The Float

Strengthening Worker Retirement Security

On Tuesday, Rep. George Miller (D-CA) and his House Committee on Education and Labor held a hearing on the problems with (and potential of) America's system of retirement savings. At the moment we don't have time to assess the committee's discussions with any completeness, but readers interested in issues concerning retirement plans in general, and congressional perspectives on the system in particular, should take a look at the committee's website and this summary from Investment Advisor.

We would also direct your attention to the statement submitted by our associate Matthew Hutcheson, which very much reflects our thinking on these issues.

Greek Tragedy? Not Quite

Via the eNewsletter published every Monday by 401kHelpCenter.com, we ran across a strange Pensions & Investments story on the allegedly ill effects of shifting default investments from cash-equivalent investments to more equity-centric target-date funds. Here are the opening 'graphs:

Defined contribution plan participants have been exposed to more financial market risk by the increased use of target-date fund strategies as default investment options and away from more secure investments, according to a new study by Greenwich Associates.

According to the report, "U.S. Defined Contribution Pension Plan Research Study," from 2007 to 2008, the share of plan sponsors using money-market or stable-value funds as their default investment option dropped to 19% from 35%, while the share of plans using target retirement date funds jumped to 53% from 35%.

Analysts at Greenwich reported a large number of employees took on exposure to financial markets in general and to equity markets in particular virtually on the eve of the biggest market collapse in 70 years, a news release about the study said.

"It's like a bad Greek tragedy," Chris McNickle, consultant at Greenwich Associates, said in the news release.

We've riffed on some of the weaknesses of target-date funds in this space (here for example). So we aren't out to defend these vehicles across the board. But what in the world is McNickle talking about? After all, those who were automatically enrolled into equity-focused target-date funds were presumably just getting started in their current plans. They may have been young workers just getting started with their very first retirement plan, or they may have been slightly older, but just getting started with a new plan.

Either way, we're pretty sure the benefits of dollar-cost-averaging new money into relatively risky vehicles during a period of plummeting asset values far outweigh the costs. In other words, in the absence of big accumulated account values, the opportunity to acquire long-term assets at fire-sale prices is clearly a great thing, and the shift away from cash-equivalents toward target-date funds has helped many American workers acquire those assets at depressed prices.

Given the overwhelming power of inertia in participants' decision-making, we think it's great news that so many American workers will be plowing money into stocks (not exclusively into stocks, of course, but more than the old default-'em-into-the-money-market-fund regime would have allowed) while they're on sale.

Are near-term target-date funds too equity-heavy? Some clearly are, but that's a separate problem. The bigger point, that automatic enrollment into target-date funds (or, better yet, target-risk funds) will almost certainly serve participants well in the long run, seems to be lost not just on (understandably) panicky participants, but on some industry professionals who should know better.

Source

John D'Antona, Jr., "Boost in target-date funds hurts 401(k)s, Greenwich says," Pensions & Investments, February 17, 2009

Disappearing Dividends

Here's an excellent Bloomberg story on the importance of dividends in equities' total returns. The opening passages are sobering:

The fastest reduction in U.S. dividends since 1955 is depriving investors of the only thing that gave stocks an advantage over government bonds in the last century.

U.S. equities returned 6 percent a year on average since 1900, inflation-adjusted data compiled by the London Business School and Credit Suisse Group AG show. Take away dividends and the annual gain drops to 1.7 percent, compared with 2.1 percent for long-term Treasury bonds, according to the data.

A total of 288 companies cut or suspended payouts last quarter, the most since Standard & Poor's records began 54 years ago, when Dwight D. Eisenhower was president. While the S&P 500 is trading at the lowest price relative to earnings since 1985 and all 10 Wall Street strategists tracked by Bloomberg forecast a rally this year, predictions based on dividends show shares are overvalued by as much as 46 percent.

"It's a greater fool theory if we always buy stocks based on earnings and we never get a penny out of it, hoping for someone to buy that stock at a higher price," said James Swanson, chief investment strategist at MFS Investment Management in Boston, which oversees $134 billion. "Dividends have been a cushion in bad times. If they go to zero it's a disaster."

Read the whole thing. And be sure to click on "graphic" up above the story's headline. The accompanying chart tells the story in one pretty (and not-so-pretty) picture.

Toles Strikes Again

Gotta love this guy...

 

 

Toles Rules

Travel has us on a sporadic-at-best blogging schedule for a few more days, but we couldn't resist these two from the invaluable Tom Toles...

 

   

Crisis Reading

A few items relevant to this crazy confluence of credit crisis and bureaucratic politics:

• Geithner Hampered by Staff Deficit as Wall Street Demands Speed (Bloomberg)
• Ailing Banks May Need More Aid to Keep Solvent (New York Times)
• MidSouth Loses Would-Be Borrowers as TARP Fails With Louisianans (Bloomberg)
• Next Challenge on Stimulus: Spending All That Money (Wall Street Journal) 
• Obama walks line between politics, economy (Reuters)

It Was Everywhere

Once again, the genius of Tom Toles...

School Is In

Two interesting items on page D2 of today's Wall Street Journal.

First, Karen Blumenthal spends a few hundred words noting that the mutual fund industry makes it very difficult for young, first-time investors to get started, even in IRAs. Though none of our clients fall in this category, we've noticed this problem in doing some "pro bono" work for young people. It really is ridiculous.

Here's a telling passage:

Decades ago, when I was a teenager, I deposited my work savings into a money-market account with Fidelity Investments, and guess what? I'm still a customer. But Fidelity requires minimums of at least $2,500 and its index funds usually require at least $10,000, to help keep expenses down, a spokesman says.

Lovely. Fidelity imposes low minimums for those who commit to contributing $200 per month or $600 per quarter, but as Blumenthal notes, that's not necessarily easy for young people who work uneven/seasonal jobs. Sometimes we wonder where investor loyalty comes from in this business. Why is Blumenthal still a Fidelity customer? The more we learn about physics and financial services, the more we understand the all-encompassing power of inertia.

Blumenthal settled on a total-market ETF from Vanguard. We think that's a good call, and the logic of her choice undercuts the mutual fund apologists who argue that ETFs' brokerage costs make them an unwise choice for small-dollar investors. No, you wouldn't want to do monthly dollar-cost averaging using ETFs. But $1,500 in one trade? We see Blumenthal's point.

Then there's this, late in the column:

The last and most resonant lesson in all this, of course, was last fall's stock-market debacle. "How did that IRA investment work out, mom?" my daughter teased over the holidays. Like the market, her IRA is down about 40%.

We know Blumenthal will make the obvious point to her daughter (we know this because she does it in the very next paragraph), but this notion, that what happens in the first year of a thirty- to fifty-year investment program is indicative of anything at all...well, it frustrates us to see stuff like this. Blumenthal's daughter should be absolutely beside herself with glee that the future of the global economy has been put on sale. And she should work hard this Summer to increase her 2009 Roth contribution when the buying's good.

Immediately adjacent to the Blumenthal riff is a Jane Kim story on 529 college savings plans offering more "safe" choices in their menus of investment options. That's fine, but as with the insurance industry rolling out "guaranteed" products to 401(k) plans after the market meltdown, this is a little like handing flood victims umbrellas...after the rain has stopped and the water is up to their knees.

As with near-retirees who are on the verge of annuitizing their savings, this is very simple: college savers with short time horizons should not be invested in volatile assets.* In fact, college savers wth short time horizons probably shouldn't even bother with the hassle of the 529 plan in the first place. The plans' tax benefits can be great for those with more than a few years to contribute (and, of course, ride out market swings). But for short-timers, what's the point? A good, solid, FDIC-insured online savings account would almost certainly be a better bet.

What we hate to see is so many people get thrown off track by market volatility. This is just another reason why good, truly independent, fiduciary advice is so indispensable to so many people. The alternatives--the do-it-yourself route on the one hand and being subjected to Wall Street's product-driven selling on the other--aren't good at all.

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* As we've written over and over in this space, the situation of the near-retiree is different. He has to protect and invest for what is likely to be a much longer period than a four- or five-year stint in college. The key for the about-to-retire, then, is to ensure that they have enough liquidity to avoid tapping into depressed assets at or near market bottoms.

Sources

Karen Blumenthal, "Obstacles for Young Investors," Wall Street Journal, February 11, 2009

Jane J. Kim, "States Offer Safe Choices in 529 Plans," Wall Street Journal, February 11, 2009

The Structure of 401(k) Fees

Here's an interesting report--The Structure of 401(k) Fees--from the Center for Retirement Research at Boston College. From the report's introduction (emphasis added in bold):

401(k) fees are so complex, confusing, or obscure that many sponsors and participants report that they do not understand either their magnitude or their consequences....Fees for some services often are set high enough to subsidize the provision of other services within the plan. In some circumstances, when the funds of a 401(k) plan are pooled with the funds of other investors, the plan's participants might be paying a share of the trading costs incurred by investors who do not belong to the plan.

This brief concludes that clearer, more complete disclosures of the fees charged by 401(k) plans would help sponsors and participants make more economical choices. These disclosures would be most effective if the structure of fees were remodeled to match more clearly the specific costs of providing the various services within 401(k) plans.

Unbundled disclosure--stipulating clearly what sponsors and participants pay for what they get, not as one global number, but for each line-item in the plan--would be a good start. Functioning markets require consumers to have adequate information. Unfortunately, the 401(k) market has not functioned well at all, saddling participants with sub-optimal plans and therefore sub-optimal outcomes.

The whole report is worth a look, but we recommend in particular Figures 1 and 2 (on pages 2 and 3, respectively), which break plan expenses into their constituent parts. This is an effective way of presenting the relevant information. Our only amendment would be that many (we'd say most) plans encounter actual costs much higher than the 1.4% to 1.6% indicated in this report.

Check it out.

Source

Richard W. Kopcke, Francis Vitagliano, and Dan Muldoon, "The Structure of 401(k) Fees," Center for Retirement Research, February, 2009

Roubini and Taleb

We're no more--but certainly no less--confident in these guys' forecasts than we are in anyone else's. But you simply must watch this.

Listen to it closely, in particular the way Roubini and Taleb respond to some of the CNBC team's questions and arguments at and after the 6:00 mark (especially, but not limited to, those offered by one Dennis Kneale).

UPDATE: The more we think about this, the more incredulous we are that the CNBC gang had these two guys on their air, with the opportunity to have a thorough discussion of the structural breakdown that has cost us all so much, and they just couldn't help themselves. They had to ask them for freaking stock tips! We live in a very strange world.