Emotions Harming 401(k) Returns?

401(k) investors are running for the hills. As they see the values of their 401(k) plans plummet, they are pulling their money out of equities (ie. stocks) and putting it into fixed income investments (ie. bonds/stable value). This according the the Hewitt 401(k) Index.

In most cases, this probably isn't the wisest decision. It's not easy watching your retirement funds, and the hopes and dreams they represent, as they seem to melt away. But the stock market is a roller coaster. It has it's ups and downs. Fortunately for investors, historically the ups have far outweighed the downs.

Unfortunately for investors, emotions take over when it comes to investing and their money. This usually makes investors buy when things are soaring and sell when things are tanking - the exact opposite of what they probably should be doing.

As Warren Buffett once pointed out, if you were going to buy a hamburger or a car, would you hope the prices of hamburgers or cars go up or down? Obviously, you'd want them to go down.

Same for stocks. The only people who should be hoping for higher stock prices are those want to sell them. Everyone else should enjoy the bargain the market is now giving them. When stocks go on sale, those who cast their emotions aside and buy can really pad their long term returns. These are the times savvy investors make their fortunes in the stock market.

As is often the case, no one has said it better than Buffet himself . . .

"Be fearful when others are greedy and greedy when others are fearful."

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Will 401k Plan Participants Finally Get What They Deserve?

Could it be? Are 401k plan participants finally going to get the information they rightly deserve?

A few weeks ago Congress was unable to pass legislation that would provide more information on the fees 401k plan participants are paying. According to an article in USA Today, it looks like the Labor Department may be stepping up to help the 65 million Americans who are invested in 401k, and similar, plans.

The proposal would require employers to disclose more information about the fees in their plans and do so in a clearer format. From the article . . .

Employees would receive details about investment expenses and past performance in a chart or similar format to allow them to easily compare fund options. Retirement plans would also be required to compare funds' investment performance with a benchmark index, such as the S&P 500. Additionally, for the first time, the plan would have to disclose each quarter the dollar amount that each participant pays for administrative services such as accounting and recordkeeping.

This proposal definitely looks like a big step in the right direction. However, it's not a done deal. We'll keep an eye on how this progresses and keep you informed as more details and information about this proposal become available.

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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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401(k) Fee Smoke and Mirror Show Continues

Score another one for those with the deep pockets.

Last month, with very little media attention, H.R. 3185, which would have required greater disclosure of 401(k) fees to plan participants, was defeated. Bill sponsor, Rep. George Miller, D-CA., announced that the bill would not be passed this year.

One of the main arguments from the 401(k) industry and the Department of Labor is that the bill would make disclosure of fees to plan participants more complex and expensive than it needs to be. So, in other words, they're saying it would cost more money to disclose the ridiculously high fees they are already charging (and legally hiding from) plan participants.

Well, the 401(k) industry may be right about this bill being more expensive, but only for them - not plan participants. We believe the bill would result in lower expenses overall for many plan participants. It would finally give participants easier access to the information they need to pressure employers to offer lower cost 401(k) options that don't unneccesarily erode their retirement savings.

We think H.R. 3185 is a very good step in the right direction. We hope the House will take it up again next year and that it will pass. 401(k) plan participants deserve to know exactly what their plans are costing them.

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Focus on Fees: The 12b-1 Fee

The 12b-1 fee has been described as one of the darkest secrets of the mutual fund industry. While we think the industry has much darker secrets, the 12b-1 fee is one investors need to keep a close eye out for.

The 12b-1 fee is an annual fee that generally ranges from 0.25% - 1% and is included in the expense ratio of the fund. It is ostensibly used to cover the marketing and distribution expenses of the fund. In that vain it’s basically a way to collect an additional fee from investors to pay for the TV ads and glossy brochures they produce to attract new money to the fund. However, as we'll discuss in a moment, that's not the only thing mutual funds use this fee for.

The 12b-1 fee is an example of what can happen to the best of intentions. The SEC authorized the creation of this fee in 1980 thinking that it would help investors. The idea was that in marketing a mutual fund, the fund would increase its assets, which in turn would lead to lower annual operational expenses through economies of scale. Investors are still waiting for their lower expenses.

As for the dark secrets about the 12b-1 fee:

• Very little of the 12b-1 fee typically goes toward marketing expenses. It’s more commonly used as a hidden way to pay brokers for using the fund in their clients’ portfolios.
• There are closed funds (funds that no longer are taking money from new investors) that still charge 12b-1 fees. Why would a fund that isn’t accepting new money need to market itself? Good question. However, a closed fund would sure want to keep paying the brokers who’ve invested their clients’ money in the fund happy!
• Some no-load funds charge 12b-1 fees. The fee can be a way of implementing a hidden load that drains money from investors’ returns. There’s a good illustration of how this works here: http://mutualfunds.about.com/od/fundfees/l/bl12b1fees.htm
  

Where to find information about 12b-1 fees

In our last few posts in this series we’ve sent you to Google Finance to see the fees associated with mutual funds. Google Finance, however, does not have information on 12b-1 fees. Morningstar.com does, however. Here’s the fee information on a Franklin Templeton Fund. On the right side of the table, the very first fee listed is the 12b-1 fee. You can see for this fund it is 1%.

This information is also available in a fund’s prospectus.

The Bottom Line

Whether it’s used to market a fund and/or pay a commission to brokers, the 12b-1 fee does nothing good for investors who pay this expense. There are plenty of funds out there that don’t charge this fee. And with no evidence funds that charge 12b-1 fees outperform those that don’t, investors are better off avoiding these fees.

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"401(k): Hidden Fees" Investigative Report on Bloomberg TV

An investigative report on hidden fees in 401(k) plans premiers on Bloomberg TV tomorrow night (Thursday, June 19 at 7PM and 9PM EST).

The report will cover how fees are eating away at 401(k) balances without plan participants even realizing it and how even financial experts have trouble uncovering these fees. If you have a 401(k) plan, and especially if you sponsor one, be sure to tune into what we're sure will be a truly enlightening report.

To get more information go to Bloomberg TV and look for 401(k): Hidden Fees - What's hiding in the fine print of your 401(k).

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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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