doesn't make for much of an ad campaign: "I talked to my financial advisor. He said scrap the beach house idea and take a part-time job."
2006 Was A Cheaper Year
Here's some good mutual fund news: a new study finds that fund fees in 2006 were the lowest in more than a quarter century.
A study going back to 1980 found that mutual fund fees and expenses haven't been lower than they were last year.
Fees declined again in 2006, continuing a multiyear trend, as ever-larger investor portfolios triggered reduced load fees and as funds continued to tamp down expenses to boost their competitiveness. Many growing portfolios had smaller fees taken out because their size enabled them to receive discounts on large purchases as well as fee waivers. Overall, it seems investors had much to cheer about in 2006.
The Investment Company Institute, the mutual fund trade group, found that investors in stock funds paid fees, including both loads and expense ratios, that averaged about 1.1 percent, a decline of .04 percent from 2005."
Fund fees are going down for two big reasons: 1) More money is being invested in funds. Fund operating costs do not go up proportionally with more assets under management, so rising assets should lower fees. 2) Investors are paying more attention to fund fees, and investing in lower cost funds.
The study is quiet about 12b-1 fees, which have been rising as a percentage of the total rake over the last two decades, as well as commissions to buy mutual funds at brokers, which have been jumping across the board in recent years. But it seems that more and more mutual fund investors are picking funds based on cost - and mutual fund companies, ever looking for ways to attract investor assets, are trying to give investors what they want. Let's give ourselves a round of applause.
Interesting ETF Facts
Five of MSN Money's 10 surprising Exchange Traded Fund facts are interesting, the other five, not so much. Here are the good ones:
- 163 versus 134. The raw number of ETFs launched in the past six months versus the number of ETFs launched in first 10 years (1993 to 2003) of the ETF business' existence.
- 23 of 93. Of the 93 international ETFs on the market, only 23 are diversified funds that invest across a range of countries, regions and sectors. The rest are country- or region-specific or international-sector funds.
- 0.67%. The average expense ratio of ETFs launched in the past six months, many of which were leveraged index funds; sector, industry or niche funds (ophthalmology, for instance); or offerings tracking specialized or custom-made benchmarks.
- 0.45%. The average expense ratio of all the ETFs launched before December 2006.
- $284 billion versus $196 billion. Barclays' share of the ETF industry versus everybody else's.
New 'Our Favorite Funds' Report
Note to MAXadvisor Powerfund Portfolios subscribers: the Second Quarter, 2007 'Our Favorite Funds' report has been posted. MAXadvisor Powerfund Portfolios subscribers can access it by clicking here. Each 'Our Favorite Funds' report reveals what our analysts consider to be the very best no-load mutual funds in each fund category.
The MAXadvisor Powerfund Portfolios is a collection of seven model mutual fund portfolios ranging in risk from very safe to quite aggressive. Each portfolio is made up of a group of terrific, no-load, low-cost mutual funds that are carefully chosen to work together to lower volatility and increase returns. You can learn more about the MAXadvisor Powerfund Portfolios (and sign up for a free trial if you like what you see) by clicking here.
In Praise of Index Funds
Walter Updegrave at CNNMoney wades into the old index-versus-actively-managed-fund debate, and comes down squarely on the side of the indexers. Here's why:
- Many (index funds) charge 0.2 percent a year or so, and some have expenses that are even lower, sometimes as low as 0.07 percent. That's a pittance compared with the 1 percent to 1.5 percent or more than most actively managed funds collect from investors.
- Index funds slavishly follow an index or benchmark, so you always know what you're getting. You don't have to worry about your large-company fund manager poaching in small caps to juice his returns, or a value manager picking up a few growth stocks to boost performance when value stocks are on the outs.
- Index funds tend to be tax-efficient, which is a fancy way of saying they generally give up less of their gains to taxes.
We think most index funds are fabulous for the very same reasons that Updegrave does, and for disengaged or inexperienced investors a well-diversified all-index portfolio is what we recommend. But when we're building portfolios for our private management clients and for the MAXadvisor Powerfund Portfolios, we use a mix of index and high-quality low-cost actively managed funds. Why? Because carefully chosen actively managed funds in out of favor areas can beat the indexes, and make up for their higher costs.
Index funds, for example, can seriously underperform actively managed funds when the largest stocks by market cap are not leading the market. Since the stock market peak in 2000, most actively managed funds have beaten the market cap weighted S&P 500. For more on this issue, read this seven-year-old article by MAXfunds co-founder Jonas Ferris which predicts that actively managed funds should start beating the indexes (which they did).
See also: Ask MAX: What's better: an index fund or an actively managed fund?
Motley Fool's 'Best Funds' List Is Really Dumb
When you spot an article titled 'The Market's 10 Best Funds', you might be tempted to think that if you'd read it you'd get a list of ten great mutual funds that are set to produce market beating returns in the years ahead. Not so for readers of a recent posting on The Motley Fool. Readers who clicked on that snappy headline were treated not to a list of inexpensive, high-quality funds in undervalued categories, but merely a list of the top performing funds of the last ten years:
- Wasatch Micro Cap (WMICX)
- Kinetics Internet (WWWFX)
- Bjurman, Barry Micro-Cap Growth (BMCFX)
- Bridgeway Ultra-Small Company (BRUSX)
- FMI Focus (FMIOX)
- Bruce Fund (BRUFX)
- CGM Realty (CGMRX)
- Bridgeway Aggressive Investors 1 (BRAGX)
- T. Rowe Price Media & Telecom (PRMTX)
- Quaker Strategic Growth (QUAGX)
As we are sure the decidedly un-foolish readers of MAXfunds.com know, one way to all but guarantee poor returns going forward is to buy funds based on past performance. Of the funds that topped the ten-year performance charts back in 2000 (Invesco Technology II [FTCHX], T. Rowe Price Science & Tech [PRSCX], Spectra [SPECX], RS Emerging Growth [RSEGX], Janus Twenty [JAVLX], Managers Captl Appreciation [MGCAX], Dreyfus Founders Discovery F [FDISX], Janus Venture [JAVTX], American Cent Ultra Inv [TWCUX], Fidelity Growth Company [FDGRX]) none have since performed better than the S&P 500.
The Motley Fool's list of 'Best Funds' is actually more likely to under perform the market going forward than funds chosen at random. That's not just foolish, it's stupid. ...read the rest of this article»
Who's Your Mutual Fund Voting For?
Is your mutual fund supporting CEO pay raises, even when the CEO doesn't deserve it? TheStreet.com reports on a new study which shows that fund managers back compensation proposals by company management more than 75% of the time:
A study of the proxy voting records of 29 mutual fund families by the American Federation of State, County and Municipal Employees, the Corporate Library and the Shareowner Education Group indicates that between July 2005 and June 2006, fund managers backed management-sponsored proposals on executive compensation just over three-quarters, or 75.8%, of the time.
That represents a slight uptick from 75.6% during the year-earlier period.
'These mutual funds are failing to protect the assets of their clients,' says Gerald W. McEntee, president of AFSCME. 'CEOs should be paid for performance. Investors in these mutual funds should be outraged that their assets are being used to prop up undeserved CEO pay.'"
That pay is undeserved, the study says, because higher pay for company management doesn't generally lead to more profitable companies:
...authors of the report cite research showing that among S&P 500 companies, the largest increases in total compensation actually correlated poorly with improvements in long-term corporate performance."
Bob Barker is Your Financial Advisor
Chuck Jaffe at Marketwatch compares fund investing to games features on the 'Price is Right'. While the analogy is a touch strained, the concepts are sound:
1. The Bargain Game: Investors looking to buy a fund ultimately should boil their picks down to a select few, and then go bargain hunting. In this case, that means examining a side-by-side description of the funds to see how they intend to accomplish their investment objective. If two funds take the same strategy, the better bargain is clearly the fund with the lowest expense ratio; if they take different strategies in the same asset class, picking the better bargain will mean balancing any additional costs against an expectation of higher returns. If a fund can't convince you that it can deliver more for your money, it's no bargain compared to a lower-cost competitor.
2. Triple Play: The idea is to hit the big prize -- a fund you can count on, that can deliver to your expectations -- in several different asset classes. The first fund tends to be easy -- because it's a broad, safe choice with the fewest chances to go wrong -- but expanding your holdings into sectors, international stocks and more makes subsequent choices more difficult. To win, an investor must own several high-quality funds that move independently, so that a market nose-dive doesn't do permanent damage and scare the investor to dump the whole thing.
3. That's Too Much: In mutual funds, this is a contest investors should play when looking at a fund's expense ratio, and they can win if they remember one simple playing hint. For a stock fund, the ''too much'' number is 1.25 percent; for a bond fund, it's 0.75 percent.
Those numbers keep a fund slightly below average for their broad category; upon seeing costs above those levels, say ''That's Too Much!'' and consider whether it's worth the excess costs. Moreover, solid funds with numbers well below those averages are showing you a key reason for their success.
4. Take Two: In fund investing, the dollar target is the amount needed to be ''set for life,'' to achieve the ultimate goal of lifetime financial security. The key is picking mutual funds -- a few from the thousands of available choices -- that the investor believes can turn current and future savings into that jackpot.
To play successfully, investors should determine their target number, the amount needed to actually reach their goals; this makes the rest of the savings and investment process easier, as it makes it possible to determine the returns needed from funds in order to reach the goal. If your funds can't deliver those necessary returns, investment and/or savings habits most likely need to be changed or the game may be lost."
Morningstar Picks – No Better Than Dartboard?
Fund ratings giant Morningstar recently released its quarterly list of fund analyst picks, and the results are disturbing.
When it comes to picking domestic stock funds, Morningstar’s analysts – professionals armed with boatloads of data and all-access passes to fund managers – actually do worse than the average investor casually picking index funds, and they seem to do no better in some fund categories than the same investor throwing darts. The implications for casual individual investors are startling.
Last quarter, we noted that their “batting average” was only slightly better than your standard dart-thrower and worse than buying index funds, but when their picks are parsed into different fund groupings, the numbers are surprisingly poor, and highlight how difficult fund picking can be, even for the experts
"...our five-year average was 65%. That means that our picks have been winners about two thirds of the time over the past three and five-year periods. We think that's solid."
As we’ve noted before, index funds generally beat their fund category average over 65% of the time. But even this measure of success belies the trouble picking funds in the key area of domestic stock funds – which is where most investors maintain the bulk of their fund holdings. Morningstar now sheds a little light on this issue:
"It's interesting to note that by asset class, the weighted batting averages show our picks have been more successful in foreign stocks, municipal bonds, and taxable bonds, and less so with domestic equity. For example, 98% of our foreign large-blend picks have been winners over the past five years, while just 50% of our domestic large-blend picks have been winners."
50% is pathetic. Any dart-thrower could expect to beat the large-blend fund category average (not the benchmark index) at least 50% of the time (half would beat, half would lose).
Morningstar does not detail their performance in other domestic stock fund categories like small-cap and mid-cap value, growth, and blend. They do state the following, however:
"Using the aggregate measure, our domestic-equity picks (excluding sector funds) returned 9.56% versus 7.76% for the Wilshire 5000 and 6.27% for the S&P 500. We're pleased with those figures, too, but recognize that market-cap bias has a hand in that success."
Market-cap bias had more than a hand in it. Fund investors may not realize just how badly large-cap growth funds have performed in comparison to other fund categories in recent years.
At the end of the first quarter of 2007, looking at the past five years (2002-2007), the ONLY fund category that underperformed the S&P 500 was large-cap growth (ironically, this is the fund category where most domestic five-star funds could be found back in 2000 before Morningstar adjusted their ratings system to look at performance in category as opposed to performance against all domestic stock funds). The large-cap blend funds' performance nearly tied with the S&P 500 in a dead heat. In other words, the dartboard fund pick from each domestic fund category (there are nine) had a 77% chance of beating the S&P 500. Five out of nine domestic stock fund categories beat the market cap-weighted Wilshire 5000. If you'd matched the domestic stock fund category averages over the past five years, you'd have beaten the Wilshire 5000.
Sometimes it's very easy to pick winners in a certain category. Bond-fund picking is all about expense ratio. There are scores of bond funds out there with total expense ratios (including 12b-1 fees) over 1%. How in the world are these funds going to perform well with bond yields around 5%? As Morningstar notes,
"In bondland, we've enjoyed a lot of success in core categories such as intermediate bond and muni national long where our batting averages are more than 90%."
As the performance of large-cap stocks improves, it will become even more difficult for fund picks to beat benchmark indexes. The typical stock fund has an average market cap lower than a market cap-weighted benchmark index.
Bottom line - picking winning funds is at best difficult, and often a total crapshoot. Many investors and even Morningstar analysts are too easily swayed by good past performance. They ignore or downplay expenses, fund asset size, reversion to the mean, and plain old luck. The vast majority of investors (and those that choose funds for 401(k) plans) should just go with index funds – if they do, they’ll probably beat Morningstar's analysts.
Insurance Industry Screws Up Important 401(k) Legislation
Participation in company sponsored retirement plans like 401(k)'s increases significantly when workers are automatically enrolled by employers versus having to sign up themselves. The U.S. Government, hoping to encourage savings rates among citizens, wants employers to do just that.
The problem is that companies are worried that if they enroll employees automatically they will get sued by said employees if the market hits the skids. Congress responds by writing the Pension Protection Act of 2006, which protects auto-enrolling employers from 401(k) related lawsuits if those employers offer certain lower-volatility "default" investment options in their 401(k) plans. A list of funds suitable for long term investment was drawn up. And that, says Chuck Jaffe at Marketwatch, is when things get complicated.
...the insurance industry was unhappy with the exclusion of stable-value funds. Stable-value offerings are popular in retirement plans; they are built to provide a set return, guaranteed by the insurer.
While they have a role in some portfolios, stable-value funds are too conservative to be the sole investment option of a worker who is not otherwise saving for retirement. The return may indeed be stable, but it doesn't provide sufficient growth over time. They might be a choice for employers fearing lawsuits about losing money, but the idea of including them as a default choice is anachronistic given the Pension Protection Act's goal of helping more workers to save successfully.
Alas, the insurance industry doesn't seem to care. Seeing its primary retirement-plan issue being cut out of the default-choice pool made the big players green with envy (several firms seem to forget that they have mutual fund arms that operate funds suitable for being the no-pick option).
And so, they started lobbying. They hit the legislators hard, getting them to write the Department of Labor. And the insurers wrote in themselves."
And now the whole thing is stuck in legislative limbo. Sure was a good idea, till greed got in the way.
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