Forbes.com - Magazine Article

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Forbes.com - Magazine Article

Good Example on Why Fees Matter

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W. Scott Simon Has a Problem with Most 403B Plans

If you need something to read this Thanksgiving holiday, Simon's seven part series on the woes of 403b plans should keep you busy.

• Part One
• Part Two
• Part Three
• Part Four
• Part Five
• Part Six
• Part Seven

Enjoy!

CNBC: THE Financial Pornography Network

Visit msnbc.com for Breaking News, World News, and News about the Economy

I loved this quote about 401k investing and investors: "They just don't have the time and they just don't understand unfortunately." This is the reason that the majority allow their portfolio to be eaten alive by the high fees of the vast MAJORITY of retirement plans. Unfortunately, most teachers 403b plans have even higher fee structures than 401k plans.

Dan Solin got the best line in, "We need less Cramer and more Bogle!" No doubt that trading is not in the best interest of long-term investors, but don't expect CNBC to change its trading over investing mindset.

Overall, CNBC did next to nothing to better inform investors in this piece. Dan Solin did not get to clarify what he thought investors should do. I am sure he would have said, "Determine your asset-allocation, buy a portfolio of index funds that represents your desired asset-allocation, and buy it as cheaply as possible."

Unfortunately, it is very hard to get rock-bottom costs in most retirement plans. Financial services professionals like to avoid talking about fees because that is what butters their bread.

When 1.5% Equals $135,000

 When does 1.5% cost an investor $135,000?  Check out this video to see a common scenario.

Bogle at the Vanguard Diehards Conference

St. Jack shares his wisdom and insights on the state of the U.S. financial system. 

Does AIG Valic / Retirement Use Vanguard for Its 401k Plan? If So, Why?

Source:  403bwise discussion board

Here is a post that suggests that AIG Retirement uses Vanguard as their 401k provider.  As one poster wondered, "I wonder how many Vanguard employees use AIG Retirement for their 401k plan?"  Uhmmmm, that would be ZERO!

"Below you will see a post from the summer that many of you may have missed. It points out that AIG-Valic does indeed know what is best for retirement savings. I thought that after the events of the last few days it deserves a repeat posting.

This spring my wife's school district and my school district have taken alternate paths in working with the new IRS regulations. My school district chose a CPA firm to assist us. The firm really seems to understand that the spirit of the new regs is to modernize the 403b and make it more transparent. My wife's school district, on the other hand, chose as consultant a firm that seems most focused on promoting the insurance industry at the detriment of teachers' retirement savings.

Previously my wife had Vanguard as an option, but after the consultant's advising, they were left with just ING and AIG-VALIC. The consultant refused to pursue Vanguard or Fidelity. After this shady deal was struck, there was a meeting for all employees who weren't previously with VALIC or ING. The purpose of the meeting was to explain the IRS changes and give the VALIC and ING time to sell their products.

After the business manager gave an introduction, I asked if I could say something and ask a question. I proceeded to read a page and a half prepared statement aggressively bringing light on the past practices of the two companies and the amount of money people lose by going with annuities. (Thanks to 403bwise for a lot of my information). When I finished, the crowd cheered and the tone for the night was set.

Next the representative from VALIC spoke and rolled out their high-fee annuities and their new mutual fund platform, or as I like to say, the bait and switch. I am sure no one will be encouraged to take this option. Of course in true VALIC fashion, she could not produce a list of fees, but promised it would be available later. (So they were chosen to be one of the two options, even though they hadn't shown a fee schedule. Typical). My wife, another audience member and I continued to hammer her with questions and she became more and more agitated. Finally, she said, "You people just don't get it. You have had 15 options for all these years. If you were in business and had a 401k, you would only have one option. You still have two good options. At VALIC, all we have is one option. We only have Vanguard..." I have never seen someone want to take back what she had said more than she did at that moment. What a smoking gun! It was as if the sky opened up and light was finally coming through years of darkness. My wife then asked why VALIC employees could have a true low-cost option, but she couldn't.

The ING guy was next and had to completely change his presentation, because after what he had just witnessed, his new platform 1.35% "all-in" (which I'm sure is a huge improvement) wouldn't have been such a great sell with us in the audience.

So maybe school systems should follow the first good advice that VALIC has ever given (albeit indirectly) and make a low-cost option available to employees."

Do Investment Costs Really Matter? If So, To What Degree?

I have been having nightmares regarding some runaway BIPs I have been dealing with lately. There seems to be a total lack of comprehension as to how negatively costs can impact total return. BIPs, or basis points, represent 1/100th of a percent, so 100 BIPs would equal one percent (1%). This term is used repeatedly by the financial services industry to discuss fees. The word "BIP" sounds harmless, doesn't it? Semantically, it is easily confused with words like "bit" which indicates small, insignificant amount. "BIP" also sounds similar to the word "blip"--a small, often unimportant, flash of light. To the uninformed it is natural to assume that the word "BIP" is also unimportant . Don't be fooled! While a few BIPs may appear to be a small, inconsequential quantity, they can destroy your investment returns.

Before you read this post any further, please take a look at this Google spreadsheet I created: The Tyranny of Compounding Costs on an Annual Investment of $1,000 at 8% from 5 to 35 Years / PDF version here. This spreadsheet illustrates just how costly investment expenses can be. This first example represents the likely returns of portfolio earning 8% annually in the Federal Thrift Savings Plan. This plan is the least costly of any that I am aware of; it charges a fee of 3 bips on total assets. In other words an investment of $1,000 has an expense of 30 cents. That is incredibly low; consequently, the investor is able to capture the vast majority of the portfolio's gains. Since only .03% is charge against the total assets, the investor earns a net return of 7.97% . Over 35 years the Thrift Savings Plans generates only $1,146 in fees. This represents less than 1 percent (actully only .83%) of the market return over 35 years. The TSP is an amazingly efficient retirement savings plan. Here are some observations regarding the rest of the spreadsheet.

1. Over 35 years, a product charging 20 bips manages to generate fees that equal approximately 5.5% of the total porfolio return.
2. A product charging 50 bips ends up with roughly 13% of the portfolio gains.
   
3. A 100 bips fee would mean that 25% of the portfolio's return ended up with the financial intermediaries.
   
4. A product with a 150 bips fee would ultimately consume 35% of the porfolio gains via fees.
5. A product carrying a 200 bips fee would result in a 44% reduction in the portfolio gains.

I have many strong opinions regarding the information in the worksheet.

1. As a rule of thumb, any investment charging more than 50 basis points is entering the realm of BOHICA. I know of no reason to pay more than 50 basis points for any investment.
2. Once an investor hits a 100 bips, the fees become punitive. Should an investor, who puts up all the capital and bears all the investment risk, really have to cut the financial intermediaries in for about 20% of the investment return? I say to Hell with these blood-sucking parasites.
3. I read somewhere (I wish I could remember where) that a retirement plan essentially forefits it tax-deferred benefit when it costs exceed 150 bips. It is easy to comprehend how a low-cost taxable investment could surpass the return of a higher cost tax-deferred benefit. After 35 years, 150 bips more than a third of the portfolio's return; that is quite a handicap!
4. We all stand on the shoulders of giants. I confess that I got the idea for this post from my financial idol--John Bogle. This post is an offshoot of this post which in turn came from Bogle's PBS interview. Here is an excellent related post on John Bogle; be sure to watch the video. It is easy to see why this man is disliked, if not downright hated, by many individuals in the financial services industry.
5. It is interesting to note that if the investment holding periods been longer than 35 years, the cut to the financial intermediaries would have been even larger. Check out this example Bogle presented on his PBS interview.
   

Why Pension Fund Beat Mutual Funds

Here is an article by Jason Zweig explaining why most pension funds beat the pants off mutual funds. Believe it or not the higher costs of mutuals funds drag returns below those of most pension funds. What a shocker! Expenses can actually lower your performance...who knew!?