Transcript
Paul Winkler: And welcome to The Investor Coaching show. Paul Winkler talking about the world of money and investing. Yes, that’s what I talk about.
Target Date Funds and 401(k)s
Okay. So you’ve got people with their 401(k)s at work and they think, Oh, you know, my 401(k) is really diverse and, and the employer’s really, really up on things and they have really good asset mixes and different investment choices. And I shake my head and go, nah, not typically now, usually so hot, not necessarily as diverse as you think it is, you know, for reasons I’ll get into. But what happens is that you’ll have these different funds that are target date funds, and it just put it all together and, and say, bam, here, if you’re retiring in 2014, he just buy this fund 2030, you just buy this fund 2055, you buy this fund and it’s managed in a way that is commensurate with the period of time before you’re going to actually retire from a stock to bond standpoint.
But if you look at various target date funds, you’ll find that they’re managed in different ways from different families. So you’ll have one that has a different asset mix than Vanguard that has a different asset mix than Fidelity that has a different asset mix than John Hancock. And so on and so forth. Then you go, wait a minute. Why would there be four different, good ways to invest for a person retiring in the year 2040? Well, you might be onto something, but it’s even deeper than that. If you look at the mixes between not just stocks versus bonds, but if you look at the mixes between large companies and small companies and value companies in growth and international versus us, you’ll see very different, very big differences between them.
And you go, wait a minute. What’s going on here. And a lot of times it’s marketing, you know, who did the best job at marketing to the employer on, you know, getting it. And I’m not saying don’t invest in your 401(k) at work. I said, you just got to realize that you might have to take a little bit more control than you think. And typically what they’ll do is they’ll not only have those funds in there, but they will also have individual funds that are investing in small companies and growth in value in international, in us and emerging markets and so on and so forth. And, and they do that so that you have other things that you can put money into so that you can’t blame them. When you know, 20 years down the road, 30 years down the road, you have way less money than you should have had.
You Have a Choice When It Comes to Your 401(k)
And you go, well, wait a minute, you guys just gave us these funds right here. And there’s oh, he also gave you other funds where you can manage it yourself. So you’ll typically see when you go into 401(k) that you’ll have a choice, man, let us manage it for you or no, I think I’ve got this. I want it a lot of times, what happens is kind of funny. If you, if you look at the websites, a lot of times what they’ll do is they’ll put verbiage in there and I’ll often say to clients when we go in there and we’re looking at things and say, no, this is for a rich rate. I’ll just point it out to them. And they are kind of funny. They try to scare you and to make it so that you think, Oh my goodness, I’m really taking my life into my own hands.
When I select investments myself, I just know, you know, they’re just trying to move people to the way that they want them to move. And it’s just kind of partly how they do it. They use language that’s very scary. So if you look at these big pensions and you say, well, how are they doing? I mean, this is where you have a big institutional manager managing a large sum of money and they had to be really, really sophisticated. And that’s what you’d think about these target funds too. That they’d be really sophisticated. Well, actually what they’re finding is not so much diversification of pension funds and educational endowments, you know, so you have a university, that’s got a plan where people give to the university and they invest the money.
Alternative investments ceased to be diversifiers in the 2000s, is what they said in the article, and have become a significant drag on institutional performance. Well, why is that? Why, why am I kind of snickering almost as I say this? Well, because back in 2008 and 2009, particularly 2009, when I was doing this show, I was seeing these huge mutual fund companies and endowments and pensions, all hand, you know, these huge investment firms, people would bring in their investment portfolios and say, if all here’s my investment portfolio.
And I would shake my head and be like, Oh, you gotta be kidding me, alternative investments. And it was the hottest thing out there, you know, commodities, alternatives, real estate investments and things like that. And, you know, there were all these alternatives to what will be typical stocks and oh, boring stocks and bonds. Oh my goodness, that’s boring. We need to have an alternative to that. And why did it become hot? Well, because some alternative investments actually moved the opposite direction of the stock market. When the market went down in 2008, you had some areas like gold, for example, you know, jumped up in and you’ll have some commodities that jumped up in value.
Look How Far the Research Goes Back
And what does Wall Street do when something’s out performing another thing, they run to it, the horses, this is out of the barn, but it doesn’t matter. They’re going to run to it because, oh my goodness, we don’t want to look like we’ve been out to lunch. We want to look like we’re up on things. So we’re going to start adding this syrup portfolio if fidelity had their target date fund and they had these target 2040 funds. And some of the other ones, I don’t know if it was the top one, I know for 2040, it was a commodities fund. It was their top holding. It was their biggest holding the most money in it. The highest percentage of the money was in that fund. I was just shaking my head going, this is nuts. This is, and people would come in and they would say, here’s my portfolio.
And I’d look at it and go, no, no, no. And then people come in their managed portfolios from the big investment firms. And I would see these, these things in the portfolio and just going, no, don’t do this. Well. What happened? Alternative investments ceased to be diversifiers. Well, there, we were only diversifiers in the year, 2008. And that’s what I told people. You had one year where they did better. And then all of a sudden, all this research came out and said, this is a great diversifier. You all added to your portfolio. And I was, I was telling people, as they’re saying, well, this research says, this is a diversifier, Paul. And I go, no, look how far the research goes back.
It doesn’t go back nearly enough for us to come to any conclusions that are worthwhile. And guess what? There we go. It became a significant drag on the portfolio, publicly pensions, underperformed by 1%, just markets by 1% per year and endowments 1.6% per year. If you look at the numbers that huge and they had these, these costs were one VAR, you know, throw that on top of that cost. So 1% to 1.7% annually. And you know, you throw that on top of doing things incorrectly and throwing this stuff in there.
And before long, you know, it’s like that Senator said a billion here, a billionaire for long it’s big money. And that’s basically what happened. You know, it’s just over and over again, we see this kind of thing. So, you know, when I talk about, you know, what it is when we talk about our 401(k) and I said, well, you know, a lot of times people think that people know more than they do. What am I talking about? Well, that refers to another article that I saw in some other studies that I’ve seen, but there’s the most recent one that I had seen this week was retirement literacy. So, you know, a lot of times you’re going into your 401(k) and you’ve got this 401(k) committee that chooses the investments and, you know, they may know enough to be dangerous and you don’t know what they know.
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Salespeople Will Be Salespeople
And don’t know a lot of times they’re relying many times on the investment company. And a lot of times you’d be shocked at how little the salespeople know at the investment company selling the 401(k)s. And, you know, I remember back when I was doing that for a living, you know, 25, 30 years ago, and I would go into a 401(k) and I’ll never forget, there’s one I went into in particular. And they said, yeah, Paul take over a 401(k). It was a friend of mine and a couple of friends of mine. And I said, would you take over this house? I said, well, I’m going to bring in the wholesaler from the big investment company. And at the time, the very, very biggest investment company that did this while I brought their wholesaler in, you know, that is a person that actually represents the company and gets investment advisors to sell their stuff.
And I bring this person in and they say, well, you know, you choose a bunch of funds, a bunch of mutual funds to put in the 401(k) for the participants. And I said, Oh, okay. All right. And I said, well, I’m looking around and going, I don’t know what to choose. And the wholesaler said, well, this is a really popular fund. This is a really popular fund. This one, this one. And they selected a bunch of funds. And the funny thing was, you know, what this person has selected where all the funds that had the best 3, 5, 10 years of records based on past performance.
And I remember it now, I didn’t know it was wrong back then, but that’s basically how they chose things. So you’d be surprised a lot of times the advisors don’t know how things work and how markets work and what areas of the market and how to actually choose funds and what criteria to look at. So it’s no surprise when I see this thing.
Retirement Literacy
That’s retirement literacy among women and men is woefully low. So what they did is they did a study on women and men. They gave them this survey and they asked them to go through these questions. And they said a large majority of Americans, especially women have failing grades when it comes to retirement literacy. Now, women, before you get hard on yourself, wait until you hear the numbers. In fact, 89% of women and 72% of men say what’s done that doesn’t seem so great. A little bit over 800 women, and about 700 men online, like men who claim to have higher levels of knowledge and then test poorly, women’s self-reported knowledge is more aligned with their actual literacy scores, according to this study.
And that to me is interesting. So men, you know, they think that they’ve got it down, the women, not so much, they realize that, you know, I probably did pretty poorly on this test. So they have a little bit more in that area. And these weren’t poor people. I’m there, they’re talking to people that have at least a hundred thousand dollars in household assets. So these aren’t, you know, not, not including their house, their primary residence. So these are not poor people that they’re asking and people that have no money invested and have no experience. These are people that should have some experience and should have some knowledge about this.
They had this guy that they started off to study with. They were talking about this guy who goes in and robs a bank and, you know, runs out of the bank. You know, robs the bank, has the money, and looks straight at the camera and waves at the camera. That’s pretty brazen. Oh, why would this person do this? And of course he’s caught, you know, pretty soon afterwards, it didn’t take long to figure out who the person was and catch them and arrest them. Well, the person actually had read a little bit, which is dangerous and finds out that one of the key ingredients in invisible ink is lemon juice and extract from lemon juice and puts lemon juice on his face and thinks that, well, you know that I’ve got lemon juice on my face. Nobody’s going to see me and cameras won’t recognize me. They won’t see me either. And, you know, shocked when he sees the pictures of himself and going, Oh my goodness, that’s my face. Yes, that’s me.
And you go, wow, that’s, that’s pretty bad. But it was just kind of funny because that’s how they started off the article. But what they did was, they drew a box. And as let’s say, the box is two inches by two inches, and then they have another box inside of it. That’s, let’s say one and a half inches by one and a half inches. Okay. So it takes up a lot of the box, but not all of the box of the bigger two inch by two inch box.
So you can imagine this, these two boxes, one inside of another. And they said, well, the smaller box is what a person that knows. And they say that they know about a particular topic, and this is the average person, what they may know about a topic. And, and what happens if you start to really question them and find out what they know about a topic, then we use say, well, how much information do you think you’re lacking? And the bigger box, the two, two by two box is what they think that there is to know about a subject. And what’s fascinating is they basically find that people think that there’s less information out there than there really is on a topic. And that is clearly true about investing.
Now, if you said, okay, well, what’s a leptokurtic bell curve? You know, most people were like, I don’t even, what are you talking about? Well, you know, that’s markets, how you measure market risk is through that. And it’s not a regular bell curve and it’s left a curtain and he can go, you know, so there was stuff like that. And you just, you don’t even what you don’t know is just an example. And then what they did is they went to people that were experts. And they said, well, how much do you know? And they had a box that may be, it may be like three by three, let’s say. And then what they do is they have another box that is like eight by eight that it’s inside of. And the point that they were making is you got this box as three by three, which is bigger than what the other person thought was knowable about a topic.
In other words, they realize there’s so much that they don’t know. Then what happens is their level of ego regarding the topic is much lower. They don’t have this overblown ego about how much they know, because they realize that they’re actually fairly inadequate when it comes to the whole topic. But what they do well is they look at the person that’s inside the two by two box and they go, well, you know, I think that person knows more than they really do.
Our Level of Confidence Matters
Why the reason comes down to is the level of confidence of the first person far exceeds what their confidence should be. You know? So that to me is really eye opening. That’s what happens. So often as we often don’t know what we don’t know, and we don’t realize how much information there is out there, you know, it’s, it’s one of the exercises we like doing in this big workshop that we teach is where we’ll have somebody that’s investing, investing in individual companies. And we’ll say, you know, why do you like this stock? Oh, Hey, I like this company. And they talk about how much they know about the company. And then we’ll start to ask them, you know, real specific questions. Well, do you know the result of the last health exam with a CEO?
Do you know what companies are actually developing products that could be competitors to the company who stock you having to own? Do you know the regulatory actions taking place in Washington that haven’t been made public yet? No. Do you know what some, and you can go on and on and people realize, Oh my goodness, there’s a lot of stuff that I don’t know. And once you get to a person to the point where they realize there’s a lot of stuff that they don’t know, and once they realize they don’t know it, then all of a sudden their level of confidence in what they’re doing goes down significantly and then relates to something else that they put in this study, which I thought was interesting. I said 43% of women felt less comfortable with investment risk because of COVID-19 crisis.
So 16% of women feel very knowledgeable about investment considerations in retirement planning, 14% of women felt knowledgeable about strategies to sustain income in retirement. And it says, well, advisers need to understand that women may come to the table with different approaches to retirement planning and with many thinking about finances holistically, or maybe more conservatively than men. And when I like to point out with regards to this, I think a lot of times people misread conservatism, you know, they may say that somebody who’s really conservative versus somebody else. And what I’ve found in just 20 years of teaching, when I guide people on 401(k)s or I guide them on retirement, I teach them it’s the same time I help them understand, well, let me show you why I’m choosing this, why this is in there, how it works, what asset mix, what asset categories, why I chose this fund over that fund.
And, you know, I don’t teach them everything I know, but I want them to get it. So that, well, number one, that they know I get it. But the other thing is, is this, when you get a person to get a better understanding of how the investments are put together and why they’re put together and what areas you’re choosing and what the criteria is and, and what the different factors that you look at, why you’ve chosen those factors to look at, whether it be cost, whether it be price to book, whether it be price to earnings ratios, whether it be market capitalization of the companies or proportion, or what industries that are held or what sectors are held in. You know, they’re all different factors that you look at. And I, and I won’t go through everything.
If a person really wants to know all that stuff, I will, but, but most people don’t want to know all those things. But once they start to understand all of these things, what I find is that people tend to be less conservative as far as they’re not as risk averse, because we tend to be very, very scared of that, which we don’t understand. And it may be just the little bit of difference in understanding between men and women, but the fact that women are more knowledgeable or they’re more conscious of their level of, or lack of, understanding as this basic study shows that makes them a little bit more conservative as a rule.
And, you know, like, like I said, you know, they’re, you can’t stereotype typically because there are some women that know way more. I got a couple of them working for me. You know, I’m very, very confident when it comes to this stuff. But here’s the reality: you can have a lot of people that tend to be a little bit more risk averse just because they don’t know. And maybe some men are less risk averse than they should be, because they don’t know that they don’t know.
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