Creating Wealth is an in-depth conversation between Bill Taber, an experienced financial advisor, and his millennial daughter about personal finance, investing, and financial planning.
Bill Taber is President of TABER Asset Management, a Registered Investment Advisor (RIA) and fiduciary firm located in Des Moines, Iowa since 1998. For decades, Bill has provided investment management services to clients, creating wealth, building wealth, growing income, and preserving capital for each and every client. TABER offers personalized asset management, wealth management, retirement planning, financial planning, and services such as 401(k) rollovers.
At the time of this episode’s recording, his daughter, Anastasia, worked in Washington D.C at a global law firm. She has since joined TABER Asset Management as an Associate Advisor and is operating a branch office in Northern Virginia.
Episode 19 - What should you be doing to manage your 401(k)? How does active vs. passive investing apply to your retirement accounts? Bill provides some historical context for the rise of the 401(k) plan and a few important takeaways when it comes to saving for retirement. Anastasia discusses the various employer sponsored 401(k) presentations she's sat through and Bill gives his thoughts on the oft recommended "target date fund."
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Anastasia: Welcome to Creating Wealth, I’m Anastasia.
Bill: Hi, I’m Bill.
Disclaimer: The views expressed today are our own, solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investment strategy. The views are subject to change and are not intended as a forecast or guarantee of future results.
Anastasia: So today we're going to discuss how to manage your 401(k). I asked my Dad some questions about ETFs and mutual funds and he found out he had a lot to discuss about actively managing versus passively managing your 401(k). So we're going to get into some definitions. And then we're also going to discuss what it is that he thinks people should be doing with their 401(k)s, so a very relevant topic to a lot of millennials.
Bill: Yeah, a very important part of people's retirement plans.
Anastasia: Yeah. So first of all, Dad, what should people be doing to manage their 401(s)?
Bill: Well, they need to pay attention to it, they need to look at the statements on a regular basis. When pension plans came out after World War Two, it was the employer’s responsibility to make sure there was enough money in a plan like that to pay their employees a fixed amount per month for the rest of their lives. However, in the mid-80s, those plans really became too expensive for employers and so they started what was referred to as 401(k) plans that basically shifts the responsibility for the money that's in that plan from the employer to the employee. And so it's the employees' responsibility to pay attention to that plan so that it grows as much as possible to provide as much retirement income as possible for them.
Anastasia: So that's where active versus passive investing comes in. I think we have talked about this in a previous episode. But for the purposes of this one, do you want to explain a bit what that difference is?
Bill: Active investing is simply knowing what you're doing, you know, having the time and having the talent to be able to make the best choices. Most 401(k) plans have a wide variety of options within them. Some of them are actively managed mutual funds, and some of them are exchange traded funds or indexes, which are passive.
Anastasia: What is an exchange traded fund and an index fund?
Bill: Well, why don't you provide the definition that you've read? (Laughs)
Anastasia: Okay, I'll answer it. (Laughs) Let's see. ETFs are exchange traded funds, they can be traded on an exchange like a stock, hence the name. They give you a way to buy and sell a basket of assets without having to buy all of the individual securities. They are passively managed, versus a mutual fund, which is actively managed.
Bill: And by passively managed, what they mean is that you're simply buying a basket. There's no consideration given to any of the fundamental things of an individual company about whether they are profitable, or are they doing well in their industry, is the management performing well for the company. It's simply just an index. And the most popular one out there probably is the Standard & Poor's 500. Which, basically, if you buy into that index or exchange traded fund, you're buying a piece of 500 different companies. But rather you're actually buying a piece of the price action, the price volatility, of those stocks in the market from day to day. So there's no decisions made about you know, which company within that 500 should be added or taken out. It's just simply there.
Anastasia: Okay. Another thing that's mentioned is ETFs also have lower fees than mutual funds. But that's because they just dump the securities in the basket and never look at it again.
Bill: Yeah, it's lower cost simply because it's just a matter of the fund company getting that started. Versus, active management has to do with people taking the time to research all the things about the companies on an ongoing basis, as I mentioned earlier.
Bill: It's more time intensive, and it adds to the cost.
Anastasia: Yeah, there's human labor involved.
Anastasia: Okay, so I've had a few different jobs and every time I get a 401(k), the company brings in a representative from the company to give us a presentation on things that we should know about our 401(k)s. And pretty much every time they've told us to just put your money in a target date fund. And I think when I asked one of the guys, for some reason, they're always guys (laughs), "If I want to pick outside of that, do you recommend that?" And he said, "Well, you know, some people do more research on their own and they'll pick different funds, but we always recommend putting your money into a target date fund."
Anastasia: So Dad, what are your thoughts on that? Because I'm sure that's something that our listeners have heard if they've sat through any of those presentations.
Bill: Yeah, well, a target date fund is a formula. Say for example, there's a target date fund that has a date of 2065 on it, which is about 40 years out. By formula, that index is going to have more stocks in it, which assumes that the longer the period of time that before you need the money, the more growth that you want to have. And it also assumes the more price volatility from stocks that you're willing to put up with. By contrast, there might be other target date funds every five years down to 2025, which is only a few years out. And that target date fund has fewer stocks, or stock indexes in it and more bonds or fixed income, which reduces the returns, but provides more price stability in that investment selection as you near retirement. And so like, for example, that target date of 2025 might have 50% stocks and 50% bonds or fixed income, and the target date fund for 2065 might be 100% stock. Does that make sense?
Anastasia: Yeah, that does make sense. What I've noticed is that I don't think they've ever been 100% stocks.
Bill: Maybe 85%, or 90%, something like that.
Bill: For the longest maturity.
Anastasia: Yeah that's essentially what has happened when I get these presentations, they ask me, "When do you plan to retire? And then just whatever is the closest year you think you're going to retire, just put your money into that target date fund." So if I think I'm retiring in 2060, put your money into that target date fund of 2060.
Bill: Well, that's good in theory, but I've actually found it to be poor in practice.
Anastasia: Hmm, why is that?
Bill: The point of 401(k) plans, overall, they have a fairly high level of costs or fees involved in them. So if you're choosing options within those funds that underperform, such as what I'm suggesting that target funds rarely outperform a really good active manager, vis a vee, like what Warren Buffet's been able to achieve, then picking those passive funds may retard your 401(k)'s ability to accumulate the wealth that you need to live off your investment income rather than having to work forever.
Anastasia: Yeah I can see that.
Bill: It's interesting to hear that you have three different employers with three different meetings, and the employers are called plan sponsors, they have the fiduciary responsibility of letting their employees know what is out there for them to do and to provide them with a reasonable amount of education. But it's interesting to hear that when you got into those meetings, each of those representatives said, "Just buy a target date fund." Because I suspect that they are there to answer any questions that people have and they don't get paid any more for assisting people in learning which actively managed funds to use that might be better than the passive index ones, so that if they get people, a lot of people, to put money in the passive indexes and just leave it there, then it's just kind of a "set it and forget it" type situation, and they don't have to do as much work (laughs).
Anastasia: Yeah, I mean, I think there may have been one, maybe they mentioned, whatever your financial advisor wants you to do if you have one. But I think their assumption is that most people don't care about what they're picking. And people don't really want to go much farther than that. And they would rather have this simple option of putting in a target date fund never having to think about it. And maybe that uncommon instance, that it performs better than an actively managed fund. But yeah, I think from their perspective, I think you're right, they don't want to have to do extra work. Or maybe it is also that they don't want to have to provide any advice. But I think it's interesting that they don't ever, in these presentations that I've been in, they haven't seemed to highlight the difference between a target date fund and picking other funds that are offered in the plan.
Bill: When these funds first got started, actively managed funds were the predominant type of investment that people could put their money into.
Anastasia: Oh, really?
Bill: It did require a certain amount of time and education on the part of the employee to know which ones to go into. And so it was after a period of time that the employees went back to their employer and said, "Just make this simpler for us." (Laughs) And so they did. And so now it sounds like some of these companies are basically telling their people, "Just make it simple."
Anastasia: Yup, that's exactly what's happening.
Bill: They're not taking the time to help those that want to get the most out of this that they can. I mean, these plans are not inexpensive. There's a certain level of fees to them. And if you're involved in funds that don't do as well as others, then that kind of works against you.
Anastasia: What do you mean?
Bill: Well, the cost of being in a 401(k) fund, if you add up all the internal fees could easily be 2-3% per year. And if you're choosing a target date fund that has an average return of 4% over a period of time, then net return you're only getting 1-2%. But if you're in some of these active funds that have done better than that, say you know 6% or maybe 8%, then it helps you get a net return to overcome those fees.
Anastasia: Are the fees really that high?
Bill: Yeah, if you look through a prospectus, you'll see it helps pay for that guy that showed up to tell you to put it in a passive target date fund. He was there because he was paid by the plan. (Laughs)
Anastasia: He was not there out of the goodness of his heart?
Bill: Yeah, what I can tell you is that I was an employee of an investment subsidiary of a major US insurance company that offers 401(k) plans to businesses throughout the US. And once I left the company, I was able to roll or transfer that plan into my own self directed IRA, which allowed me to buy individual securities and seek higher returns.
Anastasia: Because you didn't have to pay those fees.
Bill: I didn't have to pay those fees. But I also had much, much more flexibility and opportunity to do active investing, as opposed to just buying some index.
Anastasia: Okay. Yeah, I'm really curious now to see where I can find the fees that I'm being charged. (Laughs)
Bill: Usually the prospectus is 170 pages, and it's somewhere around 78 or 124...
Anastasia: Haha, they bury it! They're like, "Yeah, you don't need to know this info. It's not important." Who in their right mind is going to read a prospectus (laughs) 170 pages of it, just to find out how much they're being charged?
Bill: Yeah, some of the better plans will say up front on a simple sheet, what the investment management fees might be for some of these options. But when it gets into the thing about well, "How much did it cost the employer to set this up? And how much did they pay a company that sends these people out to do the education meetings to do what they do?" Then that's a little harder to determine.
Anastasia: Hmm, okay.
Bill: But one of the biggest issues that I have with target date funds is that it's based on a formula and formulas will work for a while, but what I've experienced in my investment career is that markets are far too dynamic for a formula to work for very long at all. So if you're invested in a target date fund that says, "If you're a long way from retirement it should mostly be stock, and if you're close to retirement, it should be a whole lot more bonds." That doesn't make any sense to me. I mean, particularly in today's environment, when fixed income investments are yielding close to zero, because of the Federal Reserve attempting to keep our economy going during this pandemic. And people that put money, a lot of money in fixed income or bonds actually might wind up with a negative return over the next few years, because--
Anastasia: The interest rates are so low--
Bill: Rates are so low, and the possibility of rates going up in the next couple years with rising inflation, which would actually cause people that own bonds or fixed income to lose money--
Anastasia: Because the inflation would outpace their returns?
Bill: Yes. And if you buy a bond that pays 1%, and rates go up, and somebody a couple years from now can now buy a bond that pays 3%, and you're sitting there with a bond that pays 1% with a maturity of 10 years, how are you going to get rid of that? (Laughs) Well, you can sell it to that person that's getting 3% on the new issue. But you'd wind up having to say, sell it for--
Anastasia: A discount?
Bill: 80 cents on the dollar.
Bill: Yeah. Not a good thing.
Anastasia: No, not a good thing. Yeah, it's crazy to me that they would include any type of bond in a target date fund for a millennial that's retiring in like 40 years.
Bill: Yeah. Well, for a 40 year fund, basically, there wouldn't be a whole lot of fixed income or bonds in there.
Anastasia: Yeah. Well, another thing about formulas is that it's very general. It's not specific to that individual.
Bill: Yeah, and everyone's circumstances are different. Everyone has different risk tolerances, different needs for cash at different periods in their lives. And so formulas just generally don't work.
Anastasia: At least in terms of investing actively or passively.
Bill: Yeah, I mean, the one that's the most predominant that I've continued to hear ad infinitum is, if you are 50 years old, you should have 50% of stock and 50% in fixed income. If you're 70 years old, you should have 70% in fixed income and 30% in stock. If you're 90 years old, you should have 90% of your money in fixed income and 10% of the stock.
Anastasia: That just feels too clean.
Bill: Yeah, it's very, very simple. People can grasp that concept. But it doesn't take into consideration, particularly inflation, that eats away at people's purchasing power. And so why wouldn't a person that's even retired, want to not have a fairly decent proportion of their assets allocated towards things that grow? Because that growth is needed to offset the cost of inflation.
Bill: We have several clients that are in their 90s that their portfolio is totally stock.
Anastasia: And they're okay with that.
Bill: Yeah, they're fine with it. They have other sources of income that they use for their living expenses, and they're simply looking to grow those assets for potentially long term care insurance needs or maybe just, you know, providing a larger legacy to their family.
Anastasia: So stocks aren't all that scary.
Bill: Yeah, they tend to grow over time. They grow better than fixed income does obviously because the average yield on fixed income today is around 1%.
Anastasia: Well, the whole idea with fixed income is just security?
Bill: Well, yeah, if you pick a good bond that's going to pay back the money that you have loaned to them, yes. It's main value in today's market is that it's not as volatile price wise as stocks are. And so if that up and down thing that you see in your statements from month to month gives you pause, then having more bonds is going to make that less volatile. But it's also going to reduce the total return that you get, that you would get from having more of your money in stock.
Anastasia: Yeah, it goes back to what we've discussed in a previous investing episode about risk tolerance, and how that affects what you would put in your portfolio.
Anastasia: So imagine you're someone who has a 401(k) plan with Fidelity, or one America or one of these large companies that employers use to offer 401(k) plans to their employees. You're someone who put your money into a target date fund, because that's what the representative recommended. But you like the idea of putting your money into actively managed funds. What do you recommend that this person do?
Bill: While there's a couple of things that if they want to do it on their own, they're going to need to look at the review sheets. There are services out there like Morningstar, Y-Charts and other companies that will analyze the active managers. They'll tell you how well they do in up markets, what they do or don't do well in down markets. They'll tell you how much is invested in different types of assets, like stocks or bonds. They might actually have a rating, a one star to five star rating, on how they do. And they'll indicate what their past performance numbers have been and they'll indicate what the costs are involved in it. You can look at those things and it's important to understand that what has worked really well the last couple years may not work real well for the next couple of years. And so you have to try to pick some active manager that's had a really good, consistent long term track record, but maybe hasn't performed at the absolute peak the last few years, but will be above average for the long haul. So that involves some education and some time. Now, going back to the time and the talent, if you're not interested in this at all, or if you don't have the time to do it, then as that education person with the fund company, the 401(k) fund company said, you can work with an advisor. And this is something that we do for our clients: if they have 401(k) plans, we know what their investment objectives are and what their risk tolerances are. And so they simply provide us with that information as to what's in their plan. And we'll take a look and say over the next year, or two or three, we think these 401K fund options will do better than others. And we think that that will happen based on the fact that long term they've done really well. But in the near term, they may not haven't done as well.
Bill: Does that make sense?
Anastasia: Yeah. Is that something that financial advisors can do? Or is there a particular type of advisor that people should look for?
Bill: Well, theoretically, any advisor should do it, but it depends upon, you know, what their emphasis is on within their business. And in particular, TABER Asset Management's emphasis is on getting the best investment returns possible. And so we continually track what 401(k) funds are doing, and what markets are doing and offer advice to clients based on the long term desirability of those funds as to which ones they should go into. And you don't want to check on your 401(k) plan every day or every week to see how it's doing. It's counterproductive. It's kind of like that squirrel that goes out in the backyard and buries a nut--you don't want to go dig it up every day just to see how it's doing.
Anastasia: That's funny because I know people who do that. You know who you are (laughs)
Bill: What you want to do is basically look at it maybe once a year, and our experience has been that if you look at it, usually around October of each year and November of each year, that's the best time to do it. But yeah, it's not something that you can just ignore forever. But once a year seems to be optimal.
Anastasia: It's kind of like watering plants, like very not thirsty plants. (Laughs) Just check in on it, you know, every six months.
Bill: Hmm. I think the actual analogy is, you don't want to dig up the acorn to see how the oak tree is growing. (Laughs)
Anastasia: Yeah, okay. So if people want someone else to do it for them, it kind of goes back to shop around and ask, "Who does this? Who provides this type of advice?" Because I think what I've realized recently is not every financial advisor might offer this service.
Bill: That's true. And it is very important because as we talked about, at least 85% of Americans don't have access to a pension plan any longer. And so what they're going to have to live on in retirement is in large part what they've been able to accumulate in their own retirement plans. I think Social Security at best was intended to only provide 30 or 40% of people's retirement income. So making the 401(k) grow as much as possible is very, very important, because it could wind up being the largest part of your retirement income.
Anastasia: Right. And I think millennials have been kind of in this just hunker down and get through it, pay off the student loan debt and get the house or whatever it is that their financial goal is. And retirement just feels so far away, and we make jokes or comments about, "Oh, we'll just never retire." But eventually, you will want to retire. And planning for it is a really, really good idea.
Bill: Yeah, it's really important. I mean, some of the biggest mistakes I've seen young people make have been that maybe they've worked for two or three or four or more employers within the first 10 years of their career. And every time they've left that employer, they've had maybe $5,000 or $10,000 or something in their retirement plan with them. And instead of rolling that into their own self directed IRA plan, and continuing to let the compounding work for it, they've taken that cash, and they've used it to pay down a student loan or to buy a car or a truck or something. And what that does is that kills that long term compounding effect, and it truly makes a HUGE difference when you go to retire.
Anastasia: Yeah, they have in the presentations I've been to, they all do show that chart. They'll compare the person who started their 401(k) at 25, versus the person who started at 35. And they'll show even if they contributed the same amount. This is how much more the person who started at 25 has just because of the compounding effect, even if they contributed less, they ended up having more in this graph that they often show us.
Bill: Yeah, that graph is very valid. I mean, I have seen six figure or seven figure differences as a result of following that.
Anastasia: Yeah. So unfortunately, it isn't the type of thing that we can put off. (Laughs) Dang it!
Bill: Yeah, you have to kind of keep multiple focuses. (Laughs)
Anastasia: So is there anything else that you want to mention?
Bill: Just throughout this pandemic, it's been a very, very challenging time to be in the advisory business. And sometimes you use your best guess, and then things may happen that way, or they may not. And so what I found interesting was an article from Barron's, which is a weekly financial magazine that talked about what actual investors--both millennial and baby boomers--have been doing during the pandemic. The millennial investors, on average, have been actually actively buying off of the lows in the market in March, when it went down 35% in three weeks, and they have kept up purchasing through the drop in the market that occurred in September. And they have tended to be buying individual securities, or individual equity options like call options. Now, by contrast, older investors, Boomer investors, that are closer to retirement sold stocks going in steadily during the market recovery. In o