How many asset allocation articles have you read in the financial media over your working career? Probably even more than articles promoting the endless benefits of “diversification.”
My good friends at The Sherman Sheet hosted a webinar last week. They shared a slide I had seen many years ago. Previously, I did not pay much attention.
Last week, the same slide hit me like a ton of bricks.
Let me first define some terms. The light blue line on this chart represents the S&P 500 unmanaged market capitalization-weighted index of 500 common stocks. These stocks are chosen, and updated, by Standard & Poor’ each year. These companies are included in this index based on market size, liquidity, and industry group representation.
The dark blue line on this chart represents the Vanguard Total International Index.
Now for the legal language….
You can’t invest directly in an index with your company 401(k) account. Past performance does not guarantee future investment results.
Here is the main point. The pure strategic-allocation investment strategy sold by mutual fund companies fails to disclose the fact that one or more of the recommended asset classes can sometimes spend an exceptionally long time out of favor.
I am talking about many years out of favor. Like, “Why on earth do I even own this mutual fund?” out of favor.
This slide illustrates how this very important index for International equities has been in the investment return dog house over and over again, compared to the S&P 500 index, over the same time period.
Has any investment management professional categorized you as an “Aggressive” investor? How about an online robo-advisor?
If so, you very likely own a meaningful amount of money in an International Equity mutual fund or index fund over the last few years.
I see this problem all the time with the individual company 401(k) retirement plan participants I talk to. Even the target date mutual funds they own in their 401(k)’s have a large percentage invested in an International mutual fund option.
Why then would any sophisticated asset allocation model recommend ownership in an International equity mutual fund at the expense of owning more shares of an S&P 500 index mutual fund?
The annual costs of an S&P 500 index mutual fund are much lower. As you can see from this chart, the annual investment returns are miles apart.
The bottom line is this. Find a reliable access to a ranking of all the mutual funds available on your default company 401(k) retirement plan menu. When you do, two elements will jump off the page.
First, the asset classes that are best-performing will be easily recognized. You can’t get a mutual fund choice right unless you know what mutual fund asset class to own first.
Second, you will be able to identify the best individual mutual funds on your default company 401(k) retirement plan menu. And those mutual funds will be in the best asset classes! Who said investment management technology is hard to understand?
With those two steps, you can easily determine “what to buy” in your company 401(k) retirement plan account.
Ric Lager
Lager & Company, Inc.
