Post #21 – Investment Vehicle Choices
In recent posts I have spent a lot of time discussing the importance of an investor’s equity allocation percentage. These posts have caused the question to be asked, “in what fund vehicle should one actually invest their retirement assets?” In this post I will give you my thoughts on this subject and some guidance.
The short answer to the previous question, “it really does not matter what fund vehicle you choose to invest your retirement assets.” As I discussed in Post #11 the biggest factor in your long term asset returns depends on your percentage equity allocation. Every study I have read has come to the conclusion that your choice of equity allocation is responsible for over 90% of your investment return. Because of this finding is why I say it does not matter what vehicle an investor uses to park their retirement assets.
But, for those who want a more practical answer, I will give you my opinion about what you might consider. As I discussed in an earlier post, you do not really have any choices with your employer 401(k) plan. You can only invest in the funds offered by the 401(k) plan. Some employer plans now have added the ability to buy individual stocks through a brokerage feature, but buying individual stocks is not something I think the average investor should be doing.
However when you change jobs you will have an opportunity to move your retirement funds to another organization. The one thing I would advise against, as I mentioned in Post #18, is moving your retirement assets in your current employer’s 401(k) plan to your new employer’s 401(k) plan. You should move all previous employer 401(k) retirement assets to an Individual Retirement Account (IRA) where you have a lot more investment choices.
In Post #18 I briefly discussed the impact of fund management fees on investment returns. Given the drag on returns of funds that charge higher fees (without any proven long term benefit), I would advise moving all retirement assets to the financial firm that charges the lowest fund fees.
The last time I checked the lowest cost fund families were Fidelity, Schwab, and Vanguard. Vanguard is always the lowest cost fund family for 2 main reasons. First, the vast majority of their funds are index funds that are designed to track an established index. This is less costly because it does not require a large stock research group that the “full service” brokerage houses employ to try to “beat the market.”
The second reason Vanguard is the lowest cost fund family is because of their corporate structure. Typical investment/brokerage firms are structured such that the brokerage house “owns” the fund and their operating costs are taken from the assets of the fund shareholders who buy into their funds. These costs include stock research groups (for each fund), the fund managers’ salary and bonuses, trading costs as well as corporate costs. This creates a situation where the more the investor shareholder makes, the less the brokerage firm makes (in profit) and vice versa.
Vanguard operates differently. They do have corporate costs but they are much lower than the typical brokerage firm. But, most importantly, the Vanguard funds are owned by the shareholders. The fund managers are, technically, employees who are on salary. Since the fund managers are just tracking the market through their particular index, there are no big manager bonuses to be paid. These 2 reasons make it virtually impossible for any other brokerage house to have lower costs than Vanguard. My wife and I have our retirement assets with T. Rowe Price and we have been very happy with them. But, if I had it to do over again, I would have rolled all our previous employer retirement funds into the Vanguard fund family. Who knows I may still move to Vanguard sometime in the future.
Keeping your retirement funds at a low cost brokerage firm is more important for younger investors as they have many years for the funds’ fees to compound and eat into their retirement assets. For older investors who do not want to change brokerage firms for whatever reason, you do not have to. All brokerage houses have their own index funds in addition to their higher cost managed funds. So it is possible to minimize mutual fund costs without changing brokerage firms. But be aware that none of these other firm’s index funds will be cheap as Vanguard’s. Check out this page on Vanguard’s site. They have a tool showing how much you would save in fund fees using Vanguard’s funds versus the industry average fund which they claim charges an average fee of 1.15%. I tried the tool to see the Vanguard fee cost savings assuming a $300,000 beginning retirement asset base for 20 years. The result was a $231,000 cost savings. I seriously doubt that the higher costs of a managed fund could achieve better returns that could overcome this management fee cost difference. Be aware this 1.15% average fee quoted by Vanguard is the average of all other brokerage firm’s funds and not just their index funds. So if a cost comparison of only the index funds of other brokerages firms were compared to Vanguard’s funds, the savings would be smaller, but significant none the less.
With a couple of exceptions, we have all our retirement assets in index funds. T. Rowe Price’s average index fund fee is about 0.40% of the managed assets. Vanguard’s average fund fee is less than 0.25%. A good way to gauge how expensive your brokerage fund’s index fund fees are is to check the fee for their S&P 500 index fund. If the fee is much more than 0.50%, I would consider moving your IRA funds to a lower cost fund family.
The bottom line here is this – if it is true that over 90% of your investment returns come from your equity allocation and not the funds you pick, paying higher fund fees is like buying a 40-inch flat screen TV at a specialty electronics store for $1,200 when you could get the same TV at Walmart for $700. How many of you would do that? When it comes to your retirement savings, it is same thing; only we are talking about, potentially, hundreds of thousands of dollars of management fee cost savings over the life of your investment assets.
Did you enjoy this post? Why not leave a comment below and continue the conversation, or subscribe to my feed and get articles like this delivered automatically to your feed reader.
Comments
No comments yet.
Sorry, the comment form is closed at this time.