A First Pass Investment Test

We are responsible  for our own retirement. Defined benefit plans are going the way of the dinosaur. Now we manage our own IRAs, 401(k)s and taxable accounts to create a nest egg from which we will drawdown at some point in the future, hopefully when we are retired or semi-retired.

What is not well known, despite considerable publicity, is that billions are going into the coffers of advisors at the expense of the people who need sizable nest eggs to finance retirement. Literally, people are giving up a sizable chunk of their nest egg for a service that doesn't produce results. This has been emphasized by John Bogle (founder of Vanguard), Burton Malkiel (author of Random Walk Down Wall Street), and also Warren Buffett (arguably the top investor of our era).

So what is a fast test to whether we may be in the large group of investor novices being taken advantage of?

Actually, it is quite easy. Take a recent statement and see what you are invested in. You should see ticker symbols for each of your investments. But, even if the investment does not not have a ticker symbol just Google the Fund's description and you should find a ticker symbol.

For example, you may find your IRA holds the Davis NY Venture A Fund. Google "Davis NY Venture A Fund" and you'll find the ticker symbol is NYVTX.

Next, go to www.morningstar.com and type the ticker symbol into the quote box. The summary page you'll come up with shows that the Fund has a load of 4.75% and annual expenses of .89%.

This is an interesting Fund in that it has performed well over the short-term with an out performance of +3.98% over the past year which you can see by scrolling down on the summary page. It is the type of Fund that a "friend" would suggest because he has had good recent performance.

But, alas, your investment horizon extends over decades. And over the long term the performance has not been good versus the S&P 500 Index. Over 5 years, for example, it has underperformed the index by -1.26%/year.

An important factor in this sub par performance is a .89%/year expense charge in addition to the load referred to above. In contrast, the SPY,  S&P 500 Index ETF Fund charges .10%/year.

So, which will perform better over the long term? Obviously, we can't tell unless we have the proverbial crystal ball but my interpretation of considerable research is that the probability of NYVTX outperforming over the longer term is approximately 10%. In other words its like trying to pull a white ball when there are 90 red balls and 10 white balls in the urn.

Interestingly the odds are better than 50% when you ignore costs. These managers are smart and are skilled at picking stocks. The problem is the high fees.

Thus, if you want to get a quick feel on whether you are investing efficiently do this simple ticker test and see first hand the fees you are paying for the Funds you are invested in.

This. of course, hasn't even looked at the other aspect - that of what you pay your advisor.

If you follow the financial news you know that all of these fees - what Funds charge and what advisors charge are coming down because investors are proactively moving to the lower cost Funds.

The suggestion here is that it is easy to see where you stand and to avoid being the last one on the bus.

Observations on Fidelity's Freedom 2050 Fund

Mike Piper at the Oblivious Investor answers a really important reader question:  "Should I Use Fidelity's Freedom Funds in My 401k?"  (read this article even if you don't use Fidelity - the applicability is wider ranging).  To answer this question, he hones in on the Freedom 2050 Fund, a target date fund targeted at employees in their mid- to late-20s who plan to retire around 2050.  The expense ratio, as he notes, is on the high side at 0.77% versus .19% for Fidelity's Index funds.  But he also looks at the composition of the fund and raises an important question.

Before looking at the question, it is worth noting that very few employees have the investment savvy to analyze the holdings of a fund.  IMHO, this is a step the plan administrator, who chooses the provider, i.e., Fidelity in this case, should take.

The Freedom 2050 Fund is a fund of funds comprised of 20 different Fidelity funds!  This is a lot of funds.  The interesting question raised is whether the Fund's holdings are structured to the benefit of Fidelity or the 401k participant.  He shows in his post that one fund comprising the Freedom 2050 Fund, a real estate income fund, comprises .06% of the fund!  This obviously will have no discernible impact on performance but will, to the benefit of Fidelity, build participation in the real estate income fund!  One has to admire Fidelity's cleverness in increasing fund size in this manner, assuming this was their intent!  It can also be used to seed participation in new funds.

For completeness purposes, it is instructive to look at the performance of the Freedom 2050 Fund:

Source: Fidelity

CLICK IMAGE TO ENLARGE  As the right-hand column shows, the Fund has underperformed its benchmark by 1.66%/year over the past 5 years.  My reading of voluminous performance data tells me that the 401k participant has about a 20% chance of picking a non-index Fund that matches or exceeds their benchmark. The unlucky 80% of non-index fund holders can pay a hefty price, as in this case.

This particular post also took my thoughts back a few years when I was managing pension fund money and was interested in the process for introducing new funds.  One large well-known provider in the 401k market place allowed employees to present new fund ideas and, if adopted, the fund would run for 1 year with employees' money to get a track record before marketing to the pension funds and the public.  If the track record was poor, the fund idea was dropped, of course.  I often thought that funds with less than 5 years' real experience (not back-tested performance!) should come with a warning label so investors were clear the fund hadn't been around very long.

New funds on the market are, many times, based on what has been successful lately and on what investors are looking for as they look in the proverbial "rear view window."  Today is a good example, with investors desperately looking for yield and finding that new yield funds are the funds du jour.

Disclosure:  Post is for educational purposes. Individuals should do their own research or consult a professional before making investment decisions.