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Wall Street is Not Your Friend

Wow, people actually listen to this carnival barker!? I feel sorry for those people who actually followed his advice. Oh, well you get some stock calls right and you miss on others.

Scott Burns: "What ‘Financial Adviser’ Means 95 Percent of the Time"

Scott Burns, whose site is here, is one of my favorite writers for one main reason–he can explain complicated subject matter to laypeople.

In this article, Burns explores the term “Financial Advisor.” He writes that only about 5% of the people using this title have a fiduciary responsibility to the clients. In other words, this 5% minority of financial advisors has a legal obligation to act in the best interests of their clients. Conversely, the 95% majority of FA’s are held to a much lower standard–the suitability standard. Unfortunately, many investors assume that the term “Financial Advisor” means that their FA is looking out for them. In reality, many are only trying to maximize their commissions, not investor returns.

Later, Burns states that FA’s cost at least 2% (200 basis points) on averages. This is not an insignificant percentage. If you are earning 10% on your investment, that represents 20% of your investment earings (2 of 10 = 20%). If you are earning less, these expenses are even more costly. Burns also cites a Harvard Business study suggesting that mutuals sold by intermediaries (brokers, FA’s, etc.) between 1996 to 2002 had an average annual return of 2.9% while those bought directly had an average annual return of 6.6%. (Read it for yourself here; be sure to check the figures on page 50 of this 61 page PDF file) So much for expert advice! I thought FA’s and brokers were supposed to increase my return…YEAH RIGHT!

I wonder what John Bogle would say about this. Actually, I already know what he would say.

Is Your Retirement Plan Robbing You Blind?

Here is a Motley Fool story on how AIG Valic, recently re-branded AIG Retirement, cost a lady 173 basis points in a 3 month period. Wow, pro-rate those costs and get back to me. Read it all.
Let’s hope the AIG Retirement is an improvement over AIG Valic. I’m not holding my breath; there is a reason they are trying to re-brand. It is an attempt to escape from their past.

Attention Georgia Politicians, Superintendents, Principals, and School Board Members: Here is How to Improve Educator Retirement Plans at No Cost

Greetings to everyone reading this article. This article is an earnest attempt to show Georgia’s educational and political leaders how they can improve 403b and 457 plans free of charge. This article is not a sales gimmick, and I do not work for any of the companies mentioned. I am a Spanish teacher at LaGrange High School who would simply like to see better retirement options available to all my colleagues in Georgia.

The Problem

• The majority of educators have their 403b/457 investments invested in insurance-based annuity products. These financial products usually have annual fees of over 150 basis points (1.5%); many have fees that are much higher. These fees are a constant drag on the investment’s return. Just how high are these fees? Ridiculously high! The Thrift Savings Plan, the federal government’s 401k plan, carries fees of 3 basis points (.03%) on its investment offerings. The Peach State Reserves, the State of Georgia’s 401k and 457 plan has solid fund offerings charging as little as 6 basis points (.06%). Finally, the Vanguard Group, whose 403b(7) plan could be offered at any school district, has many excellent investment choices charging less than 30 basis points (.30%). When compared to these three options, most 403b and 457 plans in Georgia come up short.
  

• To make matters even worse, most insurance-based annuity products also impose surrender charges on investors who wise up and decide to move their investment elsewhere. In other words, many educators are penalized for moving their money to better themselves. It is a classic scenario of “tails-I-win-heads-you-lose.” Investors can leave their money in the investment and get killed by the annuity’s high fees or they can move their money and get savaged by the annuity’s surrender charges.

• Usually 403b and 457 plans using insurance-based annuity products are serviced by company sales representatives carrying job titles such as “financial advisor” or “financial consultant”. Many educators erroneously assume that these “advisors” and “consultants” are impartial investment fiduciaries. Unbeknownst to most educators, these “advisors” and “consultants” do not have a legal fiduciary responsibility to do what is in the best interest of the investor. In reality, these individuals are legally held to a much lower standard known as the suitability standard. In other words, if the product is “suitable” for the investor the advisor has done nothing wrong legally (ethically and morally, now that is another issue). There is a huge difference in the fiduciary standard and the suitability standard. The end result is often a worst case scenario: investors believe they are dealing with an objective fiduciary when they are actually dealing with a salesman who is beholden to his company.

Two Simple Suggestions and Why They Are Urgently Needed

In order to improve the 403b and 457 plan options in Georgia, I suggest that the following two plans be added to each district’s 403b/457 options. First, every district should add a Vanguard 403b(7) plan. The Vanguard plan would result in huge savings by allowing teachers to invest in low-cost mutual funds rather than high-cost annuity products. In February of 2007 my district, Troup County School System, added the Vanguard plan; we paid nothing to add it. This could and should be replicated in every school district in Georgia. Second, every district should make the Peach State Reserves 457 a retirement savings option. Like Vanguard’s 403b(7) plan, the PSR’s 457 plan would allow teachers to invest in low-cost index funds and age-based lifestyle funds. These two simple additions would improve teacher retirement options for every teacher in Georgia.

Notice that in the previous paragraph I suggested that two retirement plan options be added. I did not say that any retirement plans from other companies should be removed. This statement will undoubtedly be mischaracterized by many in the financial services industry. These individuals usually feel threatened by low-cost competitors since such plans often cost them business. If the Vanguard and the PSR are such good plans, why haven’t you heard much about them until now? The truth is that no one, other than educators, has anything to gain by advocating the inclusion among retirement plan options. Since neither plan employs a battalion of sales reps to push their product, you will never encounter a Vanguard or PSR representative in the teacher’s lounge or at the county office. To emphasize, I am not advocating that any service provider be removed from any district’s offering; I am only advocating that Vanguard and the PSR be added.

Thus far, you have probably noticed the emphasis I place on low-cost investment options. Why am I obsessed with adding low-cost investments among teacher retirement plan options? Simple, low-cost investments pass the cost savings onto the investor while high-cost options divert money (via fees) away from the investor’s account and into the service provider’s account.

How much does your current retirement plan cost? How much do comparable plans cost throughout the country? Most people cannot answer these two simple questions. Let’s begin by looking at some retirement plans around the country. The federal government’s 401k plan, the Thrift Saving Plan (TSP) is probably the most cost-effective retirement plan in the country. It offers five basic funds and a series of Lifecycle funds that have an expense ratio of only 3 basis points. What does this mean? Simple, for every $1,000 invested TSP investors are charged 30¢ in fees.

According to a series of articles by W. Scott Simon at Morningstar, most 403b and 457b plans using annuity products offered by insurance companies charge expense ratios ranging from 200 to 500 basis points. In other words, for every $1,000 invested an investor will pay $20 to $50 in fees. Let’s compare some retirement plan options:

Thrift Savings Plan: 3 basis points / 30¢ per $1,000 invested / $30 in fees on $100,000 portfolio

Peach State Reserves: 6 basis points / 60¢ per $1,000 invested / $60 in fees on $100,000 portfolio

Vanguard Group: 20 basis points / $2 per $1,000 invested / $200 in fees on $100,000 portfolio

Most 403b / 457 products: 200 to 500 basis points / $20.00 to $50.00 per $1,000 invested / $2,000 to $5,000 on a $100,000 portfolio

Go back and look at those numbers again and let them sink in. In summary, most Georgia 403b and 457 options cost much more than the Peach State Reserves 457 plan or the Vanguard 403b(7) plan. Remember these are fees that are assessed annually. It is no wonder that high-cost plans almost always under perform more cost-effective plans.

Summary: By adding a Vanguard 403b(7) plan and the Peach State Reserves 457 plan to Georgia school districts, two low-cost options would become readily available throughout the state. These additions would inject needed competition into the Georgia’s 403b and 457 marketplace.

Teachers are Trapped in One of the "Dankest, Foulest-Smelling Cellars of the Financial World."

While this article is from 2004, it is still accurate. Here is an interesting quote:

“A lot of annuity products are designed to compensate insurance agents. They aren’t designed to provide high returns to teachers.” Scott Dauenhauer

Read the whole thing.

Lack of Access to to No-Load, Low-Expense 403b Plans

Here is a link regarding the lack of access to no-load, low-fee 403b options. Read the conclusion below; it sounds like lawsuits are starting around the U.S. The author states high-fee 403b plans negate the benefit of tax-deferred growth. Ask your friendly 403b “financial advisor”(aka salesman) what he thinks about the impact of fees on long-term investment return. Fees? What fees? Well, you see… blah, blah.

Here is the article in its entirety:
Reasons For and Responses to the Lack of Direct Access to No-Load, Low-Expense 403(b) Plans in Many School Districts (PDF file)

Conclusion:

In conclusion, 403(b) plans offer significant tax advantages to employees of school districts who desire to accumulate wealth and retire at a reasonable age. However, the tax advantages gained by 403(b) plan investors are currently being eradicated by high investment costs in school districts that deny their employees direct access to no-load, low-expense 403(b) plans. Furthermore, the proposed regulations may also deny many school district employees indirect access to no-load, low-expense 403(b) plans by repealing Revenue Rule 90-24. One can only hope that school districts and teachers unions will take a more proactive stance in ensuring that employees have direct access to no-load, low-expense 403(b) plans. Such a result would surely be of great benefit to both school district employees and school districts. However, until such a stance is taken, many attorneys will remain busy representing school district employees in their quest to gain direct access to no-load, low expense 403(b) plans and in class action lawsuits against high-expense 403(b) plan providers and, perhaps, teachers unions.

How to Manage a 403(B) according to Jane Quinn Bryant

Here are three paragraphs from page 191 of Jane Quinn Bryant’s Smart and Simple Financial Strategies for Busy People. I highly recommend this book!

HOW TO MANAGE A 403(B)

“These plans are typically offered to public school teacher, among others. I approach them with a heavy heart. You should definitely participate; they’re payroll-deductible and tax-deferred. But school districts tend to offer these plans through insurance agents, whose mutual funds and annuities cost two or three times as much as the funds in the 401(k)s. It’s dereliction of duty; you ought to scream to the school boards and administrators. There’s no excuse for sticking teachers with poorer plans than corporate employees have. Hospital 403(b)s often have better options, too.

If you’re among the stuck, however, here’s what to do.

Get the list of investment plans your school district uses (called the vendor list) from your school office. If it includes low-cost groups such as Vanguard and TIAA-CREF, or Fidelity, T. Rowe Price, and USAA, you’re in luck. Get the enrollment forms and sign up for the plan yourself. You don’t need a salesperson as intermediary. Use the diversification rules you’re seen above to choose your mutual fund.

If you’re forced to invest through an insurance agent, choose the insurer’s mutual funds rather than its annuities (for annuities, see page 201). Agents push the annuities because they pay much higher commissions. But their high costs mean poorer investment returns. Also, you usually can’t change investments until six or seven years have passed, making it difficult to rebalance. The agents who sell you 403(b)s will probably present themselves as “financial advisers,” eager to help you decide on the best ways to invest. Always remember: They’re salespeople, that’s all. For good advice on 403(b)s, see http://www.403bwise.com/.”

Yikes. Lost another one to Vanguard!

I am reading the Boglehead’s Guide to Investing and came across this line:

Yikes. Lost another one to Vanguard!

This lines is probably said by quite a few brokers / financial advisors (aka, salesmen) when their clients realize just how hard they have been getting screwed. This line is right on target. As soon as one learns how the financial services industry works, there are very few rational investment choices. In my opinion, the best choice is almost always Vanguard. If you do not believe me see the following articles.

• How AIG Valic Can Cost You Big Time!
• How AIG Valic Can Cost You Big Time! Part II
• Your Broker is Your Enenmy and My Mom’s Too

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How AIG Valic Can Cost You BIG TIME! Part II

Here is another look at how AIG Valic can cost you. As most of my co-workers know, I think that Vanguard is the gold standard when it comes to conservative, low-cost investing. Vanguard’s popularity among investors has not gone unnoticed by AIG Valic. As a result, AIG Valic offers seven Vanguard funds in its Portfolio Director annuity extravaganza. The seven funds are excellent additions to AIG Valic’s offerings; however, there is still one problem. These fine Vanguard funds are trapped in an AIG Valic annuity product; a product which, due to its high insurance expenses, guarantees that the Vanguard funds held in AIG Valic accounts will under perform the same exact Vanguard funds held directly with Vanguard. In other words, the same exact Vanguard funds will not yield the same investment returns: those at AIG Valic will return less than those held at Vanguard. In short, this is due to AIG Valic’s additional insurance expense.

Just how expensive is this additional insurance charge and what is its impact on earnings? The insurance charge is 1% on the Vanguard bond funds and 1.25% on the Vanguard stock funds. These insurance charges seem small at first glance, but they are not insignificant. Take a look at what a yearly investment of $6,000 at a 6% return would yield over 10, 20, 30 and 40 years. In each case the AIG Valic options yields a lower return than the same Vanguard fund held with Vanguard itself. Click here to see the whole spreadsheet.

$6000 Per Year at 6% Return over 10, 20, 30 and 40 Years
	10 Years	20 Years	30 Years	40 Years
Vanguard Long-Term Corporate Grade Bond Fund	$77,511.03	$213,082.18	$450,203.74	$864,942.66
Vanguard Long-Term Corporate Grade Bond Fund at AIG Valic	$73,729.26	$188,228.54	$366,042.42	$642,181.94
Vanguard Advantage	$3,781.78	$24,853.64	$84,161.32	$222,760.72

$6000 Per Year at 6% Return over 10, 20, 30 and 40 Years
	10 Years	20 Years	30 Years	40 Years
Vanguard Long-Term Treasury Fund	$77,474.69	$212,854.20	$449,416.75	$862,786.85
Vanguard Long-Term Treasury Fund at AIG Valic	$74,557.79	$193,030.62	$381,284.72	$680,421.73
Vanguard Advantage	$2,916.90	$19,823.58	$68,132.03	$182,365.12

Obviously, the longer the fund is held at AIG Valic, the larger the spread gets between the two options. However, over the course of 40 years I doubt that AIG Valic provides $180,000 to $222,000 worth of value-added service to its investors.

Unfortunately, the spread between the two products is even worse when Vanguard’s stock funds are used. Here is what $6,000 annually at a 10% return would yield over 10, 20, 30 and 40 years. In each case the AIG Valic options yields a lower return than the same Vanguard fund held with Vanguard itself.

$6000 Per Year at 10% Return over 10, 20, 30 and 40 Years
	10 Years	20 Years	30 Years	40 Years
Vanguard Lifestrategy Conservative Growth Fund	$94,440.48	$333,666.13	$939,644.76	$2,474,639.41
Vanguard Lifestrategy Conservative Growth Fund at AIG Valic	$88,968.23	$289,938.60	$743,910.67	$1,769,388.38
Vanguard Advantage	$5,472.25	$43,727.53	$195,734.09	$705,251.03

$6000 Per Year at 10% Return over 10, 20, 30 and 40 Years
	10 Years	20 Years	30 Years	40 Years
Vanguard Lifestrategy Moderate Growth Fund	$94,440.48	$333,666.13	$939,644.76	$2,474,639.41
Vanguard Lifestrategy Moderate Growth Fund at AIG Valic	$88,968.23	$289,938.60	$743,910.67	$1,769,388.38
Vanguard Advantage	$5,472.25	$43,727.53	$195,734.09	$705,251.03

$6000 Per Year at 10% Return over 10, 20, 30 and 40 Years
	10 Years	20 Years	30 Years	40 Years
Vanguard Lifestrategy Growth Fund	$94,395.26	$333,288.57	$937,874.14	$2,467,945.10
Vanguard Lifestrategy Growth Fund at AIG Valic	$88,925.89	$289,615.53	$742,535.77	$1,764,694.86
Vanguard Advantage	$5,469.38	$43,673.04	$195,338.37	$703,250.23

$6000 Per Year at 10% Return over 10, 20, 30 and 40 Years
	10 Years	20 Years	30 Years	40 Years
Vanguard Wellington Fund	$94,259.75	$332,158.71	$932,583.78	$2,447,976.14
Vanguard Wellington Fund at AIG Valic	$88,798.99	$288,648.72	$738,427.69	$1,750,693.82
Vanguard Advantage	$5,460.76	$43,509.98	$194,156.09	$697,282.32

$6000 Per Year at 10% Return over 10, 20, 30 and 40 Years
	10 Years	20 Years	30 Years	40 Years
Vanguard Windsor II Fund	$94,079.39	$330,658.78	$925,579.82	$2,421,614.78
Vanguard Windsor II Fund at AIG Valic	$88,630.10	$287,365.25	$732,988.81	$1,732,209.87
Vanguard Advantage	$5,449.29	$43,293.53	$192,591.02	$689,404.91

Wow, over the course of 40 years the same exact Vanguard fund loses about $700,000 when held at AIG Valic than when it is held at Vanguard directly. Does AIG Valic provide $700,000 worth of value-added service? I imagine for the financially obtuse they might; however, for investors with any know-how at all AIG Valic is a terrible option.

I personally would love to use the Vanguard Wellington fund or the Lifestrategy Moderate Growth fund, but AIG Valic’s insurance fee structure stops me. I cannot justify paying for services that I do not need nor want. AIG Valic’s offering of Vanguard funds within its Portfolio Director annuity extravaganza is like putting lipstick on a pig. At the end of the day, the pig is still a pig.