Completely wrong.
Another thing - don’t fear market corrections like what we have going on today. When the market is down think of it as buying stocks on sale. Those are the ones that will bring you the most as the market grows. You’ll be shocked at how quickly your 401K grows, and how far it grows if you can just keep your hands off of it for 30 - 40 years. Even a modest monthly investment that you start in your 20’s can easily be worth over a milion at retirement.
It is easy to beat index funds, and 40% or so of fund managers do it every year. Of course, the ones that do it this year aren’t the same ones that will do it next tear, and if you look it’s all just random variation, but with there being thousands of mutual funds out there, there are a few that will have beaten the index four or five years in a row, just like red will come up on a roulette wheel repeatedly. It just doesn’t mean anything.
You ever notice how the only people who say this are the people who sell actively-managed funds?
Burton Malkiel came to the same conclusion in 1973. Things haven’t changed that much since then.
If you’re concerned about the financial health of your employer’s 401k plan, they have to put out financial statements for it completely separately from their own financial statements. Assuming they’ve been audited by a competent firm, if the company shows that they have all these assets in investments in the fund separate from the main bulk of the company assets, you don’t have anything to worry about. If they don’t have separate 401k plan financial statements, then that’s a red flag that they don’t actually have that money set aside for you.
There also was a time when the main thing that a lot of people did, or perhaps were even forced to do, was keep their 401k account only in company stock. This is obviously a terrible idea from a risk management perspective, as you’re completely tied to the health of the company. 401k plans now should be offering a variety of investment vehicles that can either give you guaranteed growth, at a cost of failing to make the best returns, or returns that pretty well match the market, and your money should be divided between them based on your risk appetite.
Look, I feel like I’m fighting with one foot in a bucket here. I hope you understand that. And I want to make really clear that I resent the implication friedo makes in his post of 2:34pm.
But the index issues are very clear. The way the problem is often set up it’s shown that active fund managers don’t beat the indices every year. As if it were a failure to not win 100% of the time. This is, by many, now treated as revealed wisdom.
But that’s not the issue. The issue is whether more can be made via responsible active management on average over time. If you insist that it must beat the index each year it’s a mugs game because you’re not extending the same requirement - which no one could fulfill - to the index.
To begin with, as I said, I can’t mention specific funds or equities that do so in this forum - though I’m glad to have a private chat about it on request. I carry in my wallet a list of eleven individual equities - there are more but that’s what I could fit on the two stickies I used - that have outperformed the S&P over the last ten years. Ditto with an entire series of managed funds - again, which I can’t name here.
I know that’s cheesy, but I hope you’ll bear with me that I enjoy my job and don’t wish to lose it.
Easily raised objections:
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Ten years? Am I picking convenient end points? I choose 10 years because it’s easy to produce in Morningstar and I was at work on Saturday and a bit grumpy. What I’m attempting to point out is that it’s possible to use available data to make decisions about which funds - and fund companies, more importantly - are properly managed and have good decision-making processes.
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But funds come and go all the time! How can one choose? Surreall’s link in the post of 2:11pm indicates that on page 2 they take ‘survivorship’ into account. That means they track all funds, living or dead, into account. On the surface - and I won’t go much into the fact that cite is essentially bragging on how awesome index funds are when they’re run by a company pushing index funds - that sounds good. However, one of the secrets behind investing is to choose good, well managed, good track record funds. I would never recommend something without 25+ years worth of good performance to my clients.
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Fees! Won’t it cost me a ton? That depends. Some mutual funds are very expensive. Some are less and some are in the middle. They also vary based upon the amount invested and the investor can choose upfront fees, annual fees within a fund family or even a straight managed money account where a fee is charged each year based on total amount under management.
I’m actually a big fan of the proposed DoL rules that limit fees that brokers can charge. This makes me…a bit of an outsider among my peers. But some of the independents can charge as much as 4% (The highest I’ve heard. Some may be higher.) annually. The proposed DoL rules expand the requirement of fiduciary interest that brokers will have toward their clients. That means they would be requiring my colleagues and I to find the lowest fee possible approach that suits the clients life stage, sophistication and risk tolerance.
The secret - and I bet we all agree on this - is that one should purchase good investments and hold them for the long term. This allows one to minimize charges - whatever they might be - and to allow the investments to mature. It does cause a certain amount of capital gains issues over time but I haven’t run into a client yet that has given me a hard time about how much money they’ve made!
Again, here are some examples. Which would you prefer. I’m scrubbing the ticker symbols as a ‘JC likes to eat’ measure.
Ten Year Review
S&P500 110.43%
TKR 1 184.43%
TKR 2 150.77%
TKR 3 130.91%
TKR 4 152.07%
TKR 5 112.51%
TKR 6 141.06%
TKR 7 230.02%
TKR 8 336.56%
TKR 8 132.29%
TKR 9 127.26%
TKR 10 443.28%
All of these are widely traded, easily purchased index equities. Each of them would be an obvious choice for an all-equity portfolio. Each of them beat the S&P over the trailing 10 year period.
In terms of Bill Door’s argument that 40% beat the index each year - the question is who - and when someone does it five years in a row it’s random? That’s answered in my discussion above regarding average return over time. If you require a manager to beat the index every year then yes, they’ll fail. But that’s an unrealistic - and again fallacious - goal. The idea is how much they outperform on average. It’s also where and when they tend to outperform.
In this piece from Forbes, it’s pointed out as has been made clear by history, that in a rising market which funds outperform has a strong random chance in it. But in down times actively managed funds tend to outperform the indexes.
Here’s another cite on active management - this time about ETF investing. It uses real-world data from portfolios that contained both index ETFs and individual equities that were actively managed. It found that the active part of the portfolio tended to outperform the passive part.
I could go on, we both know. But what I’m trying to demonstrate is that we can both play cite-war, here. The end takeaway should be that arguing ‘index good!’ is far too simplistic to be a strong argument as there are plusses and negatives to both forms of investing.
That doesn’t even get into the craziness of tax efficiency, short- and long-term needs investing, generational transfer and all the other factors that go into proper investing and money management.
And Jesus, it was a long day today.
I’ll cope with this as a separate post here, then I’m going to bed anticipating another fun-filled day tomorrow.
There are two large worries in 401k investing.
First, look for the expense ratio of the funds you have. I’ve seen simple bond funds with annual costs in the 1-1.5% range. That’s downright silly. It comes about depending on how the plan was set up by management and the 401k manager. The two can choose to pay a higher annual fee from the company - and therefore charge less - possibly only a fee on each purchase of a point or two - or the company can pay less and the brokerage can charge an annual fee on all assets under management. Guess which one costs more in the long run? All expense ratios should be disclosed in the plan documents but in my experience not one person in a hundred actually reads them. I review them at times for my clients - when I don’t manage their 401k plan - and point these things out to them.
The second is annuitization issues. Some retirement plans automatically invest in an annuity for each employee. That can be fine in some instances but terrible in others. I’ve seen some where an employee has left an employer but the annuity was set up in such a way that they can’t roll it over to a new 401k or a traditional IRA. If the plan says it will annuitize your contributions read the fine print about rollovers and employment termination.
That’s utterly unconvincing. Given the sheer number of funds out there, of course there will be many that outperform the market. By chance alone, about one in a thousand randomly-chosen funds will have a ten year streak of “beating the market” each year (more precisely, the probability of achieving 51st - 100th percentile returns for 10 consecutive years is 0.00080.)
If you look through the paper, however, it found that the underperformance of ETFs (in real-world portfolios) was basically due to retail investors using ETFs to (poorly) time the market. The authors of the paper find that if the investors instead just used a buy-and-hold strategy with ETFs, then the ETF part of their portfolio would have matched the actively managed part.
That’s a very different point, and doesn’t support your argument that it’s “relatively easy” to outperform index funds.
Yes, it is rather easy to identify winners after the fact, but are you suggesting that just because a fund outperformed it’s respective index in the past that it will continue to outperform in the future? Clearly this is not the case:
I’ve heard of *pensions *being poorly managed, but with a 401-K, there are options for how you want to invest. Do you have examples of poorly managed 401-Ks?
If you’re young (more than 20 years until you retire), you probably want a mix that’s really heavy in one or two mutual funds. You can afford more risk when you’re young, and long-term, those have the highest returns of what’s typically offered in a 401-K.
And that’s practically an exact match to the results you would expect by chance alone. 2862/4 * 0.25^4 = 2.8.
FWIW, when I was doing my own research a while ago I came across a few papers (that I can’t find now…) that showed there was good statistical evidence that a very small fraction of fund managers can consistently beat the market. Basically, the distribution of fund returns has slightly fatter tails than an empirical distribution of randomly-selected funds.
That also includes a fat tail on the low end of the distribution, meaning there’s a small fraction of fund managers that are consistently worse than a monkey with a dartboard…
yes
In terms of retirement savings for most people, I suspect that investing in the worst fund in your 401k is better than doing nothing. I suspect that the people who don’t invest in their 401k are also not saving any sort of significant retirement savings at all. They end up getting to retirement age with just whatever happens to be in their checking account at that time.
So if some is asking “Should I invest in my 401k?”, the answer is almost certainly yes, because if someone is asking that question, they likely don’t have a lot of investment experience. The person asking that type of question likely is not making any type of retirement savings. So having some saving plan is better than none, even if it’s investing in the worst fund in their 401k.
So for you newbie investors, don’t get overwhelmed with all the choices and decide to do nothing. Put something in your 401k. Even you pick the worst fund, you’ll still end up with more retirement savings decades later than if you didn’t use the 401k. Use the advice in this thread and others about which fund to choose, but don’t get too hung up on feeling like you have either have to pick the best fund or do nothing.
Investing in just one or two funds is riskier than holding a more diversified portfolio, but one cannot expect to be compensated for this sort of risk (unsystematic risk/idiosyncratic risk/uncompensated risk/diversifiable risk) . There is no reason for you to expect higher returns for taking a risk that could easily be diversified away.
I’m hard-pressed to think of anything significantly more diversified than the three-fund Vanguard portfolio (Total Stock/Total Int. Stock/Total Bond).
In my 401(k) I really can’t get any more diversified than 4 funds: S&P500/International Index/Russel 2K (which is pretty lousy so I skip it and use a completion fund in a different account)/Bond Index or Stable Value. Adding anything else available may appear to increase diversification, but really just weights toward a particular sector.
I do agree that, in general, reducing diversification is uncompensated risk. I just wanted to point out that when dealing with mutual funds, adding another fund often doesn’t increase diversification (in fact sometimes it reduces it by over-weighting one part of the market unintentionally).
The point of a fund is that it is diversified. Maybe you want a couple if you want a more conservative large cap mix for some part of your money and more aggressive growth strategy for some other part.
Mine was poorly managed enough that the company ended up paying 30 million dollars to settle a class action suit for breach of fiduciary duty. Does that qualify?
Excellent post. I think you are definitely seeing the forest, not just the trees. I would add that someone who is in their 20s, 30s or 40s doesn’t want to be too timid or risk-averse, either.
All of this does take a bit of education, but it really isn’t overwhelming. I know there are people out there who think CDs are appropriate for IRAs and 401k accounts, and not just as a small portion. You are not going to build a decent retirement account if CDs and low-risk bond funds make up a large portion of your retirement accounts.
I’ve heard of young people picking funds or pension “vehicles” that promise to “protect your investment” from losses. Nobody wants to lose money, but you shouldn’t be too scared of a down market when you have decades to recover. Three or four funds that cover the US market, overseas markets and both large and small cap stocks are plenty. And then add in some bonds. A three-fund plan similar to that mentioned by Jas09 would be a great foundation for a retirement account. Or just choose a “balanced”, or “life strategy” or “target retirement” option that does the diversification for you. Pick one with a low expense ratio and then don’t worry about it.
Sure. Could you expound on the nature of the poor management? Were people making financial decisions for you? Or just committing fraud by not putting money into the accounts when they were supposed to?