The Float

Target-Date Funds Under the Microscope

Not enough time this afternoon to give this the full treatment (in part because Typepad just ate the first version of this post, which, yes, is a problem that's easily overcome with a preemptive copy-and-paste...but still...very annoying). But we ran across two items interesting pieces on target-date funds, which have been frequent topics of discussion in this space for three primary reasons:

1. They're increasingly prominent features of defined-contribution plans, and thus increasingly important ingredients in the future retirement security of millions of Americans.
2. Like 401(k) plans themselves, target-date funds are loaded with potential...and plagued by a few non-trivial (and easily avoidable) shortcomings, most of which can be traced back to non-fiduciary practices in the financial services industry and lack of awareness among sponsors and participants.
3. Whenever fund companies get excited about selling a particular type of product, it's time to add an extra layer of vigilance.

We'll have some analysis of these two pieces as soon as time permits (tomorrow morning's looking good from here). Until then, both are worth a few minutes of your time if you're interested in such things: "Twelve observations on target date funds" and "New Study Finds Target Date Industry Has Serious Shortcomings."

Participants (and Others) Behaving Badly

Tuesday afternoon we posted an item on Bloomberg television's recent feature on hidden costs in defined-contribution retirement plans. In that short assessment, we noted that plan costs come in three flavors: explicit (mutual fund expense ratios, insurance charges, recordkeeping, administration, sales loads, advisory fees), implicit (mutual fund trading costs, impaired dividend reinvestment), and behavioral (participants managing their plan assets suboptimally in one way or another).

This is necessarily imprecise, but we think the amount of attention each category of costs receives is inversely related to the extent of its effects. High explicit costs are (relatively) easy to identify and, where fiduciaries want to do the right thing, easy to correct. High implicit costs are tougher to identify, but still reducible when there's sufficient interest in doing so. Behavioral costs are exceptionally difficult to quantify, in part because the current regime of individual accounts privileges rank-and-file participants' autonomy over plan-level management (and, therefore, effectiveness).

But again, it's the behavioral costs--the toughest to quantify and the least-understood--that often wreak the most destruction on participants' long-term outcomes. As we noted back in November, the best plans feature low expenses and high-quality decision-making (see adjacent table).

Which is why we were so pleased to see Financial Engines release the results of its study of participant behavior (available here after you enter some basic identifying information). The findings, as you might imagine, were not particularly encouraging. But as we've long argued, there's nothing wrong with the defined-contribution system that can't be fixed with a few good (i.e., painfully obvious) ideas and a healthy dose of fiduciary responsibility.

Writing at WebCPA.com, Stuart Kahan has a good, short summary of the Financial Engines report. We're going to dig into the report itself and post a more substantive evaluation (probably early next week), but we did want to make special note of one general conclusion Kahan mentions in his piece. Here are the key passages:

Participants earning the lowest salaries are the most likely to make investing mistakes. More than half (53 percent) of participants with annual salaries below $25,000 have portfolios with very inappropriate risk and/or diversification, compared to 33 percent of those earning more than $100,000 per year.

...

In terms of salary, 63 percent of those earning less than $25,000 per year fail to save enough to receive the full employer match, compared to 24 percent of those with salaries between $50,000 and $75,000, and 12 percent of those with salaries greater than $100,000 per year.

None of this is especially surprising. Lower-income workers may be less financially sophisticated, but they certainly have less access to sophisticated help.* The real problem here is that a system driven primarily by participants' elective reductions of their own present income will necessarily put lower-income workers at a significant disadvantage. So not only have plan sponsors and the financial services industry (by resorting to the false security of 404(c), among other mistakes) pushed responsibility for account management down to rank-and-file participants; the system has doubled down on the problem by placing low-income participants--those who need the most help and have the worst retirement security prospects--in an especially difficult position.

This is not a satisfactory state of affairs, but we (policymakers, sponsors, service providers, participants themselves) have the means to improve upon the decidedly imperfect status quo. And time is of the essence...

~~~~~~~~~~~~~~~~

* Let's not make too much of this sophistication argument; plenty of affluent, highly-educated participants make big mistakes too, in many cases as a result of overconfidence.

Sources

"Who Benefits from Today's 401(k)?" Financial Engines, June, 2008

Stuart Kahan, "How Well Are We Handling Our 401(k)s?" WebCPA, June 20, 2008

The American Debt Culture

We're argued repeatedly in this space that whatever short-term challenges the U.S. economy faces--and there are plenty--the bigger problem is more chronic than acute, more diffuse than concentrated, and more pervasive than our society would like to admit: the unsustainability of debt-funded consumption.

To work our way out of our acute problems, the Fed will innovate, the federal government will cut checks, builders will build fewer homes, and we'll muddle through. To work our way out of our chronic problem, we'll have to save more and consume less. It's really that simple. But it won't be easy, in large part for the reasons columnist David Brooks describes in today's New York Times. Here are two key passages from Brooks:

The United States has been an affluent nation since its founding. But the country was, by and large, not corrupted by wealth. For centuries, it remained industrious, ambitious and frugal.

Over the past 30 years, much of that has been shredded. The social norms and institutions that encouraged frugality and spending what you earn have been undermined. The institutions that encourage debt and living for the moment have been strengthened. The country's moral guardians are forever looking for decadence out of Hollywood and reality TV. But the most rampant decadence today is financial decadence, the trampling of decent norms about how to use and harness money.

...

The agents of destruction are many. State governments have played a role. They aggressively hawk their lottery products, which some people call a tax on stupidity. Twenty percent of Americans are frequent players, spending about $60 billion a year. The spending is starkly regressive. A household with income under $13,000 spends, on average, $645 a year on lottery tickets, about 9 percent of all income. Aside from the financial toll, the moral toll is comprehensive. Here is the government, the guardian of order, telling people that they don't have to work to build for the future. They can strike it rich for nothing.

Payday lenders have also played a role. They seductively offer fast cash -- at absurd interest rates -- to 15 million people every month.

Credit card companies have played a role. Instead of targeting the financially astute, who pay off their debts, they've found that they can make money off the young and vulnerable. Fifty-six percent of students in their final year of college carry four or more credit cards.

Congress and the White House have played a role. The nation's leaders have always had an incentive to shove costs for current promises onto the backs of future generations. It's only now become respectable to do so.

Wall Street has played a role. Bill Gates built a socially useful product to make his fortune. But what message do the compensation packages that hedge fund managers get send across the country?

This is enormously important stuff, and the column is a non-negotiable must-read. Thinking in ideological terms, as we're more inclined to do with the political season heating up, it seems to us that both the left and the right will have to make some concessions here. For its part, the left will have to admit that the debt crisis is, as Brooks argues, a matter of values, not just economic deprivation or determinism. The right, on the other hand, will have to acknowledge that some business practices (predatory lending, cynical credit card pitches to college kids, &c.) are sufficiently harmful to merit the state's regulatory intervention and, in some cases, prohibition.

As a darkly funny aside, Brooks' mention of the distinction between the "investor class" and the "lottery class" evokes a true classic from The Onion: "New Instant Lottery Game Features Three Ways To Win, 19,839,947 Ways To Lose."

For more, check out this assessment of the issue from Barbara Dafoe Whitehead: "A Nation In Debt."

And here's the pitch-perfect Tom Toles:

Sources

David Brooks, "The Great Seduction," New York Times, June 10, 2008

Barbara Dafoe Whitehead, "A Nation In Debt," The American Interest, July/August, 2008

Election-Year Tax Politics

With the major parties' presidential nominees now known, the world's attention turns to the overwrought parlor game of projecting/guessing what will happen if one or the other is elected. Too often, which is to say almost always, these discussions miss some basic features of American political institutions, most importantly that presidents don't impose their pre-existing preferences on a perfectly receptive system. Thinking about Obama and McCain only makes sense in the context of a Congress that what will almost certainly feature bigger Democratic majorities in 2009.

Apart from the basic concepts of Poly Sigh 101, discussions of tax policy in particular often miss another basic but important point: income tax rates are marginal. Let's see how recognition of this simple fact can change the way a potential policy change is perceived.

In the most recent BusinessWeek, Jane Sasseen riffs on potential changes in federal tax law in the aftermath of the 2008 elections, in particular those provisions affecting upper-middle-class (or lower-upper-class, depending on your perspective) taxpayers (i.e., BusinessWeek's subscriber base). Here's a classic example (emphasis added in bold):

The soaring deficit, along with the fact that the Bush tax cuts expire at the end of 2010, provide much of the impetus for the coming fight over high-end taxes. If Washington doesn't act, tax rates on income, capital gains, dividends, and other areas will return to the higher rates in effect before the cuts were enacted in 2001 and 2003. Senator John McCain (R-Ariz.), the presumptive GOP Presidential nominee, has said he would extend the cuts for everyone, while Obama says he'll maintain them for all but the wealthiest. If Obama wins, some taxes could go up as soon as 2009.

By "wealthiest" Obama means married couples earning more than $250,000; for a single taxpayer, the equivalent income would be roughly $200,000. Today, taxpayers making that much fall into the top two federal income tax brackets, paying rates of 33% or 35%. Their rates would revert to the 36% and 39.6% top rates used in 2000. The same households would also see a bump up in the rates they pay on capital gains and dividends, both of which now stand at 15%.

BW readers unschooled in marginal tax rates might read this to say that affluent households' total tax bills would rise from 33% or 35% to 36% or 39.6%, respectively. But that's not the case. Instead, only that portion of a household's income over a certain point (the dividing line between brackets; north, say, of $250k) would be taxed at the higher rate.

Let's take Sasseen's example of the Hammer family, where the doctor/lawyer combo of Howard and Hope reportedly earn $300,000 a year. Now, let's assume that half of their $3,000 monthly mortgage payment is deductible interest. Let's further assume that after they take various other deductions (for their kids, charitable contributions, 401k contributions, &c.), they report $260,000 in taxable income.* Under the Obama plan--which, again, will surely be sublimated into something different in the legislative process--only the last $10,000 of their income would be subject to a higher marginal tax rate. In other words, a family with a quarter-million dollars in annual taxable income would see their federal income tax bill rise by $300 or $400 per year.

Naturally, taxpayers with much higher incomes would pay more tax, but again, only on their marginal dollars. And yes, we realize that Obama's program involves changes to capital gains and dividend tax rates. But our point here isn't to defend Obama's program, or any other program. It's to shed some light on an important feature of income tax law, which is that households' effective tax rates are much lower than their highest marginal rates. It's a distinction with an enormous programmatic--to say nothing of political--difference.

A recurring theme in Sasseen's piece is that households between the 96th and 98th percentiles (those reporting incomes between $200,000 and $500,000) would experience non-trivial hardship if their taxes were to rise. We think Sasseen's point about the cost of living varying widely across the country is absolutely spot-on. But we hope The Stanford Group's Anne Mathias had her tongue planted firmly in her cheek when she told Sasseen that the next couple years "will be a very bad time to be rich." Ummm...compared to what? It's this sort of attitude that leaves working- and middle-class Americans yelling "Cry me a river!" at the copies of BusinessWeek they pick up in the waiting rooms of their friendly neighborhood HMOs.**

Raising taxes on affluent households may or may not be a good idea. And if it's a good idea in the abstract (good, that is, relative to the alternatives, which are (a) more long-term debt for all of us, (b) big cuts in current government spending, or (c) both), reasonable people can and will disagree about what concrete form any revenue-raising should take.

We'd like to see better fiscal discipline out of Washington, and we'd like to see it start on the spending side of the equation. But whatever debates we need to have about the revenue side, let's make them precise and informative, not breathless and misleading.

~~~~~~~~~~~~~~~~

* It's probably less than $260k, but we're trying to be conservative here in order to make a general point.

** To see this in action, scan a few of the comments submitted to BusinessWeek.com in response to Sasseen's piece. Here's one example: "Oh my God, I can't believe this article. The families cited in this article may not be rich, but they are not middle class either. They are way upper class. Our income is about half of what the families in this article earn, and we live in the expensive SF Bay Area, and have no problems living comfortably. We also had no problems with the higher tax rates when they were in effect. There is something wrong when people earning $ 300,000 a year can't make ends meet. Try explaining that to families making the median of $ 48,000 a year. Your article reinforces the stereotype of business magazines that live in an alternative universe that centers around Manhattan."

Sources

Jane Sasseen, "Taxing the 'Not-So-Rich' Rich," BusinessWeek, June 5, 2008

Tim Harford, "A Secret Tax on Teenagers," Slate, May 31, 2008

Chart of the Day

In light of today's Flow of Funds report from the Fed, which showed a substantial decline in U.S. household wealth in the most recent quarter, we thought the data presented below (courtesy Investment News) were as timely as ever. Note that for the first time in the post-war period, Americans own less than half of the estimated value of their residential real estate.

 

This chart is the inevitable product of declining prices and massive equity withdrawals. Which makes us think of Maxed Out, a documentary on Americans' ever-expanding indebtedness and some of the less savory business practices that have helped us along on that path. We recommend it--though maybe not on a full stomach.

Sources

Carlos Torres, "U.S. Household Net Worth Fell the Most in 5 Years Last Quarter," Bloomberg, June 5, 2008

"Owners' equity in household real estate, 1945-2007," Investment News, June 2, 2008

Cash Levels and Active Management

In yesterday's reading list, we mentioned a Jonathan Burton story on varying levels of cash in mutual funds. Burton mentions a few funds that have maintained relatively high levels of cash in recent weeks, noting that some of these funds have performed well even as the equity markets have rebounded off their January and March lows.

Here are a couple relevant excerpts:

The volatile stock market and the weak economy have derailed many mutual-fund managers, but without the ability to bet against stocks, some are playing defense the only way they can -- by holding more cash.

In recent months that's been a smart move. Cash is king when stocks head south. A sizeable allotment to short-term Treasury bills and other cash-equivalent vehicles can dodge the worst blows of a down market and absorb its unpredictable shocks. Moreover, money on the sidelines lets a cost-conscious manager scoop up bargains as they appear.

...

Yet this seemingly safe route is not without its own risk. Cash is trash when stocks rebound. Clinging to cash at those times creates a drag that can transform a leading fund into a laggard. Since no one knows when markets will turn, and given the constant pressure -- from both their shareholders and their bosses -- to outdo a benchmark index, most fund managers stay as close to fully invested as possible; the average diversified U.S. stock fund keeps only about 4% of its assets in cash, according to Morningstar.

Financial advisers in particular look askance at funds with outsized cash positions. Advisers set and adjust portfolio allocations between stocks, bonds, cash and other investments based on a client's risk profile. A cash-rich fund can upset those plans, says Dan Moisand, an investment manager at Spraker Fitzgerald Tamayo & Moisand LLC in Melbourne, Fla.

"If you're hiring managers to buy and sell stocks, that's what they should be doing," he says. "We should be making the cash decisions, because we're closer to the client."

Now, this leads to an interesting and important discussion.

In one sense, Dan Moisand is entirely right: Advisors are closer to their clients, and they should make the big asset allocation decisions. But there's another sense in which we think Moisand is on the wrong track.

When clients want active management (i.e., the explicit pursuit of alpha through some combination of outperformance in strong markets and capital preservation in weak ones), we think they should get it in a framework that's meaningfully different from the typical mash-up of active and passive exposure delivered by conventional long-only funds.

One of the key differences between tracking-error minimizers and true active managers is that the latter are less constrained than the former, in particular in the sense that their investment mandates do not require them to be (more or less) fully invested in all market conditions. After all, money management is risk management, and managing risk can be done in one of two ways: (1) strategic asset allocation and radical diversification or (2) active hedging of one sort or another (using options, short positions, cash levels, &c.). Both methods are perfectly legitimate. But they're different! And they need to be understood, pursued, and sold differently.

Burton's certainly right that large cash positions can weigh on performance during strong market episodes. But the essence of successful money management is in delivering market-beating returns for the same level of risk or market-like returns for a lower level of risk.

If advisors are frustrated with fund managers who maintain high cash levels (or whose cash levels vary somewhat unpredictably), they should look elsewhere for pure asset-class exposure, in particular to the inexpensive ETFs and index funds designed to provide exactly that.

If they want active managers, and are willing pay for same, they should know that varying levels of exposure to risky assets is part of what any self- and investor-respecting money manager should deliver.

Source

Jonathan Burton, "Kings of Cash," MarketWatch, May 11, 2008

Equity Exodus

We've spilled a lot of pixels on the topic of rank-and-file investors' decision-making in defined-contribution retirement plans. And we're pretty sure this, from PlanSponsor.com (free registration required), speaks for itself...

Participants moved assets from equities to fixed-income investments during 80% of the trading days in March, according to the Hewitt 401(k) Index.

In fact, during the first quarter of 2008, participants transferred $2.8 billion from equities to fixed-income investments on a net basis, which is the largest quarterly equity outflow during the history of the Hewitt 401(k) Index.

In March, the overall transfer activity level was slightly above the 12 month trailing average--0.05% of balances were transferred on a daily basis. Additionally, five days of the month experienced above normal transfer activity, and two of those were "high" volume days--March 10, where transfer activity was more than twice "normal" levels, and March 18, where activity was three times normal.

Note that March 18 saw an enormous move higher in the broad equity market. Alas, this sell-low capitulation came straight outta central casting.

Source

"Participant Equities Exodus Continues in March," PlanSponsor.com, April 21, 2008

Two Housing Crises

With the whole world watching, the U.S. housing market continues to weaken. Official Washington's insistence that the bottom was in sight many months ago seemed like Wonderland nonsense even then. Today it's simply laughable. Inevitably, the financial wreckage has been extensive: consumer spending, Wall Street's too-clever innovations, household and corporate balance sheets, employment...all have taken major hits. And the bludgeoning isn't over.

That's our acute housing crisis: The rapid, ongoing decline is residential real estate prices. But there's another, more chronic crisis out there: Our excessive allocation of resources to residential real estate in the first place. Partly a function of public policy (i.e., the home mortgage interest deduction, local governments' dependence on development fees, local officials' dependence on developers' campaign contributions) and partly (more importantly?) a function of our acquisitive culture, we've devoted far too much of our national wealth to our personal castles.

The consequences of this imbalance have been substantial. The arms race in residential real estate--Bigger! Newer! Fancier!--has driven prices beyond the reach of rank-and-file workers. In certain parts of the country, housing (even rental property in some cases) has become genuinely unaffordable. But people need places to live, of course, so they stretch their ex-housing budgets with leverage against their homes and, for renters and "owners" alike, the excessive use of credit card debt.

Taking a broader macro view, housing simply isn't a productive resource. In fact, it's a dead end and often (especially in the cases of far-flung exurbs) a terrible drain on public finances, to say nothing of the environmental costs of leapfrog development. Unlike investment in education, capital stock, research and development, and various kinds of commerce-related infrastructure, housing is pretty much a black hole in terms of long-term productivity growth.

And notwithstanding the realtors' absurd claims of long-term appreciation rates, housing, in most places at most times, isn't a compelling personal investment either. At times, no doubt, homeowners can and will earn a decent return on their residential assets. But most estimates wildly underestimate the true costs of ownership, and thus overestimate the financial returns to such ownership.

We understand the significant toll the recent downturn in residential real estate has taken on many millions of people here in the U.S. and around the world. But even as we try to muddle our way through the financial aftermath of yet another bursting bubble, it would be smart--no, it would be more than smart; it would be wise--to think about the true costs and benefits of our dysfunctional relationship to our real estate.

This episode calls out for wise leadership, for a kind of societal intervention. But who's willing and able to sit us down on the couch and help us think more clearly about our chronic housing crisis? Who's capable of shaking us out of our co-dependent relationship with our homes? Unfortunately, the narrow interests threatened by a rationalized real estate market are unlikely to stand idly by while we recalibrate. And, in a classic collective action problem, the broad interests that would be served by such a rationalization are too inchoate to effect real change.

In the absence of wise leadership on this issue, our process of muddling through will be more muddled than it needs to be.

Variable Annuities: A Common Misperception

This space has featured several arguments against variable annuities. For what we think is the most interesting of those arguments, click here. Last Thursday, we ran across another entry in the ongoing annuity debate, this one from Investors Business Daily.

Here's the opening stanza of Trang Ho's story:

The basic idea of an annuity is simple: You give an insurance or investment firm a wad of money. In return, it promises to pay you a set amount of money, every year, for the rest of your life.

The fear of running out of money in old age grows as traditional pensions dwindle and Social Security leads to insecurity.

Americans reacted to that concern by pouring $134.4 billion into variable annuities in the first nine months of 2007, says the Association of Insured Retirement Solutions. That was a 15% increase in sales over the year-before period.

Assets invested in variable annuities total $1.5 trillion.

What follows, from an industry representative, reflects one of the worst--and most harmful--misconceptions in the business: the idea that the moment of retirement represents the finish line.

"It's all about protection," said Robert DeChellis, president and CEO of Allianz Life Financial Services. "No one has control over the market the day they're retiring."

That's true, of course, but it's not nearly as relevant as the annuity sales force would like people to believe. Now, it clearly is the case that weak market returns in the early years of an investor's distribution phase can inflict disproportionate damage on a portfolio's staying power. But investors can and should manage their short-term risk without locking in depressed returns by paying far too much for market exposure. Here's IBD again (emphasis added in bold):

Annuity policies, fees, charges, investment options and tax treatments are complex. Tony Bahu, a former independent insurance agent who sold annuities, says agents don't really know what they're selling or don't fully disclose all the costs.

"They made these things sound like they're a cure for cancer," said Bahu. "The agent goes out and maybe doesn't do his research and just believes what the insurance company is stating (and sells) this thing without proper knowledge or with bad information."

So what are the charges that can eat away at your returns?

Start with mortality and expense, or M&E. According to the Securities and Exchange Commission, M&E typically costs 1.25% of the total account every year. This is for taking on the insurance risk of the annuity contract. It helps cover the company's costs, such as paying the insurance agent's commission.

Administrative fees cover such items as record keeping. This can be a flat fee of $40 a year or 0.15% of the total account, the SEC says.

Surrender or withdrawal fees are the penalty for taking money out early or canceling contracts. Fees start at 8% for as long as the first 10 years of contracts, then decrease.

Variable annuities, which hold mutual funds, bonds or money markets, also charge sales loads and management fees for the underlying investments. And switching investment options can bring a transfer-fee bill.

Guess what else? A fee exists for each additional perk such as a stepped-up death benefit, long-term care insurance or protection against market declines. Some states and cities levy a premium tax--sometimes as high as 3.5%--on an annuity's value when it's sold.

Given widespread--and, we think, entirely justified--expectations of subdued market returns, these expenses could fully wipe out several years' gains. But the sales force remains undaunted:

Allianz's DeChellis defends annuities, arguing that record annuity sales show that Americans put a high premium on steady and secure retirement payments.

Actually, we think it shows that too-slick-by-half sales tactics and glossy brochures can exploit investor naïveté--to the detriment of most.

Source

Trang Ho, "Annuities: Plus Or Too Many Minuses?" Investors Business Daily, March 20, 2008

The "Lost Decade"

Amid all the chatter about E.S. Browning's big think piece in this morning's Wall Street Journal on the last 10 years in the financial markets, we'd like to make a few simple points. Let's begin with the opening passages from Browning:

Over the past 200 years, the stock market's steady upward march occasionally has been disrupted for long stretches, most recently during the Great Depression and the inflation-plagued 1970s. The current market turmoil suggests that we may be in another lost decade.

The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds.

The Standard & Poor's 500-stock index, the basis for about half of the $1 trillion invested in U.S. index funds, finished at 1352.99 on Tuesday, below the 1362.80 it hit in April 1999. When dividends and inflation are factored into returns, the S&P 500 has risen an average of just 1.3% a year over the past 10 years, well below the historical norm, according to Morningstar Inc. For the past nine years, it has fallen 0.37% a year, and for the past eight, it is off 1.4% a year. In light of the current wobbly market, some economists and market analysts worry that the era of disappointing returns may not be over.

First, notwithstanding the protestations of a few CNBCers* that Browning's story has them "depressed" today, this isn't news to anyone who's been paying even the slightest attention. As we noted on March 3rd in a piece on Warren Buffett's annual letter, back in the Summer of 2004, the Financial Times ran "Buy-and-hold on permanent hold," a piece that compared the experience of the early 2000s to the equity plateaus of the 1930s and 1960s/70s. (To compare these episodes, check out this slick trio of charts from the WSJ.)

Second, we think the primary headline on the Browning piece--"Stocks Tarnished by 'Lost Decade'"--is backward. For investors looking forward from this point, stocks have actually regained some of their luster...because the multiple compression of the last several years has improved their expected future returns. Which isn't to say that the process of multiple compression has run its course. We think more of the same lies ahead. But relative to where equities were valued in 1999 and early 2000...the last few years have made big-cap U.S. stocks more compelling in the medium term (i.e., a full market cycle) relative to certain asset classes that have clearly outperformed S&P 500-style securities. For a comparison of several major asset classes, see the adjacent WSJ graphic. Again, this does not constitute a near-term prediction about asset class performance. It's a bigger-picture argument about relative valuations and reversion-to-the-mean.

Third, as the adjacent table shows, and as any responsible participant in the capital markets knows, large-cap U.S. equities are just one asset class. So yes, if someone owned only an S&P 500 index fund (or only actively managed funds benchmarked to the S&P 500), the last nine years would have amounted to very little indeed. But prudent investors weren't so wildly over-allocated to big-cap domestic stocks, and intelligent rebalancing, let alone (as Browning points out) an ongoing process of dollar-cost-averaging, would have delivered substantial benefits over the last several years, both in terms of risk management and improved returns.

Fourth, John Bogle was exactly right this afternoon in his interview with Erin Burnett: Periods of muted returns make the management of expenses--and of investor behavior--more important than ever.

~~~~~~~~~~~~~~~~

*Overheard: Kneale and Burnett. We suspect more such claims were made while we weren't listening.

Sources

E. S. Browning, "Stocks Tarnished by 'Lost Decade'," Wall Street Journal, March 26, 2008 (subscription required)

Elizabeth Wine, "Buy-and-hold on permanent hold," Financial Times, August 30, 2004