Part one of our series on the Middle Class: The Money Class? can be found here.
Who are you? The mutual fund industry has been asking that for decades and the answers still aren’t quite clear. But they are getting closer to understanding that the vast majority (85%) of the owners of mutual funds are households. Careful with that stat though, because in truth, less than half (43%) of the households invest in mutual funds. Which means that although the vast, majority use these funds in their retirement plans (such as 401(k)s and IRAs), the majority of us don’t use those plans at all.
So as we peer into the ownership of mutual funds, we will see the still vast disconnect the public has with their own future. Although the ICI’s FactBook suggests that the median value of these mutual funds is $80,000, this represents, at least according to their research, about the same amount as their current household income.
This middle class (money class) is about 50 years old, three quarters of them are married, less than half are college graduates with about two-thirds of their assets invested in mutual funds. Once they are invested, they tend to do so via IRAs (67% of the time) or through defined contribution plans (78%). The median ownership profile suggest that these investors (with about $150,000 in total financial assets) own 4 mutual funds, three quarters of which are focused on equities.
Its no surprise that these investors are using mutual funds for retirement. With the 401(k) now well over two decades old, the mutual fund’s growth in popularity was forced by participation in these plans. Not surprising, the higher the income in the household, the greater the likelihood you own one or more funds.
What was a surprise was the involvement of advisers in the process. Advisers do add another layer of fees – perhaps the biggest complaint that comes from fund owners even though those fees are half of what they were just a decade ago – but half of these investors tapped them for some sort of advice in the recent financial downturn. In fact, between June of 2008 and May of 2009, the report noted that of those that had advisers, nearly everyone contacted them.
So what about the other half of those investors, the ones without advisers? The FactBook suggests that they instead contacted their mutual fund directly during that period.
Shareholders in these investments have altered their risk, following a relatively predictable pattern of sentiment following markets. If the market was down, the sentiment followed with the opposite happening in good markets. But risk can tell us some interesting things about the investor’s view of the mutual fund itself. If you like funds, you were more likely to take above-average risks.
Although the report doen’t suggest why this group of fund advocates assumes greater risk that those who merely tolerate the tool because it may be all they have, but we can speculate. It may have something to do with their belief that the mutual fund manager knows best, the investment carries an feeling of “mutual ” involvement and if they had done well in the past, perhaps they believe they will also do well in the future.
Retirement seems to be the reason most folks use mutual funds in the first place. Of the 117 million households that do invest in retirement planning, a third of them use mutual fund in both IRAs and defined contribution plans. That number matches the group that do nothing, have no access to a plan at work or invest on their own. The rest had one (29% with employer plans only) or the other (8% in IRAs).
This doesn’t mean that those with IRAs used them. In fact, only 15% made contributions to them in 2008 with far fewer using the catch-up provision. Of course, those that did tended to be older and if they used their employer’s 401(k) plans, their balances were usually much higher the longer they worked.
The most troublesome aspect of this participation is the focus on fees, not only by the employer (who tends to share the cost of their plan with their employees) but the employee, who, with choices that tend to charge lower fees, invested accordingly. This put the focus on fund offerings in these plans on low-cost, low-turnover funds and that meant, lesser risk. The study also suggested that the smaller the firm, the higher the fees. The higher the fees, the smaller the balances.
Much of the popularity of life-cycle funds or target date funds (ICI refers to them as target-risk) is due to the auto-enrollment feature of many of these plans. Designed to boost retirement interest, these plans often enroll their new participants in these types of funds or a generic, low-cost, low-risk index fund. While it may have increased the overall number of people in the plan, the growth of those accounts has slowed.
Based on this information, the average investor could do better, much better. But how do you get the middle class to invest more? Lower fees doesn’t seem to be an adequate selling point. Lower risk only tends to keep balances lower longer and have the net effect of luring investors to make additional or increased contributions.
Plan sponsors are still offering plans with a high expense profile (although it is lower the than fund industry overall) and may penalize their participants during poorly performing markets by withdrawing incentives such as matches or if they retain those matches, lowering other benefits such as health insurance coverage. Those same plans are concerned, if not worried about their fiduciary responsibility perhaps more so than the wealth these plans could generate.
In short, the success of your retirement plan using mutual funds relies on your continued and increased participation. And based on the numbers, we are a long way from calling these efforts a success.
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