Target Date Funds

The subject of target date funds is brought up in Pound Foolish, the book I told you I was reading in my prior post.  Their popularity in the 401k market has exploded.  According to the book, in 2004 only 2% of Vanguard's defined contribution investors used target date funds.  By 2011 it was 42%.  That is big increase in a short amount of time.

So why are target date funds a bad idea?

First, they are typically not diversified.  The typical target date fund has a few bonds, a few small cap stocks, but is primarily a large cap (US and foreign stock) fund.  This is rather marginal diversification considering that Large US and Large Foreign stock, as asset classes, are not highly uncorrelated.

Second, they are costly.  In the book, Olen states "Fidelity's Advisor Freedom series charged investors in the fund a hefty 1.08% annually.... Oppenheimer's Life Cycle series got away with a 1.68% expense ratio."  Many fund companies load these funds with their own funds, creating a "fund of funds".  This creates often times a whole new layer of expenses that are not necessary. 

Third, investors are very confused on what they (target date funds) are actually are suppose to do!  According to a survey mentioned in the book, more than half of those surveyed believed that a target date fund's performance was guaranteed.  The SEC had similar results in one of its own surveys.  Obviously this is not the case, and these funds are no more guaranteed than any other mutual fund. 

Economic Outlooks and Investments

Should the less than exciting outlook on the US economy give you reason to fret about your portoflio, especially in this political climate?  Watch this video by Mark Matson to find out:

http://www.markmatson.tv/?p=2930

Interesting Book

I've been reading a book called entitled "Pound Foolish, Exposing the Dark Side of the Personal Finance Industry",by Helaine Olen, and thus far its been an entertaining read.  To date I've read about the interesting history of Suze Orman, Dave Ramsey, and others.  I'll share an excerpt from one of the next chapters:
"Here are two things you need to know about variable annuities.  First they are increasingly being marketed and sold to baby boomers who are more and more afraid of outliving their retirement savings.  Second, this is a product so complicated, so difficult to understand, with so many financial penalties should one decide it is not the right investment after all, that Suze Orman, a former annuities saleswoman herself, begs people to stay away from them."

While they may have their place in an investors portfolio, I would tend to agree with her.  They are vastly oversold with little attention paid to their long term costs.

If I were considering a variable annuity purchase, I would ask the following questions:
1) If I cash in my entire policy in 1,5,7, and 10 years, what would be the surrender charge I would pay?
2)  If I invest my money and the market goes down by 50%, and I surrender (cash in) my entire policy, what would I get?  My original investment or something less?
3) If I assume the prevailing investment return in the market will be 6% for the next 20 years, what would my policy be worth compared to a regular investment account that has lower fees. (For this one if they can't put in it numbers for you I would be very cautious- there expenses should include M&E expense and all the costs of any riders).

Return of the Investor

I recently posted on our facebook page in regard to this story, but I also noticed an article in Investment News. 

Before January of 2013, April of 2011 was the last month that investors, as a group, invested money into stock mutual funds, versus taking money out.  At the time of this article, investors had invested a net $23.6 Billion in stock funds as of 1/16.  January did finish as a net positive for fund inflows.  From March of 2009, until the end of 2012, investors took an astounding $400 Billion net from stock funds.  While some of this was probably due to economic reasons (unemployment was very high and something has to pay the bills), another reason was simply fear and uncertainty.  According to Investment News, the return on the S&P 500 over that same time was more than 100%.  Unfortunately investors that bailed on the market missed out on that return.

Value of an Advisor

Margaret Wittkopp brought up this article at our investor education class on Wednesday in Plymouth.  This is from Financial Advisor magazine, and was a study that tracked retirement plan participants going back from 1994 through 2008.  I like this study because it looks at the average investment results of different categories of investors that we commonly see, and how their actions have likely effected their bottom line. 

The yellow line is pool or group of participants/investors that had no plan.  They had no advisor, nor did they personally try to implement any plan.  This is the "head in the sand" group.  It is probably no surprise to anyone that this group performed the worst. At the end of this study in 2008, this group had far less money than any other.

The next line from the bottom is the self directed group.  This group was actively involved with planning their retirement, but they did it on their own.  The DIY crowd.  While I can only speculate, I am guessing the reasons for this is that they did not want to pay for the services of an advisor.  That mindset is pretty common actually.  With the wealth of financial "information" out there, many people feel that paying for the input of an advisor would be an unnecessary expense.

The green line represents people that worked with someone in the financial services industry, but not necessarily a comprehensive planner; like someone that may have sold you an annuity, or a few mutual funds.  You may even own an IRA through them.  Although they can provide financial products, they really aren't giving you tax advice or overall financial guidance.  This group trailed the self directed group until later in the 2000s.  Why?  My theory is this:  I am guessing many of the self directeds after 2007 and 2008 stopped contributing or pulled out of their plans in fear (remember the market in 08?).  By contrast, the group who at least had a casual advisor was able to stay the course.

The last and best performing group worked with comprehensive advisors, people who were not just there to sell them stuff, but who helped them look at the whole picture.  Sure, these people also probably paid the most in fees, but there is evidence to suggest that the fees they paid did earn results in the long run.  These investors also weren't afraid to engage their advisor frequently for advice and education. Don't ever be afraid to call your advisor or planner.  That is what we are here for.  There is a positive correlation between how much client/advisor interaction there is, and the ultimate client experience in the end.  Both the advisor, and the client have a responsibility in that regard.