Objective information about financial planning, investments, and retirement plans

Your 401(k) is not Free

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Several studies in recent years have highlighted the fact that a significant percentage of 401(k) plan participants don’t realize that their company retirement plan is not free.   Further they were not aware that they often pay all or a portion of these expenses out of their plan accounts.

401K - Perfect Solution !?

2011 study by AARP showed that 71% of the 401(k) participants that were surveyed were unaware there were expenses associated with their retirement plan.  The survey also showed a high level of misunderstanding of plan fees even by those who were aware of them.  More recent studies have also shown significant levels of both participants who are unaware of the fees and a high level of misunderstanding, even with the advent of required 401(k) fee disclosures in 2012.

Typical 401(k) plan fees and expenses

There has been an emphasis on the negative impact that high cost 401(k) plans have on the ability of participants to save for retirement via media.  The 2013 PBS Frontline program The Retirement Gamble, for example did a nice job of highlighting the negative impact of high fees on retirement savers.  Some of the expenses that are typical of a 401(k) plan include:

  • Investment expenses.  Here I am primarily referring to the expense ratios of the mutual funds, collective trusts, annuity sub-accounts, or ETFs offered as investment choices by the plan.  Using mutual funds as an example, all mutual funds have an expense ratio whether you invest within a 401(k) plan or outside the plan.  The key is whether the expense ratios of the choices offered by your plan are reasonable.
  • Administration and record keeping.  This includes keeping track of plan assets, participant assets, ensuring that salary deferrals and matching contributions are invested in line with the participant’s elections, generating quarterly statements, as well as various testing and external reporting functions.
  • Custody of plan assets.  This is where the money invested and the mutual funds (or other investment vehicles) are housed.  Examples of custodians might be Fidelity, Vanguard, Schwab, Wells Fargo, etc.
  • Investment advisor.  The fees here are for an outside investment advisor who provides advice to the plan sponsor in areas like investment selection and monitoring and the development of an Investment Policy Statement for the plan.  However, sometimes these charges are simply the compensation for a registered rep who sells the plan to company and may offer little or no actual investment advice. 

Other than mutual fund expense ratios (investor returns are always net of expenses) these expenses may be paid from plan assets (your money), by the company or organization sponsoring the plan, or a combination of both.  For example the plan sponsors who engage my services as advisor to their plan pay my fees from company assets so the plan participants bear none of the cost.

Additionally the delivery of these various functions can be fully bundled, partially bundled, or totally unbundled.  Generally (and hopefully) the outside investment advisor is independent of the other service providers.

Providers like Fidelity, Vanguard, or Principal are example of bundled providers.  They provide the investment platform, custody the assets, and do all of the administration and record keeping.  In an unbundled arrangement, the custodian, record keeper, and the investment advisory functions are all separate and provided by separate entities.

Neither arrangement is inherently good or bad, it is incumbent upon the organization sponsoring the plan to monitor the costs and quality of the services as part of their Fiduciary duty to you the plan participant.  Plan sponsors should insist on transparency regarding all provider expenses.

BrightScope 

BrightScope is a service that independently rates 401(k) plans on a number of criteria.  Check to see if your company’s plan is ranked by them at their site. 

Mutual Fund expenses 

The required fee disclosures that I mentioned above focus on the plan’s investment options and their expenses.  You should start seeing them in the near future.

While they may not look particularly informative and don’t delve into the plan’s total costs, the investment expenses can be telling none the less.

If your plan is via a large employer, you may see institutional share class mutual funds with very low expense ratios.  As an example my wife works for a division of a Fortune 150 company and some of the index funds available to her have expense ratios less than 0.05% which is very low.

In fact looking at the fund share classes offered by your plan is also revealing.

The American Funds offer six share classes for retirement plans ranging from R1 to R6.  Using the popular American Funds EuroPacific Growth fund as an example you can see the differences in the expenses and the impact on return below.

Ticker Expense Ratio 12b-1 5 Year return
R1 RERAX 1.61% 1.00% 15.35%
R2 RERBX 1.60% 0.74% 15.35%
R3 RERCX 1.14% 0.50% 15.90%
R4 REREX 0.85% 0.25% 16.24%
R5 RERFX 0.55% 0.00% 16.58%
R6 RERGX 0.50% 0.00% 16.62%

Source:  Morningstar as of 3/14/14

Looking at this another way, $10,000 invested in the R1 and R6 share classes would have grown to the following amounts by February 28, 2014:

R1  $20,915

R6  $23,022

I think you will agree that this is a rather significant difference.

The 12b-1 fees are included in the fund’s expense ratio and generally go to compensate the plan provider, the registered rep or broker who sold the plan or other service providers.  In the case of the American Funds you generally see the R1, R2, and R3 shares in higher cost, broker sold plans.

Similar share class comparisons can be made with other mutual funds in many other families including Fidelity, T. Rowe Price, and even low-cost Vanguard.

According to Morningstar* data as of 12/31/13 here are the median expense ratios for the following investment styles:

Large Blend 1.07%
Large Growth 1.15%
Large Value 1.07%
Mid Cap Blend 1.16%
Mid Cap Growth 1.24%
Mid Cap Value 1.24%
Small Cap Blend 1.23%
Small Cap Growth 1.36%
Small Cap Value 1.31%
Foreign Large Blend 1.23%
Intermediate Bond 0.79%

 

While these are median expense levels I would say that for the most part if the funds in your plan are at these levels they are too expensive.  Index funds across these categories should be 0.25% or less.

Several studies have concluded that the biggest determinant in retirement success is the amount saved.  None the less having access to a solid, low cost 401(k) plan as vehicle for retirement investing is a big plus.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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* Affiliate link, I may be compensated if you enroll in Morningstar’s premium service at no extra cost to you.

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Target Date Funds: Does the Glide Path Matter?

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Most Target Date Funds are funds of the mutual funds of the fund family offering the TDF.  The pitch is to invest in the fund with a target date closest to your projected retirement date and “… we’ll do the rest….”  A key element of Target Date Funds is their Glide Path into retirement.  Stated another way the Glide Path is the gradual decline in the allocation to equities into and during retirement.  Should the fund’s Glide Path matter to you as an investor?

Glide PathTarget Date Funds have become a big part of the 401(k) landscape with many plans offering TDFs as an option for participants who don’t want to make their own investment choices.  Target Date Funds have also grown in popularity since the Pension Protection Act of 2006 included TDFs as a safe harbor option for plan sponsors to use for participants who do not make an investment election for their salary deferrals and/or any company match.

These funds are big business for the likes of Vanguard, Fidelity, and T. Rowe Price who control somewhere around 70% of the assets in these funds.  Major fund families such as Blackrock, JP Morgan Funds, and the American Funds also offer a full menu of these funds.  Ideally for the fund company you will leave you money in a TDF with them when you retire or leave your employer, either in the plan or via a rollover to an IRA.

What is a Glide Path?

The allocation of the fund to equities will gradually decrease over time.  For example Vanguard’s 2060 Target Date Fund had an equity allocation of almost 88% at the end of 2013.  By contrast the 2015 fund had an equity allocation of approximately 52%.

This gradual decrease continues through retirement for many TDF families including the “Big 3” until the equity allocation levels out conceivably until the shareholder’s death.  T. Rowe Price has traditionally had one of the longest Glide Paths with equities not leveling out until the investor is past 80.  The Fidelity and Vanguard funds level out earlier, though past age 65.

There are some TDF families where the glide path levels out at retirement and there is some debate in the industry whether “To” or “Through” retirement is the better strategy for a fund’s Glide Path.

Should you care about the Glide Path? 

The fund families offering Target Date Funds put a lot of research into their Glide Paths and make it a selling point for the funds.  The slope of the Glide Path influences the asset allocation throughout the target date years of an investor’s retirement accumulation years.  The real issue is whether the post-retirement Glide Path is right for you as an investor.

On the one hand if you might be inclined to use your Target Date Fund as an investment vehicle into retirement, as the mutual fund companies hope, then this is a critical issue for you.

On the other hand if you would be inclined to roll your 401(k) account over to either an IRA or a new employer’s retirement plan upon leaving your company then the Glide Path really doesn’t make a whole lot of difference to you as an investor in my opinion.

In either case investing in a Target Date Fund whether you are a 401(k) participant saving for retirement or a retiree is the ultimate “one size fits all” investment.  In the case of the Glide Path this is completely true.  If you feel that the Glide Path of a given Target Date Fund is in synch with your investment needs and risk tolerance into retirement then it might be the way to go for you.

Conversely many people have a number of investment accounts and vehicles as they head into retirement.  Besides their 401(k) there might be a spouse’s 401(k), other retirement accounts including IRAs, taxable investments, annuities, an interest in a business, real estate, and others.

In short, Target Date Funds are a growing part of the 401(k) landscape and I’m guessing a profitable way for mutual fund companies to gather assets.  They also represent a potentially sound alternative for investors looking for a professionally managed investment vehicle.  The Glide Path is a key element in the efforts to keep these investors in the Target Date Fund potentially for life.  Before going this route make sure you understand how the TDF invests, the length and slope of the Glide Path, the fund’s underlying expenses, and overall how the fund’s investments fit with everything else you may doing to plan for and manage a comfortable retirement.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss your 401(k) plan and all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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4 Signs of a Lousy 401(k) Plan

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retirement

Much has been written about the sorry state of retirement readiness in the United States.  In fact the most frequently asked question that I get is Can I Retire? 

For better or worse, the primary responsibility for accumulating sufficient assets for retirement has been placed upon our shoulders in the form of defined contribution retirement plans such as the 401(k), 403(b), etc.  The defined benefit pension plans of our parent’s generation are rapidly fading away.

It is important that you make the most of any workplace retirement plan available to you.  New required disclosures about the costs of the plan and the underlying investments were introduced in 2012 and are a good start.  However, 401(k) plans are still a mystery to many of the workers who participate in them and sadly to many of the employers sponsoring these plans.  Here are 4 signs that your 401(k) plan might be lousy.

Proprietary Funds 

By this I mean your 401(k) plan provider or a brokerage firm affiliated with the plan offering their own mutual funds.  The most extreme recent example of this is Ameriprise Financial who is being sued by a group of current and former employees for allegedly stuffing the plan offered to company employees with poor performing, high cost funds offered by Ameriprise.  To boot they are also accused of taking revenue sharing payments from these funds.

While most examples are not this egregious, it should be a red flag if your plan is stuffed with funds or annuity sub-accounts from the likes of John Hancock or Principal and they also happen to be the provider of your retirement plan.  There are often many incentives to be had by servicing brokers and other service providers to offer this type of line-up.  While they are making money off of this type of plan, such an arrangement might be costing you big-time.

Single Fund Family Line-ups 

For years the broker/registered rep community would offer a line-up filled with funds from the American Funds.  These were often the best funds that they could sell and they rightly had a good name.

Just as bad is a line-up dominated by Vanguard or T. Rowe Price funds, or any other single fund family for that matter.  Even though I highly respect both companies, no single fund family offers the best option in every asset class.

Expensive share classes 

In many cases mutual fund companies offer a variety of share classes for use by various financial advisor channels ranging from fee-only RIAs to brokers and reps seeking compensation from selling the funds.  In many cases the fund families offer several retirement plan share classes as well, again with some offering compensation to the advisor directly or to the retirement plan.

Check out the funds offered in your plan via Morningstar or elsewhere to see if there are less expensive share classes of your fund that are available.  This even extends to low cost index fund providers like Vanguard who offer share classes which carry a lower expense ratio that the basic Investor share class.

A group annuity plan

This was the traditional fare for plans offered by insurance company providers.  They are still around but if your employer’s plan is still in this format it is likely small in size or it has been in a group annuity for awhile.

A group annuity plan generally offers either mutual funds or annuity sub-accounts that are “wrapped” into a group annuity.  These are complicated and generally expensive insurance contracts that often don’t bestow any particular benefit on the plan participants.  In fact some plans carry surrender charges that make it difficult for employers to change providers.

What do I do if my 401(k) plan is lousy? 

  • If there is a company match it often makes sense to contribute enough to receive the full match.  This is free money you shouldn’t leave it on the table.
  • Do your homework and say something to those in charge of administering the company’s plan.  This may or may not result in things changing, but many employers are more sensitive to this type of input in light of the current trends toward more disclosure and transparency.
  • If your plan offers a self-directed brokerage window check this option out.  Understand the costs and any limitations involved.  Also make sure that you are comfortable choosing your own investments or that you have an advisor to assist you.
  • Focus on retirement savings vehicles available outside of your plan including an IRA, maxing out a spouse’s retirement plan (if it’s better than yours), investing in a taxable account, or a low-cost annuity (ideally one with no surrender fees).
  • Make sure not to leave your money in this plan when you leave the company, roll it over to an IRA or to a new employer’s plan.

We are increasingly responsible for our own retirement savings.  It is important that you understand how to best utilize the retirement plan offered by your employer.  A good plan can be an invaluable tool in reaching your retirement savings goals.  A lousy, expensive plan can cost you $1,000s in lost retirement savings and might be the difference between retiring in style or settling for less in your Golden Years.

Please contact me at 847-506-9827 for a free 30 minute retirement planning consultation and to discuss all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

Retirement plan sponsors, do you need an independent review of your company’s plan?  Do you need help selecting a new plan provider?  Are you looking for ongoing financial advice to help you meet your fiduciary obligations and to provide a superior retirement savings vehicle for your employees?  Please feel free to contact me to learn about our investment consulting services for retirement plan sponsors.

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Mutual Funds – The First Shall be Last and So On

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Well another year is in the books and there is no shortage of articles about what worked well and what didn’t in terms of investing.  For those of us who use and follow mutual funds it’s always instructive and interesting to take a look back as we move forward.  Here are some observations and examples from 2012 and some lessons that we can take into the future.

Artisan Mid Cap Value ARTQX 

The managers of this fund were named as Morningstar’s Domestic Manager of the Year for 2011.  So how’d they do in 2012?  The fund gained a respectable 11.39% for the year, but that only ranked the fund in the 86th percentile (bottom 14%) of its category.  Did the award go to their heads?  I doubt it.  I’ve written about this closed fund here before and it is one of my favorite mutual funds.  This fund is included in the menu of several 401(k) plans for whom I provide advice as well as in the portfolios of many of my individual clients.  The fund’s track record since its inception has been exemplary and in fact the fund ranks in the top 1% of all funds in its category for the ten years ending 12/31/12.  Artisan is a solid fund company who regularly closes funds that have become too large, including this fund.  While we can’t predict the future, the fund’s relatively poor 2012 performance is a non-issue in my mind at this point.

American Funds Growth AGTHX

My October post on this multi-share class fund asked if it was a fallen star.  Using data from the A shares, the fund had a banner 2012 returning 20.54% and placing in the 7th percentile of its category.  This comes after finishing in the 64th percentile or below in three of the five prior calendar years.   This still leaves the fund in the 53rd percentile of its category for the five years ended 12/31/12; though the fund is in the 22nd percentile for the trailing ten years.  As I discussed in the post, the fund was a top performer year in and year out until 2007.  As one industry publication pointed out, the fund has become somewhat of a “closet indexer” with its increasing correlation to the S&P 500 Index.  In fact the Vanguard Large Growth Index Fund is a far less expensive alternative that has outperformed Growth Fund by almost 300 basis points annually for the past three years and has gained almost three times as much annually for the past five years ending 12/31/12.  While I have tremendous respect for the American Funds as a group, this fund’s 2012 performance does nothing to change my view of the fund as an investment vehicle for my clients.

On a more macro level, 2012 saw the rebound of both developed and emerging markets international funds as a group after a dismal year in 2011.

What does all of this tell us, frankly not much as far as how to invest into the future

 An investment process is critical

Here are some of the factors that we usually look at when evaluating mutual funds and ETFs (from Fi360 and our Investment Policy Statements):

  • Does the fund have at least a three year track record?
  • Does the fund manager have at least a two year track record with the fund?
  • Does the fund have at least $75 million in assets?
  • Do the fund’s composition (its holdings) and its Morningstar style look like other funds in its investment category?
  • The fund’s expense ratio should be in the category’s 75th percentile.  (In reality we like to see this number much lower than that).
  • The fund’s risk-adjusted returns (Sharpe and Alpha) in the top 50% of its peer group of funds.
  • Trailing 1, 3, and 5 year returns at least in the top half of its peer group of funds.
  • Has the fund experienced a significant gain or loss in assets?
  • Has ownership of the fund changed?
  • Has there been turnover in the fund’s management?

While some investors may disagree, we believe in asset allocation and portfolio rebalancing.  We use both active and passive mutual funds and ETFs to fill the allocation slots in the portfolio, and we monitor those holdings on a regular basis.

As discussed above, there will always be fluctuations in the performance of various investments whether they are individual stocks or bonds or managed products such as mutual funds and ETFs.  Certain asset classes will underperform at various times (such as Foreign Stocks in 2011).  The point is to have an investment process in place that uses a disciplined methodology to make investment decisions.  In my experience, this is a key element in long-term investment success.

Feel free to contact me with questions about your investments.

For you do-it-yourselfers, check out Morningstar.com to analyze your investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

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Merry Christmas and Thank You

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I want to wish all of you who celebrate a Merry Christmas and to everyone a happy and prosperous 2013.  I also want to thank all of you for your readership and support.

Since moving The Chicago Financial Planner to Word Press from Blogger in June, my readership has steadily increased and again I want to thank you for that.  Here are my top 5 most read blog posts since the conversion:

How much is Financial Advice Worth? was born out of a discussion with a financial advisor colleague about a new 401(k) advice service we were trying to launch for 401(k) participants.  I asked “So how much is competent, unbiased financial advice worth?  Part of the answer lies in the benefit that you expect to receive from spending the money.”

401(k) Fee Disclosure and the American Funds was written on the heels of the initial fee disclosures for 401(k) participants mandated by new regulations this year.  I used the multiple retirement plan share classes offered by the American Funds to illustrate the need for plan participants to understand these fee disclosures and the details of the funds offered in their plan’s lineup.

Why Financial Planning is Important-An Illustration is based upon and excellent infographic offered by NAPFA a professional organization of fee-only financial advisors of which I am a member.  The infographic does a great job of diagramming the need for financial planning and how the process works.  The statistics are sobering and illustrate the need for many Americans to seek the help of a qualified financial planner.

Target Date Funds-A Look Under the Hood looks at the composition of the “Big 3” Target Date Fund families:  Vanguard, Fidelity, and T. Rowe Price.  Together these three families control about 80% of the assets invested in Target Date Funds.  Target Date Funds are a staple in 401(k) and similar retirement plans.  They are frequently used as the default option for participants who don’t specify an investment choice.  However, like any investment, it is important that you understand how these funds will be investing your money and if their approach is right for you.

Can I Retire?  is the question that I am most often asked by perspective clients.  Can I Retire?  This is not a simple question to answer.  Moreover it’s not just about being able to retire, but rather can you retire “in style?”

Again I want to thank you my readers for your support and for your readership.  My question to you is how can I be of help?  What questions are on your mind?  Please use the contact form to let me know and I will do my best to answer them.

Also please feel free to let me know what you like or don’t like about The Chicago Financial Planner.  Your thoughts are important to me.

We will continue to evolve the blog into 2013 and look for ways to offer you more information about financial planning, investments, retirement plans, and related topics.

I hope that all of you have a wonderful holiday season.

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Mutual Fund Expenses – Where Real Holiday Savings Can be Found

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Blue Piggy Bank With Coins - Retirement

As I write this its Cyber Monday, the biggest online shopping day of the year.  Where to save a few dollars on this item or that has been the focus of many news stories and discussion.  While we all like to save money on the things we buy, these savings are “chump change” compared with the savings opportunities available by reducing your expenses on the mutual fund and ETFs in which you invest.  Here are 5 tips for reducing your investing costs for mutual funds and ETFs to help grow your investments for retirement, college savings, and other goals.

Index Funds are Not Created Equal

As an example the Dreyfus Mid Cap Index Fund (ticker PESPX) has an expense ratio of 0.50% which is pricey for a core index fund of this type.  The Investor Share Class of the Vanguard Mid Cap Index Fund (VIMSX) carries an expense ratio of 0.24% and the SPDR S&P Midcap 400 ETF (MDY) has an expense ratio of 0.25%.  An investment of $10,000 in each of these funds made on May 31, 1998 and held until October 31, 2012 would have grown to:

Dreyfus Mid Cap Index

$30,743

SPDR Midcap

$31,643

Vanguard Mid Cap Index

$31,770

The above information is via Morningstar and is based upon the earliest common inception date of the three funds and also assumes reinvestment of dividends and distributions.  Note that an investment in one of the lower cost share classes of the Vanguard fund would yield even better results.

ETF Price Wars are a Good Thing

There is a price war happening among several providers initiated by Schwab to offer the lowest cost ETF.  Vanguard has jumped on the bandwagon by changing the index provider on many of its funds and ETFs; Blackrock’s ishares unit has also joined in.  While I likely would not suggest switching from an already low cost index ETF product because it is not the absolute lowest in cost, I would suggest taking a look at the offerings of the “warring” factions.  You should also take any transaction fees into account as well.  Schwab and Vanguard allow transaction free trading of their own ETFs, TD and Fidelity offer a menu of transaction free ETFs as well.

Your Financial Advisor May be able to Save You Money

In many cases I am able to invest my client’s money in less expensive share classes of a given mutual fund than they might be able to purchase on their own.  As an example PIMco Commodity Real Return as a number of share classes as do most of the PIMco Funds.  I am able to invest client dollars in the Institutional Share Class (PCRIX) with its 0.74% expense ratio and typical $1 million minimum.  This compares to the no-load D shares (PCRDX) with an expense ratio of 1.19% and a $1,000 minimum initial investment.  Often the savings in expense ratios that I can provide to my clients can go a long way in covering a portion of my professional fees.

Ensure that Your Stock Broker or Registered Rep isn’t costing you Money

The flip side of the last point is to make sure that you are not paying more in mutual fund fees just so that your broker or registered rep can make additional fees and commissions.  Case in point is if your money is invested in a proprietary mutual fund offered by the rep’s employer.  While some of these proprietary funds can be decent, all too often they are under performers that are laden with fees and charges to generate revenue for the broker and their firm.

Read your 401(k) Plan Fee Disclosures

Some plans sold by commissioned reps and producing TPAs (Third-Party Administrators) may contain funds that are not very low cost.  Case in point might be a plan with an American Funds fund in the R1, R2, or R3 share classes.  This might also be the case with some Fidelity shares classes (typically the Advisor share class), as well as with some T. Rowe Price funds (the Advisor or the R share classes).  These shares exist typically to compensate a producer.  If you see these or similar share classes for other fund families in your plan it would behoove you to ask the person who administers your plan if it might be possible to move the plan into lower cost funds or fund share classes.

We all like to find a bargain when doing our holiday shopping.  If a fraction of the time and effort that people spend on this activity went into analyzing their investment portfolios, the potential cost savings alone would dwarf anything that you might realize from finding a couple of deals this holiday season.  These savings are not just one-time in nature, but they “keep on giving.”

Check out Morningstar to review the expenses for all of  your mutual funds and ETFs and to get a free trial for their premium services.

Please feel free to contact me with questions about your investments.

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My Search for the Worst Mutual Fund Yielded a Surprising Result

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I wanted find the worst performing actively managed Large Cap Blend style mutual fund in Morningstar’s data base over the five year period ended October 31, 2012.

English: Legg Mason Tower, Legg Mason Headquaters

I was surprised to find that the fund was Legg Mason Value Trust which until earlier this year had been managed by legendary fund manager Bill Miller.  The fund has several share classes, for this analysis I used the I share class (ticker LMNVX).

Bill Miller is a legendary fund manager because he was able to beat the return of the S&P 500 Index each year over a 15 year stretch from 1991-2005.  This is an incredible feat of performance and consistency.

How did this fund end up at the bottom of the rankings?  Starting with 2006, the fund underperformed the index each year except 2009.  Let’s look at the fund’s performance over the past 10 + years:

Year Fund Return S&P 500 Return Category Avg. Return Fund Rank in Category
2002

-18.06%

-22.10%

-22.25%

13

2003

44.99%

28.68%

27.05%

1

2004

13.09%

10.88%

10.02%

14

2005

6.36%

4.91%

5.88%

40

2006

6.92%

15.79%

14.17%

98

2007

-5.73%

5.49%

6.16%

98

2008

-54.61%

-37.00

-37.39%

99

2009

41.96%

26.46%

28.17%

6

2010

7.71%

15.06%

14.01%

96

2011

-2.99%

2.11%

-1.27%

70

2012 YTD

7.72%

10.29%

8.86%

71

Via Morningstar as of 11/16/2012

In terms of category rank, 1 is the top of the category, 100 would equal the bottom.  This fund ranks in the 99th percentile of the Large Blend category for the five years ended October 31, 2012 (there was actually one fund ranked lower but it was a bit of a specialty fund so I eliminated it).

What happened to Legg Mason Value Trust?

What happened to this high flier?  While I’ve never invested either my own money or any client money in this fund, here are a couple thoughts:

The fund’s assets peaked at just under $7 billion in 2006, fund assets stood at about $328 million as of October of this year.  I’m guessing that as performance continued to slide, investors continued to redeem their shares.  The need for liquidity to meet these redemptions has most certainly been a drag on the fund’s performance.

In 2002 the S&P 500 lost over 22%; the fund was able to limit its loss to just over 18%.  In 2008 the S&P 500 lost 37% while the fund lost an astonishing 54.61%!  That means that an investor with $10,000 in the fund on January 1, 2008 saw their holdings drop to $4,539 by the end of 2008.  The value-oriented approach that had served shareholders well over the years was in the process of producing a third straight year of the fund performing in the category’s bottom 2%.

Lessons in Picking a Mutual Fund

Many argue that no active fund manager can continually outperform the markets over time.  The performance of this fund gives weight to that argument.  I will leave this discussion to others, but there are several lessons to be learned here:

  • Every market environment is different.  During the market decline of 2000-2002 there were still a number of mutual funds and market sectors that held up pretty well.  During the sharp decline of 2008-09 pretty much no strategy worked well.  Funds such as Dodge & Cox Stock which had been stars in the 2000-2002 timeframe saw their strategy backfire and sustained out-sized losses for their shareholders.
  • A precipitous decline in assets often becomes a snowball.  In the case of Legg Mason Value Trust fund assets declined from just over $6 billion at the end of 2007 to about $1.35 billion at the end of 2008.  This is a greater drop than can be accounted for by the fund’s investment losses.  The level of redemptions served to amplify to fund’s losses.  This issue has continued through the present and has limited the fund’s ability to take advantage of the market rally since March of 2009.
  • It’s hard for superstar funds and managers to outperform forever.  Fidelity Magellan and American Funds Growth are two examples.  On the flip side the managers at Fidelity Contra and Fidelity Low-Priced Stock have continued to be top performers over long periods of time and in the face of significant asset growth in their funds.  They are the exception rather than the rule.

Evaluating an actively managed mutual fund is not an easy task, which is another argument for index products.  Many actively managed funds are not worth the extra expense ratios they charge.  This is not to say that there are not some excellent actively managed funds that are worth investing in.  Just be prepared to understand why these funds have been successful and to monitor them for changes in key personnel, major fluctuations (up and down) in the level of fund assets, changes in the fund’s investment process, and organizational changes that might impact the investment process among other factors.

Please feel free to contact me with your financial planning and investment questions.

Check out Morningstar.com to analyze your mutual funds and to get a free trial for their premium services.

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Mutual Funds – B Shares are a Dumb Ox

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English: Oxen in Marine Drive, Mumbai, India.

I’m guessing that our family is no different from most in that we have some unique ways of communicating.  For example, beef tenderloin was a dish that my wife would make on a number of special occasions as the kids were growing up.  She cooked it in a black roasting pan with white specs, hence beef tenderloin is forever know as “polka dot pot meat” in the Wohlner house (the black roasting pan is long gone).

In this same vein, the word oxymoron has been changed to “Dumb Ox” in Wohlner speak.

Several years ago I was having lunch with a CPA who was also licensed as Broker Dealer and sold securities including loaded mutual funds to some of the firm’s clients.  I’ve never understood how a trusted advisor like a CPA could turn around and sell financial products for a commission, but that is for another post.  Over lunch the CPA said “… I know that you will disagree, but I often think there is nothing better for many clients than a good B Share…”   He’s right I do disagree, to me a “Good B Share” is the ultimate “Dumb Ox” (no offense to any Oxen intended).

Share Class Comparisons

In the world of commission and fee-based financial product sellers, one way for these brokers and registered reps to be compensated is via commissions from selling mutual funds.  The main share classes where this occurs are A, B, and C Shares.  Using the American Funds Growth Fund as an example let’s take a look at the differences in these three share classes:

Share Class Ticker Front Load Deferred Load Expense Ratio 12b-1 fee
A AGTHX 5.75% 0% 0.71% 0.24%
B AGRBX 0% 5.00% 1.46% 1.00%
C GFACX 0% 1.00% 1.49% 1.00%

Source:  Morningstar.com

The American Funds, like an increasing number of fund companies no longer sells B share mutual funds.  However, even if there are no new B shares being sold; many investors are still trapped in the overpriced funds by the surrender charges.

With the A shares, a $10,000 investment would incur an upfront sales charge of $575, meaning that $9,425 would be invested in your account.

The No Front Load Option – B Shares

As an alternative for investors who didn’t want to pay the upfront sales charge B shares were created.  While there is no upfront sales charge and the entire $10,000 is invested, the ongoing expenses of the fund are considerably higher.  Additionally you are literally trapped in the fund by the deferred sales charge which starts at 5% and declines by 1% each year until it goes away altogether in year 6.  While you can generally exchange your fund for another B share fund in the same fund family, you will get hit with the surrender charge should you sell any or all of the shares.  At the end of the surrender period the B shares are supposed to revert to the less expensive A shares.  I’ve heard of instances where B shares were not automatically moved to the A shares, it is always a good idea to read your brokerage statements.

What if I still own B shares?

If you hold B shares of any fund family I suggest the following:

  • If your fund has moved out of the surrender period and has not moved to the less expensive A shares call your financial advisor and ask why.
  • If your fund is still in the surrender period do a cost/benefit analysis to determine if moving out of the fund and buying into a less expensive (and presumably better performing) alternative would be cost effective.  Basically you want to look at the difference in the annual expenses of the B share fund vs. the alternative and determine how long it would take you to breakeven after incurring the surrender charges based on the cost savings.
  • Consider firing the financial advisor and the firm that put you into the B share in the first place.  I’ve been in this business a long time and I can’t see any reason to have put a client into a B share except greed (though I’m open to listening to other explanations).  The ongoing payments to the brokerage firm (the 12b-1 portion of the expense ratio) and the “handcuffs” placed on shareholders by the surrender charges are quite lucrative for the broker, and serve to reduce your returns.  At the very least confront the advisor and ask them why you were sold a B share in the first place.
  • I’m biased on this subject and in the interest of full disclosure I am a fee-only financial advisor and I do not accept commissions or sales loads of any kind.

As always, be sure that you understand ALL expenses and fees that you will be paying when working with a financial advisor.  What you don’t know can really reduce your investment returns.

Please feel free to contact me with your financial planning and investment questions.

Check out Morningstar.com to review and analyze your mutual funds and all of your investment holdings.  Get a free trial for their premium services. 

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American Funds Growth – A Fallen Star?

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falling star

My last post asked Mutual Funds – Should You Pay Extra for Active Management?  As a follow-up I am taking a look at an actively managed Large Growth fund that was once a top-flight performer, but has really slipped in recent years.

Readers of this blog may note that two of the most popular posts have dealt with the American Funds in the context of their use in 401(k) plans.  American Funds Growth remains a major holding across the 401(k) universe.

The asset base of American Funds Growth (across all share classes) is huge at just over $116 billion, but it is down considerably from its 2007 high of about $202 billion.  Still the fund remains the largest in the Large Growth category.

Let’s compare Growth’s A Share class with the Investor Share Class (the most expensive) of the Vanguard Growth Index Fund.

The A shares have a low expense ratio of 0.68%, but the Vanguard fund’s expense ratio is 0.24%.  The average fund/ETF in this category had an expense ratio of 1.22% as of June 30.  Note the A shares carry a front-end sales charge; the returns below do not reflect this.

YTD

12 months

3 years

5 years

10 years

Amer. Funds Growth

17.86%

27.94%

10.03%

0.06%

8.72%

VG Growth Index

18.20%

31.08%

14.90%

3.39%

8.22%

As of September 30, 2012 – courtesy of Morningstar.

A Former Star Performer

The superior performance of American Funds Growth over the ten-year period is consistent with the fund’s annual performance.  From 2002-2006 the fund outperformed the Growth Index fund during each of these years.  Further the fund ranked no worse than the top 18% of all of the funds in the Large Growth Category.

A Fall From Grace

Since 2006, the story is a different one.  American Funds Growth  has lagged the Growth Index fund in each of these years.  Further the fund has ranked in the lower half of the Large Growth category in 3 of those 5 years.  For the three years ended September 30 the fund ranks in the 74th percentile (bottom 24%) of the Large Growth category.  The fund ranks in the 68th percentile for the trailing five years and the 24th percentile for the trailing ten years.

A Closet Index Fund?

While American Funds Growth’s expenses are generally reasonable (though not for some of the share classes that are sold via the broker channel) what are you getting by paying the extra cost?  Further, the fund’s R-Squared (a measure of correlation) with the Russell 1000 Growth Index over the past three years is over 97%.

Essentially the fund has become a closet indexer with lagging performance and higher expenses.  I’m not saying American Funds Growth will never be a consistent long-term performer again, nobody can predict the future.   I respect the American Funds as an organization.  But why invest in a closest index fund when you can invest in the real thing?  If your broker or registered rep tries to convince you otherwise ask them the same question.

Please feel free to contact me with your investing and financial planning questions.

For you do-it-yourselfers, check out Morningstar.com to analyze your investments and to get a free trial for their premium services.


Morningstar Stock Fund Investment Research

 

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Mutual Funds – Know Your ABCs

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The mutual fund companies in many cases do nothing to make selecting or understanding their funds easy.  One area of potential confusion for investors is (in some cases) the myriad of share classes available among the same fund.

An assortment of United States coins, includin...

Under the broker-sold model, the basic share classes are A, B, and C.  Using the American Funds Washington Mutual Fund, a Large Cap Value fund, as an example here is a comparison of the returns and expenses by share class:

A – AWSHX B – WSHBX C – WSHCX
3 yr return 15.66% 14.79% 14.72%
5 yr return 1.21% 0.44% 0.40%
10 yr return 6.11% 5.31% 5.25%
Expense ratio 0.62% 1.38% 1.42%
Front Load 5.75% NA NA
Max Def Load NA 5.00% (6 yrs) 1.00% (1 yr)
12b-1 fee NA 1.00% 1.00%

Source:  Morningstar

All three share classes are sold by commissioned based and fee-based advisors.

  • The A shares are the cheapest to own over time; however investors pay an upfront charge of 5.75%.  For every $10,000 invested, $9,425 actually goes to work for you with the rest going to the broker.  Typically there is no load for purchases above a certain dollar level and subject to some restrictions exchanges between other funds in the same family will not incur a sales load.
  • The B shares are no longer sold by the American Funds and many other fund companies.  While there is no front-end load, the deferred sales charge starts at 5% in the first year, drops to 1% by year 6, and disappears in year 7.  This means that there is a back-end sales load if you sell in the first 6 years.  In addition, the 12b-1 charge which is part of the expense ratio makes the fund more expensive to own each year.  This fee goes to compensate the broker in lieu of the front-end load.
  • The C shares have a level load in the form of a 1% 12b-1 fee that never goes away.  In addition there is a back-end load in the form of a 1% deferred sales charge for the first year.  With both the B and C shares, there is typically no additional charge for transferring to another fund in the same family and share class, though this could trigger a taxable situation if there is a gain and the fund is held in a taxable account.

Beyond the load world, there are still a number of share class options to consider:

  • A number of fund companies offer separate retirement share classes for use in 401(k) plans.  The most robust menu of retirement plan share classes belongs to the American Funds.  Continuing with the American Funds Washington Mutual example, there are 6 retirement plan share classes with the following expense ratios:
    • R1 – 1.40%
    • R2 – 1.39%
    • R3 – 0.96%
    • R4 – 0.65%
    • R5 – 0.35%
    • R6 – 0.31%

These lower expenses fall right to your “bottom line” in the form of higher returns to shareholders.  If your plan contains funds in what appear to be a higher cost retirement share class (whether via the American Funds or other fund families) this might be a reason to question those who are responsible for running your company’s plan.  The fund expense disclosures that you have likely received by now for your company retirement plan are a great starting point to review the expenses of all investment options offered by the plan.

  • Even low cost provider Vanguard has different share classes for some of their funds; generally the more advantageous share classes have a higher minimum investment than their base Investor share class.  Using the Index 500 Fund as an example, the Investor share class has a low expense ratio of 0.17%.  However, if you have $10,000 invested in this fund you will have access to the Admiral share class with an ultra-low expense ratio of 0.05%.  In some situations the next level fund for investors might be the Signal share class with an identical expense ratio.  If you hold the Investor share class check with your custodian to see which share class you are eligible for.  Typically if you invest directly with Vanguard they will notify you automatically if you are eligible for the Admiral shares.
  • One of the advantages that I am able to offer my clients is access to more advantageous share classes than they could generally get on their own.  One example is the PIMco Total Return bond fund.  The D share class is no-load with a $1,000 minimum investment.  This share class carries an expense ratio of 0.75%.  I have access via Schwab to the Institutional share class of the fund, which usually carries a $1 million minimum investment and a much lower expense ratio of 0.46%.  This difference is significant especially in a bond fund.  This is a benefit that many advisors can bring to their clients across various investment platforms.

These just a few examples of differences in share class among the same mutual fund.  Whether you invest on your own, via a financial advisor, or within your company retirement plan; it behooves you to understand and question the various share classes available to you.  While the differences in expense ratios may seem small, the impact of a lower expense ratio can be huge in terms of the amount you accumulate over time.

Please feel free to contact me with your investment and financial planning questions.

For you do-it-yourselfers, check out Morningstar.com to analyze your mutual funds and other investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

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