A self-directed 401(k) plan enables your employees to select how to invest their plan funds, usually from a family of mutual funds offered by a plan sponsor. If your closely held business has this type of plan, there is a way to avoid losing your retirement funds to Wall Street and improve the economic health of your company’s 401(k).
Modern Machine Shop,
I am on the warpath to change a system that has long-been broken, not delivered its promises and skimmed billions of dollars in unearned fees from your 401(k)s.
Let’s start with the “buy and hold” myth. According to an article called “A 10-Year Scam Called the Stock Market” by Michael Lombardi, the stock market is at the same level today as it was 10 years ago despite interest rates falling since 2001. “Buy and hold” for the long term has been the worst investment advice to follow during the past 10 years. Worse yet, when you factor in inflation, the intrinsic value (the price your must pay for goods and services) of your retirement funds has gone down instead of remaining still.
Now, let’s dig a bit further into mutual funds. Douglas Davenport’s article, “The Market Data Against Fundamentals” says, “An annualized return from 2000 through 2008 for large-cap U.S. stocks show a market return of -0.27 percent.” But, get this: “The average mutual fund return for the same period was -3.25 percent.” This is because more than two thirds of this economic tragedy is directly attributable to “loss due to [mutual] fund expenses.” The article adds that $21 billion in fees have been paid to mutual funds for no performance over the last 10 years.
I find it interesting that during the first decade of this century, the professionals who manage mutual funds could not increase the value of their funds. However, let me take a moment to defend the beleaguered mutual fund managers.
Each mutual fund has predetermined and fixed limitations that put it at an investment disadvantage. They can be strictly limited in their investment choices; must be fully or almost fully invested; and cannot go short, even if the manager thinks his market area is about to enter a bear market.
Nevertheless, mutual funds are an expensive investment choice. Except in a long-term bull market, even the fund managers do not make money. Yet the 401(k) system dictates that each participant makes the investment decisions for his or her own account. How many have investment training and experience?
Maybe a better question is, how did the current system get started? Section 401(k) was added to the Internal Revenue Code in 1974. Starting in the early 1980s through the end of the century—with a few hiccups in between—the market was in a bull market mode. Mutual funds became the new investment darlings. Combining 401(k)s and mutual funds was a great opportunity for Wall Street and plan sponsors. Self-directed 401(k)s were born, and they prospered with the rising market.
However, these systems do not reduce employer liability, even though employees make their own investment decisions. Simply put, the boss can be sued by participants in the company 401(k) plan.
It’s time for a change, but how do we accomplish this? Maybe it’s easier to examine the “how” as goals. First, you want to avoid employer liability, and second, achieve an acceptable rate of return while minimizing risk.
Avoiding liability is easy to do. The owner(s) or trusted employee(s) become trustee(s) of the 401(k) plan. Then, the trustees hire a professional money manager to invest the plan funds and monitor the investment results.
To increase rate of return, I recommend an investment manager who uses a strategy known as “trend following.” This strategy does not attempt to predict market or stock movements. Instead, the strategy capitalizes on the market’s natural movements. A trend-following manager takes advantage of what is actually happening in the market rather than trying to predict the future.
Trend following turns volatility from a foe into a friend. A trend is a strong, sustained move that can last from several days to a number of years. A trend may be rising or falling and is applicable to any specific security or index (such as the S&P) or commodity (such as oil, gold or the Euro).
The basic concept behind the strategy is simple. For example, when the investment is gold, and gold is trending up, the manager is long gold. If it is trending down, the manager is short gold. If gold is flat, the manager stays in cash temporarily. The real beauty of trend following is that you can make money not only when the market goes up, but also when it goes down.
I work with a manager who uses trend following, and his numbers for rate of return are acceptable. In 2008, when the S&P lost 37 percent, the manager’s strategy was up more than 29 percent. The annualized rate of return from December 2006 (when the strategy was first implemented) to March 2011 is 18.5 percent. (Remember, prior results do not necessarily predict future results).
If you want to make a killing in the market, this strategy is not for you. However, if you want to shoot for a conservative, steady and proven return, you’ll embrace this trend-following strategy.
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