Monday, July 20, 2009

Save money, live better

AlphaNinja - That's Walmart's motto, but if applied to retirement savings it can drastically improve investment results. This issue is among the most critical out there, and I'll write about it in more detail in the future.

The WSJ is out with a must-read on 401k funds.

Employers are making it easier for workers in 401(k)s to own low-cost index funds and exchange-traded funds, a move that has implications for the mutual-fund industry.

As it stands, roughly 90% of the $1.5 trillion in 401(k) and other defined-contribution assets in mutual funds are in actively managed offerings. This is the case despite clear evidence from studies that index funds tend to outperform their actively managed rivals.

The stodgy 401(k) world won't change strategies overnight. Fund companies won't easily relinquish their active-management fees, which tend to be higher than those charged on index-tracking products, especially at a time when rocky markets are pinching profits. And actively managed funds tend to do more "revenue sharing," which involves fund companies making payments to plan administrators.

I borrowed that title (Save Money, Live Better) from Walmart for a reason. A quick analysis shows that saving one percent a year in management fees can lead to a 21% increase in monthly retirement income. Of course, this is based one one person's time horizon, contributions and expected return. The important thing is that even with different assmptions, the lower expenses lead to better results.

The mutual fund industry is of course petrified of such a (further) shift to index funds, but it is coming. Every time someone pays a front end load, they're killing their expected returns, and their retirement income. Even more egregious are 12b-1 fees -->> or did you not know you're paying an extra % to help your mutual fund manager market their funds to other people?

It is probably counter-intuitive that I write so often about individual stocks and short(ish) term trades while now suggesting that people index their money. That's because in the near term I see a sideways market that will reward stockpicking.

The majority of equity retirement funds (bond funds can also be indexed cheaply) will not beat the market on a long-term basis, so people should not be "paying-up" for this.

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