Sunday, November 2, 2014

401(k) Investing the Low Cost, High Rate of Return Way ... Fire the "Experts" and Follow the DIY Road to Provide for Your Family's Long Term Financial Well Being

Individual investors often unwittingly pay commissions of 1% to 4% or even higher to non-risk taking, non-funds providing "professional" brokers and investment managers. What individual investors pay varies and depends on the type of investments made on their behalf and the individual broker or money manager. But whatever they pay, the sad truth is that individuals as a rule pay far too much to the "experts" and receive far too little of the total return. In fact, when compared to annualized investment returns instead of total assets being managed, individuals are charged multiples of those 1% to 4% amounts. The charges in relation to returns range from 10% to 50% or even more than 100% of the total invested. And that's a very bad deal for the individual and a very good deal for the "expert."

For example, paying a 4% or front end commission for a mutual fund purchase which earns an 8% return in year #1 translates as follows -- the selling broker gets 50% of the money made and the individual fund provider and risk taking individual investor gets the other 50%. This 50/50 split is a very good deal for the selling broker and a very bad deal for the individual investor who bears 100% of the risk and provides 100% of the funds. And even if it's "only" a 1% fee charged and a 10% rate of return, that's still 10% of the individual's investment earnings going to the broker. And if it's a year when the market declines, then the broker takes more than 100% of the rate of the return and the individual loses all the way around, because the "expert" always gets paid, rain or shine.

But it doesn't have to be that way. And it shouldn't be that way. There's a better way. The DIY way.

Individual 401(k) and IRA savers and investors can materially improve their investment results over time. It's low cost, simple, easy and fun to do. All that is required is some reasonable expenditure of time and effort.

John Bogle on why your retirement program stinks offers this useful guidance for the DIY beginner:

"How important are fees to your retirement plan's success? As Vanguard founder John Bogle pointed out in a recent discussion with analysts, it's really all that matters.

Fees easily wipe out a huge portion of the yield on stocks, he said, more than 63% for your money.

That's the real danger to retirement savers, especially folks over 45. With fewer years of work ahead to save and compound, every penny counts. Fees are fixed costs that are consciously structured to suck money from your accounts, regardless of performance.

Nothing about stocks is guaranteed. Yet research shows that stocks have provided an annualized return of between 6.5% and 7% after inflation, well above other investment types.

The reason for that superior number is simple enough: reinvested dividends. Companies recognize the role of investors as owners and give them cash income in the form of a dividend.

Retirement savers who reinvest those dividends end up with far more money, a compounding effect that accelerates over the years. It's how reliable retirements are built.

But what if you don't get to reinvest your money? What if someone else keeps it?

That's Bogle's simple point: If stock dividends average 1.9% and the average mutual fund charges its investors 1.2%, then the investor is left with just 0.7% in net yield to reinvest. "We eat up all of our dividends with stock expenses," Bogle said . . . .

In short, there are two certainties in your retirement plan: Income from stocks and bonds and the level of fees you pay. Since most managers can't beat the market after deducting their fees, your best shot at retiring well is to secure a market return and consistently reinvest the dividends.

Assume for a moment that you get no joy from the markets. Your investments are flat for 12 months straight. In reality, you did collect income. In a straight Standard & Poor’s 500 Index investment, that's the 1.9% dividend yield Bogle explained.

The other certainty, then, is the fees. Subtract those and you're down to 0.7%. It isn't a maybe. Brokerage-based investment advisers and mutual fund managers will take their cut in fees regardless of performance. You can count on that.

Let's add up the pain. Imagine that a $10,000 investment to which you add $10,000 a year for three decades grows at 1.9% — just the dividend yield gets reinvested, so we're not counting appreciation for the moment. At the end of 30 years, then, you should have $424,564.

If instead you reinvest 0.7% (which is what really happens to many folks), your return over those years comes to $347,192. You get $77,372 less of the money you earned over the years. All of that cash goes to the managers.

Your broker's pocket

You might be itching at this point to interject, "Well, I'm not worried. My manager beats the market." And you might be right about that this year and next. But over the long run he won't.

Fund managers eventually have down years. They give back the earnings of previous years. They gather up too much money and start to post returns that match the market before fees. Subtract those fees and quickly you fall behind. . . .

That money flows just one way, by design — out of your plan and into the pocket of a broker."

Summing Up

Individual investors should not pay high and ongoing fees to brokers and other investment managers for one simple reason. They won't get their money's worth. It's that simple.

In fact, we all too often make what could be really simple and very low cost needlessly complicated and extremely costly. We do that because we don't take the upfront time to know all the facts.

Saving and investing our retirement funds can and should be both simple and easy.

All that's required is the desire to do what's right for ourselves and our families and then setting aside enough time to become knowledgeable about the basics of DIY investing in a 401(k) or IRA.

Consistently applied effort will do the rest for us as MOM (my own money) rules are activated.

That's my take.

Thanks. Bob.

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