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 Published
Monday, July 23, 2007
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This
Project shows success in microcosm
by Stephen Butler
I recently spent a contemplative weekend at the bottom of Concord's
Nautilus Aquatics' 12-foot pool struggling to qualify for my scuba
diver's certificate.
The exercise in which the instructor deliberately turns off the
air reminded me of running a small business. Business on a small
scale offers decisionmaking with an immediate cause-and-effect
relationship.
There is little opportunity to flop around in a sea of cash provided
by lenders and investors while you make critical mistakes, pass
the buck and slowly ride the burn rate to oblivion. It's more
like Hemingway's "Death in the Afternoon."
At my company, Pension Dynamics Corp., we have spent the early
part of the summer working on a novel project. We thought we might
determine how good we are at running retirement plans compared
to the other guys.
For us, as a microcosm of the financial services industry, we
are large enough to represent a meaningful statistic while not
so large that our project would be overwhelmed by, say, 30,000
company 401(k) plans.
We have generally maintained that keeping investment costs low,
choosing funds with superior performance from a universe that
includes all funds, and educating employees effectively would
lead to superior results in the aggregate.
With about 8,000 participants, more than 200 client companies
and about 400 different mutual funds in all of the accounts combined,
we built a spreadsheet that showed us where all the money was
invested.
Each client company typically offers about 15 investment choices,
but money through the years has gravitated toward popular fund
families after annual reviews of performance.
Roughly half of all plan money is in the Vanguard family of funds,
and about a quarter is in a combination of Dodge and Cox, T.Rowe
Price, and the American funds. The rest is sprinkled out across
a variety of mostly pure no-load funds.
We eliminated all bond and money market funds, initially, because
we were interested in determining how equity money, in general,
had been performing.
Assuming that the entire universe of money and funds represented
one investor, what would the average yearly rate of return have
been over the past three and five years?
It was 16.6 percent for three years and 13.2 percent for five
years. The three- and five-year time periods ended as of May 31.
The five-year period included the last year of down market. The
total stock market index returns were 14 percent and 11 percent,
respectively. Few investment programs achieve market averages
-- much less beat them.
A "weighted average" of a group of investments is the
rate of return times the amount of money in each investment. We
add up all the earnings and divide by the total amount of money
in the plans.
Having a proportionately large amount lot of money in an investment
that does well increases the average, and vice versa. To weight
the returns based on where the money is invested is the only correct
way to gain an appreciation for how well a group of investors
has performed.
If we compare this weighted average against the same calculation
for a typical plan offered throughout the 401(k) industry, it
beats the average based on our preliminary comparisons.
Why? Because most 401(k) plans have investments chosen for several
wrong reasons.
First, a typical plan has high sales and marketing costs built
in and paid by participants in largely hidden fees. There goes
1 percent of annual earnings.
Next, financial institutions operate 401(k) plans as tools to
sell their own, often expensive, proprietary funds. This objective
excludes the rest of the universe of great fund families that
may have demonstrated superior performance in many categories.
(Even Schwab's vaunted "no-transaction-fee" fund marketplace
includes only those funds that charge enough in annual expense
ratios to pay what Schwab charges to be in the NTF category. So
much for the "no-fee" claim.)
Finally, inadequate investment education prompts people to chase
the previous year's best performing fund, and they fail to rebalance
-- a recipe for poor performance.
We think our composite result is a standard of comparison. It
represents where money has actually been invested. It does not
reflect a practice plaguing the industry today whereby 401(k)
sales efforts show how a selection of funds chosen after the fact
would have outperformed an incumbent group.
If you have a plan that you think has done better, send the information
to us and we'll run it through our weighted average test. We need
the investment results through June for three years and five years
and the amount of money in each investment.
We would appreciate the opportunity to expand our research. Remember,
each additional single percentage point of annual gain increases
retirement assets by 20 percent in 30 years.
This is a comparison we should all be making.
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