A new year gives you a chance to develop new habits.
For 2017, may I recommend this resolution? I will learn more about my retirement account.
With that in mind, I asked author William A. Birdthistle to answer some reader questions left over from a recent online discussion. His book “Empire of the Fund: The Way We Save Now,” reveals how little investors know about how their 401(k) and other retirement plans work.
Q: Could a major mutual fund company suffer a scandal similar to Bernie Madoff’s? [Madoff ran one of the largest Ponzi schemes in U.S. history.]
Birdthistle: Major fraud at mutual funds is highly unlikely. Unlike Madoff’s private funds, public funds like mutual funds are heavily regulated by the Investment Company Act of 1940, which is enforced by the Securities and Exchange Commission. Specifically, mutual funds are obligated to retain an independent custodian (usually a major bank) to hold custody of the fund’s assets (such as cash and the portfolio investments).
Does that mean that collusion between adviser and custodian is impossible? The subprime debacle of 2008 taught us that lots of previously unthinkable behavior is no longer impossible. I think the extremely small risks associated with investing in a mutual fund — particularly a reputable one — are vastly outweighed by the harm you might suffer putting the money anywhere else.
Q: Would it be inadvisable to park our nest egg exclusively in government securities for the next four years? My husband and I fear bad effects from a Trump administration. We’re lucky to have our money in the Thrift Savings Plan [for government employees and military personnel], but, after the election, we moved all of it to the G fund [a government securities fund exclusive to the TSP]. Are we shooting ourselves in the foot?
We probably have 30 to 40 years of retirement ahead of us. After Trump is gone, our plan is to diversify and invest a little more aggressively to maintain our lifestyle.
Birdthistle: First, lucky you to be in the TSP. It’s practically impossible to find fees as low as the TSP’s anywhere.
If you’re worried that the federal securities in the G fund will perform poorly, bear in mind that many Treasury securities are already at rock-bottom interest rates, so although negative rates are possible, rates are more likely to increase in the years ahead, generating greater returns for you.
If, instead, you’re worried that maladministration will actually threaten the full faith and credit of U.S. securities, then I would say that the U.S. government has never defaulted and remains unlikely to. If the U.S. defaults, the aftershocks would hurt almost every other conceivable investment. Consider that since Election Day, the stock market has been up far more than most predicted possible under a pending Trump administration.
Q: Should we exit all actively managed funds and reinvest in index funds? What are we giving up?
Birdthistle: Yes. What would you be giving up? High fees with no assurance of positive returns.
In slightly more seriousness, the vast majority of ordinary investors have neither the time nor the training to evaluate which claims of active managers are true, which active managers actually do beat the market, and which ones beat the market consistently. Without processing that information accurately, investors are simply paying a very high premium in the hopes that more expensive advice will be better advice. Yet study after study refutes that hope.
An incredibly small number of active managers beat the market consistently. The alternative — investing in low-fee index funds — is the most sensible conclusion. Low-fee index investing may not always produce wonderful returns (though it has a very strong track record), but it will — by definition — perform as well as the benchmark and will do so relatively inexpensively. Modest as those results may be, they are powerful and, in a financial battlefield obscured by fog, they are comfortingly certain.
After reading Birdthistle’s book, I was motivated to ask more questions myself. My husband and I have started the year by going over our retirement accounts. We are going to re-examine the fees we pay and our investment choices.
Let 2017 be the year that you take a closer look at your retirement savings. Don’t just blindly throw money in your account. No one can predict the unpredictable when it comes to your nest egg. But at least you can become better informed about what there is to know for sure.