Friday, May 20, 2011

Good news/Bad news

While we have all been, on occasion, asked to choose between the good news and the bad news, when it comes to your 401(k), both sides of the question mean something. Today, I'd like to look at some of the good news, bad news that has been coming out of the world of the 401(k).

Good news: People continue to contribute to their 401(k). A recent Investment Company Institute report found that only 2.4% of investors using this sort of plan did not contribute in 2010. This is considered a generally good statistic for two reasons: the resurgence of the company match may have prompted more people to begin to contribute more in 2010 than they did in 2009 (3.4% ceased contributing) and two, the stock market rewarded these folks for doing so. This means that account balances also increased.

Bad news: Those who did continue to invest actually pulled money from the equity side of the investment equation. The ICI was confused by the pattern, which typically dictates that when the stock market does well, investors tend to increase their holdings rather than withdraw. The shift they suggest may point to a lower risk tolerance which doesn't necessarily explain why there was an increase in international exposure.

Good news: There is a much clearer understanding of the risks involved in the investment world. Although there are still a sizable number of senior investors (those at least 65-years-old) who are willing to take above average risks with their portfolios, most recognize the danger in doing so.

Bad news: too many younger folks are unwilling to assume risk via equity investments. While 10% of the 65-year-olds reported they take on above average risk, their counterparts in the  35-to-49 age group admitted that they do as well. Defining above average risk is often difficult to do. Related to a balance of investments, with popular sentiment suggesting a gradual decrease in more volatile investments (equities) to more conservative ones (bonds, fixed income), this group may be making these adjustments too soon in their investment lives. If, as popular sentiment suggests that we will work longer, a 35-to-49 age group could possibly be leaving a certain amount of aggressiveness untapped. If you are thinking that you will work until 70[years-old and beyond, a 35-year old should invest in much the same way as 25 year-old would have just ten-years ago.

Better 401(k) choices
Good news: There has been over the last several years, an acknowledgement of sorts from the plan sponsor world that better choices for their participants is directly correlated to the types funds offered. Fees dominated the conversations held by plan sponsors and administrators as those that used their plans turned their focus on how much each investment was costing them. Plan costs eat away at potential returns. So many plans reduced the number of funds offered and with those reductions, the types of funds offered. The shift to a larger selection of index funds and target date funds may have helped create a better investment environment for those using the plans.

Bad news: As fees were lowered amongst the plan's offering, the plan itself became more expensive. This change in how the fees are levied make both the newly low-cost funds offered simply appear as if this were a bait and switch. Fee disclosure will only increase in the coming years as the Department of Labor looks to better reporting of these costs. The trouble is you may not where to look and may be able to little about these costs. You can sue over poor investment choices. But unless you actually leave the company you work for, the 401(k) you have is what you are stuck with.
Good news: The turnover rate in the mutual funds offered by your company's 401(k) has dropped somewhat over the years. This is reflective in the choices. Index funds have near zero turnover, rebalancing only when the index shifts. Target date funds tend to shift in a similar way but don't offer the investor anyway of knowing how much is being turned over in the funds within the funds.

Bad news: While turnover is often equated with higher fees, a certain amount of this activity is generally considered acceptable if the rate of return is increased as a result. Most investors will shift their money into a fund based on the size. And the larger the fund, the more cumbersome investing becomes and because of that, the lower the turnover.

Target Date Funds
Good news: Target date funds have increased in plan usage from a scant $57 billion in 2000 to almost a trillion dollars invested in 2010. The good news here is limited to the success of the fund families marketing strategies and the required auto-enrollment of new hires. Add to that the financial debacle of 2007-2008 and numerous investors in 401(k)s simply saw the risk in these self-directed plans as too confusing. Turning to target date funds seemed on the surface to be the most logical conclusion for most.

Bad news: Target date funds still have some hurdles to jump through before they gain my seal of approval - no that they are necessarily currying my favor. They remain murky at best. Most target date funds, with the exclusion of those that comprise of index funds only, are a fund of funds. This suggests that a fund family, rather than close a poorly performing mutual fund, simply roll the fund into a target date fund. Because of this, there are still transparency issues. Add to that the suggested target date may not be your target, that no two target date funds are at the same point in investment holdings (risk) as a similarly dated cohort, that there is no fund manager who can offer conclusive evidence that this is the best method of rebalancing and lastly, that most users tend to set-it-and-forget-it.

Good news: As I mentioned, they have dropped over the last several years. But most investors still make assumptions that fall squarely into the "if it is an index fund, then it must cost less". This lower cost is mostly true and is  normally attributed to index funds, even though some smaller index funds that track the S&P 500 charge considerably more than their larger counterparts for the same investment. Even with that in mind, an investor can build not only a well-balanced portfolio using index funds alone, they will do so at a much lower cost than any other investment portfolio in their plan.

Bad news: Most target date funds act as if they can do what they do for less, they don't. Some target date funds have expenses and fees that are well north of 0.80%.

Good news: more folks are using their options across more age groups and accessibilities. Most mutual funds are held inside 401(k)s by twice compared to those held outside. Add to that the growing number of average to lower income households entering this market for the first time using this sort of investment.

Bad news: Education still has a long way to go. Trusting, finding or using an advisor is still the purview of the more affluent investor. The average balances in these plans increased but it suggests that was a result of an increase in the stock market value rather than an increase in participation or contributions.

No comments: