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Target Date Funds: 6 Considerations Before Investing

April 24, 2013 By 4 Comments
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Target Date Funds are a staple of many 401(k) plans. Most Target Date Funds are funds of mutual funds. The three largest firms in the TDF space are Fidelity, T. Rowe Price, and Vanguard with a combined market share of about 80 percent. All three firms use only their own funds as the underlying investments in their target-date fund offerings. Some other firms offer other formats, such as funds of exchange-traded funds, but the fund of mutual funds is still the most common structure.

Here are 6 considerations to think about when deciding whether to use the Target Date Fund option in your company’s retirement savings plan:

Is the Glide Path really that important?

Much has been made of whether the Glide Path (a leveling of the fund’s equity allocation into retirement) should take investors to or through retirement. Target Date Fund providers spend a lot of time devising and administering the Glide Path that their funds use into and through your retirement years.   Before making too much of this, however, the key question is what will you do with your retirement plan dollars once you retire? TDF providers hope that you take the money invested in their Target Date Funds and roll these dollars into an IRA with them, maintaining your Target Date Fund position.  There are big dollars at stake for them.  In reality you might take your money out of the plan and do something else with it, including consolidating these funds with other retirement assets already in an IRA perhaps at another custodian.

How does the allocation of the Target Date Fund fit with your other investments? 

Many 401(k) participants invest their retirement dollars in a vacuum—meaning they don’t take their investments outside of the plan into consideration when making their investment choices. This is fine for younger workers just starting out.  Their 401(k) investment might be their only investment and the instant diversification of a Target Date Fund is fine here.

For those with other outside investments such as taxable accounts, a spouse’s retirement plan, and perhaps an IRA rolled over from old 401(k)s, this is a big mistake. Given that TDFs are funds of funds you might become over or under allocated in one or more areas and not know it as your account grows. Factoring the Target Date Fund allocation into your overall portfolio is critical. 

Is the Target Date Fund closest to your projected retirement date the right choice for you?

For example, a 2020 Target Date Fund is conceivably meant for someone who is 58 and retiring in seven years. If you were to take three 58-year-olds and look at their respective financial situations and tolerance for risk, it is likely that they are all fairly different. Plan providers need to do a better job of communicating to plan participants that the fund with the date closest to their projected retirement date may not be the right fund for their needs. Look at your own unique situation and pick the TDF that best fits your needs. 

Understand the underlying expenses

In some cases, the overall expense ratio may be a weighted average of the underlying funds. Others may also tack on a management fee to cover the costs of managing the fund. As with any investment, understand what you are being charged and what you are getting for your money. 

Target Date Funds don’t equate to low risk

Many participants are under the mistaken impression that investing in a Target Date Fund is a low risk proposition. As we saw in 2008, nothing could be further from the truth. Many investors in 2010 funds saw losses in excess of 20 percent. A recent review of more than 40 Target Date Fund families showed the share of stocks in the funds designed for those retiring in the current year ranged from about 25 percent to about 75 percent. As with any mutual fund, look under the hood and understand the level of risk that you will be assuming.

Investing in Target Date Funds doesn’t guarantee retirement success 

Contrary to the belief of some, investing in a Target Date Fund doesn’t guarantee that you will have enough saved at retirement.  Building a sufficient retirement nest egg is all about how much you save and how you invest those savings.  Target Date Funds may or may not be the best investment vehicle for your needs.

Target Date Funds can be a good vehicle for 401(k) participants and others who are not comfortable allocating their own investments. Unfortunately, TDFs are not a set it and forget it proposition. Investing in Target Date Funds requires periodic review to ensure that the fund you have chosen is still right for your situation. Retirement plan providers and sponsors also need to do a better job of communicating the benefits, pitfalls, and potential uses of these funds to plan participants.

Please feel free to contact me with questions about 401(k) investment options or about your overall financial and retirement planning needs.  Check out our Financial Planning and Investment Advice for Individuals page for more information about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your Target Date Fund and all 401(k) investment options 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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Target Date Funds Don’t Guarantee Retirement Success

January 23, 2013 By 7 Comments
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English: Target

A recent article in the Wall Street Journal professional edition was entitled “Target” Funds Still Missing the Mark. The premise of the article was that Target Date Funds were falling short in their investment returns and were doing nothing to help 401(k) participants regain some of the ground they had lost during the 2008-09 stock market decline.  Another Wall Street Journal Article in early 2011 cited an Alliance Bernstein survey of 1,000 workers which over half “mistakenly believed that using target-date funds would guarantee that their retirement income needs will be met.”

As both a financial planner working with individual investors and as an advisor to several 401(k) plan sponsors I find this survey result appalling and disturbing.  Moreover, it reinforces my concerns that 401(k) participants as well as some plan sponsors really don’t understand the pros and cons of Target Date Funds.

The fund companies offering them would be the first to tell you that there is nothing guaranteed about TDFs. There is a growing movement within the retirement plan space to add guaranteed-income products to Target Date Funds, but this won’t guarantee retirement success either.

Is a Target Date Fund the right choice for you?

The key to determining if a Target Date Fund is the right choice for your retirement savings is to understand them.  If you are considering a TDF for all or part of your 401(k) account or as an investment in general, here are two things to consider:

  • Target Date Funds from various providers with the same target date may vary widely as to their asset allocation and investment approach. There is no requirement that a TDF with a given target date have any particular allocation to equities, fixed income, etc.  The fund with the target date closest to your intended retirement might not be the best fund for your needs. As with any investment, you need to look at the fund’s investment allocation in light of your financial goals, risk tolerance, etc. You should also look at the fund as a part of your overall portfolio if you have investments outside of your retirement plan, such as IRAs, taxable accounts, a spouse’s retirement plan, and the like.
  • Many Target Date Funds are funds of the mutual fund company’s funds. This is the case for Vanguard, Fidelity, and T. Rowe Price, which collectively have about 80 percent of the TDF assets. This is not good or bad, but you should take a look at the funds that make up the TDF that you are considering. In some cases, I’ve seen fund companies use funds other than what I consider to be their top funds; perhaps they are looking to add assets to these funds.

Target Date Funds gather a huge amount of assets for the fund companies offering them, both as a component in many 401(k) plans and as a rollover vehicle when participants leave their employer.  Remember your investment choices should be all about you and what’s right for your situation.

Most of all, remember that the biggest single determinant in retirement success is the amount saved. If you start early, save as much as you can, have a financial plan in place, and make good investment choices, you will give yourself a good shot at accumulating enough to fund your retirement.  There are no guarantees of course.

Please feel free to contact me with questions about 401(k) plan and about your retirement planning needs.

Check out our Resources page for links to a variety of tools and services that might be beneficial to you.

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3 Financial Products to Consider Avoiding

January 14, 2013 By 26 Comments
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Red and white sign to avoid construction zone

It’s a New Year and many of us are looking to start the New Year out on the right foot financially.  Couple this with the upcoming tax season and this is prime time for the financial product sales types.   Before buying ANY financial product make sure that this product is right for you in terms of your overall financial situation.  Financial products are tools and just like your projects around the house you should use the right tool for the job and not the tool that the financial rep wants to sell to you.

Here are three products that you should consider avoiding:

Equity-Indexed Annuities 

Equity-Indexed Annuities are an insurance-based product where the returns are tied to some portion of the performance of an underlying market index such as the S&P 500.  Your gains are limited to a portion of what the index gains and there is generally some sort of minimum return to limit (or eliminate) your risk of loss.  As you can imagine these were pitched heavily to Baby Boomers and retirees after the last market downturn and are still being sold based upon fear today.  Two problems here are generally high expenses and surrender charges that keep you locked in the product for years.  The reality based upon my experience is that while most investors suffered major losses during 2008-09, my clients (and the clients of other financial advisors with whom I network) had generally made up those losses in a relatively short period of time and now find themselves decently ahead of where they were.  I’m not sure that an expense laden Equity-Index Annuity would have made them any better off.  If you decide to go ahead with the purchase of an Equity-Indexed Annuity be sure that you understand all of the details including index participation, expenses, surrender charges, and the health of the underlying insurance company.

Proprietary Mutual Funds

 It is not uncommon for registered reps and brokers, who are compensated all or in part by commissions or trailing fees from the mutual funds they sell, to suggest mutual funds from the family run by their employer.  While some of these funds are perfectly fine, all too often in my experience they are not.  Whether from high fees and/or low performance these are often investments to be avoided.  A lawsuit against Ameriprise Financial brought by a group of participants in the company’s retirement plan alleges the company breached its Fiduciary duty by offering a number of the firm’s own funds in the plan and these funds then paid fees back to Ameriprise and some of its subsidiaries.  JP Morgan settled a suit by some retail investors over the bank steering clients into their more expensive proprietary funds over those of other families.

While this is most common in the world of fee-based and commissioned reps, if you are working with the advisory units of a fund company such as Fidelity or Vanguard you should also question recommendations that are exclusively or mainly into their own proprietary funds.  Though I like and use funds from both families you should still question these types of recommendations.  Moreover anyone who pushes you to invest mainly with mutual funds offered by their employer should be questioned vigorously.

Load Mutual Funds

It is important that you understand the ABCs of mutual fund share classes.  In the commissioned/fee-based world reps often sell mutual funds that offer compensation to them and to their broker-dealers.  A shares charge an up-front commission plus a trailing fee (often a 12b-1) of somewhere in the neighborhood of 0.25% or more.  B shares charge no up-front commissions, but carry an additional back-end load as part of the ongoing expense ratio.  This can amount to an addition 0.75% or more added to the fund’s annual expenses.  In addition these shares also contain a surrender charge that typically starts at 5% if your sell the fund before the end of the surrender period.  B shares have been largely phased out by many of the major fund providers.  C shares typically have a permanent 1% level load added to the fund’s expense ratio and carry a one year surrender period.

Look I certainly don’t provide financial advice for free and wouldn’t expect any other professional to do so either.  Unless the person to whom you are paying these pricey loads is providing extraordinary advice, this is a very expensive way to go.  My very biased opinion is that you should look for a fee-only advisor who isn’t compensated based upon the products they sell to you.  Rather fee-only advisors generally act as fiduciaries and are paid for their professional advice and expertise without the conflicts of interest inherent in selling financial products.

The above comments are general and reflect my opinions.  However no financial product is right or wrong in every case.  Before making any financial or investment decision it is best to review your specific situation.  Consult your financial advisor if you work with one.

Please feel free to contact me with questions about any financial products you may be considering or to address your investment and financial planning advice needs. 

Do-it-yourselfers check out morningstar.com to analyze your investments and to get a free trial for their premium services. Check out Personal Capital for a variety of online services including expense tracking, financial planning capabilities, and investment monitoring.

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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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Does it Matter Who’s Managing Your Mutual Fund?

November 5, 2012 By Leave a Comment
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One of the analytical tools that I use in my practice is the fi360 Toolkit.  They rank mutual funds and ETFs on 11 criteria, one of which is the tenure of the fund manager.  In order to receive a top ranking here, the manager must have tenure of at least 2 years.  We generally use 3 years in our Investment Policy Statements.

Does this mean that you should dump a fund if you learn that the manager is leaving?  Not necessarily.

The Vanguard Example

As an example, for many years Gus Sauter was responsible for the management of most of Vanguard’s index funds.  Several years ago he stepped out of the day-to-day management of the funds into the role of the firm’s Chief Investment Officer.  In my opinion, Vanguard’s index products have not missed a beat.

Mr. Sauter is retiring at year-end after the transition to a new index provider for a number of their funds.  On both counts I suspect Vanguard will again not miss a beat.  Why?  People are a critical part of the investment management process.  But so is the process.  Based upon my experience Vanguard has both in place.

Fund manager changes – done well and not so well

In another example, I have used Columbia Acorn International Z fund for a number of years in some client portfolios.  It is an actively managed small/mid cap foreign equity fund.  The fund had been managed by legendary manager Ralph Wanger, he was then joined by his wife (an outstanding fund manager herself) Leah Zell; Zell then was the sole lead manager until May of 2003 after Wanger’s departure.  She was succeeded at the fund by her two top underlings.  I had notified my clients of the change and suggested a wait and see approach.  This was a wise move as the fund has continued to perform well and also to perform within my expectations for the fund.  Again an example of having solid people in place (including depth) and having a solid investment process in place.

Perhaps the ultimate example of the other side of this coin is the soon to be shuttered Janus Worldwide fund.  Janus was one of the hottest mutual fund shops of the 1990s Dot Com boom in the markets.  The fund was very ably managed by Helen Young Hayes and at its peak had over $44 billion in assets.  The fund was a top performer until the bear market of 2000-02 when the fund’s performance really sagged.  Hayes left the fund in 2003; there have been several managers since, in many ways mirroring the revolving door in the executive suite (five CEOs since 2003).  None of these mangers subsequent to Hayes have been able to duplicate the fund’s past performance, the fund ranks in the bottom 3% of its peer group for the past 10 years.  The fund is scheduled to be merged with another Janus fund shortly.

It does matter who is managing your mutual fund, but beyond that it is important that the fund have a strong investment process in place.  While the fund’s management might seem to be more important for an actively managed fund, in reality proper management of a passive index fund is just as important.

Please feel free to contact me for a review of your investments. 

Check out morningstar.com to analyze your mutual funds and all of your investments.  Get a free trial for their premium services.

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Mutual Funds – Are “Family Values” Important?

October 22, 2012 By 2 Comments
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Over the years I’ve been asked whether there is a mutual fund family (or families) that I prefer.  My answer is generally

My Investments from the last year or so

along the lines that I choose mutual funds and ETFs based on screening and their fit in a particular client portfolio.  This is absolutely true but there are families that I do tend to use more than others.

For example, for the individual client assets which I custody at Schwab (which is the bulk of them):

  • Vanguard mutual funds and ETFs comprise about 22% of these assets.
  • PIMco mutual funds, ETFs, and closed end funds make up just over 10%.

In addition to Schwab I have individual clients with a smattering of assets at other custodians, including Vanguard.

A significant portion of my practice involves providing advice to several 401(k) plans, as well as a couple good-sized pension plans and foundations.  Both Vanguard and PIMco are well-represented, along with Fidelity.  In the case of Fidelity two of the larger 401(k) plans are administered by Fidelity and we do have a number of Fidelity funds in both plans (along with a number of non-Fidelity funds).

In the case of Vanguard I am drawn to their low cost index products, I rarely use their actively managed funds.  In the case of PIMco the bulk of the assets are in three of their funds. Their fixed income expertise and their research orientation are impressive.

A Sample 401(k) Menu

Beyond this a look at the funds and ETFs that I use would reveal no particular loyalty to any family or fund provider.  I am typically looking for something in a particular fund in a given asset class and I don’t really care which fund family they are affiliated with, unless I uncover some negative aspect about the fund company.  As an example, here are the fund families represented in one of the 401(k) plans for which I serve as advisor:

  • Vanguard (4 index funds plus their Target Date Funds)
  • American Funds
  • American Beacon
  • PRIMECAP
  • Artisan
  • BMO Funds
  • Northern Funds
  • Dodge and Cox
  • Oakmark

Red Flags to Look For

While I am fund family agnostic, there are however, some fund family red flags that might give you pause when considering an investment.  Here are three:

  • A sense of general turmoil.  Janus is a prime example of firm where this concern is prevalent to me.  The company is on its 5th CEO since 2003 and they have experienced a noticeable amount of manger turnover.
  • Refusal to close popular funds.  One of the things that I really like about Artisan (a relatively small fund firm in Milwaukee) is that they routinely close funds when they take on too much money for the managers to effectively manage.  Perhaps the “poster child” here is Sequoia who had reopened their lone fund in 2008 after being closed to new investment for over 20 years, feeling comfortable for the first time that they could effectively manage new money.  They just re-closed the fund once again in the past year.  It seems to be a rule that money follows performance.  A fund that has a couple of really good years will attract waves of new investors.  In my opinion it is irresponsible for the fund company to keep the fund open if they don’t feel they can effectively manage these inflows.  In my opinion this is the definition of greed overruling shareholder interests.
  • A commissioned or fee-based rep who pushes a particular fund family, especially if that family is also his/her employer.  A recent example involves a lawsuit against JP Morgan Chase alleging that their reps pushed the company’s proprietary funds over those from other families.  I suggest asking many questions of this rep if you like them, or better terminating the meeting on the spot if you are a prospective client.

As an individual investor I would caution you against loyalty to any fund family.  Rather start out with the overall portfolio allocation that you are shooting for and then pick the best funds/ETFs to fill those “buckets.”  Ideally this is an outgrowth of your financial plan.  As a practical matter you might be unable to buy some funds due to investment minimums and other factors.  However there are many custodians that offer access to a wide array of funds across many families.  I would generally suggest going that route vs. limiting yourself to a situation where you only have access to a single family or a very small number of fund families.

As is always the case, nothing published on this blog constitutes investment advice nor should you take it as such.  Please see the Disclaimer page for more.

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

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

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Vanguard Target Date Funds – A Look Under The Hood

October 17, 2012 By Leave a Comment
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I’ve written several posts on Target Date Funds for this blog.  I have mixed feelings about them.  On the one hand TDFs do

Vanguard

provide investors with a professionally managed all-in-one investment solution.  Ideally you invest in the fund with a target date closest to your anticipated retirement date and the fund does the rest.  The manager typically lightens up on equities over time until the fund reaches its Glide Path into retirement, which is a point where the equity allocation levels off and you “glide” into retirement.

This is great in theory, but the reality is that across various fund families TDFs with the same target date can vary widely in their allocations and as to when the Glide Path starts.  Personally I like TDFs more for younger investors versus those who are within say 15 years or so of retirement.  Target Date Funds have become a staple in 401(k) plans due to the safe harbor given to plan sponsors who use them as the default investment choice for those plan participants who do not make an election of their own.

Fidelity, T. Rowe Price, and Vanguard control about 80% of the TDFs assets.  Let’s take a look under the hood at the Vanguard Target Retirement funds.

Vanguard offers funds with target dates beginning in 2010 and going out to 2060 in five year increments.  Additionally they offer an Income version of the fund for those already in retirement.

Low Cost and Simple

Vanguard’s approach is both simple and low cost.  The underlying funds consist mostly of Vanguard’s low cost index funds.  The overall expense ratio of the funds is a weighted rollup of the underlying funds and currently ranges from 0.17% to 0.19%.  This is far less expensive than either Fidelity or T. Rowe Price and each of the Vanguard funds ranks in the top (lowest expense) percentile of their respective peer categories.

Solid Performance

  • Each of the funds from the 2010 through the 2050 fund received a top ranking from Fi 360 a mutual fund and ETF ranking service that I utilize in their most recent rankings through the quarter ended September 30, 2012.
  • The Retirement Income fund received a score of 6 from Fi 360 meaning that it ranked in the top 6% of the 211 funds in its category based upon the 11 ranking criteria used by the service.
  • The 2055 and 2060 funds do not have enough history to receive a ranking.

Glide Path and Asset Classes

Vanguard uses 7 asset classes in its TDFs; Fidelity uses 11; T. Rowe Price uses 12.  This is not good or bad, but does reflect Vanguard’s more basic approach.

Vanguard’s Glide Path levels off at age 72; Fidelity’s at age 80; T. Rowe Price’s at age 95.  The Glide Path assumes that the investor will hold the fund until death; this may or may not be the case in reality.

Are Target Date Funds the Right Answer? 

As mentioned above, I have mixed feelings.  On the one hand TDFs are often a better solution than simply letting one’s retirement plan assets languish in a money market account.  On the other hand I am convinced that investors who are either comfortable doing their own allocation or who utilize an advisor are generally better served by tailoring an allocation from among the menu of investment choices offered in their 401(k) plan.

As far as Target Date Funds go, I generally like the Vanguard version for their basic, easy to understand approach and their low cost.

Check out Morningstar to look under the hood of Vanguard’s Target Date Funds and to compare them against other alternatives that you might be considering.  Get a  free trial for their premium services.

Please feel free to contact me with questions regarding your investments and your retirement planning issue.

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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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Choosing a Mutual Fund – Avoid These 6 Mistakes

September 19, 2012 By 10 Comments
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Mutual Funds for Dummies ... U.S. Funds at War...

As of July, 2012 there were 7,699 U.S. mutual funds.  As a financial professional who does this for a living I have access to a number of data bases and screening tools to help me choose the right funds for my client’s portfolios.  I often wonder how individual “do it yourself” investors choose from among the available options for their portfolios. Choosing the right mutual fund is always tough, but picking the wrong fund can have dire consequences. Here are a few mutual fund selection mistakes to avoid.

Always assume that a “brand name” translates into a good mutual fund. This fallacy has never been more evident than during the recent arbitration award against JP Morgan in connection with its brokers pushing their proprietary high-fee, low performing mutual funds over those of other fund providers.  Even excellent fund families such as Vanguard have had problem funds over the years.

Relying on lists of top funds.  There is nothing wrong with these lists per se.  However, looking in the rearview mirror constantly is not a safe way to drive, nor is it a good way to choose a mutual fund. The common disclaimer in the investment world is that “past performance is not an indication of future results.” Last year’s top fund might continue to deliver top performance, or it might not.

Ignoring a fund’s history.  At the risk of contradicting my last point, it is instructive to look at how a fund performed in both absolute terms and relative to its peers during various types of market conditions.  For example did the fund lose more than other funds of the same investment style during the market drop of 2008?  Did it also gain less than its peers during the 2009, a year of recovery in the markets?  Also look at qualitative history.  Is the same manager who compiled the fund’s stellar track record still managing the fund?

Avoid funds you’ve never heard of. The 2011 Morningstar Domestic Equity Managers of the Year are from Artisan, a smallish fund shop based in Milwaukee. These managers run the large, mid, and small-cap value funds offered by Artisan. While the award was for 2011, this team has done a solid job over the past ten years under difficult market conditions. Unfortunately for new investors (but not for existing shareholders), two of the three funds managed by this team are closed to new investors.   Selecting a mutual fund is about research and fit with your investment objectives, not about the fund ads you might see in the press.

Assume all index funds are created equal. Nothing could be further from the truth. Different funds tracking the same index can vary greatly in their expenses and structure, which will impact their performance. Additionally there may be transaction costs for some funds at various custodians which can eat into your returns, especially for smaller transactions.

Assume that the fund companies have your best interests in mind. I’m not saying that any fund company is out to hurt investors, but on the other hand they are in business to make money. A number of fund companies are publicly traded.  Their first duty is to make money for their shareholders in hopes of increasing their share price.   New fund offerings are often the result of recent market trends, good or bad. Don’t invest based on the hype fund companies might create around these new offerings. Rather, invest with your goals, risk tolerance, and your overall plan in mind.

Choosing the right mutual fund, individual stock, or ETF is difficult. Make sure you select investments based upon solid research and based upon their fit with your overall portfolio.

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 – 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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