OCtObeR 29 - nOvembeR 4, 2009 | Issue 18-44
ccording to a Dal- Fees are the strongest predictor of
e
bar Financial Ser- a fund’s performance. John Bogle, Termites eat
strange. Consider the consumer out-
cry if grocery stores started charging
vices study that founder of Vanguard Funds, commonly an extra line-item fee to cover their
tracks investor re- shares a simple and compelling math-
c
away at the
advertising.
turns, from 1989 ematical equation that highlights the In addition to the standard invest-
to 2008 the S&P importance of managing fees. If the
n
A500 yielded 8.35% performance of all of the market partic- very founda-
ment management expenses, mutual
fund companies have agreed to pay
annually. But the average investor only ipants make up the average return (A), retirement plan providers so they can
a
earned 1.87% over the same period. This then after fees (B), investors underper-
tion of your
be included on a short list of available
fact deserves restatement. The average form the market by the amount of those funds within a 401(k).
investor received less than a quarter of fees (A - B = C). Thus the higher the fees,
the general market return and did not the higher the underperformance. And retirement
If we were describing the Mafia,
we would call these arrangements
even keep pace with inflation. when you find out you have termite “kickbacks.” Retirement plan provid-
The study suggests that average damage, the first thing you need to do
investors would enjoy better out- is call the exterminator.
plans. They
ers have convinced the public they are
merely “revenue-sharing” agreements.
e
F
I
n
comes if they simply invested in bank The obvious solution for average
certificates of deposit (CDs) rather investors is to find proven invest-
hide in layers
However, this is not the sharing you
learned about in kindergarten. Mutu-
than trying their hand at more ag- ments with the lowest administra- al fund companies create a new “class”
m
gressive investing. We certainly do tive fees. However, they are left in a
not endorse abandoning the equity very difficult situation. Most do not
of financial in-
of shares, often called “retirement
shares” in standard plans or “insur-
o
markets. Seeing so many people for- have the time or expertise to uncover
go their retirement dreams, however, these hidden costs. In a market with
termediaries
ance class” inside of annuities. These
new shares are created with higher
H
is very discouraging. so many 401(k) options, we would fees than the standard fund to pay for
We call the difference between the expect highly competitive pricing. In-
market return and typical investor re- stead, investors and plan sponsors of
that all take
these types of fee arrangements: the
fifth termite.
turns the “termite gap.” Termites eat small to medium market cap compa-
away at the very foundation of your nies display very little price sensitivity
a bite out of
Unless you are lucky enough to
participate in a large corporate 401(k)
retirement plans. They hide in lay- when making 401(k) investment deci- plan, you typically will not find more
ers of financial intermediaries that sions. The Government Accountabil-
all take a bite out of your portfolio. ity Office (GAO) found t
your portfolio.
than a small handful of no-load Van-
hat 80% of
guard funds or index funds in these
And the most dangerous termites lie 401(k) participants are unaware they
accounts. You will find a large list of
within your emotions. are paying any fees.
funds that try to justify their high
Many mutual funds with an-
expenses by raising their risk levels
nual operating fees more than 1%
Seven
through active management. The cost
will likely underperform and should
of portfolio turnover is the sixth ter-
be avoided. Request a copy of each
mite affecting expenses. Higher port-
fund’s prospectus and use a magnify-
folio turnover increases the transac-
ing glass to uncover these first three
tion costs of buying and selling the
Termites
hidden termites. Look for subjects
individual securities in a mutual fund
like “wrap fees,” “subtransfer agency
or other investment account. These
fees” and “mortality and expense fees”
(M&E). M&E fees are an extra insur-
transaction costs are not separately
ance charge in annuity contracts. You
identified but are netted with the in-
m
may have heard that combining your
vestment return.
o
.
c
That Eat Your
investments with your insurance is a
Management fees in the 401(k)
bad idea. Inside a retirement plan, it is
industry run about 1.6% for the av-
r
a terrible idea.
erage equity fund. Add in portfo-
a
a
401(k)
The fourth hidden termite is
lio turnover costs and
12(b)1 fees. These fees actually pay
the impact of sales
.
c for a fund’s advertising, which is
charges, and an-
other 1.4% of cost
w
MAROTTA ON MONEY bY has been added.
w
DAviD JOhN MAROTTA That brings the
w
AND MATThEw illiAN
1.6% management
| fee or expense ratio
y
up to 3% a year for a
l
k
typical 401(k) plan.
e High fees do not need to be
e
put on a 401(k) plan. We’ve
W
designed dream
t
e
401(k) choices
for our small
t
A
s
business owners with less
e
than half those amounts.
l
Incentives always exist for
A
e
the industry to hide these
R fees. So being an informed
R investor is critical.
A
The seventh and final
A
termite is found within.
C
Common sense tells us to buy low
and sell high. The evidence of mu-
tual fund flows suggests that many
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