Objective information about financial planning, investments, and retirement plans

Dow 18,000 – A Big Deal?

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In February of 2013 I wrote Dow 14,000 – Big Deal or Just a Number?  Today the Dow Jones Industrial Average closed at 17,778 after a 421 point gain.  This is on the heels of a better than 200 point rise yesterday marking the average’s largest two day gain in 12 years.  Dow 18,000 looks like it will not be far off.

Just as I thought Dow 14,000 was a pretty meaningless number, I also think Dow 18,000 is equally meaningless.  In fact there are many, including yours truly, who think the Dow Jones Industrial Average isn’t all that meaningful as a benchmark.

Rather than focusing on the level of the market you should focus on your portfolio and your investment strategy.  Some specific action steps you might consider:

Rebalance your portfolio

You should have a strategy to review your overall portfolio on a regular basis (annually, semi-annually etc.) to ensure that your asset allocation is within your target allocation.  Invariably certain asset classes will outperform or under perform.  Bringing your portfolio back into balance forces you to sell off some winners and fund those asset classes that have underperformed.

Market leaders and laggards shift periodically and this approach adds a level of discipline to your strategy.  Mostly rebalancing helps mitigate investment risk.

Keep expenses low 

You can’t control how the markets will perform.  You can control your investment expenses.  Specifically:

  • Mutual fund and ETF expenses.
  • Trading costs at your custodian.
  • The cost of financial advice

Revisit your investment strategy 

I view market highs as a great time to revisit your investment strategy and your financial plan.  If you’ve been fully and properly invested your portfolio has hopefully risen along with the markets.

Where does this leave you in terms of progress towards achieving your financial goals?  This is a good time to revisit your financial plan.

The Bottom Line

Is Dow 18,000 a big deal?  Not in my book and frankly I wonder if anyone besides the financial news media really cares.  I suggest focusing on the details of your portfolio and your strategy and ignoring the hype.

Check out an online service like Personal Capital to manage all of your accounts all in one place or purchase the latest version of Quicken.  Check out our Resources page for more tools and services.

What I’m Reading – March Madness Edition

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It’s a bit of a lazy Sunday here and I am half surfing the web and half watching the NCAA Men’s basketball tournament.  I’m not the college basketball fan that I once was, but I still love March Madness and watch every game that I can.

In 1939, H.V. Porter of the IHSA coined the te...

Here are some financial articles that I’ve read lately that you might find interesting and useful:

The Ultimate Guide to Understanding Your 401(k) A great piece loaded with information for those who might be new to 401(k) investing or who just want to learn a bit more by Harry Campbell on his blog Your Personal Finance Pro.

Five strategies to get the most Social Security another excellent and informative piece by Robert Powell at Market Watch.

And You Thought Just Tuition Was Expensive a nice piece on the Morningstar site that discusses how college expenses other than tuition can really put a strain on parents and students trying to pay for college.

Are You Paying Too Much For Mutual Funds?  Dana Anspach does a good job of addressing this important question at U.S. News.

The IRS Releases Their “Dirty Dozen” Tax Scams for 2014 was featured on Jim Blankenship’s excellent blog Getting Your Financial Ducks in a Row.

Americans and Retirement: 3 Worrying New Findings discusses EBRI’s most recent Retirement Confidence survey on Wall Street Cheat Sheet.

If you are new to The Chicago Financial Planner here are the three most popular posts over the past 30 days:

Your 401(k) is not Free

Life Insurance as a Retirement Savings Vehicle – A Good Idea?

7 Retirement Investing Tips

Well that’s it I hope you enjoy some of these articles and the rest of your Sunday.  I’ve watched a couple of good tournament games so far with hopefully more to follow.  Cool and sunny here today, but none the less good grilling weather, chicken is on the menu for tonight.

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. 

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. Click on the Amazon banner below to go directly to the main site or check out the selections in our Book Store.

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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. 

The Chicago Financial Planner is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small fee, yet you don’t pay any extra. Click on the Amazon banner below to go directly to the main site or check out the selections in our Book Store.

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

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1% a Small Number with Big Implications

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Percent Symbols - Best Percentage Growth or In...

The inspiration for this post comes from fellow finance blogger and financial advisor Jim Blankenship and his November is “Add 1% to Your Savings Month” movement.

It’s amazing how a small number like 1% can have such a big impact on your investments and the amount you’ll be able to accumulate for goals like retirement.  Here is a look at the impact of saving 1% on your investment expenses.

Mutual fund expenses matter

Using two share classes of the American Funds EuroPacific Growth fund as an example, the chart below illustrates the impact of 1% in expenses on the growth of your investment.  I was able to find two share classes of this fund whose expense ratios were exactly 1% different.  The B shares (ticker AEGBX) carry an expense ratio of 1.59% and the F-2 shares (ticker AEPFX) which carry and expense ratio of 0.59%.  Using Morningstar’s Advisor Workstation I compared the growth of a hypothetical $10,000 investment in each fund held over three time periods.

5 years ending 10/31/13 

Value of $10,000 investment
B Shares $17,710
F-2 Shares $18,606

 

As you can see varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $896 a 5.1% increase over an investment in the B share class.

10 years ending 10/31/13

Value of $10,000 investment
B Shares $22,677
F-2 Shares $24,734

 

Again varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $2,057 a 9.1% increase over an investment in the B share class.

From 4/30/84 through 10/31/13 

Value of $10,000 investment
B Shares $205,652
F-2 Shares $260,042

 

Once again varying nothing more than the expense ratio in these otherwise identical mutual funds, investing in the fund with a 1% lower expense ratio resulted in the accumulation of an additional $54,390 a 26.4% increase over an investment in the B share class.

A couple of things about the above comparison:  The assumption is that an investor put $10,000 into each of the funds and held them for the full time period, including the reinvestment of all fund distributions.  Any potential taxes or the expenses of engaging an investment advisor were not considered.  Further B shares are no longer available to new investors and even when they were they would generally convert to the less expensive A shares after a period of time.  None the less this comparison illustrates the impact saving 1% on your investment expenses can have on your returns and the amount you can potentially accumulate over time. 

How to reduce investing expenses 

While you may not always be able to save a full 1%, reducing your investment expenses by even a fraction of 1% can have a significant positive impact.  Here are some ideas that may help:

  • Utilize low cost index mutual funds and ETFs where possible and where they fit your investment strategy.  In many asset classes index funds outperform the majority of actively managed products.  Combine this with low expenses and index funds have a major leg up on most of their competitors.
  • In all cases make sure that you invest in the lowest cost share class of a given mutual fund that is available to you.
  • Avoid sales loads whenever possible.
  • Understand the expenses associated with the investment choices in your company’s 401(k) plan and the plan’s overall expenses.  If they are excessive consider asking your company’s plan administrator to look at some lower cost alternatives.  You might also  consider limiting your contributions to the amount needed to receive the maximum company match (if one is offered) and invest the remainder of your retirement savings elsewhere.
  • If you work with a financial advisor you must fully understand all of the ways in which your advisor makes money from your relationship.  This might include fees (hourly, flat-fee, or a percentage of assets).  In some cases the advisor makes money from the investment and insurance products they sell to you.  This can include up-front sales commissions (loads), deferred loads (B shares which are mostly obsolete), and level loads (C shares).  Additionally the advisor may make money from trialing commissions (12b-1 fees) or surrender charges incurred if your sell out of some mutual funds or annuity products too early.  If you are a regular reader of this blog you know that I am horribly biased in favor of using fee-only advisors (of which and I am one), avoiding the inherent conflict of interest that can arise when an advisor earns money from the sale of financial products. 

Saving 1% might seem like a trivial endeavor, but as you can see it can have big ramifications for investors.

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

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

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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?

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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 contact me at 847-506-9827 for a free 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.   

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

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Mutual Fund Expenses – Where Real Holiday Savings Can be Found

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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

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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-Should You Pay Extra for Active Management?

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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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