In terms of the evolution of America’s retirement health, we’ve moved from defined benefit programs, pensions, to defined contribution. … Describe what’s happening to our retirement health as these [different] instruments are introduced and the rush of people into mutual funds. …
… In my new book, which is called The Clash of the Cultures, I have a chapter on future retirement planning, and it says our retirement system is … headed for a train wreck unless we do something about it.
I start off, simply put, with Social Security, which has to be changed in gradual, small ways to become solvent again. … Then you go to corporate defined benefit plans. They are assuming — and state and local government defined benefit plans even worse — they are all assuming that the market return in their portfolio will be 8 percent a year.
There is no way under the sun that they’re going to earn 8 percent. It’s just impossible. No matter what they do, they’re stuck in a bind given the kind of markets we expect in stocks and bonds. … The best they can really hope for is a 5 percent return unless some wonderful, attractive scenario for the future unfolds, which is really unimaginable. If anything, it’s going to be worse.
So if you think about them compounding their returns at 4 percent instead of the 8 percent that they build into the plan, they’re going to have to start putting a lot of money into those plans. They’re going to be bankrupt.
Those plans have been dying out for a long time.
… They’re dropping out. They’re changing to defined contribution plans, the corporations are. But if you have a bad year, you don’t make any contributions for your employees, the management says, “Can’t afford it this year,” well, that’s the year they should afford it. So the defined contribution system is deeply flawed.
And what it really is — when you look at IRA and 401(k), and particularly 401(k) thrift plans — they are thrift plans. They are not retirement plans. They were never designed to be retirement plans, but we’re using them to build a retirement plan now, and it simply is not going to work. …
The 401(k) arrived. What prompted its creation?
… Some very smart people found a sort of loophole in the law, not a bad loophole, where you could have companies put their money in and employees put their money in together, and you could get clearance to make sure that didn’t have any taxes on it. That’s the 401(k) plan in essence.
But you can get out of it when you want. You can say you have an emergency when you want. And here’s the worst of it: You can pick any fund that you want. …
If you want to gamble with your retirement money, all I can say is be my guest, but be aware of the mathematical reality. The chances you will do better playing that game are infinitely small. If I want to put a number on it, let me just say [off the] top of the head that maybe you have 0.1 of 1 percent chance of beating the market over time.
Now, think about this for a minute. You’re 25 years old, and you’re going to invest for the next 50 years, so you’re going to buy an index fund and hold it all that time. You never have to worry about the manager. There aren’t new brooms that come in and sweep clean.
Now you buy an actually managed fund. First of all, half of the actively managed mutual funds that are out there today aren’t going to be around 10 years from now. There’s going to be a 50 percent failure rate. We’ve had that in the past, in the last 20 years. …
So how can you be a long-term investor if the fund you own doesn’t last for the long term? And then there’s something else. Even if you’re lucky enough to be in that half of funds that does survive, they’re going to have a new manager every five years. That’s how long a portfolio manager lasts in this business.
So if you have, say, four mutual funds, you’re going to have four managers every five years, and if you take that to 50 years, you’re going to have 40 managers. Think about the possibility of 40 mutual fund managers with those high fees coming anywhere near the return of an unmanaged low-expense index fund. It just isn’t there. Mathematically can’t be there.
The marketing tells you otherwise. And the industry has created legends, such as Peter Lynch at Fidelity Magellan Fund, who outperform the broad market, outperform your index fund, year after year after year. So in the interest of giving people choices, the industry puts forward funds like Magellan and gives you an opportunity to beat the market. Isn’t that a good thing?
Well, if only the past were prologue it would be a great thing. But look, the Magellan Funds are a great example. … The pressure from employers to bring in outside funds, to have “open architecture” for their investors, was so powerful that we allowed them to add Magellan Fund.
Bad judgment. Magellan Fund reached its peak over the market in 1992. It had $105 billion of assets in 1992. It has been pretty much an abject failure, worse than mediocre, in the 20 years that followed. Way below par. And the fund now has assets of $10 billion. That’s $95 billion smaller, 92 percent smaller than it was in 1992. Everybody’s getting out of Magellan now. …
I start off, simply put, with Social Security, which has to be changed in gradual, small ways to become solvent again. … Then you go to corporate defined benefit plans. They are assuming — and state and local government defined benefit plans even worse — they are all assuming that the market return in their portfolio will be 8 percent a year.
There is no way under the sun that they’re going to earn 8 percent. It’s just impossible. No matter what they do, they’re stuck in a bind given the kind of markets we expect in stocks and bonds. … The best they can really hope for is a 5 percent return unless some wonderful, attractive scenario for the future unfolds, which is really unimaginable. If anything, it’s going to be worse.
So if you think about them compounding their returns at 4 percent instead of the 8 percent that they build into the plan, they’re going to have to start putting a lot of money into those plans. They’re going to be bankrupt.
Those plans have been dying out for a long time.
… They’re dropping out. They’re changing to defined contribution plans, the corporations are. But if you have a bad year, you don’t make any contributions for your employees, the management says, “Can’t afford it this year,” well, that’s the year they should afford it. So the defined contribution system is deeply flawed.
And what it really is — when you look at IRA and 401(k), and particularly 401(k) thrift plans — they are thrift plans. They are not retirement plans. They were never designed to be retirement plans, but we’re using them to build a retirement plan now, and it simply is not going to work. …
The 401(k) arrived. What prompted its creation?
… Some very smart people found a sort of loophole in the law, not a bad loophole, where you could have companies put their money in and employees put their money in together, and you could get clearance to make sure that didn’t have any taxes on it. That’s the 401(k) plan in essence.
But you can get out of it when you want. You can say you have an emergency when you want. And here’s the worst of it: You can pick any fund that you want. …
If you want to gamble with your retirement money, all I can say is be my guest, but be aware of the mathematical reality. The chances you will do better playing that game are infinitely small. If I want to put a number on it, let me just say [off the] top of the head that maybe you have 0.1 of 1 percent chance of beating the market over time.
Now, think about this for a minute. You’re 25 years old, and you’re going to invest for the next 50 years, so you’re going to buy an index fund and hold it all that time. You never have to worry about the manager. There aren’t new brooms that come in and sweep clean.
Now you buy an actually managed fund. First of all, half of the actively managed mutual funds that are out there today aren’t going to be around 10 years from now. There’s going to be a 50 percent failure rate. We’ve had that in the past, in the last 20 years. …
So how can you be a long-term investor if the fund you own doesn’t last for the long term? And then there’s something else. Even if you’re lucky enough to be in that half of funds that does survive, they’re going to have a new manager every five years. That’s how long a portfolio manager lasts in this business.
So if you have, say, four mutual funds, you’re going to have four managers every five years, and if you take that to 50 years, you’re going to have 40 managers. Think about the possibility of 40 mutual fund managers with those high fees coming anywhere near the return of an unmanaged low-expense index fund. It just isn’t there. Mathematically can’t be there.
The marketing tells you otherwise. And the industry has created legends, such as Peter Lynch at Fidelity Magellan Fund, who outperform the broad market, outperform your index fund, year after year after year. So in the interest of giving people choices, the industry puts forward funds like Magellan and gives you an opportunity to beat the market. Isn’t that a good thing?
Well, if only the past were prologue it would be a great thing. But look, the Magellan Funds are a great example. … The pressure from employers to bring in outside funds, to have “open architecture” for their investors, was so powerful that we allowed them to add Magellan Fund.
Bad judgment. Magellan Fund reached its peak over the market in 1992. It had $105 billion of assets in 1992. It has been pretty much an abject failure, worse than mediocre, in the 20 years that followed. Way below par. And the fund now has assets of $10 billion. That’s $95 billion smaller, 92 percent smaller than it was in 1992. Everybody’s getting out of Magellan now. …
by PBS, Frontline | Read more:
Image: uncredited
