Saturday, May 14, 2011

Afford to Retire?

We've talked about putting sufficient money away during your working life so you won't be consuming Purina during the sunset years. John Bogle -- founder of Vanguard Mutual Funds -- sounds an additional cautionary note:

What percentage of my net growth is going to fees in a 401(k) plan?

... [A]n individual who is 20 years old today ... has about 45 years to go before retirement -- 20 to 65 -- and then, if you believe the actuarial tables, another 20 years to go before death mercifully brings his or her life to a close. ... If you invest $1,000 at the beginning of that time and earn 8 percent, that $1,000 will grow in that 65-year period to around $140,000.

Now, the financial system -- the mutual fund system in this case -- will take about two and a half percentage points out of that return, so you will have a gross return of 8 percent, a net return of 5.5 percent, and your $1,000 will grow to approximately $30,000. One hundred ten thousand dollars goes to the financial system and $30,000 to you, the investor. Think about that. That means the financial system put up zero percent of the capital and took zero percent of the risk and got almost 80 percent of the return, and you, the investor in this long time period, an investment lifetime, put up 100 percent of the capital, took 100 percent of the risk, and got only a little bit over 20 percent of the return. That is a financial system that is failing investors ...

The point Mr. Bogle makes is that over time, high fees in a 401(k) Plan or Mutual Fund can eat you alive. One or two percent sounds relatively small, but when you multiply that over thirty ... forty ... forty-five years, the magic of compounding allows those percentages to eat you alive.

In my reckless youth, I didn't get this concept at all, and so I allowed a "Financial Advisor" to take two percent of my total nut right off the top. And over time my total assets were gnawed down a lot.

As John Bogle points out, if you're into saving and investing for the long haul, low fees are essential, otherwise your returns will take a major hit. But go read the interview linked above. Bogle pinpoints a lot of the problems faced by young investors (workers?) socking money away in a choppy environment.


Anonymous said...

Thank you for posting this. I'm 35 and have some retirement savings, but I found John Bogle's estimate of what a 40-year old starting from scratch needs to save for retirement to be useful.

Anonymous said...

Here's a particularly important part of the interview:

It's a generational storm that is coming in large measure because capitalism has gone astray. We have had what I describe in my book as a pathological mutation from traditional owners of capitalism, where the owners put up the capital and got the lion's share of the rewards, to a new form of managers' capitalism, where the managers, often aided by accountants and the financial system and the marketing system, are putting their own interest in front of the interests of the last-line owners, whether it's the direct owners -- the stockholders of America -- or the indirect owners -- the pension beneficiaries, mutual fund shareholders and the like. They simply aren't getting a fair shake.

Now play it out in terms of the retirement system. How does what you call managerial capitalism affect the defined benefit part of our retirement system, pensions?

... Well, on the corporate side, our CEOs and other highly placed executives in the company are basically getting paid for keeping the stock price rising. And the way you do that, if you can't earn money the hard way -- be more efficient, develop new markets, do a lot of innovation -- you start to manufacture earnings the financial way, changing the financial assumptions. Here, one of the big changes is raising the assumptions on your pension plan beyond reason, which means you make a nice profit that year; you know, you are paid basically on your profitability. But you as an executive are putting that impossibly high return on your pension plan, and those pensioners will eventually have to pay the price, or the corporation will have to.

In other words, the people we've allowed to be in charge of our major corporations and our financial systems are tweaking the rules to progressively take the wealth of the investing classes (mostly us middle and upper-middle class working stiffs) and enriching themselves. It's a rigged game.

Anonymous said...

Amen. Another reason why the very people who spout "free market capitalism" do everything in their power to prevent it.

Anonymous said...

Thank you for posting this.

Anonymous said...

Yeah. After several years of no longer being able to get a union gig, I rolled all my animation union 401k money into Vanguard index funds IRAs. Their index funds have FAR less fees than the 401k plan!

Steve Hulett said...

... Their index funds have FAR less fees than the 401k plan!

Half true.

The Vanguard Target Funds cost exactly the same in the 401(k) Plan as they do at Vanguard.

The VTFs are funds of index funds, and I pushed hard to get them included in the Plan's offerings. We also have some other non-Vanguard index funds that aren't bad, but their costs are somewhat higher than equivalent Vanguard funds.

Steve Hulett said...

Let me add:

For a long time, I pushed and agitated to get Vanguard as TAG's 401(k) Administrator.

One problem: Vanguard just isn't set up to administer multi-employer plans. They can do single-employer 401(k) Plans just fine, but they're not geared for our type of plan.

We've tried to get them twice. Having their target funds in the Plan's investment platform has been (to date) the best we can do.

hmmmm... said...

8% yield? really? colour me skeptical!

Jason MacLeod said...

Steve, thanks for your comments. For those in the Guild 401k plan, there are Vanguard Target date funds, and the Northern Trust index funds are also not too bad as far as expense ratios go. You can find the expense ratio for every fund in the Guild plan through the Mass Mutual website - it's in the Morningstar prospectus. It ought to be front and center instead of buried away...

There is a lot of good reading on the Bogleheads website as well. One thing that stuck with me is using expense ratios as a predictor of future performance.

Please keep posting on this topic from time to time. The ideas you are putting out there definitely bear repeating.

John said...

I'm another person who has been greatly helped by these kinds of posts. I've gone from someone who had no idea about investing (and didn't care), to at least having some general understanding about asset allocation and basic strategy. Thanks!

If I had any criticism of the union 401(k), it would only be that Mass Mutual's "The Journey" website seems wholly inadequate and primitive. Maybe I'm doing it wrong, but I can't find any way to view past transactions, let alone download them to Quicken.

Steve Hulett said...

We've checked the website and there presently there is no way to download info to Quicken.

We will talk to Mass Mutual about it.

Tutti said...
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