Author Topic: Where most of your 401k money goes to: making Wall Street wealthier  (Read 9970 times)

SisterX

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This is depressing:

http://wallstreetonparade.com/2013/04/pbs-drops-another-bombshell-wall-street-is-gobbling-up-two-thirds-of-your-401k/

For those seemingly small 2% fees, when you're only getting about a 7% return it means that the company you've invested with is taking 2/3 of your wealth over time.

momo

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #1 on: April 25, 2013, 02:59:09 PM »
Definitely supports why keeping investment costs and management fees low is essential. It is also why I am against paying a business like Betterment, when I feel I should "make time" to learn the fundamental basics of investing and money. No one cares more about your money than you do.

Additionally, the information contained in this article is precisely why I do not support active money management too. Think of it another way, would you choose to continue to pay someone for their money management services, if they continued to lose you money? Were you aware, most money managers (registered investment advisers) get paid regardless if their chosen investments perform terribly? Personally that disgusts me. If most of us performed below what was expected at our job, how many of us believe we would still remain employed? Just think about it.
« Last Edit: April 25, 2013, 04:55:07 PM by StashtasticMomo »

grantmeaname

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #2 on: April 25, 2013, 03:32:43 PM »
I don't think that 2% is really "seemingly small" as index funds enter their fifth decade.

Jamesqf

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #3 on: April 25, 2013, 06:35:57 PM »
Sorry, but this is just more propaganda from the "How dare you invest your own money instead of depending on the government" crowd.  Anyone with a claim to a basic mustachian understanding of finance ought to be able to pick out the glaring flaws.  For instance, if the fund you're investing in has a 2% expense ratio, and it doesn't justify those fees by producing better returns, then all you have to do is invest your money somewhere else.

Second, that 2% expense ratio is not what you use to calculate results, it's the difference between 2% and the costs of an index fund, or doing your own investing.

It's also not entirely "your" money that you're investing.  Part of it is (likely) a company match, part is avoided taxes.  No way most of that money is going to "Wall Street".  And if you didn't invest in the 401K/IRA, what would you be doing with the money?  Spending it on Arab gas and Chinese consumer junk?

GreenGuava

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #4 on: April 25, 2013, 10:11:16 PM »
For those seemingly small 2% fees, when you're only getting about a 7% return it means that the company you've invested with is taking 2/3 of your wealth over time.

Who is it that thinks 2% fees are small?  Those are huge!  My weighted average expense ratio - even including the funds in my 401(k) that, IMO, are too high expense ratio (one is as high as .32%!) - is .15%. 

That costs matter and 401(k)s can be bad in the cost department shouldn't be news to anyone here.  I'm also pretty sure I can't be the only person on this board who looks at a future employer's 401(k) plan when considering an employment plan.  That others aren't -- well, that's their problem.  And if employees don't care, I don't see why employers should care (or be made to care).

LowER

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #5 on: April 25, 2013, 10:28:10 PM »
2%..........I think I just threw up in my mouth. Usury comes to mind. I'll second the experience that my average investment fees are close to 0.15%. Thank you Vanguard mostly and also Fidelity Spartan funds.

Run your numbers at FIRECALC and then throw in 2% versus 0.18. THAT will make you throw up in your mouth.

Jamesqf

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #6 on: April 26, 2013, 01:08:18 PM »
So let me pose a question here:  I've held two mutual funds with T. Rowe Price for over 10 years, the Equity Index 500 (PREIX) and International Discovery (PRIDX).  PREIX has a 0.30% expense ratio, and a 10-year return of 8.26%.  PRIDX has 1.23% expense ratio, and 10-year returns of 15.83%.   Is it worth an additional 0.93% expense to get nearly double the return?  Is "Wall Street" unfairly enriching itself by letting me buy PRIDX?

grantmeaname

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #7 on: April 26, 2013, 02:58:52 PM »
Is it worth an additional 0.93% expense to get nearly double the return?
Well, it would be, if there were any evidence that active management were capable of producing higher returns. Since there's not, all you're getting for your additional .93% expense is .93% less of a return.

Another Reader

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #8 on: April 26, 2013, 03:42:51 PM »
Even Vanguard doesn't agree with Grant.....

https://personal.vanguard.com/pdf/s356.pdf

Their actively managed funds outperformed index funds after expenses according to their own study.

I own a number of T. Towe Price funds that clearly outperformed their closest indexes and the market as a whole.  The index fervor here approaches religious fanatacism.  It's just plain wrong.
« Last Edit: April 26, 2013, 03:46:11 PM by Another Reader »

matchewed

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #9 on: April 26, 2013, 03:56:23 PM »
Weren't they comparing their actively managed funds to Non-Vanguard managed funds in that paper?

grantmeaname

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #10 on: April 26, 2013, 03:57:45 PM »
From your own damn document:
"Over the past 20 years, less than 25% of actively managed U.S. equity mutual funds outperformed their relevant style benchmarks. Additionally, research has shown that the underperformance of actively managed funds is relatively consistent across various countries, market segments, and time periods".

Another Reader

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #11 on: April 26, 2013, 04:00:33 PM »
The most absurd conclusion in this silly piece is that somehow the money manager got 2/7 of the rate of return and ended up with 2/3 of the total hypothetical ending value if the investment received 7 percent annualized while you got 5/7 of the rate of return return and ended up with 1/3 of the hypothetical ending value.  Someone does not understand the math or is obfuscating it.  The fee is paid periodically, over the investment period.  Each time the fee is paid, the amount of capital compounding decreases.  The recipient of the fee can then invest their 2 percent from that time forward.  No one receives 2/3 of the hypothetical ending value.

There is a good argument here for avoiding high fees that do not result in even higher returns, but no argument for theft of 2/3 of one's money having occurred.

And, Grant, 25 percent did outperform, including Vanguard's funds.  If you are paying attention, you ought to be able to find them.

Another Reader

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #12 on: April 26, 2013, 04:02:14 PM »
From the Vanguard document:

There is strong theoretical and practical evidence that most actively managed equity funds will underperform their benchmarks.1 To some, this makes the use of active management seem like a fool’s errand with little chance of long-term success. And yet many investors remain drawn to the prospects of outperforming a benchmark with active management. This apparently counterintuitive situation leads some investors to wonder if there are any concrete ways of increasing the probability of success with active management. We believe there are.

grantmeaname

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #13 on: April 26, 2013, 04:04:29 PM »
And, Grant, 25 percent did outperform, including Vanguard's funds.  If you are paying attention, you ought to be able to find them.
Of course. It's trivial to find the mutual funds that did outperform an index over some past time period. You can't invest in "has already outperformed", you have to invest in "will outperform", which is why we don't have all our money in Fidelity Magellan. Since there is no or very little continuity between consecutive periods of outperformance, that's something that you can't do just by "paying attention".

matchewed

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #14 on: April 26, 2013, 04:12:59 PM »
I'm still looking in that pdf for where they prove that actively managed funds outperform index funds. All their data is comparing their actively managed funds to others actively managed funds. A statement saying they think they can isn't proving that they can. And if only 25 percent of funds can outperform their respective index then you've got maybe a 1 in 4 shot of picking that fund? A higher shot if you go for one with low fees? And a real good shot of hitting market performance with incredibly small fees if you go with the index fund.

Another Reader

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #15 on: April 26, 2013, 04:19:20 PM »
I'll go with a management team that has consistently outperformed the market for 10 or 20 years.  Like that guy at the money management job interview told you, it's their job to find the funds that do outperform.  It's my job too, at least for my money, and so far (over 30 years) I have done the job well.


Another Reader

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #16 on: April 26, 2013, 04:29:58 PM »
Look at the chart at the top of Page 8.

No question there are a lot of poorly managed mutual funds out there run by companies that don't care about the ultimate buyers of their products.  Sadly, a lot of these funds end up in 401(k) plans.  But there are good actively managed funds out there.  Markets are NOT random.  Some people are very good at understanding the businesses that underly stocks and at understanding the behavior of markets.  Over time, those people should and do outperform indexes. 

matchewed

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #17 on: April 26, 2013, 04:58:41 PM »
You're totally right about page 8. I missed that and was wrong.

I'm not sure if randomness is in question here. It is mostly that for those 25% of funds which can outperform the market, how many of them do that with fees taken into consideration? I'm not trying to besmirch actively managed funds. I'm just viewing it from the perspective of the customer. How does the customer sort through the bullshit to find the active managers that will always outperform the market (no offense assuming that is a guarantee)? Or can the customer get a no nonsense index fund which will do okay for low fees?

Pardon the language I know there isn't much potty mouthing here but I enjoy the occasional expletive.

Another Reader

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #18 on: April 26, 2013, 05:34:01 PM »
The best funds may not always outperform the market.  But over time, and after fees and expenses, the compound rate of return will be higher.  There are a LOT of bad managed funds out there, and they are still around because the fund company can muscle them into retirement plans or pay commission-based financial advisors to sell them.

One of the things I start with when I see a high average rate of return over many years (in no way the same as the compound rate of return) is the hypothetical growth of $10,000 over 10 years.  Several brokers offer this on the fund performance page and some versions are interactive.  If you take several similar funds plus the closest index and put them on the same graph, you can see who has performed well over 10 years and who has not.

I also start a search with companies known for their good performance and their committment to their retail customers.  Fidelity, T. Rowe Price, and Vanguard are the three large companies I like, although I own other funds.  I look at the fund managers and how long they have been managing the fund.  I don't want to select a fund where most of the performance was produced by managers that are no longer managing the fund. 

There used to be a site called Fund Alarm, which sadly seems to have disappeared.  It was always fun to run Prudential's latest 457 plan offerings through that model to see how bad they really were.  I don't know what the proprietary model included, but they would turn up some stinkers that Morningstar had rated three stars or above.  Between Morningstar and Fund Alarm, it was pretty easy to avoid bad funds.

I'm not against owning index funds and ETF's, I own them as well.  They are easy to set and forget and they are tax efficient.  For each account, I focus on what are the best options offered by the vendor. 

Managing your money takes time and patience.  But no one cares as much about your money as you do.

Jamesqf

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #19 on: April 26, 2013, 11:03:06 PM »
Is it worth an additional 0.93% expense to get nearly double the return?
Well, it would be, if there were any evidence that active management were capable of producing higher returns. Since there's not, all you're getting for your additional .93% expense is .93% less of a return.

So you're claiming that TRP is fudging the figures on its fund returns?  (Maybe you should let the SEC know?)  Or is your argument that you could somehow find an "index" fund with low expense ratios that would invest in the same stocks & produce better returns?

From your own damn document:
"Over the past 20 years, less than 25% of actively managed U.S. equity mutual funds outperformed their relevant style benchmarks. Additionally, research has shown that the underperformance of actively managed funds is relatively consistent across various countries, market segments, and time periods".

Might not this have something to do with the way the underperforming funds are managed?  As an extreme case, take that "Buy lots of options on Apple stock" fund that was mentioned here a month or so ago.  And then there are a whole bunch of get-rich-quick and/or invest according to your politics/paranoia funds. 

You need to remember that the fact that many funds/investment strategies don't work well is not proof that they all do.  As for instance, the PRIDX strategy of seeking growing companies in emerging markets has, over the last decade, provided better returns than investing in a well-managed index fund.  (Of course that's not to say that conditions won't change to where it's no longer a good strategy.)  Likewise, value investing tends to outperform simple index funds over time.

This isn't saying that index funds are bad: they're a pretty decent investment.  (And as I say, I've owned that PREIX index fund for well over a decade.)  But holding them to be the absolute optimum strategy seems to be rooted in a belief that markets are rational, which is easily disproved by a glance at the news.

Hamster

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #20 on: April 26, 2013, 11:49:15 PM »
The most absurd conclusion in this silly piece is that somehow the money manager got 2/7 of the rate of return and ended up with 2/3 of the total hypothetical ending value if the investment received 7 percent annualized while you got 5/7 of the rate of return return and ended up with 1/3 of the hypothetical ending value. 
I think it was poorly stated. Annually deducting 2% from an initial balance for 50 years reduces the total value by 2/3, or (more relevant) reducing annual compounded gains from 7% to 5% reduces total gains by 2/3 over 50 years. From the article :
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Pull up a compounding calculator on line. Take an account with a $100,000 balance and compound it at 7 percent for 50 years. That gives you a return of $ 3,278,041.36. Now change the calculation to a 5 percent return (reduced by the 2 percent annual fee) for the same $100,000 over the same 50 years. That delivers a return of $1,211,938.32. That’s a difference of  $2,066,103.04 – the same 63 percent reduction in value that Smith’s example showed.

Ovid

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #21 on: April 27, 2013, 06:14:14 AM »
When speaking of these fees, are they just talking about expense ratios of the underlying funds or are they talking about more hidden/non-obvious fees on retirement accounts? 

Jamesqf

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #22 on: April 27, 2013, 11:41:27 AM »
I think it was poorly stated. Annually deducting 2% from an initial balance for 50 years reduces the total value by 2/3, or (more relevant) reducing annual compounded gains from 7% to 5% reduces total gains by 2/3 over 50 years.

But again, it's a false comparision between a fund that actually exists in the real world. and a Platonic ideal in which someone could magically invest in the same stocks without any expenses at all. 

For example, say that you've placed a bug in the fund offices, and so know what stocks they're going to buy & sell.  You're bent on reducing costs, so you buy & sell the same ones yourself.  Do you think you can do that for free?  Do you think you can even get the same rates as a major fund?  No, you can't.  So the difference is not 2% vs 0%, it's 2% vs whatever your expenses would be.

Hamster

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #23 on: April 27, 2013, 12:59:42 PM »
I think it was poorly stated. Annually deducting 2% from an initial balance for 50 years reduces the total value by 2/3, or (more relevant) reducing annual compounded gains from 7% to 5% reduces total gains by 2/3 over 50 years.
So the difference is not 2% vs 0%, it's 2% vs whatever your expenses would be.

True enough. The 2% is an exaggeration as it isn't comparing real expense ratios. For me, there are 2 issues - performance and fees:
1) If there were no difference in in expense ratios, would an actively managed fund be expected to outperform an index fund?
2) If performance were equal, what effect would the difference in expense ratios have on your final outcome?

There are others far more expert than me on this topic, and maybe I've just bought into my interpretation of "Bogle-think". But, my general understanding is that, on average, managed funds not only under perform indices, they cost more as well. Even picking a great performer for the last 20 years doesn't mean that they are more likely to outperform indices in the next 20.

So, everything is overstated, but the take home message is the same - Low cost index funds will serve you better than paying fees for actively managed funds (which provide larger relative benefits to "Wall Street", while increasing cost for the investor).

Jamesqf

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #24 on: April 27, 2013, 10:06:00 PM »
But, my general understanding is that, on average, managed funds not only under perform indices, they cost more as well. Even picking a great performer for the last 20 years doesn't mean that they are more likely to outperform indices in the next 20.

Sure, but not all funds are average.  It does take some work to weed out the underperformers, and of course there are no guarantees (just as there are no guarantees that index funds won't do another '08 crash), but it is possible to find ones that have good odds of returning better than index funds, even after management fees are deducted.

sol

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #25 on: April 27, 2013, 10:28:20 PM »
It does take some work to weed out the underperformers, and of course there are no guarantees... but it is possible to find ones that have good odds of returning better than index funds, even after management fees are deducted.

While technically true in the short term, history has shown that the funds with the best returns right now are not the same ones that will have the best returns in five years, or the ones with the best returns five years ago.  Check for yourself.

If you're claiming that your astute analysis can find the best mutual funds year after year, and consistently switch to this year's winners, then where's your Ferrari?  Why aren't you the richest man in the world?  Because nobody else can do that.

Jamesqf

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Re: Where most of your 401k money goes to: making Wall Street wealthier
« Reply #26 on: April 28, 2013, 10:52:04 AM »
While technically true in the short term, history has shown that the funds with the best returns right now are not the same ones that will have the best returns in five years, or the ones with the best returns five years ago.  Check for yourself.

Have done, and have put money where mouth is.  See example above.

You're also making the mistake of taking things to extremes.  Can I pick the best funds?  Of course not.  Can I pick ones that follow investment strategies which are likely to, over time, produce better returns than index funds?  Yes. 

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If you're claiming that your astute analysis can find the best mutual funds year after year, and consistently switch to this year's winners, then where's your Ferrari?  Why aren't you the richest man in the world?
 

Because starting from near-zero (which I did), even a 20% return won't make you the richest man in the world in a couple of decades.  Has made me fairly prosperous, though.

The analysis isn't all that astute, either.  It's things like "invest in emerging markets", "buy stocks with favorable P/E ratios", or (back in the early '90s) buy tech stocks, and get out before the bubble pops. (Arguably I got out about 18 months too early on that one, but better than 18 days too late :-))

As for the Ferrari, I'd prefer a Lotus, and the main reason I haven't bought one is that there's not enough room for my two dogs.

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Because nobody else can do that.

Warren Buffett seems to be doing ok.