When our good friend 'Nan' paid us a visit last Wednesday she was distraught. She had to sit down to relate what happened to her the past month and even joked, "if this keeps up I may have to move in with you guys!". What happened? Evidently, she'd lost $6,000 last month in her three retirement -based mutual funds. This would be bad enough except that she's also lost $1,000 in each of the two previous months, for a total of $8,000 down the tubes. What added insult to injury is that up to the month of the first loss she'd not managed any positive earnings.
What happened? Her first suspicion is that she was a person who'd been tricked by her financial advisor into accepting funds packed with "collective investment trusts" - a new twist on classical mutual funds, which have now been replaced by many companies in their 401(k)s (we will get to the reasons in a minute).
If the term rings a bell it may be that you recall that before 1929, millions of ordinary folk were driven into the infamous 'investment trusts' that caused them to lose everything. These 'investment trusts' were the forerunners of today's funds and then - as now - touted as "the little guy's way to enter the stock market". The problem is there was no regulatory oversight of these investment trusts so that the big players rigged the markets to their advantage (including having insider information) so they could parlay the little guys into ruin.
I immediately disabused Nan of any notion her mutual funds were really hidden collective investment trusts given that the latter's expense ratios are "typically 0.2 to 0.3 percent less" than regular mutuals. Also the collective trusts are common to newer versions of the 401(k) as opposed to her retirement funds. (She's been out of the work world for three years).
However, I did suggest she check up on the soundness of any and all "retirement target date funds" - two of which she held, and which are "designed to provide you with an age-appropriate diversified portfolio that you can carry to and through retirement—making them a one-stop approach to retirement investing" (according to one Prospectus).
Definitely, I suggested she sit down with her advisor and ask him to show her where the major losses of the fund components occurred, in which categories (e.g. energy, finance, emerging markets etc.)
Nan also expressed (briefly) an interest in going our conservative route of foregoing the stock market and equities entirely in favor of buying immediate annuities. However, she admitted - after giving it some thought - she didn't wish to "give up control of large chunks of money" which would be required. (Basically, in return for paying an insurance company one lump sum, e.g. $100,000, you get a non-varying fixed income for life. )
Those who wish to check out what monthly income they can obtain for fixed lump sums can go to:
Back to these collective trusts. According to a WSJ report ('401ks Take a New Tack', Sept. 27-28, p. B7):
"These investments look and act a lot like mutual funds but generally have lower fees and disclose less about their inner workings to 401(k) participants"
The piece goes on to note they currently account for 16 percent of the $15 trillion now in 401(k) retirement and pension plans. (These trusts are exclusively for 401(k)s)
Another difference (ibid.):
"They are sponsored by banks and trust companies and primarily overseen by banking regulators rather than subject to the rules of the Securities and Exchange Commission."
The chief difference is that these collective trusts are "less transparent" - according to Brooks Herman, head of data and research at Brightscope Inc. which tracks plans. (Ibid.)
Also, their cost advantages:
"stem mainly from the fact they are exempt from the Investment Company Act of 1940, which governs mutual funds."
Recall this Act was passed in the wake of the original 'investment trusts" debacle of the 1920s.
The specific difference is that the collective trusts are not required to deliver prospectuses and periodic reports like mutual funds. This means you won't necessarily know what is in them. Nor are they required to make periodic filings with the SEC. (Also, collective trusts don't have ticker symbols and 401(k) participants can't track their performance or compare them with other investments using public websites which publish mutual fund performance data.)
All of these aspects you'd be wise to find out about, especially given the longer the existing Bull Market ages the greater the probability there is for an even bigger correction than the one last month, or even a crash. See the graphic for Bull Market longevity below:
We do hope Nan is able to find out what happened with her retirement funds, but that may require pressing her advisor really hard for answers.
Enjoy the DOW while you can, just bear in mind who is really prospering and who won’t lose even if there’s another stock market crash. (The 'Street' collects commissions and fees from both winners and losers.)