Clements on Index Fund Investors

Here's a nice piece by Jonathan Clements at MarketWatch on index fund investor performance versus active fund investor:

Are index-fund investors smarter?

The article presents interesting findings by Morningstar on dollar-weighted returns for active fund investors and index fund investors that support what we present here on an ongoing basis.

What interested me was his observation on why indexers tend not to jump in and out of the market at the wrong time.  He observes that indexers have a single worry - the performance of the market whereas active fund investors have two concerns - the performance of the market and the worry of the active fund they are invested in.

Although he didn't mention it, this combined with the risk averseness of investors clearly makes active fund investing for many investors a real challenge - especially in volatile markets such as we have experienced recently!

Real World Investment Fees

Here is what advisors see.

C.P. is 74 years old.  Her assets are at a popular brokerage, E.J., where she has an advisory relationship.

C.P. is not high net worth.  She has $112,666, of which $47,497 is with E.J. She has $62,600 in savings at a bank that is earning a pittance that she wants to get invested.  This is her nest egg!

Cursory reading has convinced her that having the $62,600 with E.J. in high-cost funds is not in her best interest.

Here is a list of her current investments with E.J.:

Fund/Ticker Symbol	Load	Mer	Invested Amount $s	12 Mo. Performance (%)	Rank
ABALX	Front/5.75	.59	6,798	8.70	19
ANCFX	Front/5.75	.61	9,507	10.46	60
AFRCX	Back/1.00	1.53	2,388	1.49	54
ACTFX	Back/1.00	1.62	3,290	11.71	19
HYMCX	Back/1.00	1.53	1,438	9.37	66
LWSCX	Back/1.00	1.96	7,634	6.55	39
ISFCX	Back/1.00	1.91	5,536	2.38	78
CAIBX	Front/5.75	.62	4,275	5.96	11
AEPGX	Front/5.75	.84	2,057	1.70	40
AGTHX	Front/5.75	.66	2,316	9.40	61
AIVSX	Front/5.75	.59	2,253	10.52	60

 
Note that the Mers, annual expense ratios, range from .59% to 1.96%/year.  Note, as well, that the largest investment is in a front load Fund that takes 5.75% right at the get-go.  Hmm!

The ranks shown are from Morningstar.  They average out to 46, which means the performance numbers are roughly average; and because Funds tend, on average, to underperform their respective  market sectors after all expenses over the long term, it is likely that C.P. would have a difficult time getting good performance with this setup.  This is especially the case when you understand the impact of the loads which put the client significantly behind the starting line.

Her asset allocation, obtained by putting the above ticker symbols and dollar amounts into the Morningstar X-Ray utility, shows:

4% cash
46% U.S. Stocks
15% Foreign Stocks
31% Bonds
3% Other

I'm not sure, on top of everything, whether C.P. pays an advisory fee.  If she does, it obviously just digs the hole deeper.  She, then, would be paying a fee to be put into high-priced funds - a recipe for building an advisor's account but not the customer's account.

To add insult to injury, there is a charge of $95 to terminate each account.  The above listing is for two accounts:  a regular account and a small IRA.  Ooch!!  Think about this.  If they do a bad job and you want to fire them, they charge you for sending info to another custodian. 

Do You have a Good 401(k)?

In today's world where we are responsible for our own retirement, a good 401(k) is extremely valuable.  If you are young and you have a good 401(k) and you take advantage of it, you are on the track to spending the last third of your life in really, really good shape.

Don't know how to do it?  Read this blog or hundreds like it, or read Millionaire Teacher by Andrew Hallam or The Elements of Investing by Malkiel and Ellis.  These books will take you two weekends, at most, and will put you on the aforementioned path.

But how do you know if you have a good 401(k)?  One thing you might want to do is visit www.brightscope.com where you may find your company 401(k) listed and rated.

Another approach is to read

 7 Clues That Your 401(k) Plan Sucks by Robert Berger.

Incidently, his website Dough Roller is one of my favorites that I check weekly for the articles he lists!

In this article he wrote for Daily Finance, Berger has the following important points to examine on determining the quality of your 401(k):

• employer match - in just about every instance, a match should be taken advantage of.  How do you find if you have a match?  Ask Human Resources or look at a recent statement.  Statements will have "employee contribution" and "employer contribution"(if any) listed.
• Roth 401(k) - if you have a Roth 401(k), it is good; and consideration should be given to using it.  Know that you won't get the upfront tax break for using it; but, going forward, you'll never worry about taxes again (assuming Congress doesn't change the law ;).
• Index Fund offerings - generally, if you don't have low-cost index fund offerings, then you should limit your contributions to the company match and use an IRA elsewhere.  If you aren't sure of what a low-cost index fund is, read the above mentioned books.  If you have low-cost index fund offerings (example: Fidelity Spartan Funds), then your path to a successful retirement is straight forward.  Use them to the fullest extent allowed!

Berger's article lists other important considerations.  One important point to note is at the very beginning where a lawsuit is referenced concerning a Plan Administrator.  If your 401(k) has only high-expense fund offerings, you may want to highlight the case mentioned with a yellow highlighter and drop it off in your Human Resource person's mailbox.  The days of clueless administrators choosing poor fund choices for plan participants is slowly coming to an end.