Tag Archives: financial advice

Stock Pickers vs Indexers

My Comments: Which approach is best for you? Not for me, but for YOU?

For the past dozen years or more, my efforts on behalf of clients to use historically good fund managers has largely failed. And not just because of what happened in 2008-09.

Yes, I still made my money as an advisor. But increasingly I couldn’t justify it in terms of the results. Many clients, listening to the likes of Jim Cramer on TV, decided they could get better results elsewhere. I hope they were successful but the odds were not in their favor. If you follow the link below, you’ll better understand why I say this.

My approach today is to use one of the two major global index families and either give away my advice to those who will accept it, or charge what a few years ago was considered a ridiculously low fee. Some people just have absolutely no capacity to figure it out for themselves which is what gives people like me a license earn an income.

Clients have two basic choices: either do it all yourself, of find someone to help you. Regardless of that decision, the next step on the decision tree is how much unprotected exposure to the stock, bond and other markets can you live with.

The trauma from the crash in 2008-09 is still very much alive in peoples minds. To the extent you want exposure to the markets and at the same time protect your downside, there are some very clear solutions. To the extent you are OK with watching your assets crash and burn, indexes at least eliminate most of the management costs. This is a good thing.

Either way, I can sleep at night and not feel like caveat emptor is the ruling maxim.

Why Reducing Investment Losses Is So Important

My Comments: There are times to be cautious and there are times to throw caution to the winds. As you get older, caution is increasingly common.

One way to solve your dilemma is to focus efforts on limiting what we call downside risk. That’s the opposite of upside risk for those of you just figuring this out. Most people have no problem with the upside. I’ve never had a client pissed at me for helping them make a lot of money.

However, for the past two plus years, it’s been elusive. There is a remedy but first, let’s set the stage for controlling downside risk. This idea become increasingly critical in retirement when you start using your retirement savings to pay bills.

Raul Elizalde  |  April 6, 2017

Investing in stocks can be brutal. According to research, the S&P 500 lost at least 10% from a previous high every two-and-a-half years on average, and at least 20% every six. A 30% loss happened every 13. It has fallen 50% from a peak three times since 1954. Remarkably, losses of this magnitude contradict the models we use to describe market behavior.

For example, the largest S&P 500 one-day loss was 20.5% in October 1987. According to a widely used model of stock market returns (which assumes they form a bell curve around an average), the likelihood of the 1987 loss is roughly equivalent to picking the right card in a deck with as many cards as atoms in the known universe. In other words, that loss could not have happened.

Limit Your Losses When the Market Drops

Clearly the problem is not that impossible events happen; it is rather that our models are inadequate, and a lot of analysts have tried to come up with better ones. So far, this quest has proven fruitless. We still can’t predict markets with any meaningful accuracy. This is why markets are not so much like the weather, but rather like earthquakes, which scientists now admit are unpredictable.

But here is the good news: we cannot predict earthquakes, but we know how to build earthquake-resistant structures. Likewise, we cannot predict markets, but we have techniques that can help us limit losses when markets tank. There are some very basic reasons why limiting losses is more important than producing strong returns.

A well-known example goes like this: If you lose 50% of $100 you need a 100% return on the remaining $50 to break even. This means that a large percentage loss requires a very large percentage gain for full recovery.

But a far more important example is this: If you only lose 20% of $100, you will need just 25% to bring the remaining $80 back to $100. So a small loss requires much less effort to come out from it.
Limiting Losses Even More Important in Retirement

This is even more important for retirees who use savings to pay for living expenses.

For example, taking $10 after a portfolio falls from $100 to $50 leaves the saver with only $40. A subsequent 100% return only takes the portfolio back to $80. That means that the $10 withdrawal turned into $20 because of its bad timing.

But when $100 only falls to $80 and $10 are taken, a subsequent 25% recovery on the remaining $70 brings the value up to $87.50. This means that the $10 withdrawal turned into $12.50—a much smaller penalty for taking money out at the worst possible time.

The moral is clear: limiting losses is an essential element in portfolio management.

How to Limit Losses

Limiting losses requires some basic processes in place. The best known is diversification, or investing in a mix of assets that tend to move in different directions. But a mix that looks diversified today may not be diversified tomorrow, especially when markets take a turn for the worse. This is because in down markets investors sell everything and correlations go up sharply. Therefore, a mix that does not take into account how the market cycle changes is prone to go through periods where diversification goes away just when investors need it most. Adapting portfolios to market conditions requires dedication, patience, and a well-designed set of rules.

This is, or should be, the professional portfolio manager’s job. Some investors insist that the portfolio manager’s job is simply to beat the market by picking a high proportion of winning assets. Accordingly, they are willing to pay a premium for those managers who seem to have the hot hands. This is a bad approach, commonly known as “chasing past returns.”
Many studies show that virtually no active fund can consistently beat its benchmark, and not because of fees. According to Standard & Poor, which publishes a regular analysis of fund performance, most funds underperform their benchmarks both before and after fees.

The simple explanation is that poorly diversified funds can only outperform their benchmarks through superior forecasting. But, just like for earthquakes, forecasting the market accurately is impossible. As one academic put it:

Going back to basics, the idea “to invest successfully in the stock market, you need to know whether the market is going to go up or go down” is just wrong. (Professor David Aldous, UC Berkeley – The Kelly criterion for favorable games, Lecture 2)

While limiting downside exposure is crucial in portfolio management, having this protection in place at all times can be frustrating. If the market keeps on rallying, the “insurance” against declines may appear to be an unnecessary drag on returns, just as going through the expense of building a house that is earthquake-resistant may seem like a waste as long as there are no earthquakes.

We have all complained about paying for insurance that we don’t seem to need. This is understandable as long as disaster does not strike. But the temptation to cancel insurance can be dangerous. If you are not yet convinced this is so, please reread the first paragraph to see why having a systematic process to protect investments from losses is a good idea.

China Can’t Carry Global Economy if U.S. Stumbles

My Comments: Last Thursday and Friday I re-posted two articles about the US and China. This is related to those two.

We as a nation have about $20T (that’s TRILLION) of debt. Sooner or later, we have to pay it back, and #45 has promised huge infrastructure and defense spending increases. Either we grow our way out of it (creating more debt to get started), cut a piece out of everything we now spend money on, or change our tax structure. My opinion is it’s going to have to be all three.

Donald Trump has expressed an interest in tax reform. At least I think he has; I’m not sure anymore what he has in mind, if anything. But if the repeal of ObamaCare is any indication, that effort, as much as anything, gave tax cuts to those who are already rich. Trickle down economics has been shown to not work and is a false mantra. If he thought health care was complicated, he hasn’t seen anything yet when he starts to tackle tax reform.

So how do we keep everything on track if the US economy stumbles? A growing middle class following World War II gave rise to our strength as a global economic power. But that middle class is disappearing and with it will go our role as a financial power on the global scale. It’s the middle class that buys stuff like houses and cars and all the goodies America is famous for. Nothing I’ve seen or heard from the Trump camp is directed towards revitalizing America’s middle class.

By Nathaniel Taplin on March 31, 2017

Suddenly it’s a world upside down–investors are deserting U.S. growth plays as skepticism about Donald Trump’s agenda rises, while overcapacity-ridden China and aging Japan are looking unexpectedly strong.

Better growth in the world’s second- and third-largest economies, which both posted surprisingly good manufacturing numbers Friday, is great news for Asia and commodity exporters.

It won’t do much to help major developed economies, however, if growth in America and Europe falters along with Mr. Trump’s pro-business agenda.
Better growth in China does contribute in one key way to the so-called Trump trade: It boosts global inflation through higher commodity prices. The close correlation between global commodities and Chinese real-estate investment shows the bulk of the big bounce in prices since early 2016 is due to the cyclical recovery in China, rather than the rhetoric around plans for increased U.S. infrastructure spending.

That means that a big part of the uptick in global inflation numbers –which central banks from Europe to the U.S. have worriedly noted has mostly been driven by fuel prices rather than rising wages–is about China as well.

Unfortunately that is the wrong sort of inflation: Rising commodity prices in consumer countries such as the U.S. and nations in Europe erodes purchasing power and ultimately means lower growth. Strong growth in Chinese construction, meanwhile, is an enormous help for Australian iron-ore exporters and copper miners in Chile, but it doesn’t do much for the U.S. or Europe–the likes of heavy equipment maker Caterpillar(CAT) aside.

Faster growth in China and Japan will doubtlessly help certain firms and sectors on the margins–but these are still highly protected economies, unlike the U.S. and European powerhouses such as Germany and the U.K.

The primary effect of better growth in China’s “old” economy is still higher commodity-price driven inflation –reflation indeed, but not of the happy variety. With Mr. Trump’s agenda under assault and political uncertainty in Europe still rising, the West needs to look to itself to keep growth ratcheting higher.

It’s Bubble Time!

My Comments: I’ve been around long enough to have experienced some bubbles in the markets and they’re not pretty. Especially the one in 1987 when my colleagues and I stared at each other in disbelief as our money and that of our clients disappeared in a cloud of dust. We’re due for another. And while this article is mostly about a housing market bubble, we have one building in the S&P500 and the DOW. You should be very careful if you are in retirement or planning to enter it soon.

Chris Martenson / Feb. 27, 2017
It’s impossible to predict with certainty how much more insane our financial markets will get before an inevitable correction. But my personal bet is: A lot!

For my reasons why, take a few minutes to watch the chapter on bubbles below from The Crash Course. For those who haven’t seen it before, the takeaway is this: bubbles pop only when greed in the market has been exhausted. https://youtu.be/7KpwrJHC6_0

Bubbles make no sense economically. Or rationally. But they happen all the time as a part of the human condition. Even while financial bubbles are enabled by dumb monetary and banking decisions, their actual genesis is rooted in primal human emotions. Greed on the way up, and fear on the way down. The hardest part about these bubbles is not being swept up in them. As the above video shows, history is chock full of asset bubbles. We humans just never seem to learn. Like Charlie Brown’s endless attempts to kick Lucy’s football, we get suckered in by the promise of easy riches, only to end up flat on our back when the market suddenly yanks that promise away.

Wash, rinse, repeat.

Most of you reading this might be thinking “Hey, I’m a reasonable, intelligent person. I won’t fall victim to the next bubble.” Perhaps, but maybe not. The numbers say that the majority of you will. Unfortunately, being smart — even a genius — is no protection against being ruined by a bubble.

Remember from the video that even Sir Isaac Newton, easily one of the most brilliant humans ever to live, got his clock cleaned by the South Sea Bubble:
Bubbles are much easier to enter than to exit. As they build, all your friends and neighbors are diving into the pool and enjoying easy riches. You deserve some of that good fortune, right? And there will be plenty of eager parties willing to help you get on the bandwagon.

When the bubble pops, though, action becomes much harder to take. At first, everyone assumes that the sudden drop is a temporary aberration and that the party will shortly resume. As prices fall further — and they typically fall at a faster rate than when they were rising — folks become paralyzed by fear on the way down, slowly realizing that their paper profits may indeed be gone for good. At first they’re unwilling to give up the dream of the “sure thing” they so recently had, and then, once the losses start mounting, they find themselves resistant to locking in those losses by selling. Instead, they hold on to the increasingly threadbare hope that prices will at least recover to where they can ‘get their money back.’

Of course, that never happens. For all those who bought in during the mania, their money was hopelessly betrayed the moment they placed their bet. And that’s what bubbles are – merely bets. And that bet is: I bet I can get out before everyone else.

That’s mathematically impossible for the majority. It’s really only possible for a very tiny few who have the vision and the discipline (and more often than not, the luck) to pull it off. Very rare are the people who get out at the top.

Don’t Be A Victim

So, to avoid becoming victim in the future, the first thing you need is the clarity to know when you have a bubble on your hands.

Well, it really doesn’t get any clearer than this:
Why Toronto (and Other Cities) Inflate Housing Bubbles to the Bitter End
Feb 20, 2017

“Let’s drop the pretense. The Toronto housing market and the many cities surrounding it are in a housing bubble,” Bank of Montreal (NYSE:BMO) Chief Economist Doug Porter told clients in a note last week.

Many have called it “housing bubble” for a while, but now it’s official, according to BMO.

In January, the benchmark price and the average price were both up 22% year-over-year, with the average price of detached homes up 26%, of semi-detached homes 28%, of townhouses 27%, and of condos 15%. Double-digit price increases have become the rule in recent years.

But this jump was “the fastest increase since the late 1980s – a period pretty much everyone can agree was a true bubble – and a cool 21 percentage points faster than inflation and/or wage growth,” Porter explained in his note, cited by BNN.

Holy smokes! Or rather, what are people smoking up there? Bubble weed, or something. A 22% yr/yr gain? On top of a string of recent years of double-digit gains?

Here are two more features about bubbles we need to keep in mind:
1. Bubble exist when prices rise beyond what incomes can sustain
2. Bubbles always have a blow-off top

First, house prices rising a ‘cool’ 21 percentage points above wage growth over a single year is the very definition of bubble behavior. Simple math tells us that anyone who borrows to buy property eventually has to pay that loan back.

The money to pay back that property loan comes from wages. Ergo, property prices and wages cannot depart from each other forever, or even for very long, without a lot of repayment defaults resulting.

As for ending in a “blow-off top”, that’s just how history tells us bubbles finally exhaust themselves. They draw in every last sucker and lazy-thinking ‘investor’ until there’s no “greater fool” left willing to pay a higher price. This doesn’t require 100% participation from the local population; only 100% participation from everyone who can be drawn in. When that finally happens, that’s when the bubble bursts all of its own accord.

There’s another way for a bubble to end, but it practically never happens.

Responsible bankers and lenders could prevent the bubble’s formation by simply not lending ridiculous amounts. It almost never happens for the same reasons that people buy overpriced houses: greed and our social programming to follow the herd. If all your banker buddies are making big bucks writing loans to anyone who can fog a mirror, then you’ll be rewarded for doing the same. Nobody wants to be the lone, unpopular voice urging restraint when the crowds are going wild.

The quotes below from the 1850s show how this dynamic is nothing new to society:
Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.
In reading The History of Nations, we find that, like individuals, they have their whims and their peculiarities, their seasons of excitement and recklessness, when they care not what they do. We find that whole communities suddenly fix their minds upon one object and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.
―Charles Mackay,in Extraordinary Popular Delusions and the Madness of Crowds

Well, the good people of Toronto — as well as Vancouver, Palo Alto, Melbourne, and a large number of other real estate markets — have fixed their minds on the delusion that the recent skyrocketing price appreciation means that home prices will continue to always rise from here. So get in now! You can’t lose! Don’t risk getting priced out of the market!

What is particularly crazy about this is that we just saw 10 short years ago how this movie ends. But those caught up in the current mania simply aren’t thinking logically right now. They’re fully captured by the bubble mania. And, as before, it’s lonely out here for those of us trying to be the voice of sanity and reason. Nobody wants to hear that now. And later, once the painful correction has wrought its destruction, those of us who dared to sound an alert may be blamed as responsible for the losses – as if by pointing out the delusion we caused the burst to happen.

Conclusion
I could go on and on, risking being the boy who cried wolf, and point out all the other obvious bubbles infecting our financial landscape that all but assure a very difficult future of financial and economic pain. But I won’t at this time, having already pointed out the major bubbles in last week’s article, The Mother of All Financial Bubbles.

The delusion much of society wants to believe in is that we can get something for nothing. That is, to become rich, all we have to do is buy an asset like a house or Apple (NASDAQ:AAPL) stock and simply wait. The wealth will just magically arrive. No work performed, nothing new created, nothing done. Just buy, and wait.

Of course, even a cursory examination of all of life in nature (or before humans invented thin-air money printing) quickly reveals that actual wealth comes from hard work, usually coupled with taking risks. But somehow we’ve slipped back into the common and very human delusion of that our current culture has somehow figured out how to escape the old bonds of wealth creation. This time is different!

The Romans re-minted coins in smaller and less pure weights and it worked! For a while. Then its empire collapsed on itself. Zimbabwe (and now Venezuela) printed and it worked! For a while. Then its citizens were left impoverished. Society’s dangerous conceit is in thinking that somehow we’ve managed to, this time, escape the hard rules of wealth creation and have discovered a new principle by which we can all get wealthy without doing anything at all. All you have to do is play the game. Put your money to work! Buy stocks and houses and you can’t go wrong!

And it’s working! For now. But when we back up a bit, it’s pretty easy to see how this cannot be true. Not for the majority. Why? Because real wealth isn’t a paper gain on a house. Nor is it even money in the bank. Or a large stock portfolio. Real wealth consists the final things you consume: food, appliances, transportation, entertainment, clothes, energy, etc. Those are real things. They have to come from somewhere. Which means they have to be produced, stored, transported, and sold. By themselves, your cash and your stock portfolio have no value. Those are merely claims on true wealth.

So how can it be possible for everyone to be exponentially increasing their claims on real wealth, without the underlying pie of real wealth itself, increasing at an equivalent rate? It’s not. And that’s the painful lesson that gets learned and re-learned as each new generation gets duped and then dumped by an asset bubble. Sadly, bubbles used to happen only once in a generation. Once those burned by the last bubble have died off, the younger generation has no living memory to prevent them from getting suckered by the next one. But for some reason, our current generation has something of an addiction to bubbles. We’ve lived through the tech stock bubble, the real estate bubble, and now we’re living inside the ‘everything’ bubble.

What’s wrong with us?

My advice is to sell your house if you live in Toronto, or a similarly bubblicious real estate market. Similarly, reduce your exposure to stocks and bonds at these record highs, and develop a wealth protection strategy with a financial adviser who understands the risks in today’s markets. Know what the bubble signs are and be smarter than Newton by standing aside, nodding knowingly, and tolerating your “smart” friends and neighbors. It’s one of the very hardest things to do, but it’s also one of the most important. Odds are high you’ll be proven the smart one once the current bubble bursts.

Investment Strategies for Your Retirement Accounts

InvestMy Comments: A phrase I’m known to use from time to time is that ‘life is generally better with more money than it is with less money.” While this might seem obvious, there are many people whose efforts to have more money have fallen flat. Here’s a few ideas that might help you.

Michelle Mabry, CFP®, AIF® January 26, 2017

With interest rates coming off a 36-year low and expected to rise, most investors expect to see bond prices fall and consequently deliver a negative return in what is considered a low-risk asset. We have seen a rebound in equities, and with the S&P 500 and Dow at all-time highs, some say the stock market is richly valued. As a retiree seeking income from your investments and looking to preserve your principal, where can you turn? What are ways retirees can invest for income and still minimize risk?

You have always heard you need a diversified portfolio and that has not changed, but what has changed is how you diversify it. Retirees need to determine the proper asset allocation of stocks, bonds, cash and alternatives based on income needs, time frame, and tolerance for risk.

How to Diversify Investments in Retirement

Let’s look at bonds first. If you invest in a traditional bond portfolio you are exposing yourself to interest-rate risk as rates rise and bond prices fall. You need to understand the average duration of the bond investments you hold. For example, a typical intermediate-term bond fund will have a duration of 5-10 years. If the average duration is eight years, then a 1% increase in rates will result in an 8% decrease in the net asset value (NAV). This would wipe out all the interest gains and then some. The shorter the duration, the less the potential loss.

So it is important to look for other assets that have low-risk characteristics or standard deviation similar to bonds but produce absolute returns, that is, a positive return regardless of which way rates are moving. Floating rate income, TIPs and some market neutral funds can be a good way to diversify your fixed-income portfolio. You may also want to look at structured notes as a way to produce yield and protect your downside.

Dividends as Equity

For the equity portion of your retirement portfolio, consider blue chip dividend-paying stocks or dividend growth strategies. Many large-cap funds pay dividends in excess of 2.5%, plus you have the upside appreciation potential over time to keep pace with inflation during your retirement years. Remember to keep focused on the longer term and not be too concerned with short-term volatility. Dividend-paying stocks have outperformed most other asset classes over time. Small-cap stocks have been one of the best-performing asset classes, so it would make sense to find dividend-paying small- and mid-cap equities as well.

When searching the universe of mutual funds and ETFs, there are not many of these, but a couple that have attracted our attention are WisdomTree Midcap Dividend Fund and WisdomTree Small Cap Dividend Fund with yields of 2.63% and 3.03% respectively as of December 30, 2016. Of close to 2,000 ETFs available in the U.S., a search revealed only four that are exclusively dividend-driven and which also hold just domestic small- or mid-cap stocks. Two of the portfolios feature issues that have exhibited dividend growth while the other two ETFs (the WisdomTree funds) include all dividend payers in their capitalization range.

Include Alternative Assets for Diversification

Also important in developing a portfolio for retirement is a focus on absolute return strategies, and many of these fall into the alternative asset class. Alternatives are anything that is not a stock, bond or cash. Alternatives have no correlation or negative correlation to other asset classes so they are great diversifiers. Our retired clients typically have one-third of their portfolio in alternatives. Examples include managed futures and long/short strategies as well as volatility strategies using options. An example is LJM Preservation and Growth which has shown a positive return every year since its inception 10 years ago with the exception of one year, 2013, when the stock market went straight up and there really was no volatility. The fund was up in 2008 when stocks and bonds were not, and therein lies the importance of a diversified portfolio to manage risk.

By rebalancing your investments quarterly or semi-annually back to the original investment allocations you can create the cash needed to sustain your monthly withdrawals in retirement until the next rebalance. We do not recommend a withdrawal rate in excess of 4% in light of current market and economic conditions.

Stock Manager of $37 Billion Doesn’t Believe the Earnings Hype

roller coaster2My Comments: Monday, post #2.

First, you don’t get to manage $37B unless you know what the hell you are doing.

Two, the higher we go, the harder will be the fall. Put a lot of your money in cash and keep it there until the dust settles.

by Jonas Cho Walsgard / February 19, 2017

Global stock investors may have their hopes set too high for 2017.

With rising stock prices, analysts may need to dial back their expectations with companies missing earnings growth estimates posing the biggest risk to equity markets, according to Robert Naess, who manages 35 billion euros ($37 billion) in stocks at Nordea Bank AB, Scandinavia’s largest bank.

“There’s too much optimism,” he said in an interview in Oslo on Wednesday. “It’s definitely too high. I’m pretty sure I’ll be right.”

Stocks have rallied amid signs of stabilization in China’s economy and bets that President Donald Trump will boost U.S. infrastructure spending, roll back regulations and cut taxes. The Standard and Poor’s 500 Index has risen 28 percent since hitting a low in February last year pushing up price to earnings to more than 21 times, the highest since 2009. Positive earnings per share growth is estimated at 15 percent for the S&P 500, according to data compiled by Bloomberg.

“This indicates that it’s a bit expensive,” the 52-year-old said.

Investors shouldn’t be fooled by top line sales growth as profitability is set to be squeezed by rising wages amid declining unemployment, the fund manager said. With margins already high, corporate earnings estimates will have to come down, he said.

Naess and his partner Claus Vorm quantitatively analyze thousands of companies to build a portfolio of about 100 “boring” stocks. They invest in companies with the most stable earnings and avoid expensive stocks, a strategy which delivered an 11 percent return for the Global Stable Equity Fund in 2016. It has returned 16 percent on average in the past five years, beating 96 percent of its peers.

The fund this year has boosted its stake in EBay Inc. while its biggest increases last year included Walgreens Boots Alliance Inc., Walt Disney Co., Verizon Communications Inc. and Apple Inc.

“It’s always better to have stable equities,” Naess said. “Long term you will get better returns. Good companies continue to be good. More cyclical companies have a tendency to stumble now and then.”

And while investors could be overestimating future company earnings, they may also be putting “too little weight” on potential risks from U.S. policy changes by President Donald Trump, such as potential trade conflicts, Naess said.

“There’s still risk with Trump even if the market receives it very positively,” he said. “There’s more risk now than before. The outcome range with Trump is wider.”

Have You Heard About The New Fiduciary Rule?

moneyMy Comments: This falls into a ‘did you know’ category. You’ll find an explanation of the term ‘fiduciary’ in paragraph four below.

Many of my followers are employed by universities and colleges, cities and counties, and other not-for-profit organizations across the country including churches. If this is you, then you may have money in a retirement plan sponsored by your employer, and it falls under IRS Code Section 403(b).

If you are employed in the private sector and have an employer sponsored retirement plan, then you fall under IRS Code Section 401(k). Or you might simply have an IRA account somewhere.

There is a new rule that will take effect on April 10, 2017, unless the Trump administration kills it, which they’ve said they will. The rule says that if I give you financial advice about your retirement money, that advice must be in YOUR best interest. I can’t just sell you something that is more or less suitable for someone your age; it has to be in your best interest.

A similar rule applies to doctors, attorneys, CPAs and architects, and has done so forever. The new rule says if I don’t act in your best interest, within the scope of an understanding of what exactly is in your best interest, I can be held accountable under the law and not be able to walk away saying “buyer beware”.

Here in Gainesville, Florida, there are tens of thousands of employees of the University of Florida, of Santa Fe College, of the City of Gainesville, of Alachua County and so on. If any of them participate in a sponsored plan, whomever is giving them advice is exempted from the new fiduciary rule.

That’s not to say that their advisor is not willing and able to be bound under a fiduciary standard, but it does say that neither they nor the firm they work for will be held accountable as a fiduciary if the new rule didn’t expressly exempt 403(b) accounts.

Buyer beware indeed.

By Mark P. Cussen, CFP®, CMFC, AFC | November 1, 2016

The Department of Labor’s (DOL) new rules that automatically elevate all financial advisors who work with retirement plans or accounts to the status of a fiduciary have already had a substantial impact on the retirement planning industry. Large firms are spending millions of dollars in their effort to restructure their business and compensation models to comply with these regulations. The goal of the new rule is to prevent advisors from recommending products that pay high commissions to them, but aren’t necessarily in the best interests of the client.

However, the new rules only apply to IRAs and qualified retirement plans in the private sector. They do not apply to 403(b) or other retirement plans that are used by non-profit entities that qualify as charities under Section 501(c)3 of the Internal Revenue Code. And this segment of the retirement planning market is considered one of the worst when it comes to plans that have high fees, poor investment choices and lax management by plan custodians.

The Need for Reform

403(b) plans in particular are common retirement plans for educators. Marcia Wagner, principal at The Wagner Law Group, told InvestmentNews in an interview, “It’s almost laissez-faire. The teachers can be marketed by people who are very good providers to the marketplace and people who aren’t, and it’s a problem.” Despite their similarity to qualified plans in terms of contribution limits and plan sponsorship, 403(b) plans do not fall under ERISA guidelines and are therefore not subject to the new requirements of the DOL rule.

Jania Stout, the practice leader and co-founder of the Fiduciary Plan Advisors group at HighTower Advisors echoed Wagner’s sentiments in an interview with InvestmentNews. “It’s kind of like the Wild, Wild West. Teachers are really at the mercy of whoever’s sitting in the cafeteria they’re walking into that day. It could be a good representative. Or they’re trying to put them in a product that’s two or three times more expensive.”

Other Exempt Plans

Private plans at higher educational institutions and some churches are also exempt from ERISA guidelines as well as state and federal defined contribution plans, such as the thrift savings plan. It is also possible to structure a plan that would normally fall under ERISA guidelines so that it becomes exempt, such as by prohibiting employer contributions. 457 plans are also immune from ERISA regulations. (See also, The Fiduciary Rule’s Impact: How It’s Already Being Felt.)

And some schools even set up their plans with an open type of arrangement where any vendor can offer investment options in their 403(b) plan as long as certain requirements are met. There are consequently some plans that have over a hundred different vendors offering investment alternatives to plan participants. Obviously, this level of diversity gives the plan participants thousands of investment options to choose from, which can be overwhelming for many participants who are not financially savvy. And many participants also have no idea how much they are paying in investment fees.

TIAA-CREF published a report in 2010 that revealed the average annual asset management fee for school retirement plans in the state of California was a whopping 211 basis points, while participants in Texas school plans were paying 171 basis points. Both of these states use the open-access approach with their plans. But participants in schools in states with controlled access paid much less. Plan participants in Iowa and Arizona only paid 87 and 80 basis points per year for each of those respective plans.

The Bottom Line

Although the sponsors of plans that fall outside of ERISA guidelines will not be legally required to meet the requirements of the DOL’s new fiduciary rules, they may feel pressure from their members or from the school districts to begin moving in that direction. Time will tell how the DOL fiduciary rule impacts these plans.