Good To Great

One of the most successful business owners I know is a man called Bob. Part of his success comes from a group of workers who are extremely loyal and dedicated to him because he provides them with a perfectly designed 401(k) plan. When Bob started his plan he had a number of employees who were not particularly interested in participating in a retirement program. His younger people don’t have the sense of urgency that the more mature employees did. Others had no thought of ever retiring. Bob’s solution to this dilemma was to present the 401(k) program as a form of profit sharing. Most 401(k) programs have a provision for the employer to match a percentage of the payroll deductions made by the employee. Employee participation immediately rose because they initially saw it as a pay raise. As a follow-up to this Bob told his employees that the company contribution would be based on the company’s profitability. Over time his company’s profitability started to grow and as it did the return to the employee also grew. As a group his employees work ethic increased and they became more conscientious about the way they treated customers.

Hurray For The Unemployment Rate

We are starting to see chatter in the media about how this market is getting ahead of itself and is therefore about to tumble back. Pundits point out that over the past year the market growth rate has outpaced that of the economy by a significant amount. The implication is that at some point soon the market will have to fall back to the level of the economy. There is one data point however which supports those who feel that the market can continue to grow; that data point is the 7.5% unemployment rate. An analogy can be made between the recovery from a cold and the recovery from a recession. At some point in time you’ll get better and be cured. Our current level of unemployment leaves room for the economy to grow. Stay the course

Food For Thought

All mutual funds, both actively managed an index funds, are the product of an investment company. Investment companies are for profit companies. They build and operate mutual funds which they sell to the investing public. All mutual funds generate profits and expenses. The expenses are paid for by the customers and the investment company keeps the profits. Because of the activity that they generate in their portfolios, actively managed mutual funds are costly to operate. This is why actively managed mutual funds generally underperform the market. Not only do they generate expenses through their trading activity, but actively managed mutual funds have portfolio managers who are attractively compensated. Index funds owners pay a smaller percentage of their net asset value to the investment company. But, the index funds do not generate the expenses associated with actively managed mutual funds.  Therefore, is it not possible that index funds are close to as profitable actively managed funds?

Danger Ahead, Ignore It

In this week’s column, Zweig states that some investors are starting to invest in their brokers company. The important thing is not what they are doing, but why they are doing it. Their motivation comes from the fact that the market is at record highs, gold is tumbling and bonds pay nothing. He doesn’t come right out and say it, but the implication is that it’s time for investors to start making adjustments in their portfolio.  This is the way it always happens. At first there’s whisper about the need to do something. Then as time goes by and the market continues to climb, the whispers turn into a shout. At this point it is critical that 401(k) index investors remember that “there are some things you can know and some things you need to know.” What you need to know is that index investing will outperform your ability to time the market.  So, ignore the media and devote your time and energy to something you enjoy.

 

An Inexpensive Lunch

A lot of ink has been used examining the impact that fees and turnover costs have on mutual fund performance and minuscule amount of ink has been used to explain that not every investor’s goal is performance. During my career as an investment professional I ran across many people who were willing to accept a reduced rate of return in exchange for a reduction of risk. Many advisors respond to this situation using a portfolio of mutual funds that are periodically rebalanced. In return for their advice on the selection and rebalancing of the portfolio the broker charges a fee in addition to that of the mutual fund. Some may criticize this approach, but if the investor fully understands what they are paying and what they are getting, this is a reasonable solution. The important disclosure is that the investor understands the ramifications of this approach on performance.   

 

 

No Free Lunch

Most investors, particularly those with 401(k) accounts, could improve their investment returns by spending less time focused on the market and more time monitoring their investment expenses. Wall Street is very good at charging fees and making them less than transparent.  Every mutual fund, whether it is a load or a no-load fund, charges a maintenance fee. The fee results from the trading activity within the account that is supposed to increase the investment performance. However, the data show that the performance of the mainstream equity mutual funds is equal to the performance of the market minus the maintenance fee. Or to put it another way you are paying for something that you are not getting. A major reason index funds outperform actively managed funds is that their low trading volume results in extremely low maintenance fees. 

 

A Fee By Any Other Name

The first mutual funds were owned by the shareholders and paid the fund manager a small portion of the assets to manage the portfolio. The early years of the fund industry witnessed slow growth as the market recovered from the Crash of 1929, but it matured in 1940 Congress when passed the Investment Company Act. The next decade saw the US fully engaged with World War II. By the late 1950s, the economy had recovered as technology companies such as Polaroid, Xerox and Sperry Rand came into being. Wall Street has never backed away from an opportunity to make a buck. A Boston broker by the name of Jerry Tsai created a group of mutual funds that focused on the dynamic growth of the technology sector. Soon the investing public would refer to them as GO GO funds. Demand for these funds skyrocketed and as they did the fund industry discovered new and creative ways to charge investors to participate.