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The Ameriprise 401(k) Lawsuit – What Does it Mean to You?

February 13, 2013 By 4 Comments
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English: Ameriprise Financial Center in Minnea...

A lawsuit brought by a group of current and former employees of financial services firm Ameriprise has been allowed to proceed.  The suit alleges that Ameriprise violated their fiduciary obligations as the sponsor of the 401(k) plan it offers to employees.  The main issue is that Ameriprise offered a number of its proprietary mutual funds as options in the plan; these funds were allegedly expensive compared to other non-proprietary options that could have been utilized.  Further it is alleged that these funds paid revenue sharing and other fees to Ameriprise and several of its subsidiaries.

What does this mean to you as a 401(k) participant? 

The implications of this suit are pretty clear.  If Ameriprise is found to be guilty of breaching its Fiduciary duty by stocking their 401(k) plan with sub-par, expensive proprietary funds this moves us further along the path of accountability by retirement plan sponsors for the retirement plans offered to their employees in my opinion.

During 2012 your company (generally via its retirement plan provider) provided several disclosures regarding your 401(k) plan.  While some of these disclosures were not all that revealing (and others may have been downright cryptic) these disclosures began to “open the curtain” a bit.  In anticipation of these disclosures I am aware of several providers who improved their plan offerings as well as activity on the part of a number of plan sponsors who started to look at other platforms and providers for their organization’s 40(k) plan.

The temptation among many employees is to ignore information received about your 401(k).  Hard to blame them, much of this information is poorly written and hard to understand.  However, you would be wise to review the disclosures received and any future disclosure materials.  Do your best to become an informed plan participant.  Review the mutual funds (or other investments) offered.  Are they typically at least in the top half of their category in terms of investment performance?  Are the expenses low relative to other funds in the same fund peer group?  Could less expensive share classes of the funds offered that be considered?  This last point includes even low cost index funds that may be offered.  For example, low cost Vanguard has several share classes that are lower in cost than their basic Investor share class.

I’m not necessarily advocating that you sue your employer for offering lousy investments or for sponsoring a plan that is sub-par, but there is nothing wrong with joining together with other co-workers and presenting your concerns about the plan to your employer.  By definition a 401(k) plan and other defined contribution plans put the onus on you to save and invest for your own retirement.

What does this mean to organizations that sponsor 401(k) plans? 

To say that companies who offer 401(k) plans, consultants and advisors (like yours truly), and ERISA attorneys are watching this suit with a great deal of interest is an understatement.  Essentially this suit could say to employers that if you offer a crappy, high cost 401(k) plan with lousy investment choices it could cost you.  And you know what, with the number of lousy 401(k) plans that I’ve seen offered over the course of my career this advisor would have no sympathy for Ameriprise and those involved with their plan should they lose the suit.  Offering your own funds and receiving revenue sharing from them to boot, really?  What’s OK about that?  I wonder how much of their own money senior Ameriprise executives have in these proprietary funds.

My hope is that this suit will help motivate employers who don’t already focus on offering the best 401(k) plan possible to look at ways to improve their plan.  I am fortunate to have a group of 401(k) sponsor clients whose main concern is doing the best that they can for their employees.  Don’t get me wrong, these companies are concerned with meeting their Fiduciary obligations and managing their Fiduciary liability as a plan sponsor.  I view these goals as being very consistent with offering a top-notch plan for their employees.  From my experience a sound process to choose and monitor investments based upon an Investment Policy Statement generally results in a better result for the plan participants.  Add to this a regular review of the plan providers (record keeper, custodian, etc.) and you have the ingredients of a solidly run plan.

I wonder what Tommy Lee Jones would say to the employees if he was used as a spokesperson to “sell” the 401(k) plan internally?  

Morningstar.com is a great tool for reviewing and analyzing the mutual funds offered in your plan.  I use this site every day; check out the free trial for their premium services. 

If you are a 401(k) plan participant and would like some help allocating your account from among the choices available to you, and/or with your overall financial planning and investment needs please feel free to contact me. 

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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Annuities: The Wonder Drug for Your Retirement?

January 7, 2013 By 8 Comments
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Annuities: The Wonder Drug for Your Retirement?
Annuities are often touted as the “cure” for all that ails your retirement.  Baby Boomers and retirees are the prime target market for the annuity sales types. You’ve undoubtedly heard many of these pitches in person or as advertisements. Many of these pitches pander to the fear that many investors feel after the last stock market decline.  After all, what’s not to like about guaranteed income?

What is an annuity?

I’ll let the Securities and Exchange Commission (SEC) explain this in a quote from their website:

“An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.

Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates, and not capital gains rates. If you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties.

There are generally three types of annuities — fixed, indexed, and variable. In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.

In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.

Variable annuities are securities regulated by the SEC. An indexed annuity may or may not be a security; however, most indexed annuities are not registered with the SEC. Fixed annuities are not securities and are not regulated by the SEC. You can learn more about variable annuities by reading our publication, Variable Annuities: What You Should Know.

http://www.sec.gov/answers/annuity.htm”

What’s good about annuities?

 In an uncertain world, an annuity can offer a degree of certainty to retirees in terms of receiving a fixed stream of payments over their lifetime or some other specified period of time.  Once you annuitize there’s no guesswork about how much you will be receiving, assuming that the insurance company behind the product stays healthy.

Watch out for high and/or hidden fees 

The biggest beef that I and many other financial advisors have about annuities are the fees, which are often hidden or least difficult to find.  Many annuity products carry fees that are pretty darn high, others are much more reasonable.

There are typically several layers of fees in an annuity:

Fees connected with the underlying investments.   In a variable annuity there are fees connected with the underlying sub-account (accounts that resemble mutual funds) similar to the expense ratio of a mutual fund.  In a fixed annuity the underlying fees are typically the difference between the net interest rate you will receive vs. the gross interest rate earned.  In the case of an indexed annuity product the fees are just plain murky.

Mortality and expense charges are fees charged by the insurance company to cover their costs for guaranteeing a stream of income to you.  While I get this and understand it, the wide variation in these and other fees across the universe of annuity contracts makes me shake my head.

Surrender charges are fees that are designed to keep you from withdrawing your funds for a period of time.  From my point of view these charges are heinous whether in an annuity, a mutual fund, or anyplace else.  If you are considering an annuity and the product has a surrender charge, avoid it.  I’m not advocating withdrawing money early from an annuity, but surrender charges also restrict you from exchanging a high cost annuity into one with a lower fee structure.  Essentially these fees serve to insure that the agent or rep who sold you the high fee annuity (and the insurance company) continues to benefit by placing handcuffs on you in terms of sticking with the policy.

Who’s really guaranteeing your annuity? 

When you purchase an annuity, your stream of payments is guaranteed by the “full faith and credit” of the underlying insurance company.  This differs from a pension that is annuitized and which is backed by the PBGC, a governmental entity up to certain limits.

Outside of the most notable failure, Executive Life in the early 90s, there have not been a high number of insurance company failures.  In the case of Executive Life, 1,000s of annuity recipients were impacted in the form of greatly reduced annuity payments which in many cases permanently impacted the quality of their retirement.

Insurance companies are regulated at the state level; state insurance departments are generally the backstop in the event of an insurance company failure.  In such an event, you may receive some portion of the payment amount that you expected, but likely there will some period of time that elapses before this occurs.

The point is not to scare anyone off of buying an annuity but rather to remind you to perform your own due diligence on the underlying insurance company.

Should you buy an annuity? 

Annuities are not a bad product as long as you understand what they can and cannot do for you.  Like anything else you need to shop for the right annuity.  For example, an insurance agent or registered rep is not going to show you a product from someone like Vanguard that has ultra low fees and no surrender charges because they receive no commissions.  Yet as a fee-only advisor, I generally use annuities from providers of this sort when an annuity is appropriate.

An annuity can offer diversification in your retirement income stream.  Perhaps you have investments in taxable and tax-deferred accounts from which you will withdraw money to fund your retirement.  Add Social Security to the mix which provides a government-funded stream of payments.  A commercial annuity can also be of value as part of your retirement income stream, again as long as you shop for the appropriate product.

Far too many annuities are sold rather than bought by Baby Boomers and others.  Be a smart consumer and understand what you are buying, why a particular annuity product (and the insurance company) are right for you, and the benefits that you expect to receive from the annuity.  Properly used, an annuity can be a valuable component of your financial plan.  Be sure to read ALL of the fine print and that you understand ALL of the terms, conditions, and restrictions before writing a check.

Please feel free to contact me with your financial planning and investing questions at any time, including questions about an annuity you may own or one that you might be considering.

Please check out our Resources page for links to some tools and services that might be beneficial to you.

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Mutual Fund Expenses – Where Real Holiday Savings Can be Found

November 26, 2012 By 4 Comments
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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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Mutual Funds – B Shares are a Dumb Ox

November 12, 2012 By 6 Comments
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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?

October 10, 2012 By Leave a Comment
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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.

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Mutual Funds-Should You Pay Extra for Active Management?

October 8, 2012 By 5 Comments
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I was recently quoted in the industry publication Investment News in an article discussing how many Large CapCommon Sense on Mutual Funds: New Imperatives ... domestic equity mutual funds have become very highly correlated with their benchmark index.

The article’s author cited the American Funds Growth Fund of America as an example with its three year R-squared to the Russell 1000 Index having increased to 98% from 77% just five years ago.  R-squared measures the strength of the statistical relationship, in this case between the fund and its benchmark.

Here are my two quotes from the article:

“If I buy an active fund in the large-cap space, I want somebody who’s going to do something over the long term to outperform,” said Roger Wohlner, a financial planner at Asset Strategy Consultants. “Why pay 70 or 80 basis points for active management that doesn’t give you much differentiation from the index?” 

“Downside protection is one of the reasons that led Mr. Wohlner to rush some of his clients into the $5.5 billion Sequoia Fund (SEQUX) when it briefly opened to new investors in 2008. As the S&P 500 fell 37% in 2008, the Sequoia Fund fell 27%.” 

Both quotes reflect my belief that an active mutual fund manager needs to add value beyond what you can find in an index mutual fund or ETF.

Index Funds Often Outperform Their Actively Managed Peers

Especially with Large Cap funds, quite often index funds out perform a large percentage of their actively managed peers.  Let’s look at an example:

Vanguard Growth Index Signal (VIGSX) – Large Growth Category

YTD

1 year

3 years

5 years

10 years
Fund Return

10.77%

6.49%

17.66%

3.06%

5.97%
Category percentile

24

8

14

17

28
# Funds in category

1,543

1,499

1,328

1,137

736

As of June 30, 2012 via Fi360.com

By way of explanation:

  • Category percentile represents its ranking among all of the mutual funds and ETFs in this Morningstar Category.  For example for the three years ended June 30 the fund ranked in the top 14% of the 1,328 funds in the category with a three year track record.
  • The fund delivered these results quite cheaply.  The fund’s expense ratio is 0.10%.  This compares to the average mutual fund/ETF in this category of 1.22% as reported by Morningstar.
  • While this share class may not be available to all individual investors, the Admiral Share class ($10,000 minimum investment) and the ETF version (which can be traded commission-free at Vanguard) of this fund also carry a 0.10% expense ratio.  Even the basic Investor share class is very cheap to own with a $3,000 minimum investment and a 0.24% expense ratio.  In addition there are many other excellent index ETFs in this category that are solid low cost choices.

Why Pick an Actively Managed Fund? 

A bit over half of the money that I have invested on behalf of my clients is in some sort of index product, across both mutual funds and ETFs.

That said I still use a number of actively managed mutual funds as well.  What am I looking for in an active fund?

  • A long-term track record of excellence.  There are still a number of active fund managers who in my opinion add value.
  • A manager who excels at controlling their fund’s downside risk when the markets drop.
  • Superior management in an investment style that is not well-represented by index products.

As we have seen especially over the market cycle of the past decade, it is increasingly difficult for actively managed mutual funds to add value to investors over and above what inexpensive index funds deliver.   This is especially true with equity funds.  If your financial advisor suggests a portfolio of pricey actively managed mutual funds ask why (especially if these funds are proprietary products of their employer).  What added value do these funds provide over less expensive index alternatives?  If you advisor is paid all or in part via commissions I’ll bet his/her compensation is part of the answer.

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.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

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Mutual Funds – Know Your ABCs

August 20, 2012 By 12 Comments
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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 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.

Photo credit:  Wikipedia

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401(k) Fee Disclosure and the American Funds

July 9, 2012 By 16 Comments
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About two years ago I wrote what remains one of the most popular posts on this blog American Funds-The Secret Sauce for 401(k) Plans.  The point of the article was to look at 401(k) plans sold by many commission-based advisors to smaller employers consisting solely of mutual funds from the American Funds as investment options.

In light of the new disclosure requirements which will shed light on the costs associated with the investment options offered in 401(k) plans I wanted to take a look at how the various share classes offered by the American Funds for retirement plans would stack up under the portion of the required disclosures that deal with the costs and performance of the plan’s investment options.

The one American Funds option that I use in a couple of 401(k) plans is the EuroPacific Growth fund.  This fund is a core large cap foreign stock fund.  It generally has some emerging markets holdings, but most of the fund is comprised of foreign equities from developed countries.  I am able to use the R6 share class, the least expensive of the retirement plan share classes.  Let’s look at how the various share classes would stack up in the disclosure format:

Share Class

Ticker

Expense Ratio

Expenses per $1,000 invested

Trailing 1 year return

Trailing 3 year return

Trailing 5 year return

R1

RERAX

1.62%

$16.20

-6.98%

16.16%

-0.49%

R2

RERBX

1.61%

$16.10

-7.00%

16.14%

-0.52%

R3

RERCX

1.13%

$11.30

-6.52%

16.71%

0.00%

R4

REREX

0.85%

$8.50

-6.26%

17.04%

0.27%

R5

RERFX

0.55%

$5.50

-5.98%

17.40%

0.57%

R6

RERGX

0.50%

$5.00

-5.94%

17.43%

0.48%

3 and 5 year returns are annualized.  Source:  Fi360   Data as of 3/31/2012

Note the 3 and 5 year returns for the R6 share class are estimated by Morningstar as this share class just came into being in 2009.  On an actual participant disclosure report the 3 and 5 year numbers would be left blank. 

While the chart above pertains only to the EuroPacific Growth fund, looking at the six retirement plan share classes for any of the American Funds products would offer similar relative results.   Check out Morningstar to track all of your 401(k) holdings and get a free trial for their premium services.

The underlying portfolios and the management team are identical for each share class.  The difference lies in the expense ratio of each share class.  This is driven by the 12b-1 fees associated with the different share classes.  This fee is part of the expense ratio and is generally used all or in part to compensate the advisor on the plan.  In this case these would generally be registered reps, brokers, and insurance agents.  The 12b-1 fee can also revert to the plan to lower expenses.  In past years we have used the R4 shares of this fund and the 12b-1 fee went to lower the expenses for those participants investing in the fund.  The 12b-1 fees by share class are:

R1                   1.00%

R2                   0.75%

R3                   0.50%

R4                   0.25%

R5 and R6 have no 12b-1 fees.

The R1, R2, and R3 shares are generally used in plans where the 12b-1 fees are used to compensate a financial sales person.  This is fine as long as that sales person is providing a real service for their compensation and is not just being paid to place the business.

Plan sponsors (the employers sponsoring the plan) were supposed to receive disclosures from all covered service providers who receive any compensation from plan assets by July 1 which detail their compensation, the source(s) of their compensation, and the services they are providing to the plan.  It is my hope that any plan sponsor who looks at a disclosure from any financial advisor who has their plan in R1, R2, or R3 shares does a thorough round of due diligence to find out why their participants are in these expensive shares and what services the advisor is providing to justify receiving these hefty fees.

If you are a plan participant and you notice that your plan has one or more American Funds choices in the R1, R2, or R3 share classes, in my opinion you have a lousy plan and you are overpaying for funds that are generally mediocre to poor performers.  It is incumbent upon you to ask your employer if the plan can move to lower cost shares or even a different provider.  Check out Morningstar’s tools to stay on top of your American Funds 401(k).

If you would like an independent review of your company’s 401(k) plan, please feel free to contact me.

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Vanguard and the Power of Twitter

December 8, 2010 By 13 Comments
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Two upfront disclaimers:

1.      Nothing in this post or on this blog should be construed as financial advice or a recommendation to take any action of any kind.  Financial decisions should be made only after a careful review of your personal situation and in consultation with your tax and financial advisor.
2.      I have a great deal of respect and admiration for the Vanguard organization.  Across my base of individual and institutional clients I use a number of Vanguard mutual funds and ETFs.
That said Vanguard recently made a decision to lower the investment minimums on its Admiral Share class of funds for investors in these funds who hold their shares at Vanguard.  The Admiral shares offer an even lower expense ratio than Vanguard’s Investor Share class which already has very low expenses.  This is a great gesture on Vanguard’s part because they are essentially earning less by doing this.  Other than the expense ratios, the fund portfolios are the same across all Vanguard share classes.
However, Vanguard did not initially extend this opportunity to Vanguard fund shareholders at other custodians such as Schwab or Fidelity.  Though this did not impact a large number of my clients, I viewed this as unfair to clients of many financial advisors.  Like many advisors, I use Schwab as my primary custodian for most of my individual clients and one of my larger retirement plan clients.  There we hold mutual funds and ETFs from a variety of fund companies, including Vanguard. 
The idea of Vanguard treating the clients of financial advisors holding their funds elsewhere differently (and worse) than shareholders who dealt directly with Vanguard really bothered me.  This seemed very “un-Vanguard-like.”  Most of my institutional clients are already in lower cost share classes; additionally I have tended to use Vanguard’s ETFs for most of my individual clients which carry a very low expense ratio that is generally comparable to Vanguard’s lowest expense mutual fund share class.
None-the-less I sent several Twitter messages to Vanguard saying in effect that it was wrong to treat our clients as second class shareholders and also asking them why they were anti-advisor.  Evidently so did a number of my fellow advisors and consultants because a short time later I received an email saying that a similar opportunity would be made available to advisor clients at other custodians.  The social media activity was mentioned to me in a conversation with a Vanguard rep.
The point is that Twitter and social media can be a powerful communications tool for financial advisors.  In this case it proved to be an excellent vehicle for us to pressure Vanguard to do the right thing for our clients.  Many mutual fund companies are using social media as a vehicle to engage advisors and shareholders.  That’s great, the more we know the better able we are to make intelligent investment choices for our clients.  The flip side is that the fund companies should expect to be called out when they do something as short-sighted as what Vanguard did recently. 
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American Funds-The Secret Sauce for 401(k) Plans?

June 28, 2010 By 9 Comments
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Many registered reps selling 401(k) plans in the small to mid-sized market would have you believe this.

To be clear, I have enormous respect and admiration for American Funds as a fund family. They offer a number of excellent funds. They have a deep management/research group. I use several of their funds in 401(k) plan line-ups and in the accounts of some of my individual clients (no-load share classes).

Contrary to what these registered reps may tell you, an all American Funds lineup is not, in my opinion, a complete 401(k) solution.

  • There are no domestic small or mid cap funds in the American Funds line-up. These are typically core asset classes in a well-balanced plan lineup.
  • For 401(k) plans, the R class of shares is typically used. For smaller plans this might entail the R1 or R2 share classes, larger plans can use the much more reasonable R4 or R5 share classes.
  • For example looking at the Large Value Washington Mutual Fund
    • R1 expense ratio is 1.43% which includes a 12b-1 fee of 0.99%
    • R2 expense ratio is 1.50% which includes a 12b-1 fee of 0.75%
    • R3 expense ratio is 0.97% which includes a 12b-1 fee of 0.50%
    • R4 expense ratio is 0.69% which includes a 12b-1 fee of 0.25%
    • R5 expense ratio is 0.39% with no 12b-1 fee
  • In the case of most registered reps and commissioned brokers, the 12b-1 will go to compensate them for their involvement with the plan.
  • These expenses take their toll on the quality of the fund. Washington Mutual’s R1, R2, and R3 shares earned a score of 42 in the Fi360 ranking system as of 3/31/2010. This score is just in the top half of the peer group. By contrast the R4 shares earned a score of 23, which places this share class in the top quartile of its peer group. The R5 shares earned a score of 17.
  • Looking at this another way, the five year average annual return for the R1 shares is 0.47%; for the R5 shares it is 1.55%.

As a plan sponsor, if your advisor suggests going with an all American Funds line-up for your company’s 401(k) plan, you should ask many questions.

In the commissioned world, the American Funds represent one of the best fund families many of these reps can sell. As with other top-notch fund families such as T. Rowe Price and Vanguard, using a line-up consisting exclusively of any fund family is usually not a good idea and generally does not provide the best 401(k) line-up. This approach may be in your broker’s best interests, but as a 401(k) plan sponsor you need to do what is in the best interests of the participants in your company’s retirement plan.

Check out Morningstar’s tools to track all of your 401(k) plan’s investment choices and get a free trail for their premium services.



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