New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 11,000 subscribers:

Articles are published Mon/Wed/Fri. You can unsubscribe at any time.

Investing Blog Roundup: Friends and Enemies

As an individual investor, it’s difficult to know who is on your side. It can be hard to distinguish one financial services firm from another or one industry group from another.

That’s why I was interested to see Daniel Solin’s new series for US News in which he categorizes various industry parties as “friend” or “enemy” — no room in between. (In reality, I think there is a bit of a gray zone. But quick categorizations can still be helpful for investors trying to work their way through the morass that is the investment industry.)

Investing Articles

Thanks for reading!

Does a Bond Fund’s Yield Tell You Its Level of Risk?

A reader writes in, asking:

“One of the fund choices in my 401K is Bond Fund of America (RBFCX). It has a much lower yield than Vanguard’s Total Bond Market Index Fund: 0.98% vs. 1.57%. With bonds, low yield should mean low risk. But based on the descriptions of the two funds, I don’t see why Bond Fund of America would have less risk.”

Comparing Holdings

Fund names and fund descriptions can be misleading. I think the best way to assess a fund’s risk level is to actually take a look at what’s inside. Typically, that means going to Morningstar.

For a bond fund, I click over to the “portfolio” tab on the fund’s Morningstar page and look at two important pieces of information:

  • Average duration, and
  • Composition of the holdings with regard to credit quality.

In terms of interest rate risk, Bond Fund of America is slightly safer than the Vanguard Total Bond fund, with an average duration of 4.55 years rather than 5.18 years. But from the credit quality perspective, Bond Fund of America is somewhat riskier, mostly due to having a significantly smaller allocation to Treasury bonds than Vanguard Total Bond has (~17% rather than ~37%).

Looking at Pictures

While I’m not one for comparing performance for the sake of picking the higher-performing fund, I do think past performance can be useful for getting an idea of how risky a fund is. One of my favorite ways to do this is to plot a fund’s performance against the performance of a fund I’m more familiar with (e.g., comparing a U.S. stock fund to Vanguard’s Total Stock Market Index Fund).

The following Morningstar chart (click to enlarge) shows the last 10 years of performance for Bond Fund of America (in blue) as compared to Vanguard Total Bond Market Index Fund (in orange).

VBTLXvsRBFCXscaled

In short, while these funds are at least in the same general ballpark in terms of degrees of risk (e.g., much less risky than a stock fund), the American Funds fund does appear to have somewhat greater overall risk due to its lower average credit quality.

SEC Yield: After Expenses

So, if the Vanguard fund has slightly less risky bonds, why does it have a higher yield?

Expenses.

A fund’s SEC yield is calculated on an after-expense basis. This is why, for example, if you compare the SEC yield on the Investor Shares and Admiral Shares versions of a given Vanguard fund, you’ll see that they differ by an amount equal to the difference in expense ratios.

The R3 share class of Bond Fund of America that this reader has in his 401(k) has an expense ratio of 0.92%. In contrast, Vanguard Total Bond Market Index Fund’s expense ratio is just 0.10% (for Admiral shares). If the two funds’ holdings were exactly the same, the difference in expense ratios would give the Vanguard fund an SEC yield that’s 0.82% higher than the yield of the American Funds fund.

The Political Risk of Delaying Social Security Until 70

Some people argue that holding off on claiming Social Security is akin to betting that there won’t be any rule changes. I don’t think that’s true. While certain Social Security reforms would make it advantageous to claim earlier, other reforms wouldn’t change the decision at all, and others could actually make it more advantageous to delay claiming benefits.

The five potential Social Security reforms that I see suggested most often are:

  1. Increasing or eliminating the payroll tax cap,
  2. Increasing the payroll tax rate,
  3. Increasing the full retirement age,
  4. Means testing benefits in some way, and
  5. Switching from regular CPI to chained CPI for calculating cost of living adjustments.

Increasing the Payroll Tax Cap or Tax Rate

Increases to the payroll tax cap or payroll tax rate are the easiest reforms to assess for our purposes: They would have no effect on the way benefits are calculated and therefore would not change the when-to-claim decision in any way.

Increasing the Full Retirement Age (FRA)

Increasing the full retirement age does not change the age at which you can claim benefits. Rather, it’s simply a reduction in the amount of benefits you would get at any particular age. (For example, if you claim retirement benefits at age 64 with a full retirement age of 67, you get 80% of your “primary insurance amount.” If your FRA was 68 instead of 67 and you claimed benefits at age 64, you would only get 75% of your primary insurance amount.)

How would an increase in the full retirement age affect the when-to-claim decision? It wouldn’t dramatically change the break-even math, assuming the change is not applied to anybody already age 62 or older. Nor would it change the fact that delaying Social Security is like buying an inflation-adjusted lifetime annuity that has a higher payout than what you can get from a private insurance company.

For people who subscribe to the “build a safe floor of income” retirement planning philosophy, an increase in their FRA would actually mean they should claim later than they otherwise would. That is, if you have a certain level of safe income that you’re trying to achieve, and your benefit is reduced due to an increase in your FRA, you would then need to delay benefits until a later date in order to hit the necessary level of safe income.

Means Testing

Given that there are many different ways in which Social Security means testing could be implemented, it’s impossible to make a generalized rule about how means testing would impact the when-should-I-claim-benefits decision. So let’s consider a few different possible scenarios.

If the law implementing means testing includes a grandfather clause exempting people already old enough to receive benefits, the change likely wouldn’t impact the decision in any dramatic way.

Similarly, if your income (or wealth, if that’s how the means testing is done) ends up being below the point where means testing takes effect, your decision process would be no different than it is now.

If the change does affect you, and it simply works out to a percentage reduction in your benefits throughout your entire retirement, the analysis is roughly the same as it is for an increase in your full retirement age. (That is, it doesn’t change the break-even math, it doesn’t make delaying any worse of a deal, and it means that if you have a certain level of safe income you’re looking to achieve, you’ll have to hold off on claiming benefits even longer in order to reach that level of safe income.)

On the other hand, if means testing is implemented somewhere in the middle of your retirement and people old enough to receive benefits are not exempted via a grandfather clause, that would mean that claiming earlier would have been relatively more advantageous than it would have been if no such change is implemented. (That said, given that waiting to claim benefits is currently advantageous for most single people and decidedly advantageous for the higher earner in most married couples, the implementation of means testing might not have enough of an impact to make it a good idea to claim early. It all depends on the magnitude of the means testing — would your benefits be reduced by only a little, or by a lot?)

Switching to Chained CPI

One proposal getting a lot of discussion recently is to switch the calculation for Social Security cost of living adjustments to chained-CPI rather than CPI-W. This would result in benefits growing at a slower pace over time. Such a change would make claiming early more advantageous than it currently is, because it would mean that, in inflation-adjusted terms, benefits received later are smaller than benefits received earlier. So the sooner you receive the bulk of your benefits, the better.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: How Much Should I Save?

“How much money should I save each month?”

That’s one of the questions I get most often. And I’m not exaggerating when I say that I think it might be the single hardest investing-related question to answer. But, I thought Matthew Amster-Burton did an admirable job of tackling the topic this week for Mint.com’s blog:

Investing Articles

Other Money-Related Articles

Thanks for reading!

Getting Changes in Your 401(k)

Monday’s request for feedback about lobbying for a better 401(k) plan drew lots of responses. It was great to hear from people in a wide variety of circumstances — investors with success (and un-success) stories, people who work in HR departments and who are in charge of making plan decisions, small business owners with similar responsibilities, and investment advisors who provide plan-related services to employers.

Given the volume of replies, rather than sharing them all with you, I’ve tried to synthesize the group’s input into a handful of useful action steps below.

Figure Out What You Want

Step #1, naturally, is to figure out precisely what you want to request. Do you simply want to request the addition of 2-3 low-cost funds to your plan (e.g., a bond index fund and a stock index fund)? Or are you requesting an entirely new plan?

Based on reader input, it appears to be a heck of a lot easier to get funds added to an existing plan than to get your employer to change plan providers completely. This makes sense. It’s easier for management to add a new fund or two than to research new providers, choose one, and move everything over to them. In addition, there’s nobody who has a huge interest in fighting back against the addition of a few new funds, whereas, when trying to switch providers, the representative from the current provider will of course fight tooth and nail to convince management not to switch.

That said, if your plan has high administrative fees (that is, costs in addition to the expense ratios of the funds), switching plans is going to have a bigger impact than simply adding a few low-cost funds.

A third option, if your plan administrator allows it, is to request that your employer add an option to invest outside of the normal fund choices. For example, Fidelity’s BrokerageLink and Schwab’s Personal Choice Retirement Account both allow employees to pick their own funds.

Make Your Request in Writing

Next, write a respectful email to the plan fiduciary (or fiduciaries, if it’s a committee rather than a single person) clearly explaining the change you’re seeking and your reasons for the request.

If all you’re requesting is the addition of another fund or two, this email doesn’t have to be a big deal. You may be successful with the following approach:

  • Provide a source of information that speaks to the importance of low-cost options — reference a few studies or perhaps provide a link to the recent PBS documentary.
  • Briefly highlight the key points of the above-mentioned studies.
  • Specify which funds you would like to see added. It can be helpful to provide multiple options. For example, if you want a low-cost international fund, suggest 2-3 different choices (ideally, one of which is run by a fund family who already has some funds in the plan).

If you’re requesting an entirely new plan, you’ll probably want to include more information in your letter. (The Bogleheads wiki article on campaigning for a better 401(k) has a sample letter you may want to look at.) For example, in addition to providing references to applicable research, you may want to:

  • Briefly mention that the plan fiduciary has a legal obligation under the Employee Retirement Income Security Act (ERISA) to ensure that the cost of services provided to the plan is reasonable, and that a breach of such fiduciary duties can result in liability for the fiduciary.
  • Provide a total of all the costs that plan participants are paying (e.g., average fund expense ratio, plan fees, advisory fees, sales loads if applicable).
  • Suggest a meeting to discuss your request and to respond to any concerns they might have.

Again, providing multiple choices (e.g., Employee Fiduciary or Vanguard) can be a good idea to prevent the possibility of coming across as biased in favor of some specific company.

If your request does not get a response, don’t be afraid to follow up.

Get on the Investment Committee

If your employer has an investment committee that makes decisions for the retirement plan, you will want to see if you can attend the next meeting. Or, even better, see if you can take a role on the committee. (This was a very common refrain among readers who were successful at getting changes implemented.)

Get Help

Naturally, the more employees there are requesting a change, the more motivation management will have to make a change. So if you can find other people who are also interested in lower-cost investment options, so much the better.

Tips for Small Business Employees

In the 401(k) industry, more assets means more bargaining power. So if you work for a business that has added many employees over the last several years, it’s possible that your employer would now have access to lower-cost providers who were not available when the plan was initially created. Be sure to mention this to the plan fiduciary.

In many cases, the plans that are very expensive to employees are very inexpensive to the employer. But in the case of a business with few employees, the business owner is likely one of the largest participants in the plan. So he/she may come out ahead with a switch to a plan that is less expensive to plan participants. Be sure to bring this up.

If, like many small businesses, your employer offers a SIMPLE IRA instead of a 401(k), you may not want to bother with lobbying for changes, because you can roll the money out of the SIMPLE and into a regular traditional IRA at a brokerage firm of your choice (without having to leave your employer) as long as you have had the SIMPLE IRA account for at least two years.

Maintaining Perspective

Throughout this process, it’s ideal to avoid criticizing your plan fiduciary’s decisions — and when you do have to criticize to do so in as tactful a way as possible. You don’t want the decision-maker(s) getting defensive, because then it will be impossible to change their mind on the matter. In addition, it’s important to remember that, from the employer’s perspective, a 401(k) is an employee benefit — they don’t have to offer it at all.

A Question for You: Getting Changes in Your 401(k)

After watching last week’s Frontline documentary dealing with 401(k) fees, several readers wrote in to ask what they can actually do about the situation. They know the investment options in their employer-sponsored plans stink, but they don’t know how to go about persuading their employers to make any changes — either adding lower-cost funds or switching plan administrators.

Unfortunately, I don’t have any good input here. I’ve never lobbied an employer of mine to get better fund choices in a 401(k), nor have I seen any research on the topic.

So that’s my question for you: Have you ever tried to get your employer to make changes to your 401(k), 403(b) etc.? If so, what did you try, and what were your results? I’m interested in hearing stories of both successful and unsuccessful efforts — both are useful pieces of information.

I’ll share the results (anonymously of course) on Wednesday.

Thank you!

Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a financial or investment advisor, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2013 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy