How To Deal With 401(k) Investment Choices

[boloboffin]

This is a cry for help. I just went to my local Borders yesterday, looking for help specifically with making choices for my 403(b) plan. I am presented with a vast array of mutual funds in which to invest my retirement savings. How do I evaluate them? How do I know what is better and what is worse? That's what I wanted to find, and could find nothing specific for helping people make investment choices in this area.

I've titled this with 401(k) because it's much more prevalent that people have these rather than a 403(b).

I've found a good article on line that has me evaluating my fund choices now for fees. And I'm not the type to change investments on a whim - any changes I make will be once a year. But is there a better way to evaluate these complicated statements of a hundred or more differing funds besides blind luck?

[balrog666]

This is a cry for help. I just went to my local Borders yesterday, looking for help specifically with making choices for my 403(b) plan. I am presented with a vast array of mutual funds in which to invest my retirement savings. How do I evaluate them? How do I know what is better and what is worse? That's what I wanted to find, and could find nothing specific for helping people make investment choices in this area.

I've titled this with 401(k) because it's much more prevalent that people have these rather than a 403(b).

I've found a good article on line that has me evaluating my fund choices now for fees. And I'm not the type to change investments on a whim - any changes I make will be once a year. But is there a better way to evaluate these complicated statements of a hundred or more differing funds besides blind luck?

Go to the YAHOO Finance section and look up each fund.

Get the Morningstar ratings, the sector of each (US, European, Asian, Large Cap/Business, Small Cap/Business, Emerging Markets, etc), the fund manager's name and length of service, the past performance over the last 3, 5, and 10 years, the expense ratio, the risk factors, etc.

Then throw that all away and go with the top three in the 3-year rating that are in different sectors.

[boloboffin]

I have just received some tips from a mysterious source - a terribly mysterious source. They asked that I repost, so here it is.

While I cannot help you in evaluating funds from an economic point of view, here are some tips to consider.

1) GOOD CALL on looking at fees. That eats your return very quickly. There is no excuse for paying much at all when there are high quality funds with low/no fees.

2) Diversify. A good diversified fund, AND/OR several different investment types help shield you from some severe losses if a particular sector goes down the tubes.

3) As a follow-on to #2, if you company offers their own stock as an investment option, keep the percentage VERY low. Note that 0 is a very low number. I happen to work for a company whose stock just dropped 50% over the last 8 months. Some people in the company are in real trouble because not only did the company give matching funds in stock, they had chosen stock as their primary investment.

4) One interesting thing to look at is the ages and tenures of the fund managers. Diversity in experience, ages, and tenure can help keep a fund on an even keel instead of veering directions.

5) Know your investment goal. If you are young, consider being much more aggresive (keeping in mind point 2 above). You can absorb losses better. If you are close to retirement age, you don't have time to recover from a large drop.

Thank you for the Yahoo! Finance section tip, balrog. The focus on the 3 year rating sounds sensible to me.

Just for more information - I'm 40 years old in October, but my job is not stressful physically, and I plan on being able to do it until a retirement age of 70. So I'm comfortable with moderate to aggressive tactics in investment.

I'm very well diversified right now (12 different funds with 5% or 10% in each) in a good mix of sectors. My fees are high in some and low in others, and I've already identified good substitutes for the high ones. I definitely want to check on the managers as well now. We don't have stock options in my company - we are a non-profit, so they can't do that, I believe. And Enron just haunts me when I consider buying stock in a company I work for.

But keep the good info coming.

[Paul C. Anagnostopoulos]

Good advice. Fidelity has excellent research tools, too.

It's rarely worth buying mutual funds with front-end loads. There is almost always a no-load fund that is just as good or better.

Back-end loads aren't so great, either, but if you plan to stay in the fund for years, it's less of a problem.

Don't churn your funds.

Most people don't have enough international exposure.

~~ Paul

[bpesta22]

Are you young? If so, screw diversity and take mega-risk. Put all your money in stocks, and rotate between international, small caps large caps and real estate.

Follow the fed; when rates are going from low to high, stick em large caps and international stocks; when the reverse happens stick em in real estate and small caps.

The feds been raising for a while now (though not the past 2 or 3 times) and the dow peaked just a few weeks ago. I got 100% in large caps and didn't switch:(

Realize too that I'm happy to provide advice on how other people should invest! Seriously though I'd bet pros would tell you that most young people don't take enough risk with their retirement funds.

[The Atheist]

Seriously though I'd bet pros would tell you that most young people don't take enough risk with their retirement funds.

Possibly, but for the very good reason that high risk investments sometimes fail and advisers don't like failures.

The advice given so far is excellent - diversity, low fees, track record.

Given that fund managers will offer a choice of funds to go in, you can gain exposure to a small amount of risk-markets so as to limit exposure while giving you the chance of a smaller rake-off if they hit paydirt.

Bit like a dollar each way - not too conservative, not too risky.

[T'ai Chi]

I've found a good article on line that has me evaluating my fund choices now for fees. And I'm not the type to change investments on a whim - any changes I make will be once a year. But is there a better way to evaluate these complicated statements of a hundred or more differing funds besides blind luck?

There typically are options for the fund to change itself automatically thoroughout time. For example investing in riskier things when you're younger to more stable things when you're older, and have the allocation get updated each period automatically to reflect this.

[Mercutio]

There typically are options for the fund to change itself automatically thoroughout time. For example investing in riskier things when you're younger to more stable things when you're older, and have the allocation get updated each period automatically to reflect this.

Agreed--This was the case at our university--the two tricks are, it is still up to you to decide how much risk at any given point, and I would recommend finding out who are the people at your job who are responsible for managing these funds, and take advantage of every opportunity they give for information. (I did not do so, early on, and am finding it very helpful later on. But continue to be skeptical, even with what they tell you. Evidence is a good thing.)

[Wolfman]

I've gotta' admit, I'm more of an "all my eggs in one basket" kinda' guy...my basket being myself. I've followed a strategy of starting a company, building it up, then selling it; and using that money to start a new, bigger company.

Great strategy if I continue to do well (which has been the case up to now); of course, if I fail at some point in the future, I lose pretty much everything.

[Jaggy Bunnet]

3) As a follow-on to #2, if you company offers their own stock as an investment option, keep the percentage VERY low. Note that 0 is a very low number. I happen to work for a company whose stock just dropped 50% over the last 8 months. Some people in the company are in real trouble because not only did the company give matching funds in stock, they had chosen stock as their primary investment.


I agree with this in part. However I would make a couple of points:

If you have the opportunity to invest in your own companies stock, and receive a matching amount of stock for free from the company, then even if the companies stock drops by 50%, you have not lost any money. You put in $100 and your total holding is now worth $100. In many cases it would be possible to ensure that you benefit from the matching shares by purchasing put options at below the current market price to lock in some gain.

If you have the opportunity to buy any stock at a significant discount to the market price (which was effectively the case here) then you should consider the restrictions on how long you need to hold (I assume you can't invest one day, get the matching stock and then sell on day two) in assessing whether it represents a bargain. Also see point above about use of derivatives.

Even if it looks a bargain then the advice about the need for diversification still applies - getting shares at half price is great, but gambling your entire financial future on a single company is generally not good advice.

[Jaggy Bunnet]

I've gotta' admit, I'm more of an "all my eggs in one basket" kinda' guy...my basket being myself. I've followed a strategy of starting a company, building it up, then selling it; and using that money to start a new, bigger company.

Great strategy if I continue to do well (which has been the case up to now); of course, if I fail at some point in the future, I lose pretty much everything.

If you take company 1 and make a success of it, there is no reason why you should need to invest all of the money in company 2. With a track record it is much easier to attract external finance and they should not require you to put all your assets at stake, provided that you have enough cash in to hurt if it goes wrong. With the first company this often means all assets, but that is normally because the owner has few other assets, not because the funders require you to have everything you own at stake.

From company two onwards, it is not unusual to be largely using other people's money - what you bring to the table is your skills and track record.

[roger]

Then throw that all away and go with the top three in the 3-year rating that are in different sectors.Bad idea. "past returns are no guarantee of future performance" is not just legalese. It's an entirely true statement. Studies of funds that show up in the top for rankings actually perform worse than the average market in subsequent years. Statistically, you are likely to underperform following this method.

If you don't have knowledge to buy individual stocks, buy indexes. These are funds that track the major indexes. Most mutual funds do worse than the indexes. There's a good reason for that - institututional money (mutual funds and the like) make up 70% of the market. In most senses, they are the market. So it stands to reason that the market can't beat the market. Then, you are being charged fees; even if you aren't paying a front or back load the fund still charges management fees, usually in the 1% range, but some are 2-3%. So, on average, mutual funds do worse than the market.

So, what to do? Fortunately, there are funds that track the market. A fund that tracks the DJIA, for example, will buy the 30 stocks in the DJIA. A S&P 500 fund will buy the 500 stocks in the S&P 500. Because there is almost no cost to doing this, fees will run around 0.1%, and your performance will essentially match the market.

Vanguard sells a lot of these funds. If you are not paying transaction fees for buying stocks, then there is an instruments called an ETF. An ETF is a stock, but it is a stock that buys you a piece of a mutual fund. The advantage is that you can buy and sell as many or as little as you want at any time. Mutual funds usually have locks - if you sell before 6 months, you pay a fee, for example. OTOH, if this is a retirement account, this kind of lock up shouldn't affect you. Definitely stay away from ETFs for now if you have to pay a fee to buy them.

You'll probably get a lot of advise that is contrary to mine, but look at how many people have consistantly beat the market - meaning over decades, not years. The results is almost no one. Now, you, or the mutual fund you pick, might be the next Warren Buffett, but do you really want to bet your retirement on this when you have to come to JREF to ask how to invest your money (not an insult at all, just pointing out the knowledge level involved)?

I won't get to specifics too much, but I'll point out that in general the international economies are very strong now, and the dollar is weak. This translates into a investment strategy to put a fair amount of money overseas. Again, stick with indexes. Things like the EAFE (basically a europe index), etc.

Remember, every piece of advise steering you away from indexes is making the assumption that you are able to pick stocks better than the majority of the people in the market, and the majority of the money in the market is being run by full time finance professionals. Do you think you can do dentistry better than your dentist? Well, why do you think you can invest better than the professionals?

There is an answer to that. Institutional investors are bound and limited in many different ways that the small investor is not. We can take advantage of that and do things that they can't. But it still takes knowledge. Getting stock tips from online newletters, forums, the TV is not the way to do it. Think about it - everyone in the world has access to that same information - what are the chances that you personally will outsmart everyone else and profit from that information?

When you get to the point of picking individual stocks, I recommend looking up first Malkiel "A Random Walk Down Wall Street" - which is a compilation of research detailing just how hard it is to beat the market. Then, look up the investing methods of Benjamin Graham. This is the style that Warren Buffett started with (he was a student of Graham), and is the only investing method that Malkiel thinks is intellectually defensible. After that, if you disagree with that analysis, you will have a substantial education in investing and have an intellectual basis for disagreeing. I'll point out that Warren Buffett advises buying index funds for 99% of investors.

Hope this helps.


ETA: John Bogle is the person to read about buying index funds. You can easily get his books at the library. Read a book, buy some indexes, and you'll only need to look at your portfolio once a quarter or so. For example, here (http://en.wikipedia.org/wiki/John_Bogle) is a wikipedia article on him, and you'll see that my advise above is basically parroting him. Don't try to actively pick mutual funds, past performance is not a predictor, buy index funds, and hold them. Pretty simple, really.

[bpesta22]

Bad idea. "past returns are no guarantee of future performance" is not just legalese. It's an entirely true statement. Studies of funds that show up in the top for rankings actually perform worse than the average market in subsequent years. Statistically, you are likely to underperform following this method.
.

I agree, and I think it's regression to the mean. The best performing funds last year likely contained many good picks, but also a lot of luck (random error in stock price all in an positive direction). Next year, by regression to the mean, the error variance in the picks should be more average (i.e., randomness that pushes the stocks down as much as up). An average amount of luck this year is worse than lots of luck last year, so the end result is the best three funds last year perform worse (more average) this year.

In fact, there's a strategy based on regression to the mean called the dogs of the dow. For the same reasons but reversed, pick the worse performing funds last year and buy em.

[roger]

Read Malkiel on the dogs of the dow. Stocks don't have memory. They don't know they are up, and due to regress. One could argue the buyers have memory, but I'm not aware of any evidence showing that prices thus are due to regress to the mean. Looking at short term performance, stock prices are random. And, this analysis does not take tax impacts and other transaction costs into account.

All these tricks are great ways to lose money.

[bpesta22]

Read Malkiel on the dogs of the dow. Stocks don't have memory. They don't know they are up, and due to regress. One could argue the buyers have memory, but I'm not aware of any evidence showing that prices thus are due to regress to the mean. Looking at short term performance, stock prices are random. And, this analysis does not take tax impacts and other transaction costs into account.

All these tricks are great ways to lose money.


Regression to the mean is a fact of life, and applies to stocks too. Being able to spot it (i.e., is the stock trading more than 2 sd's above it's average because it's improbably unlucky, and thus will regress back, or because it's fundamentals have changed so that its new true market price has increased) is the challenge.

I think regression would occur especially when stock prices move in random ways.

Figuring out how to spot it though is the catch. I'm not claiming I or anyone can, but stocks do regress.

[Segnosaur]

If you don't have knowledge to buy individual stocks, buy indexes. These are funds that track the major indexes. Most mutual funds do worse than the indexes. There's a good reason for that - institututional money (mutual funds and the like) make up 70% of the market. In most senses, they are the market. So it stands to reason that the market can't beat the market. Then, you are being charged fees; even if you aren't paying a front or back load the fund still charges management fees, usually in the 1% range, but some are 2-3%. So, on average, mutual funds do worse than the market.


I have to pretty much agree with your assesment... index funds are (in my opinion) the best investment around... Not only do they almost always have lower management fees than 'selected' mutual funds, there is another advantage:

In a traditional mutual fund, most of the money will be invested in stocks/bonds. But, the mutual fund company will also need to keep at least some of your investment in cash (in order to give the company the flexibility to buy/sell stocks). With an index fund, there is less buying/selling of stocks, so the company offering them does not need to keep as much of your investment in cash.

The result? More of your money is working for you earning income, and less is kept as cash earning nothing.

(Note: I am Canadian, so our financial systems are a little different. But, there are similarities too... I'm assuming our index funds work the same here as there.)

[roger]

Regression to the mean is a fact of life, and applies to stocks too. Being able to spot it (i.e., is the stock trading more than 2 sd's above it's average because it's improbably unlucky, and thus will regress back, or because it's fundamentals have changed so that its new true market price has increased) is the challenge.

I think regression would occur especially when stock prices move in random ways.

Figuring out how to spot it though is the catch. I'm not claiming I or anyone can, but stocks do regress.
I must have misread you. I thought you were talking about the kind of betting people do at the roulette table where they think "it came up black 4 times in a row, red is due". No, black is just as likely in the next, though the law of big numbers does tell us we will revert to the mean over time.

[portlandatheist]

I must have misread you. I thought you were talking about the kind of betting people do at the roulette table where they think "it came up black 4 times in a row, red is due". No, black is just as likely in the next, though the law of big numbers does tell us we will revert to the mean over time.
Great analogy. I'm always amazed about how misunderstood this concept is. Each and every time you flip a coin, it's always a 50% chance that it will land on heads, regardless of how many times it came up as tails previously. In other words, the coin has no "memory" of previous runs.

[bpesta22]

Great analogy. I'm always amazed about how misunderstood this concept is. Each and every time you flip a coin, it's always a 50% chance that it will land on heads, regardless of how many times it came up as tails previously. In other words, the coin has no "memory" of previous runs.

The two are related though. Regression to the mean happens. Thinking that things regress to the other side of the mean / that probability needs to correct itself / that black is due since many reds just came up, is the gambler's fallacy.

[boloboffin]

There is another idea I've run across and it sounds good to me. But, hey! What do I know?

Rebalancing. My particular 403[b] provider (ING) has an option for an automatic rebalancing schedule on a quarterly, semiannual, or annual basis. The information I've seen on rebalancing makes sense to me - it's the way people like me can buy low and sell high. I'm thinking about setting up a quarterly rebalancing schedule at the same time I switch to the funds with lower fees. Wise or not?

[Paul C. Anagnostopoulos]

How much does rebalancing your chakras cost, and will they watch out for capital gains in the process?

I'm thinking maybe once a year, not every quarter.

~~ Paul

[phildonnia]

!! Obviously, this is not financial advice !!

Most 401(k) providers have "lifecycle" funds, designed specifically for confused people such as yourself. They invest as ideal for the typical individual, and they rebalance automatically. They also change the investment mix as your retirement approaches.

They usually have a year in the title, like "Fidelity Freedom 2030", which is the year you plan to retire. This particular one is investing in aggressive stocks right now, but as 2030 approaches, it will shift to bonds and munis, and finally, after 2030, it will be almost entirely money-market and CDs.

[bigred]

High loads (trying to remember....I believe anything approaching 1% or more) are rarely worthwhile, as you can find comparable or better mutual funds with less (or no!) of a load.

I ended up hiring a financial advisor. Money well spent IMO.

[bobdroege7]

There are loads and fees.

Even no load funds have fees, it is a good idea to take those into consideration when pickin funds.

Index funds typically have the lowest fees, but why buy an index fund when you can buy Spyders and Diamonds?

Buy Spyders and Diamonds if your 403b allows, they are like index funds but lower fees. Spyders track the S&P 500 and Diamonds track the DOW.

But the best advice is to educate yourself enough to satisfy your risk tolerance.

There are some radio talk show on saturdays that are very educational, results may vary by area. Some will recomend mutual funds by name, or give recomendations on various stocks etc.

[nescafe]

When you get to the point of picking individual stocks, I recommend looking up first Malkiel "A Random Walk Down Wall Street" - which is a compilation of research detailing just how hard it is to beat the market. Then, look up the investing methods of Benjamin Graham. This is the style that Warren Buffett started with (he was a student of Graham), and is the only investing method that Malkiel thinks is intellectually defensible. After that, if you disagree with that analysis, you will have a substantial education in investing and have an intellectual basis for disagreeing. I'll point out that Warren Buffett advises buying index funds for 99% of investors.

Hope this helps.

Seconded. Unless you can take the time to really research stocks, go with indexing. Nothing beats that strategy over the long term (we are talking 30 year planning horizon here), and an extra 30 years of an extra percent of returns a year (due to lower fees that index funds charge) really add up -- here is some math:
2 funds, we will assume each has a gross return of 9% per year.
A is an actively managed fund that has a 1.5% expense ratio
B is an index fund that has a 0.5% expense ratio
Let sit for 30 years with no additional investment
A's returns are $80,000*1.075^30=$700396
B's returns are $80,000*1.085^30=$924660

Going with an actively-managed fund cost you $224264.

This is just a toy example, of course, but the benefits of index funds as an investment strategy for retiring should be obvious.

[boloboffin]

!! Obviously, this is not financial advice !!

Most 401(k) providers have "lifecycle" funds, designed specifically for confused people such as yourself. They invest as ideal for the typical individual, and they rebalance automatically. They also change the investment mix as your retirement approaches.

They usually have a year in the title, like "Fidelity Freedom 2030", which is the year you plan to retire. This particular one is investing in aggressive stocks right now, but as 2030 approaches, it will shift to bonds and munis, and finally, after 2030, it will be almost entirely money-market and CDs.

In my plan, these funds have the highest fees yet. None of the funds I had before had fees that high.

[fxm]

In my plan, these funds have the highest fees yet. None of the funds I had before had fees that high.

That's because they are "funds of funds" -- so on top of the fees assessed by the underlying funds held, there's an additional fee for managing the main fund.

If you have the discipline to duplicate what a lifecycle fund does for you, then by all means, save yourself the extra money and do it yourself. But a lot of folks don't have that discipline, and are willing to pay extra to have someone do that for them. As long as the after-fee returns are in the range you're looking for, there should be no problem.

It's good to focus on fees, to make sure you aren't paying too much, but don't make it the only factor for deciding on an investment.

[Dunstan]

There are some radio talk show on saturdays that are very educational, results may vary by area. Some will recomend mutual funds by name, or give recomendations on various stocks etc.

I suppose there might be some good shows out there, but every one I've ever heard has been awful. They usually have some subscription newsletter, book, or mutual fund they're pimping out of self-interest, and most of them seem to provide uninformed advice. There's one show in Los Angeles (I think it's syndicated, so it might be elsewhere, too) that consists of people calling in and asking "I have 300 shares of XYZ company, what should I do?" The host then looks up XYZ on his computer and provides some impromptu technical analysis ("well, it's trading at its 30-week low, and there seems to be some resistance at the $40 level, so hold it for now and sell it if it gets to $40 again"). I'm willing to be persuaded that technical analysis can work in certain circumstances, but "some bozo in a radio studio doing 10 seconds of work" is not such a circumstance.

I'm skeptical that radio provides good financial advice. The kind of advice most people need is simple and boring; while effective, it doesn't make for interesting radio.

[geni]

When you get to the point of picking individual stocks, I recommend looking up first Malkiel "A Random Walk Down Wall Street" - which is a compilation of research detailing just how hard it is to beat the market. Then, look up the investing methods of Benjamin Graham. This is the style that Warren Buffett started with (he was a student of Graham), and is the only investing method that Malkiel thinks is intellectually defensible.

In theory certian types of insider tradeing should also be pretty logical. Slight issues with legality mind.

[bigred]

Totally agree on talk radio.

In fact IMO talk radio in general is practically by definition idiotic.

[BWV 1080]

Outperforming the market is a zero sum game - the average dollar receives the market return less fees. For most people, low cost index funds are the best option

[Francesca R]

Outperforming the market is a zero sum game - the average dollar receives the market return less fees. For most people, low cost index funds are the best optionFully agree, and fees are the largest eroder of wealth in retail managed funds by far.

[Ben Tilly]

Regression to the mean is a fact of life, and applies to stocks too. Being able to spot it (i.e., is the stock trading more than 2 sd's above it's average because it's improbably unlucky, and thus will regress back, or because it's fundamentals have changed so that its new true market price has increased) is the challenge.

While there is a real phenomena called regression to the mean, you're completely mistaken in your description of it.

In stocks, regression to the mean suggests that the future performance of a stock or stock fund with exceptional performance is more likely to be average (ie closer to the mean) than its past performance has been. Studies have verified this, and verified an even stronger statement. Namely that future performance is uncorrelated with past performance. So exceptional past performance is no indicator of how it will perform next.

However there are some trends that are persistent. Volatile stocks (ie ones which have fluctuated a lot) tend to remain volatile, and sedate stocks tend to remain sedate. Also there are correlations between stock movements that do not easily go away. (For instance tech stocks tend to move together.) While these correlations are important for financial theory, as an individual investor there isn't much you can do with that information. (In finance they lead to a concept called "beta". Which in turn allows us to do interesting things like create portfolios that in the long run tend to outperform the market, at the price of increased short term volatility. If you want to invest in one of those, look for "growth funds".)

I think regression would occur especially when stock prices move in random ways.

Figuring out how to spot it though is the catch. I'm not claiming I or anyone can, but stocks do regress.Spotting regression to the mean is easy. Making use of it is not. And if you have any hope of using regression to the mean as a way of picking stocks that are due to do well, then you've completely misunderstood the concept.

[bpesta22]

While there is a real phenomena called regression to the mean, you're completely mistaken in your description of it.

In stocks, regression to the mean suggests that the future performance of a stock or stock fund with exceptional performance is more likely to be average (ie closer to the mean) than its past performance has been. Studies have verified this, and verified an even stronger statement. Namely that future performance is uncorrelated with past performance. So exceptional past performance is no indicator of how it will perform next.

However there are some trends that are persistent. Volatile stocks (ie ones which have fluctuated a lot) tend to remain volatile, and sedate stocks tend to remain sedate. Also there are correlations between stock movements that do not easily go away. (For instance tech stocks tend to move together.) While these correlations are important for financial theory, as an individual investor there isn't much you can do with that information. (In finance they lead to a concept called "beta". Which in turn allows us to do interesting things like create portfolios that in the long run tend to outperform the market, at the price of increased short term volatility. If you want to invest in one of those, look for "growth funds".)

Spotting regression to the mean is easy. Making use of it is not. And if you have any hope of using regression to the mean as a way of picking stocks that are due to do well, then you've completely misunderstood the concept.

I don't think I mis-stated the concept. The problem is that when a stock changes in price you can't tell if it's for a valid reason (financial performance) or just a random fluctuation. Further, the true value of a stock is likely changing frequently, which sucks for anyone waiting for today's stock price to regress to yesterday's mean.

If you could somehow ID a stock whose movement over some time period was due solely or mostly to randomness, then you certainly could make money shorting or buying it at the extremes (assuming nothing changes to move the stock price for real in the time it takes you to make the transaction).

If beta is the SD about the mean price of a stock, then I'd guess the higher the beta the more potential money one could make, all else being equal.

I submit "closer to the mean" is the problem in your statement. We have no way of knowing what the true mean is to tell when a stock is likely to regress. But, if there's randomness involved, things will regress.

You said spotting regression to the mean is easy (for stocks, I assume?) Can you give an example?

[Francesca R]

If beta is the SD about the mean price of a stock, then I'd guess the higher the beta the more potential money one could make, all else being equal.The beta is the sensitivity of a stock's returns to the returns of the "whole" market. A stock with a beta of 0.5 will (on past data) rise 5% in the same period when the market rises 10%, and a stock with a beta of 2 will rise 20%. Betas are historical estimates but have some theoretical validity. A high beta won't help you make (or lose!) money unless you have a market-beating skill in predicting the direction of the market itself :)

[bpesta22]

The beta is the sensitivity of a stock's returns to the returns of the "whole" market. A stock with a beta of 0.5 will (on past data) rise 5% in the same period when the market rises 10%, and a stock with a beta of 2 will rise 20%. Betas are historical estimates but have some theoretical validity. A high beta won't help you make (or lose!) money unless you have a market-beating skill in predicting the direction of the market itself :)

Thanks for the clarification; I agree with the last statement, which is why I included all else being equal as some weasel words.

[Ben Tilly]

The beta is the sensitivity of a stock's returns to the returns of the "whole" market. A stock with a beta of 0.5 will (on past data) rise 5% in the same period when the market rises 10%, and a stock with a beta of 2 will rise 20%. Betas are historical estimates but have some theoretical validity. A high beta won't help you make (or lose!) money unless you have a market-beating skill in predicting the direction of the market itself :)

The last sentence is only true in the short term.

Historically the market tends, over time, to go up. A high beta portfolio will tend to go up more than the overall market. So, in the long run, a high beta portfolio is likely to outperform the market as a whole. At, of course, the cost of significantly increased volatility.

So beta cannot help you beat the market on a day to day basis. But over a decade to decade period, it should.

[Ben Tilly]

I don't think I mis-stated the concept. The problem is that when a stock changes in price you can't tell if it's for a valid reason (financial performance) or just a random fluctuation. Further, the true value of a stock is likely changing frequently, which sucks for anyone waiting for today's stock price to regress to yesterday's mean.

Sorry, but you're wrong. And repeating your misunderstanding of the concept doesn't make you right.

If you could somehow ID a stock whose movement over some time period was due solely or mostly to randomness, then you certainly could make money shorting or buying it at the extremes (assuming nothing changes to move the stock price for real in the time it takes you to make the transaction).

According to all of financial theory, it is impossible to identify from the movement of stocks which stocks are changing price due to randomness, and which are because of real changes in underlying value.

If beta is the SD about the mean price of a stock, then I'd guess the higher the beta the more potential money one could make, all else being equal.

Oh joy. Another term for you to promptly try to fit into your already mistaken preconceptions. And, of course, you thereby get it wrong. I guess that going a google search like http://www.google.com/search?hl=en&q=beta+finance&btnG=Google+Search was just too much work for you?

I submit "closer to the mean" is the problem in your statement. We have no way of knowing what the true mean is to tell when a stock is likely to regress. But, if there's randomness involved, things will regress.

When you say "true mean" and mean something different than the current stock market value of the company, you're inventing a poorly defined concept that has no basis in financial theory or statistics.

Sure, there is a theoretical way of telling the true mean, and that is to estimate the intrinsic value of the company. Warren Buffett claims that doing this is the secret of his success. Unfortunately lots of people do that, and everyone gets different answers. This information is, in fact, a good part of the information that goes into determining the stock price.

In fact financial theory holds that the stock price is a better estimate of what the true price should be than what any individual stock market participant can come up with. Indeed it is easy to demonstrate that if an individual participant can come up with better estimates than the stock market, then that participant can make money off of the stock market. (As a matter of practical fact, this has proven very doable. Unfortunately the cost of doing the necessary research tends to exceed the returns to be made. Unless you're named Peter Lynch or Warren Buffett.)

And since there is no better estimate of "true price" available than the actual stock market price, the stock market price is the only price that we can reasonably study. And therefore it is the one that people in finance do talk about.

You said spotting regression to the mean is easy (for stocks, I assume?) Can you give an example?

Sure. If you take the 10 stocks that performed the best in the last month and make a portfolio out of them, the odds are very good that that portfolio's performance next month will be much closer to the market average than their performance last month.

In other words the future performance of stocks with exceptional past performance is closer to the mean than their past performance. Which is exactly what regression to the mean predicts.

[Geek Goddess]

In my 401(k), I tried to put as much pretax money as I could spare, and always as a minimum the amount that the employer matched. That's an immediate 100% return, to my feeble brain's way of looking at it. On any financial plan I've had through an employer, there were no fees or loads to purchase thruogh a payroll deduction plan. That may have just been the companies that I worked for. Some of them had fees to sell, but not to buy. I put in the same amount each month, to get the dollar-cost averaging.

My last employer had about 10 choices on mutal funds, bond funds, and a couple of 'equity fund' options. I had a friend at Merrill Lynch look them over and recommend a couple that would be different from what I held in my IRA accounts, which contains rollovers from two previous employers. In that, at first I had two mutal funds, one large cap and one small cap, but I have slowly diversified with those until now I also have a Latin American mutual, a couple of blue chips that pay dividends (I've doubled my intial investment in Altria over the past four years, for example), a utility, an oil company, a defense industry. When something has doubled for more, I sell part of it and try to find something else that appears to be undervalued. I've had some pharmaceuticals, but sold them after they rose 50+%. At one time I had 200 shares of Starbucks, but sold it after it doubled. It then increased even more, but I don't look back. My friend at Merrill Lynch manages my account: she doesn't churn my holdings, seldom calls me, and understands that I prefer steady growth to sexy risk-takers. She does the research for me. Yes, she gets a commission, but I have calculated that into my returns and am ahead. I probably wouldn't have figured out those choices on my own. Although some individual funds/stocks have lost a bit, over time I've been making 10-20% each year. Some people might not find that impressive, but I'm content because I don't worry about volatile stocks from day to day.

My boss has built a business from scratch, from humble beginnings, and is now a multi-millionaire. He has a rather small portfolio given his assets, but owns two houses in a resort town that he keeps rented for winter skiers and summer hikers. I'm not sure what terms he used to finance them, but he rolled pretty much every penny he made back into them and paid them off in 5-7 years. He pays someone who is local to provide cleaning services after rentals (which the renter must pay for) and has a handyman that checks on things and keeps them repaired. The first few years he broken even, but since they have been paid off, they are profit centers. I looked into doing something similar but using my IRA for the purchase, and every bit of research I found said that it was almost impossible to do, due to IRA restrictions on active versus passive income, how you handle the costs (of repairs, etc), and so on.

If I were starting over, I would like pick mostly index funds.

[bpesta22]

Ben, I could be misreading the tone of your post, but I feel like I ran over your puppy or something. If this is too emotional a topic for you, let me know…


Sorry, but you're wrong. And repeating your misunderstanding of the concept doesn't make you right.


Sorta like you repeating I'm wrong makes you right :rolleyes:


According to all of financial theory, it is impossible to identify from the movement of stocks which stocks are changing price due to randomness, and which are because of real changes in underlying value.


Well, I don't claim the endorsement of all of financial theory, but this sounds exactly like what I said in my previous post:

"The problem is that when a stock changes in price you can't tell if it's for a valid reason (financial performance) or just a random fluctuation."

How is my statement different from yours?



Oh joy. Another term for you to promptly try to fit into your already mistaken preconceptions. And, of course, you thereby get it wrong. I guess that going a google search like http://www.google.com/search?hl=en&q=beta+finance&btnG=Google+Search was just too much work for you?


My apologies. I thought beta was the standard deviation around a stock price; I see it's not. I conceded the point and thanked the first person who corrected me on this. Do you feel I should have done more at this point? A google search would have indeed shown my mistake, but the previous poster already pointed it out, and she did receive my thanks for pointing it out.


When you say "true mean" and mean something different than the current stock market value of the company, you're inventing a poorly defined concept that has no basis in financial theory or statistics.


I'm not sure I agree with this. I obviously lack your financial acumen, but I was relying on Spearman's classical model of reliability where an observed score (e.g., a stock price) is equal to its true score (e.g., its fair market value) plus error (e.g., random fluctuations). Errors can be positive (artificially inflating the stock price) or negative (the opposite) but they wash out over time / repeated testings, with a mean error score of zero.

When an observed score contains a non-zero error component (versus an error score with a mean of zero), the next measurement will most probably regress to the true score. QED.
We seem to both argree that stocks vary for random reasons. Therefore, stocks regress to the mean, just the way I said they do above.

I did Google search this one, and came fairly quickly across an article on investing that mentions the words “true score” thus illustrating that it’s not my invention, nor is it poorly defined, nor does it lack bases in financial and statistical theory:

http://www.economics.pomona.edu/GarySmith/earningsRegress/earningsRegress.html

In the end, I think we’re arguing the same thing: Stocks regress, but no investor has the information needed to tell whether the current stock price is a reliable indicator of its true score, or loaded with error, and therefore due to regress.




Sure. If you take the 10 stocks that performed the best in the last month and make a portfolio out of them, the odds are very good that that portfolio's performance next month will be much closer to the market average than their performance last month.


See, this vague example makes my point. Stocks regress, yes, but which specific ones and exactly when is what I was hoping you’d provide an example of. Is IBM’s current price a reflection only of its fair market value or is it loaded with some large error (relative to the SD of it’s error, which I thought was related to Beta)? That is unknowable.

If O=T + E, and all we got is O, we can’t use regression as a strategy to make money on stocks. I don’t see this as all that different from your conceptualization of regression to the mean.

[Antiquehunter]

I'm very well diversified right now (12 different funds with 5% or 10% in each) in a good mix of sectors. My fees are high in some and low in others, and I've already identified good substitutes for the high ones. I definitely want to check on the managers as well now. We don't have stock options in my company - we are a non-profit, so they can't do that, I believe. And Enron just haunts me when I consider buying stock in a company I work for.

But keep the good info coming.

When I read this, in MY personal, layman's opinion, I think you're TOO diversified - unless your portfolio is already VERY large. I manage my own retirement funds, which are... of a moderate size (there are 6 decimal places in the number and the first digit isn't a 1) and I'm in 5 individual stocks and one basket-type fund. That's it. Now - I'm a rule breaker, and I'm sure that a 'professional' would suggest I'm nuts - however, the law of diminishing returns kick in, if you own too many different things.

The reason you're BUYING mutual funds in the first place is to leverage diversification. So - why get a whole bunch of funds? Research and pick a winner, and go with it. Schwack some money into a stock type of fund and money into an income type of fund (preferred shares, bonds etc...) for balance, if you're super conservative. Go into three funds if you are REALLY risk-averse - stocks/growth, income and money market. Or - you can try my method:

Buy shares of quality firms, with a buy and hold perspective. 10% stop-loss on all new acquisitions, then a rolling 10% stop-loss moving forward to ensure you take profits. Cut off a chunk of your holdings and put it into an ETF or a mutual which based on your research will beat the money market / T-Bills for not much additional risk. Relax & enjoy.

I don't know how much you have to play with, but if I was in 12 different funds with no more than 10% of my holdings in any one inidividual fund, then I can pretty much guarantee that I would have a very sub-par return. You're pretty much guaranteed to move to the 'mean' with that much diversification. There CAN be too much of a good thing...

My $0.02.

PS - specific stock recommendation: I am a happy holder of PWI-UN.TO which was just the subject of a buyout from Abu Dhabi - a 32% overnight spike yesterday. I suspect that other quality Canadian Natural Gas / Oil Income Trusts that have been beaten back of late may become prime buyout targets from Europe / Middle East, especially given the weakening US dollar. I would look at that sector - and many of these trusts trade on the US market as well.

[Geek Goddess]

To add to what AH wrote, a lot of mutual funds overlap, so even though you hold many different funds to diversify, you may find that some fund have a great deal of overlap. If 7 of your 10 funds have a dozen of their top stocks in common, you aren't really diversifying.

[Esperdome]

To add to what AH wrote, a lot of mutual funds overlap, so even though you hold many different funds to diversify, you may find that some fund have a great deal of overlap. If 7 of your 10 funds have a dozen of their top stocks in common, you aren't really diversifying.

I agree. Most 401k plans these days have a good spread in funds and fund objectives that being invested in more than 4-5 is too much. I'm comfortable with just two right now.

On the other hand, IRAs can be more problematic if you did like I did early on, bought something different every year. I've got them all corraled to one brokerage now, so I hope to tame them gradually over the next year or so.

[GreNME]

Go to The Motley Fool (http://www.fool.com/retirement.htm?ref=G02A04) website and get some excellent (and quick) breakdowns on retirement strategies.
There, fixed if for you.

Get the Morningstar ratings, the sector of each (US, European, Asian, Large Cap/Business, Small Cap/Business, Emerging Markets, etc), the fund manager's name and length of service, the past performance over the last 3, 5, and 10 years, the expense ratio, the risk factors, etc.

Then throw that all away and go with the top three in the 3-year rating that are in different sectors.

And in four years start all over again, because you find that you actually have available only 75% of the money you've actually been putting in to begin with.

Or...

In my 401(k), I tried to put as much pretax money as I could spare, and always as a minimum the amount that the employer matched. That's an immediate 100% return, to my feeble brain's way of looking at it.

Heed this advice immediately. Every reputable source you will find will tell you to max out any employer matching, for exactly the reason that it is immediately 100% return on investment.

For where to put your investments, follow the mantra of "diversify" but make sure to split things into groups. Most company retirement plans have in their employee forms the ability to choose types of investment 'packages' that group a number of similarly-focused investment types in order to offer the person choosing the benefits of diversity without having to perform as much market research. They are typially grouped in three categories: conservative, minimal risk, high risk. Some have these split into four or five categories, but you can adjust your choices accordingly to fit the general strategy.

The strategy is to make sure you have percentages of where your money is invested in each group. For instance: if you are young, go heavy on some of the higher-risk investments for a while for greater year-to-year returns. Even if a single high-risk investment posts a loss, other high-risk investments will more than make up the difference. Split the rest of your percentage between the other two, with slightly higher focus on the conservative investments if you are more safety-minded, more on the minimal risk if you think you will eventually be making enough salary for other investment / retirement planning in the future (Roth IRA, index funds, drips, etc.). If you're older, you want to go a little less heavy on the high-risk stuff, but still invest at least 25-30% of your overall investment in high-risk in the hopes of pulling those higher returns. Do the same as I mentioned earlier with the other risk levels. Your plan will send you regular statements to let you know how your money is doing-- read them. Get a spreadsheet or, if you can afford, a money management program and track the numbers for your investment year-to-year. They will give you the indication of whether you should alter your investments some.

If you have options for investing in currency markets, then put at least some money there. With few exceptions, those markets change gradually, giving you time to shift them if you see the market starting to move. Don't be afraid of putting some into investments that are overseas, especially Canadian and European markets. There isn't anything significantly different or inherently better about them, but money is money and not all of the money flows exclusively through American investments.

I won't pretend to tell you that I can give you all of the different types of things you should put your money into. Instead, the best thing for you is to point you in a good direction, and the Motley Fool is one of the best resources out there for someone who wants to start learning how to best make use of their money for retirement and invesments. Some other places to look at on their website: investing with small amounts (http://www.fool.com/dbc/qa/qa13.htm), article on small investing (http://www.fool.com/dbc/qa/qa03.htm), article on drips (http://www.fool.com/school/Drips.htm), some newsletters on investing (http://www.fool.com/shop/newsletters/index.htm?ref=foolmart&CATALOGID=82)-- don't spend money on one unless you've read its description and think it can be helpful. Their newsletters are good, but are wasted money if you're getting unhelpful information you can't do anything with.

[balrog666]

My reply here was facetious. I will make that a little more obvious next time.

[ZirconBlue]

My reply here was facetious. I will make that a little more obvious next time.

The Narn: always so impulsive.;)

[BWV 1080]

When I read this, in MY personal, layman's opinion, I think you're TOO diversified - unless your portfolio is already VERY large. I manage my own retirement funds, which are... of a moderate size (there are 6 decimal places in the number and the first digit isn't a 1) and I'm in 5 individual stocks and one basket-type fund. That's it. Now - I'm a rule breaker, and I'm sure that a 'professional' would suggest I'm nuts - however, the law of diminishing returns kick in, if you own too many different things.

The reason you're BUYING mutual funds in the first place is to leverage diversification. So - why get a whole bunch of funds? Research and pick a winner, and go with it. Schwack some money into a stock type of fund and money into an income type of fund (preferred shares, bonds etc...) for balance, if you're super conservative. Go into three funds if you are REALLY risk-averse - stocks/growth, income and money market. Or - you can try my method:

Buy shares of quality firms, with a buy and hold perspective. 10% stop-loss on all new acquisitions, then a rolling 10% stop-loss moving forward to ensure you take profits. Cut off a chunk of your holdings and put it into an ETF or a mutual which based on your research will beat the money market / T-Bills for not much additional risk. Relax & enjoy.

I don't know how much you have to play with, but if I was in 12 different funds with no more than 10% of my holdings in any one inidividual fund, then I can pretty much guarantee that I would have a very sub-par return. You're pretty much guaranteed to move to the 'mean' with that much diversification. There CAN be too much of a good thing...

My $0.02.

PS - specific stock recommendation: I am a happy holder of PWI-UN.TO which was just the subject of a buyout from Abu Dhabi - a 32% overnight spike yesterday. I suspect that other quality Canadian Natural Gas / Oil Income Trusts that have been beaten back of late may become prime buyout targets from Europe / Middle East, especially given the weakening US dollar. I would look at that sector - and many of these trusts trade on the US market as well.


A couple of issues here

First there is no "return penalty" for diversification. It is actually the closest thing to a free lunch. At some point, a large number of holdings will converge to a market return, in which case it makes more sense to buy and index fund, but if one has 100 investments with equal prospects of outperforming the market, then the best thing to do is buy all 100.


Stop losses are misleading in that a 10% stop will not protect you from a larger loss. Stocks gap down in response to information, so that 10% stop can liquidate you at potentially, say, a 30% loss.

[BWV 1080]

The last sentence is only true in the short term.

Historically the market tends, over time, to go up. A high beta portfolio will tend to go up more than the overall market. So, in the long run, a high beta portfolio is likely to outperform the market as a whole. At, of course, the cost of significantly increased volatility.

So beta cannot help you beat the market on a day to day basis. But over a decade to decade period, it should.

And Fama & French showed empirically that high-beta has actually underperformed historically. So much for theory

[BWV 1080]

This is why diversification is important - the geometric mean return (what you actually compound your money at) is always less than the simple average annual return.

Why this is important, say that a group of 30 stocks each has an expectation of a 10% annual (continual compounded) return. Each stock has an individual standard deviation (of log returns) of 30% (not atypical for individual stocks) but combined in a portfolio, the non-correlated company-specific (and non-compensated according to theory) risks net out, leaving a 15% standard deviation for the 30-stock portfolio.

The 30 stock portfolio will actually, on average compound at a higher rate of return over time.

The geometric mean return differs from the expectation, or arithmetic by half the variance.

So the 1-stock portfolio geometric average return is exp[10% - (30%)^2 /2] = 5.65%

the 30-stock portfolio's geometric average return is exp[10% - (15%)^2 /2] = 9.28%

Now the dispersion of the 30 stock portfolio is much less and potentially the non-diversified portfolio could significantly outperform it, but it is a stupid bet.

The intuitive logic here is that if one has a return of in year 1 of 10% and a return in year 2 of -10% the average is zero but the portfolio has actually lost 1% (1.10 * 0.90) = 0.99 . Up 30% in year one, down 30% in year 2 translates to a 9% loss - losses are extremely difficult to make up. The risk of a large drawdown in say a 5-stock portfolio is too great for most investors to bear.

[JEROME DA GNOME]

This is a cry for help. I just went to my local Borders yesterday, looking for help specifically with making choices for my 403(b) plan. I am presented with a vast array of mutual funds in which to invest my retirement savings. How do I evaluate them? How do I know what is better and what is worse? That's what I wanted to find, and could find nothing specific for helping people make investment choices in this area.

I've titled this with 401(k) because it's much more prevalent that people have these rather than a 403(b).

I've found a good article on line that has me evaluating my fund choices now for fees. And I'm not the type to change investments on a whim - any changes I make will be once a year. But is there a better way to evaluate these complicated statements of a hundred or more differing funds besides blind luck?


If you have a mortgage you should not be investing in any plan.

Tell you what. Add the money you would be investing and apply it to your principal balance of your mortgage. Calculate how much sooner you would have the debt payed. Then use the money you are not paying for your mortgage as investment capital.

Remember that compound interest works both ways.

[Hindmost]

snip...

PS - specific stock recommendation: I am a happy holder of PWI-UN.TO which was just the subject of a buyout from Abu Dhabi - a 32% overnight spike yesterday. I suspect that other quality Canadian Natural Gas / Oil Income Trusts that have been beaten back of late may become prime buyout targets from Europe / Middle East, especially given the weakening US dollar. I would look at that sector - and many of these trusts trade on the US market as well.

I owned a Canadian oil trust...about six months ago or so, there was a proposed change to the tax law associated with the trust. It was going to reduce some of the tax advantages. If I recall, it is not due to go into effect for a few years, but it did cause quite a bump at the time it was announced.

glenn

[JEROME DA GNOME]

I owned a Canadian oil trust...about six months ago or so, there was a proposed change to the tax law associated with the trust. It was going to reduce some of the tax advantages. If I recall, it is not due to go into effect for a few years, but it did cause quite a bump at the time it was announced.

glenn

This is an example of the potential problems with long term investments that are tried directly to potential changes in the law. In the 401(k) example you would have to pay a 10% penalty plus taxes to escape the detriment to your investment that a new law causes.

Everyone must remember that Social Security benefits were never to be taxed as income. Today they are!

Pay your debt. Then use the saving from the compound interest that you were paying to invest.

[Antiquehunter]

If you have a mortgage you should not be investing in any plan.



I disagree.

If your mortgage is at a reasonable rate (such as mine at 4.7%) then provided you can get a better return on your money than 4.7%, it makes sense to be investing. Furthermore, in the US where you have tax incentives on your mortgage interest, you may have even less incentive to pay down a low interest rate mortgage.

Re: Income trusts - yes, our charming Prime Minister reneged on a campaign promise related to the taxation of income trusts, and this caused a minor meltdown. However, there has been much recovery, and the quality income trusts continued to pay their dividends at 14-16% returns throughout the market confusion. For a buy and hold investor like myself, I did very well with the sector, and remain invested in a basket fund of income trusts.

Trying to find an investment vehicle that has NO political / legal risk attached is... impossible.

[JEROME DA GNOME]

I disagree.

If your mortgage is at a reasonable rate (such as mine at 4.7%) then provided you can get a better return on your money than 4.7%, it makes sense to be investing. Furthermore, in the US where you have tax incentives on your mortgage interest, you may have even less incentive to pay down a low interest rate mortgage.

Re: Income trusts - yes, our charming Prime Minister reneged on a campaign promise related to the taxation of income trusts, and this caused a minor meltdown. However, there has been much recovery, and the quality income trusts continued to pay their dividends at 14-16% returns throughout the market confusion. For a buy and hold investor like myself, I did very well with the sector, and remain invested in a basket fund of income trusts.

Trying to find an investment vehicle that has NO political / legal risk attached is... impossible.


That 4.7% rate is still compounding over 30 years. This about doubles the price of the home even with this low rate; thus a $350,000 home will cost about $700,000. The tax savings are only on the interest payed and represent a tax savings of decreasing amounts as you pay less interest with each payment. This would be a savings of about $2500 in the first year and about $150 in the 30th year of the loan. Using the maximum contribution limit of the 401(k) plan of $15,500 per year and choosing to pay principal on the mortgage instead of using the 401(k) you will have payed the debt in 15 years and not 30. This saves about 33% of the total loan. That is a savings of about $230,000 dollars. Now without a payment to make you have approximately $22,000 dollars in your pocket every year that can be invested any way you like.

Of course there are risks to all investments. The point is the 401(k) investments are saddled with aggressive penalties if you either need the money or want to change the investment to something that is not subject to a current law change. In other words you are stuck.

[ZirconBlue]

That 4.7% rate is still compounding over 30 years. This about doubles the price of the home even with this low rate; thus a $350,000 home will cost about $700,000. The tax savings are only on the interest payed and represent a tax savings of decreasing amounts as you pay less interest with each payment. This would be a savings of about $2500 in the first year and about $150 in the 30th year of the loan. Using the maximum contribution limit of the 401(k) plan of $15,500 per year and choosing to pay principal on the mortgage instead of using the 401(k) you will have payed the debt in 15 years and not 30. This saves about 33% of the total loan. That is a savings of about $230,000 dollars. Now without a payment to make you have approximately $22,000 dollars in your pocket every year that can be invested any way you like.

Of course there are risks to all investments. The point is the 401(k) investments are saddled with aggressive penalties if you either need the money or want to change the investment to something that is not subject to a current law change. In other words you are stuck.

In every 401K plan I've participated, I was able to freely change my investments around at will. There is a penalty for early withdrawal, but many plans have loans you can take out against them. There's a small upfront fee, and you pay interest, but the interest is paid back to your 401(k), not to the bank.

And, I think you're forgetting about employer matching contributions. In the plans I've participated in, that's a 50-100% immediate return on your contribution.

[Antiquehunter]

Not to mention the tax-free growth within the 401k (or Canadian RRSP) plan... The value of tax deferral on the Canadian RRSP front is huge. If you're earning enough to max out your RRSP contributions and are paying down a $350,000 mortgage, then you're going to be in the highest marginal tax bracket in Canada - something around 48-52% in most provinces combining federal and provincial taxes. Whacking as much into your RRSP as possible, reducing your current year tax liability, combined with the tax free growth of your investment within the plan AND the fact that when you start drawing down your RRSP holdings in your retirement you'll be at a much lower marginal rate (likely) - makes your RRSP one of the most important investments you can make.

One reason why Canadian lendors are somewhat isolated from the woes of the US subprime meltdown are our stringent lending policies. Firstly, a conventional Canadian mortgage is amortized over 25 years, and requires a 25% downpayment. For first-time homeowners, there are insured loans allowing down to a 5% downpayment for inexpensive homes, with insurance rates applied.

[JEROME DA GNOME]

Not to mention the tax-free growth within the 401k (or Canadian RRSP) plan... The value of tax deferral on the Canadian RRSP front is huge. If you're earning enough to max out your RRSP contributions and are paying down a $350,000 mortgage, then you're going to be in the highest marginal tax bracket in Canada - something around 48-52% in most provinces combining federal and provincial taxes. Whacking as much into your RRSP as possible, reducing your current year tax liability, combined with the tax free growth of your investment within the plan AND the fact that when you start drawing down your RRSP holdings in your retirement you'll be at a much lower marginal rate (likely) - makes your RRSP one of the most important investments you can make.

One reason why Canadian lendors are somewhat isolated from the woes of the US subprime meltdown are our stringent lending policies. Firstly, a conventional Canadian mortgage is amortized over 25 years, and requires a 25% downpayment. For first-time homeowners, there are insured loans allowing down to a 5% downpayment for inexpensive homes, with insurance rates applied.

The thing about these "pre-tax" contributions are that we do not know what the laws will be in the future. The governmnet may need the money. We have seen from experience that despite the promise that Social Security benefits would not be taxed as income it currently is.

As far as you employer adding 50% to your contribution this is additional income and you could ask for the money in cash. The same way that you could ask for the cash instead of health insurance if you can get a better deal on your own.

In my experience the individual employee tends to undervalue their worth because they do not understand the system. They think that the benefits they receive are non-negotiable. Everything is negotiable. I have many friends that accept benefits that they do not want or need instead of asking for what they do need.

And so, the debt cycle continues with a future fantasy that all the rules will stay the same and the value of the money will be comparable.

[ZirconBlue]

The thing about these "pre-tax" contributions are that we do not know what the laws will be in the future. The governmnet may need the money. We have seen from experience that despite the promise that Social Security benefits would not be taxed as income it currently is.

We already know that the money will be taxed when withdrawn, and has already been put in before tax withholding. Are you saying that the government is going to suddenly pass laws to make us liable for taxes on previous years' untaxed income?

As far as you employer adding 50% to your contribution this is additional income and you could ask for the money in cash. The same way that you could ask for the cash instead of health insurance if you can get a better deal on your own.

In theory, you could. I'm extremely skeptical, however, that any signficant number of employers would give you cash in lieu of matching contributions, or in place of their portion of the health insurance. Further, matching contributions are based on how much you contribute; if you're not going to be investing any of your own money in the 401(k), then they stand to save a lot of money in not matching your contributions, rather than giving you free bonus cash.

In my experience the individual employee tends to undervalue their worth because they do not understand the system. They think that the benefits they receive are non-negotiable. Everything is negotiable. I have many friends that accept benefits that they do not want or need instead of asking for what they do need.

Maybe, but I would need serious evidence to convince me that the sort of benefit trading you propose would even be an option to a significant number of employees. Letting individual employees opt out means that the company has less "buying" power for the remaining employees that do wish to have those benefits, raising costs to the company and those employees.

And so, the debt cycle continues with a future fantasy that all the rules will stay the same and the value of the money will be comparable.

The whole premise is that the future value of money will not be comparable. That's why you invest it rather than putting it in your mattress. And the rules don't have to stay the same. If they stop making the contributions tax deductible, then it might be time to stop making contributions. But your previous contributions will still already be invested and will continue to grow. If we're going to consider a scenario where the government decides to start taxing that money that was previously invested pre-tax, well, then we might as well plan for the government seizing the home that we paid off early, too.

[Paul C. Anagnostopoulos]

I'm thinking that the average investor does not have enough international coverage.

~~ Paul

[Paul C. Anagnostopoulos]

I have one word for you: Fidelity Contrafund (FCNTX).

~~ Paul

[Pyrts]

We've been using financial planners for a number of years. We can either go along with his suggestions or not go along with them, but we get a person who can explain the basics and actually talks with us if we have questions.

We've done well with the advisors. I also read up on the subject, but books may be several years out of date (it takes about a year for a book to get published) and sometimes there can be significant changes in regulations and options in that time.

[Plantfoam]

My 401k is through Fidelity as well, and they have served me well.

I have roughly 25% in large cap growth, 25% in mid cap, and the rest is in the international fund. I only wish that I would have switched to my current choices sooner, instead of holding on to the default stuff like bonds (ick!).

When I want to play with individual stocks I have a Scottrade account on the side. As far as retirement funds go, I stay far away from stocks.

[bpesta22]

The thing about these "pre-tax" contributions are that we do not know what the laws will be in the future. The governmnet may need the money. We have seen from experience that despite the promise that Social Security benefits would not be taxed as income it currently is.

As far as you employer adding 50% to your contribution this is additional income and you could ask for the money in cash. The same way that you could ask for the cash instead of health insurance if you can get a better deal on your own.
.

I doubt a company could or would do this as it would violate erisa standards for qualified deferred compensation. Doing it for one person could make the whole plan, I think, unqualified which would create nasty tax consequences for both the company and the employees.

You might have the right to take cash in lieu of medical insurance, but by definition you can't take deferred compensation today.

[JEROME DA GNOME]

I doubt a company could or would do this as it would violate erisa standards for qualified deferred compensation. Doing it for one person could make the whole plan, I think, unqualified which would create nasty tax consequences for both the company and the employees.

You might have the right to take cash in lieu of medical insurance, but by definition you can't take deferred compensation today.

An individual can negotiate any compensation with their employer.

[JEROME DA GNOME]

We already know that the money will be taxed when withdrawn, and has already been put in before tax withholding. Are you saying that the government is going to suddenly pass laws to make us liable for taxes on previous years' untaxed income?


They have taxed previously non-taxable income in the past.


If we're going to consider a scenario where the government decides to start taxing that money that was previously invested pre-tax, well, then we might as well plan for the government seizing the home that we paid off early, too.

They need guns to remove someone from their home. To tax an account they only need the "bank" to comply.

[bpesta22]

An individual can negotiate any compensation with their employer.

I'll defer to any tax experts here but they cannot negotiate compensation that violates federal law. the only way a company can offer a 401k is if they adhere to erisa standards regarding qualified deferred compensation. The match is an incentive for people to start saving for their retirement now. The match is tax effective from both the ee and er point of view. Paying out 50% to those who take the income now would make that income-- and perhaps the whole plan-- non-qualified.

The problem is, for any other employee to get the match, he/she has to defer his/her own income too. Letting you get it without the deferral wouldn't happen (and might not be legal).

[JEROME DA GNOME]

I'll defer to any tax experts here but they cannot negotiate compensation that violates federal law. the only way a company can offer a 401k is if they adhere to erisa standards regarding qualified deferred compensation. The match is an incentive for people to start saving for their retirement now. The match is tax effective from both the ee and er point of view. Paying out 50% to those who take the income now would make that income-- and perhaps the whole plan-- non-qualified.

The problem is, for any other employee to get the match, he/she has to defer his/her own income too. Letting you get it without the deferral wouldn't happen (and might not be legal).

It is not illegal for an employee to say that he wants a raise instead of participating in a voluntary retirement plan.:)

There are no laws that state the maximum an employee can be payed.