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Don’t fall for the Red-Herring arguments about your Retirement Accounts February 17, 2014

Posted by shaferfinancial in Finance, Uncategorized.
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Often I talk to people about their retirement. It is a depressing situation because not only are many people not putting enough into their retirement accounts, but most are totally dependent upon 401Ks with mutual funds. Many can’t seem to wrap their head around the trouble coming down the pike at them from using these vehicles to fund their retirement. It is human nature to forget painful experiences so most of what happened in 2008-09 is now so far into the rear view mirror that it is forgotten. This post is aimed at those still hanging on to the myth that a 401k [with or without a employer match] is going to create sufficient retirement income for them.

Recently I was looking at a Seeking Alpha, a popular financial website which features many authors, both professional and non-professional. What attracted my attention was a post by Larry Swedroe. Mr. Swedroe is a financial professional with a history of working deeply in Wall Street. Of late, he has published multiple books on passive investing, specifically why people should put their money into passively managed mutual funds that he sells. He offers up reams of evidence that no one can beat “the market” over time, so it is at best a waste of time and effort to try and at worst a way to lose all your money. This evidence comes in the form of academic studies of which there is a mountain of supporting his points. He argues persuasively that an investor should just dump their money into a variety of passively managed index funds and sit while it grows into a retirement account you can retire on. He relies on what Neil Postman coined “scientism.” Which basically means using the moniker of science to wrap your ideas into, so that it will be more readily accepted. Mr. Postman thought this was a sign of our times and I agree with him. He had some pretty amusing research himself that proved his point, but that was the ironic point. Mr. Swedroe liberally uses the terms “risk adjusted returns,” “alpha,” “beta,” etc. to demonstrate his point, but this is just a way to impress and have people not question his main thesis.

So what is the red-herring argument here? All his evidence looks at the performance of money managers. But what he should be really talking about is the performance of individual investors that invest in the mutual fund industry. Folks like him will argue all day long about the ability of money managers to beat the market, but who really cares? It is how much retirement income you have at the end of the day that matters. And that is really not very dependent upon whether some money manager beats the market or doesn’t. It is much more dependent upon your behavior as an investor and the returns you receive not as an average but the order of returns you receive.

Now Mr. Swedroe is a very smart and informed fellow, so he must be aware of the data that demonstrates that individuals get returns that are 3-4% less than the returns of the investment vehicles they put their money into. Why isn’t he talking about that? I think he is doing a service by pointing out the obvious truth that it is really hard to beat the market over time for a money manager or an individual investor. And I am sure he has clients that, like him, are true believers in passive index investing. But the real problems of individual investing is one of human psychology and market variability that his passive approach does nothing to alleviate.

Greed and fear are a staple of the human psyche and it comes out in force when we have money involved. Greed is what causing folks to move from one hot mutual fund to another [too late to take advantage of the over performance unfortunately] and his approach should help with this emotion. But that fear part is really an issue. Fear is what causes people to sell their shares in mutual funds after a major downward movement. Greed is what causes them to buy it back after the market moves up. It is this cycle that causes the individual under performance. Now I bet he would say that if people just listened to his advice then they would avoid this. But lets be honest here, human emotions run our lives and no one is excluded from them. The data he ignores demonstrates this cycle happening every time, with people selling low and buying high. Even passively managed funds go down in bad markets and no matter how persuasive he is, people will sell from fear or from real need [losing a job in a recession isn’t a rare occurrence]. Nothing he offers will change this fact.

I have covered sequence of return risk often here, but it bears repeating. You can get an adequate average returns and still fail to have sufficient retirement funds if the actual returns include some really bad years within 5 years before or after your retirement. You simply don’t have enough time to recover. Its simple math and you don’t need all those academic studies to understand this.

This gets me to the final point. It is a red-herring argument to tell people that if they keep their expenses low, buying those indexed mutual funds, that it will create a bountiful retirement. Is it the amount of expenses you pay or the amount of retirement income that is the important part here? I think most people would say they really don’t care about expenses but really care about that monthly check they receive in retirement. By collapsing those two parts into one, saying that keeping expenses low will automatically increase your retirement income, is not only untrue, but is the second red-herring argument made by these folks.

So they hide behind “scientism” and low expenses with the expectation that people won’t actually take the time to understand the failure of their advice to the majority.

Do yourself a favor and not enter into the argument over passive versus active investing or risk adjusted returns or low expenses=more money. They are all red-herrings to the true issue of failure of the mutual fund/401K strategy itself.

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