A ray of choice
By offering their employees freewheeling brokerage accounts within traditional 401(k) retirement plans, some firms crack open new options for tax-deferred investing.
"Don't confuse brains with a bull market."Skip to next paragraph
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For decades that slogan, said to be emblazoned on one Texas stockbroker's wall in 1980, was easy to ignore.
An almost 20-year bull market in both stocks and bonds was the rising tide that carried all boats higher. And the investment tool of choice for many - the tax-deferred 401(k), often pumped up by matching contributions from the corner office - looked like a pleasure craft.
Investment options made available through many such plans included a range of stock, bond, and money-market mutual funds. Almost any mix of the three offered smooth sailing from the early 1980s all the way to the spring of 2000.
Many investors, money managers, and retirement-plan sponsors mistakenly attributed profitable performance to the soundness of their strategies.
But a reality check arrived in 2000 in the form of a nasty bear market that lingers today. Most equity funds lost money because their goal was not to protect the money, but to provide investors with "exposure" to a diversified group of stocks, a particular industry sector, or a particular style of investing, experts say.
This practice generally meant a given category of stocks would be owned regardless of whether its value moved up or down.
In this bear market, fund managers have been rewarded by their bosses for outperforming similar funds and relevant indices, rather than for generating positive returns. That definition of performance represents the industry's standard incentive, according to Deb Brown at Russell Reynolds Associates, a global executive-recruitment firm.
For example, a manager whose fund fell 22 percent while the S&P 500 index lost 24 percent would be hailed even though the investors lost their shirts. In many cases, the manager actually had performed "well," given the guidelines he or she was required to follow - guidelines outlined in the fund's prospectus.
Of course, the fact that a manager beats his peers means little to investors losing their retirement money.
Hope for better retirement-plan results in the future may hinge on employers providing better investment options and better investor education.
One sign of progress on that first front: Schwab and other firms now offer optional self-directed brokerage accounts within retirement plans. These accounts give employees access to a vast array of mutual funds not offered in their current plans, as well as individual stocks and bonds.
That kind of access can give small investors the flexibility to eke out gains even when major funds are staggering in lock step, say experts. And some investors are stepping up.
"Today 70 percent of new retirement plans that come on board at Schwab utilize self-directed brokerage accounts," says Jim McCool, a Schwab vice president. Some 5,300 retirement plans at Schwab include 100,000 self-directed brokerage accounts.
In fact, more than half of employers are offering self-directed accounts or considering offering them, according to a 2001 survey by Hewitt Associates.
Since most equity mutual funds diversify over many stocks, a high percentage of them tend to perform very similarly to each other and to the broad market indices, such as the S&P 500.
One example of the great uniformity of performance by most equity funds: For the 12 months ending March 31, 71 out of a list of 74 Fidelity equity mutual funds lost money, with 63 of them losing more than 10 percent, and 43 losing more than 20 percent. The odds of picking a winner were slim, while diversification between funds would have virtually ensured a net loss of significant size.
"Almost all equity funds have capital appreciation as their objective," notes Brian Portnoy of Morningstar, the mutual-fund tracker in Chicago. "It's very rare for an equity fund to have capital preservation as its objective."
Jim Rose would not have been surprised by the Fidelity statistics. An active individual investor who lives near Boston, he called Fidelity early in the bear market several years ago and asked if the firm had any bear-market equity funds, funds designed to profit during a declining market.