WSJ Struggles to Find 401(k) Expenses

If a reporter from the Wall Street Journal has trouble figuring out what she's paying in 401(k) plan expenses, what chance do the rest of us have?

In an interesting article today, WSJ reporter Karen Blumenthal opened up the hood on her 401(k) account to take a look inside. She got some fee information from her plan provider's website, some from a "Summary Plan Description" from her company's HR department, and some from Morningstar. Even after going to three separate places, there was still one fund in her plan that she couldn't get information for.

Hopefully, the new DOL proposal requiring more fee and fund disclosure on 401(k) statements will help reduce, if not eliminate, all the legwork 401(k) plan participants have to do to get fee information.

A few other points of note from the article:

1. This paragraph toward the top of the article is about the relationship between fund expenses and performance.

"In almost every study we've run, expenses show up as a very significant predictor of future performance," says Christine Benz, director of personal finance at Morningstar Inc., the investment research firm. In other words, over time, funds with lower fees are likely to outperform those with higher fees in the same category. By contrast, says Ms. Benz, "our data indicates that past performance is a weak indicator" of future results.

2. The reporter's plan is better than most. Her employer covers many of the administrative expenses, there are index fund options, the expense ratio data (for most of the funds) was fairly easy to find, and the funds had no loads.

To read the entire article, click here.

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A Financial Headline You'll Never See

Did you catch this story that made big news last week? The Yahoo! headline read:

"Ex-hedge fund manager ordered to pay $300 million."

It's about former hedge fund manager Paul Eustace who, according to the Commodity Futures Trading Commission, "cheated clients by sending out fake account statements." Evidently Eustace told clients that their portfolios were valued at over $230 million while he "fraudulently operated the funds and lost millions of dollars."

So what's the financial headline I bet you'll never see?

"Ex-index fund manager ordered to pay $300 million"

I wonder how many more millions of dollars Eustace's clients would have in their portfolios right now if they had just put all their money in a low cost index fund or ETF instead of a risky (and evidently fraudulent) hedge fund.

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More 401(k) Problems?

Here's an article from IndexUniverse.com titled "Auditors Finding More 401(k) Problems".

The article talks about the IRS is finding a "substantial" increase in the number of compliance problems in 401(k) plans. Not surprisingly, the problem is especially troublesome for small businesses.

It's a short article, and worth a quick read. We especially agree with the sentiment in it's conclusion:

"So what does this all mean for index investors? It could be another sign that pressure is building to clamp down even more on the use of high-priced actively managed funds."

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A Blue Ocean Plan for America’s Investors

Big news this week in our town. Our beloved Anheuser-Busch agreed to a buyout by Belgium brewer InBev.

Throughout the merger talks a lot of attention has been focused on AB’s so-called "Blue Ocean" plan which targets savings at the company of $1 billion dollars over the next three years.

We’d like to propose a similar Blue Ocean plan for American investors. It’s estimated that investors are currently shelling out around $100 billion dollars annually in fees to Wall Street. That’s about twice what InBev paid for our beloved AB. And as we've already discussed on this blog, investors are getting worse than nothing in return for this money.

It’s time for investors to get serious about doing some big cost cutting in their investment accounts. As you’re watching your portfolio’s value drop like the level of Bud in kegs at a frat party, take a close look at the fees you’re paying.

Think about what you’re getting in return.

Think about how those fees are further depleting your account balance.

Think about the studies that show the performance of low cost index funds beats 80% of actively managed funds in any given year.

Think about how much more money you could have in your retirement fund, 401(k) plan, endowment, foundation, or child’s education fund if you weren’t paying ridiculously high fees for suspect investment advice.

So investors, we urge you to follow the example of AB-InBev and do some significant cost cutting of your own.

And while the ultimate ramifications of AB’s Blue Ocean plan remain to be seen, we’re confident that implementing your own Blue Ocean plan in your investment portfolio could end up being one of the smartest decisions you ever make.

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Focus On Fees: The Sales Load

When it comes to mutual funds, a load is another name for a sales fee that investors may pay to a mutual fund company for buying or selling shares of a fund. Think of it as a commission that the fund company gives to brokers who sell the fund to investors.

A load mutual fund charges this fee to investors, a no-load fund does not.

Loads usually cost between 4% - 8% which comes directly out of investors’ assets. The Financial Industry Regulatory Authority (FINRA) has capped sales loads for mutual funds at 8.5%.

There are two main types of loads:

Front-end loads are paid when you purchase shares in the fund. If you invest $100,000 in a fund with a 6% front-end load, you will pay $6,000. That means only $94,000 of your money will actually get invested in shares of the mutual fund.

Back-end, or deferred loads, are paid when you sell or redeem shares of a fund. Back-end loads are usually based on either the amount of your initial investment or the value of the investment when you sell shares – whichever is lower. If you invest $100,000 in a fund with a 6% back-end load, the full $100,000 gets invested in the fund. When you sell, however, you will pay $6,000 as long as the value of your investment is still $100,000 or more. If the value of your investment has dropped to $90,000 when you sell, the sales charge will be $5400. This is not always the case, however. You could end up paying a deferred load on the full amount of your investment if it increases in value.

One last note on back-end loads. The amount of the load may be affected by how long you own the fund. For example, the load could be 6% if you sell within the first year then drop to 5% if you sell in the second year and go away completely after some timeframe. To find out how the deferred loads are calculated check a fund’s prospectus. (Or, better yet, just stick with no-load funds so you don’t have to worry about this.)

There is a third, less common type of load - the constant load fund. Constant load funds charge an annual sales fee to investors. The loads on these funds tend to be lower than those of front-end and back-end mutual funds. To offset these “lower” fees, however, these funds will usually have higher expense ratios than those with front or back end loads.

As is the case with expense ratios, it’s pretty easy for investors to find out what the load is for a mutual fund. You can find it in the fund’s prospectus or on your favorite finance site.

Let’s look at the page for the Vanguard Small Cap Index fund on Google Finance. On the right side of the page under “Key Statistics” there is a line item for “Front load” and “Deferred load.” In the case of this fund, there are no sales charges so it is considered a no-load fund.

Next, let’s look at the page for the Fidelity Advisor Small Cap Value A fund. Notice that next to “Front load” in the Key Statistics section this fund has a load of 5.75%.

Lastly, we’ll look at the page for the Fidelity Advisor Small Cap Value B fund. This is a back-end loaded fund, as seen by the 5% listed by “Deferred load” in the statistics.

(Quick side note: funds that are designated as having Class A shares usually have a front-end load, Class B shares usually indicates a fund with a back-end load. In the case of the Fidelity funds above, they are basically the same funds containing the same investments. The only difference is when they charge the load to investors.)

The most important lesson for investors when it comes to loads can be illustrated by looking at this chart. It compares the returns for the funds we looked at above. As you can see, the no-load Vanguard index fund greatly outperformed the two loaded Fidelity funds. In fact, over the past 5 years, if you had invested in the Vanguard fund, you’d have over 3 times as much money in your account than if you owned either of the Fidelity funds.

In all fairness, there are probably some loaded small cap value mutual funds that have outperformed the Vanguard index fund. However, while Wall Street and money managers would like you to believe otherwise, paying a sales load for a mutual fund does not guarantee a higher return. There is no evidence that load funds can outperform no-load funds.

Paying a load does guarantee two things:

1. Your broker will make more money than if you bought a no-load fund.

2. The fund will have to outperform the market – and then some – in order for you to just match the returns of an index fund.

When it comes to sales loads on mutual funds, it’s best to follow the advice most commonly given by everyone except those who sell loaded mutual funds: avoid them and stick to no-load funds.

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Warren Buffett Big Bet Against Hedge Funds

An interesting wager between Warren Buffett and Protégé Partners LLC, a money management firm that runs funds of hedge funds, became public recently.

Buffett has long held that the best investment for most investors in the simple index fund. He believes, as do we at Blue Ocean Portfolios, most investors will achieve better returns over the long haul by NOT paying money managers to actively manage an investment portfolio.

Protégé disagrees.

So Buffett and Protégé each put up about $320,000 on a wager over whether Vanguard's S&P500 index fund will outperform five funds of hedge funds selected by Protégé over the next 10 years. The winner will be decided based on total average returns net of all fees, expenses, and costs. Proceeds of the bet go to the charity of the winner's choice.

The question for you as an investor is: Would you bet against Warren Buffett?

For more details on the wager see the CNN Money article here.

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Want to Know Warren Buffet's Single Best Investment Idea?

Last weekend Berkshire Hathaway shareholders made their annual pilgrimage to the company’s annual meeting to hear the Oracle of Omaha and his partner, Charlie Munger, share their wisdom on investing.

One shareholder asked what is the single best specific investment idea that Mr. Buffet would recommend to an investor in their 30s.

The answer?

“I would just have it all in a very low-cost index fund from a reputable firm, maybe Vanguard. Unless I bought in a very strong bull market, I would feel confident that I would outperform . . . and I could just go back and get on with work.”

Wall Street has spent billions of dollars trying to convince investors that their money managers have special skills, powers or magical abilities that enable them to regularly outperform the market.

And here, the man widely regarded as the Greatest Investor Who Ever Lived, says the low-cost index fund is his best investment idea. Not only that, but he thinks investors who use index funds will “outperform.”

So you have:

• “Low cost”
• “Outperform”
• A strategy that lets you “go back and get on with work” or whatever else you want to do (ie. peace of mind)

So tell me again why investors paying money managers around $100 billion a year to try to beat the market?

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Avoid This $100 Billion Scam

$100 billion dollars.

That’s what investors are collectively paying Wall Street every year in an attempt to beat the stock market. This according to the results of a new study, “The Cost of Active Investing,” by Dartmouth Professor Kenneth R. French.

So what do investors get in return? According to Professor French’s research, worse than nothing. In fact, the study finds that if investors had simply invested in a passive market portfolio (ie. index funds) between 1980 and 2006, they would have boosted their average annual return by 67 basis points.

And as we've written about before, Small Percentages Add Up To Big Money.

There’s an excellent article in the New York Times that examines this study in more detail. The bottom line?

“The best course for the average investor is to buy and hold an index fund for the long term. Even if you think you have compelling reasons to believe a particular trade could beat the market, the odds are still probably against you. “

You can read the New York Times article here.

You can download Professor French's study here.

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Great Tool for Investors: Mutual Fund Expense Analyzer

Want to find out exactly what your mutual funds will cost you in fees?

Here's a great little tool from the Financial Industry Regulatory Authority (FINRA) to help you do that:

http://apps.finra.org/investor_Information/ea/1/mfetf.aspx

It's a calculator where you select the mutual fund you own from an extensive list (you even enter what share class you own ... A shares, B shares, etc.). Then enter the amount you have invested, the expected annual return, and the holding period (the number of years you plan to own shares).

The calculator then shows you what your investment will grow to and how much you will pay in fees over the timeframe selected.

You can also compare funds. Try entering funds that your investment advisor has bought for you or you selected for your 401k/403b plan. Then compare that to the equivalent Vanguard index fund or ETF. The difference in fees can be eye-opening.

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The Huge Gap Between Fund Returns and Shareholder Returns

They’re hard to ignore.

Those eye-popping returns featured in the ads for the mutual fund industry are very attractive. Why try to match the market when it looks like you can smash the market by investing in the right mutual fund?

Unfortunately, things are not always as they appear.

At a talk to the Financial Industry Regulatory Authority, John Bogle, the founder of Vanguard, shared some startling data.

Returns for the S&P500 from 1980 – 2005: 12.3%

Returns of the average fund from 1980 – 2005: 10%

And how well did investors do in that time period? No one knows for sure, but it appears they did much worse than 10%.

As an example of how bad investors might have fared in that time period, Bogle looked at the returns of the 200 funds with the largest cash inflows from 1996 – 2005. Those funds reported average returns of 8.9% for the period. The dollar-weighted returns (the returns shareholders actually earned) were an abysmal 2.4% - just 25% of what the funds themselves returned.

Of course the fund industry will say that it’s the investors fault for not staying fully invested during that time. Bogle has a different view however. He sites 3 main reasons that the mutual fund industry plays a big role in the dismal returns actually earned by investors.

1. “It was we in the fund industry who created those new funds that were to create such havoc for investors. As the market soared ever higher, we introduced those 494 brand new “New Economy” funds. Only a precious few of the major fund marketers had the courage to stand firm against the market madness, and forbear from creating and offering such funds.

2. When we had funds whose performance turned “hot,” we marketed them aggressively. Our public relations departments were willing co-conspirators with the press in establishing interviews with our “star” portfolio managers, many of whom, inevitably, turned out to be comets.

3. The higher a fund’s performance soared, the more we advertised our returns. Example: In March 2000, the month the market hit its high, there were 44 equity funds that advertised their performance in MONEY magazine. The average advertised annual return was +86 percent. Imagine! (During the next three years, these funds were to plummet by 39 percent.) Unsurprisingly, after the fall, in the October 2002 issue ofMONEY there were only four funds that did so.”

We have two lessons here:

1. Invest for the long term. Market timing does not work.
2. The “eye-popping” returns featured in the ads for actively managed funds are very misleading. The overwhelming evidence out there indicates that investors would be much better off investing in low cost, passively managed index funds.

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How Golf Can Make You a Better Investor

Imagine shooting par every time you play golf.

It doesn't matter whether you're playing Augusta National or your local public course. It doesn't matter whether it's a beautiful, warm sunny day or a cold, blustery, rainy one. You are guaranteed to shoot par.

Do this over the course of your lifetime and your performance will surpass all but the Tiger Woodses of the world. In fact, shoot par day in and day out and you'll probably end up in the Golf Hall of Fame!

This is because par is not average. Par is just the benchmark all golfers use to measure their performance. Most golfers will never beat par in their lives, let alone do it consistently.

For investors, the index (usually the S&P 500) is the benchmark used to measure their performance. And as is the case with par in golf, the index is not average.

Most investors will fail to match (let alone beat) the index. Even the investment "pros" usually fall short of the benchmark. In fact, in any given year approximately 80% of all mutual funds underperform their benchmark index.

How to Shoot Par With Your Investments

The good news for investors is that it's easy to "shoot par" when it comes to investing. By investing in index funds or ETFs, investors can tie their returns to those of the index. No matter what the situation or what the market conditions, index investors will achieve returns that match the index.

Do this over the course of your lifetime and you can increase your odds of a comfortable retirement – which will give you plenty of time to work on that golf game!

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Winning With Index Funds

The video below from Money Talks News compares running a sports team to running a mutual fund.

While it's probably wise to bet on the sports team that has a highly compensated manager calling the shots, that's not the case with mutual funds.

Watch the video to find out why . . .

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Good Companies, Bad Stocks?

There are many aspects of investing that still remain somewhat mysterious.

William Bernstein, is his book The Intelligent Asset Allocator, made me ponder this when he profoundly stated:

“Good companies are generally bad stocks, and bad companies are generally good stocks.”

You may remember the best selling book back in 1982, In Search of Excellence, by Tom Peters. This book objectively discussed the characteristics of what Peters considered the best companies at the time. Peters cited 40 companies who, by his criteria, were “excellent” companies.

In 1994, a researcher named Michelle Clayman from Oklahoma State took the same criteria and made a list of “unexcellent” companies or, in other words, companies which would have scored the lowest based on the criteria set forth by Tom Peters.

Clayman discovered that if an investor would have bought one portfolio of excellent companies and another portfolio of “unexcellent” companies, the “unexcellent” portfolio would have outperformed the excellent portfolio by an amazing 11% per year over the next five years!

Similar evidence is apparent in the Dogs of the Dow Theory. The dogs, as represented by the ten highest dividend yielding stocks, have generally outperformed the overall Dow 30.

This notion may be at the heart of why so many professional money managers and individual investors under-perform versus their benchmark. As William Bernstein stated:

“No matter how many finance journals they read, they cannot bring themselves to
buy bad companies.”

Indexed-based Exchange Traded Funds do not take a position on whether the companies in the underlying index are good or bad. They have a broad representation of both “excellent” and unexcellent” companies.

The positive stock market move in recent years has made a lot of professional managers look smart. But do not be fooled. Ask the question, “How much of the return generated by a money manager or mutual fund can be directly attributed to the underlying market?”

You may be surprised when you discover that the underlying market actually produced higher returns than most active money managers and mutual funds!

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The Upside of a Down Market

The recent market fluctuations have many investors running for the exits. Those who are selling in a panic, however, are missing out on a golden opportunity. How so? One only needs to turn to another dose of wisdom from Warren Buffett to find the answer.

"If you expect to be a net saver during the next 5 years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."

Investing in a falling market is when savvy investors can really pad their long term returns. Trying to time the market, however, is a losing game.

So how can you stay sane in a tough market and take advantage of it when investments are on sale? Simply stick with these sound investing principles:

1. Take advantage of dollar cost averaging by investing a set amount on a regular basis. You'll automatically buy more shares when prices are low and fewer shares when prices are high.
2. Diversify through asset allocation. Assets classes act differently. While large cap stocks are going up, small caps may lag behind. By using asset allocation to diversify across a number of different asset classes you will minimize the negative impact a drop in any one asset class has on your savings.
3. Regularly rebalance your portfolio. Besides keeping your portfolio in line with your investing goals, rebalancing will also automatically ensure that you buy low and sell high.
   

Following the above tried and true principles, as we do here at Blue Ocean Portfolios using low cost ETFs and index funds, will help you take advantage of the opportunity market volatility creates.

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