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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.

On 401Ks April 22, 2009

Posted by shaferfinancial in Finance, Uncategorized.
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60 Minutes did a section on 401Ks that mimicked what I have been telling folks for several years.

Thanks to NAKED CAPITALISM for this partial transcript:

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When employers began turning 401(k)s into retirement plans, the financial community was not shy about promoting them as such. The prospect of trillions of dollars in the hands of unsophisticated investors opened the door for all sorts of potential abuses.

“The fact is that the typical 401(k) investor is a financial novice. They don’t know a stock from a bond. And we give ’em a list of 20 or 30 mutual funds with really, really powerful names, you know, they sound like, ‘Gee, that’s where I want to have my money,'” Hamilton said,

“What are the, generally, the quality of the mutual funds in 401(k) plans?” Kroft asked.

“Mediocre,” Hamilton replied. “I’m being real honest with you, with half the funds on the list really dogs, what people would characterize as dogs shouldn’t be on the list to start with.”

“There clearly has been a raid on these funds by the people of Wall Street. And it’s cost the savers and the future retirees a lot of money that would otherwise be in their account, independent of the financial collapse,” Rep. George Miller [D-CA] said.

Congressman Miller is chairman of the House Committee on Education and Labor, and a staunch critic of the 401(k) industry, especially its practice of deducting more than a dozen undisclosed fees from its clients’ 401(k) accounts.

“Now you got a bunch of economic wizards jumping in and taking money out of your retirement plan, and they don’t wanna tell you how much, you can’t decipher it in simple English, and they’re not interested in disclosing it, or having any transparency about it,” Miller told Kroft.

“And most of the people that look at their 401(k)s have no idea that these fees are being taken out?” Kroft asked.

“No. Where would you find it? Where would you find these fees in this prospectus? You can look on any page you want, and when you’re all done reading it, and you will find some of the fees and the commissions here, but you won’t find them all, and I’ll bet you won’t find half of ’em,” Miller said.

There are legal fees, trustee fees, transactional fees, stewardship fees, bookkeeping fees, finder’s fees. The list goes on and on.

Miller’s committee has heard testimony that they can eat up half the income in some 401(k) plans over a 30-year span. But he has not been able to stop it.

“We tried to just put in some disclosure and transparency in these fees. And we felt the full fury of that financial lobby,” he said.

David Wray, a lobbyist for the 401(k) industry, says he favors disclosing the fees, but his partners in the financial industry don’t.

Asked if he thinks most people know these fees exist, Wray said, “I think they know that there are fees. They don’t know exactly how large they are.”

“Why do you think the financial services industry is opposed to fee transparency?” Kroft asked.

“I don’t know that they’re opposed to it. I think the issue is that…,” Wray replied.

“You don’t think they’re opposed to it?” Kroft asked. “You’re a lobbyist in Washington, right? You know they’re opposed to it. …George Miller hasn’t been able to get a bill to the floor.”

“I think they want to keep the systems as simple and not make changes. They like the way things are. And whenever you push people out of their comfort zones, you know, it’s an issue,” Wray replied.

“I mean, they’re comfortable with the situation because they’re making a ton of money or they have made a ton of money,” Kroft said.

“Well, and their systems are set up in certain ways. You know, this is gonna be a big change,” Wray replied.

60 Minutes wanted to ask Wray, who’s been so bullish on 401(k) plans, one last question about what the future holds for people like Terry and Donna McNally and Kathleen Coleman.

“Most of the people that we’ve talked to are 50 and 60 years old and have sustained these losses say there is no way they’re ever gonna make them back. Do you agree with that?” Kroft asked.

“I think we have to be truth tellers,” Wray replied. “I think that when a person has hit this point, and we’ve had this unfortunate situation, I don’t think we can misrepresent what the possibilities are.”

“And reality is that money’s not coming back that they’ve lost,” Kroft said.

“They can’t count on it,” Wray replied. “They have to…it may. Maybe they have long, maybe if they work ten more years, it’ll come back by the…but it’s important that they not have unrealistic expectations.”

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Where have all those critics of life insurance as a retirement vehicle gone too?  Perhaps, hiding from the folks they sold those mutual funds to?  Now more than ever, people need advice based on real data about what works and doesn’t work.  Give me a call 727.804.9271!