Why All the Excitement Over Bitcoins?

Why All the Excitement Over Bitcoins?

Bitcoins are maybe the most unique and potentially revolutionary financial instrument to come along in a very long time. While to many people they are an esoteric, extremely complex instrument they have only barely heard of and don’t understand, millions of people around the world have opened accounts recently to buy and sell them and the price has skyrocketed in 2017, up 16 times since January.

Coinbase, www.coinbase.com, a large bitcoin exchange that only began in 2012, this week had 13.3 million users according to CNBC, an increase of 300,000 users in the last week alone. That 13.3 million users compares to 10.6 million active brokerage accounts at Charles Schwab, one of the leading U.S. investment firms https://www.cnbc.com/2017/11/27/bitcoin-exchange-coinbase-has-more-users-than-stock-brokerage-schwab.html. This year, the price of a bitcoin is up from just under $1000 in January to just under $17,000, prompting a lot of recent news. The Wall St. Journal and Barron’s have run recent large articles, even front-page articles last week. This might be a little more than a fad.

Private Currencies – Really?

What is a bitcoin? Is it currency? Is it an investment? It is both. Where does it gets its wildly fluctuating value, up 16X since January? Well, that raises the basic question of what a currency is and how its value is set.

In the U.S. any person other than a bank can create a currency. Yes, Virginia, it’s true, the government need not issue a currency, approve it or regulate it, though it can regulate or outlaw it. In fact, according to Wikipedia, there are currently over 4,000 currencies in use in 35 countries. The value of the currency depends on what people would exchange for it. Two people could agree to use Monopoly money as currency between them if they wanted to.

The price would be literally whatever the people who accept it as payment say it is. Does that really mean that I can arbitrarily say your dollar is only worth 50 cents? Yes, it does, but since other people would likely trade more than I would for it, you’ll deal with them instead and my 50 cents offer won’t be accepted. The value will be what you can get, and because there are so many buyers and sellers, the value of a dollar is very closely agreed upon today.


That’s how bitcoin and other electronic or “cryptocurrencies” work. The available supply of bitcoins is set by a promise not to issue any more and the price is what anyone accepting it agrees it is. The more people that want to buy it, the higher the price, and people have been lining up by the millions around the world.

Bitcoin exchanges, of which there are a great number, keep track of transactions, which are all electronic and whatever the last trade was at is the price. Exchanges are set up to facilitate buying and selling because most buyers and sellers do not know each other. That is the idea of a stock exchange too, but those are heavily regulated, much more centralized, pricing is much simpler, and no one is doing any “mining,” a complex process I don’t have space to cover here.

Because buyers can shop many different places and the transactions are actually between individuals, not so much institutions as yet, the price varies, sometimes significantly, especially between countries. However, as volume has exploded, the variations are becoming smaller. There is no official price or index, but some larger exchanges, of which Kraken is the largest, are being quoted. Any that price goes up or down as more or less people demand it. After all, the supply is fixed. You can see a list of larger U.S. exchanges at https://www.bitcoin.com/buy-bitcoin

Buying Bitcoins

You cannot buy bitcoins at Schwab or Merrill Lynch or any bank, only through an exchange like the ones listed here https://www.bestbitcoinexchange.io/. The vast majority of this is done online. While it can be done in person, I would be very careful there, the commissions are 5% or more and these are transactions between individuals, not a store you walk into. Think Craigslist, but with trading currencies you barely understand.

Having said that, there are now bitcoin ATMs. To find one, see https://coinatmradar.com/state/34/bitcoin-atm-north-carolina/

You can even buy the bitcoins in your IRA at https://bitcoinira.com/ although I almost hate to write that because I think this is much too speculative for retirement savings.

Please note that nothing in this article is a solicitation for you to buy or sell bitcoins or any other cryptocurrency or invest in any exchange or related business. I have no financial or other interest in bitcoin exchanges or any company or product related to them and I have not exchanged any bitcoins as of this date (December 13, 2017).

Legal Tender

So, what do you actually have when you exchange dollars for bitcoins?

Well, “on 6 August 2013, Federal Judge Amos Mazzant of the Eastern District of Texas of the Fifth Circuit ruled that bitcoins are “a currency or a form of money” (specifically securities as defined by Federal Securities Laws), and as such were subject to the court’s jurisdiction.[15] In August 2013, the German Finance Ministry characterized Bitcoin as a unit of account,[16][17] usable in multilateral clearing circles and subject to capital gains tax if held less than one year” (Wikipedia https://en.wikipedia.org/wiki/Private_currency accessed 12/13/2017).

I was surprised to learn that you can buy regular products with bitcoins at Microsoft, Expedia, Overstock and you even buy gift certificates to Amazon, Kohl’s, Home Depot at https://www.egifter.com/bitcoin/ and the list is exploding.

Security is Critical

Bitcoins are digital money only. kept it in your digital wallet, either online, on your phone, computer or offline hard drive. They can be hacked or stolen or lost if you forget the password to locate it but there are security measures you can take such as encryption, multi-factor ID and storing it offline on your hard drive. If you buy bitcoins, talk to the exchange about security measures and read up and keep up.

If the idea of purely electronic currency seems ridiculous, remember that you probably spend 99% of your dollars electronically with a debit or credit card or online payment and that your paycheck or other payment may be done via auto-deposit. Your stocks and bonds are bookkeeping entries, not paper certificates and your interest is credited as an entry in your account bookkeeping. Not much in the way of money today is carried in physical form. I rarely carry more than $50, though with an ATM I can turn electronic entries into paper bills.

Futures Contracts on Bitcoins

Bitcoin valuation seems to be a matter of rapidly increasing demand which is driven partly by increasing acceptance of it as payment and by the perceived endorsement of it by financial institutions that have started to look at ways to make money on this. It is very noteworthy that two futures exchanges, the CBE and CBOE are just now starting to trade futures contracts on bitcoins, which is the eyes of some, legitimizes bitcoins and to others gives them the ability to hedge their bitcoin investments by using futures contracts. It also opens the door to products like ETFs that can be bought and sold in traditional investment accounts, although the SEC has not to this point approved any product applications.

Reasons for Demand Growth

Why would anyone give anything for a bitcoin? For several reasons.

  • Because others will, and that is the most basic reason why any currency has value.
  • As a speculative investment. In other words, when they see that its price has skyrocketed, they are buying, hoping it goes up more. After all, not many people knew about it until recently, the supply is fixed, and millions of people are opening accounts and buying it.
  • Mainstream retailers are starting to accept bitcoins as payment
  • Futures are now available on the futures exchanges like CME and CBOE. This helps to legitimize it and also might make it more stable as the capability grows to hedge trading positions.
  • Large financial institutions like Morgan Stanley are starting to invest
  • The amount issued is fixed by a promise never to make any more available than are currently out there. People like that because they’ve seen the consistent decline in value caused by governments issuing more of their currency, making it less valuable. That has been the appeal of gold over the years and really for any physical asset like a particular painting or even real estate. They’re not making any more of it. People call that a store of value.
  • It is decentralized, owned and traded by people all over world and not issued or controlled by any government, though several outlaw its purchase or use for purchases.
  • It is hard for governments to trace transactions. That makes it ideal for money laundering which has triggered regulation to fight that, but many people that are not drug dealers or arms merchants like this feature too. For this reason, some governments have outlawed cryptocurrency trading.
  • People in some countries have trouble with their government limiting available investments or how much currency they transfer outside the country. The anonymity and difficulty of tracing transactions helps get around this. This is why it is so popular in China.
  • The idea that this is the future of monetary transactions using blockchains, the vehicle by which cryptocurrencies are linked, secured and verified, will become a widespread platform for how currencies and trading are handled
  • Excitement around something so revolutionary and yet so basic and the amount of money that some have made


I actually have serious concerns about the security of digital currencies and the ability to just simply lose your money because for example you forgot the password to your digital account on your hard drive.

Can the value of cryptocurrencies like bitcoin also go down? Absolutely. It fluctuates in value continually.

So, Is it the newest version of a speculative investment bubble like the infamous South Sea tulips? Is this 2008 on steroids?

Actually, I think this is potentially much more like the tech bubble in 1999. That’s the last time I saw rocket launch-type price charts like Bitcoin’s. Back then, if you remember, everyone was talking about and making money on tech stocks. People were quitting their jobs to be day traders. The multiple of earnings for which NASDAQ companies sold went from 20X earnings to 190X. That did not end well, as many tech stocks lost 70-80% of their value over the next few years. In fact, I’ve never seen a chart like bitcoin’s that did not have its mirror image on right side, with very steep losses, though I have to admit that I’ve never seem a chart as dramatic as bitcoin in 2017.

When prices go nearly straight up, buyers are buying with little to no understanding or commitment, they are just buying because a lot of money has been made in a short time and they want in on it. If the price rolls over and heads down, they sell for the same reason, it is just going down and they are losing money fast.

That’s the risk now. It is impossible to know how many of those 300,000 new accounts last week were “fast money” as opposed to people who were buying the concept of a digital currency for the reasons I listed above. I have to think it is the majority, maybe the vast majority. Do we really need a digital currency, and if so, will the demand be so strong that the price going from $961.79 to $16,590 today is reasonable? I don’t think so.


Long term, there may be enough gathering critical mass, regulations and hedging using futures that cryptocurrencies have staying power. It is not out of the question that we could actually be watching a revolution in the world’s financing of trade. Bitcoin, or something related, may be the next step in the evolution of currency, the ultimate means of exchange and investment.

There has been talk for a long time of an alternative to the U.S. dollar as the world’s reserve currency. The idea of a basket of currencies has often come up and the main appeal is diversification, the lowering of risk by getting away from the fortunes of any one issuer having a dramatic effect on pricing. A widely accepted cryptocurrency could accomplish that.

At the same time, it could become the ultimate financial threat, an electronic currency so pervasive that if you are not digitally connected, you cannot buy or sell. Those familiar with the biblical prophecy that no one could sell or buy without a certain mark on the hand or forehead might easily see the connection between the necessity to be digitally connected to access their money and authoritarian control of that permission. In fact, it doesn’t take biblical prophecy to see that.

 Wrapping Up

This is the high tech, digital, rapidly evolving Wild, Wild West of money and “investing,” a West that is being settled at an amazing pace, one that could only exist in the time in which we live. Of my clients, I would guess that most, especially older clients, will not buy cryptocurrencies and that the whole idea mystifies and scares them.

Right now, you’re on your own if you want to buy them. Do a lot of research and be careful. Ask lots of questions, read up and keep up. Software and websites are changing at a lightning pace and the nuts and bolts of how things are tracked and valued using blockchains and mining is much more complicated than what I have had space to go into here.

Again, please note that this article is descriptive and educational only. It is not a solicitation to buy or sell bitcoin or any other cryptocurrency and I have no financial interest in any bitcoin exchange or product at this time, nor do I own any cryptocurrencies as of December 13, 2017, although I do not rule out that at some point I might buy bitcoins for myself. At this time, I have no immediate plans to do so.


This entry was posted on Wednesday, December 13th, 2017 at 4:09 pm

Did Your Plan Costs Increase 20-30% in 2016-2017?

Congratulations on a nice growth in retirement plan assets in 2016 and 2017.

Now, how much did your fees go up?

If you have a single provider for your retirement plan and your plan assets are under $25 million, chances are very high that your plan fees went up at exactly the same rate as your plan growth. So, if your plan assets, including salary deferrals, matches and investment growth net of fees went up 20-30% or more during 2016-2017, your fees very likely went up 20-30% or more too. Ouch!

Worse, with a single plan provider, costs most likely went up, not just on the investments, but on record-keeping, custody, fiduciary services and administration too – even without an increase in service.

In a 2% inflation world, doesn’t 20-30% seem, “Just a little outside” of reasonable? Would you expect the recipient of that big increase to bring it to your attention so you could put an end to it? One would hope so, but…probably not.

How about looking into switching to a plan provider where most plan costs are fixed? That way, you can really celebrate when your plan grows. As an Accredited Investment Fiduciary and Professional Plan Consultant with decades of experience, I can show find ways to get your plan costs under control. Dave Hoshour AIF PPC 704-698-1040 Cornerstone Investment Services

This entry was posted on Monday, November 6th, 2017 at 3:03 pm

Is Morningstar Mutual Fund Research Worthwhile?

Recently, the Wall St. Journal, the most wisely read financial newspaper in the U.S. ran a long research article very critical of the Morningstar rating rating system that awards funds 1 to 5 stars. The ratings are very widely followed and are the basis for a great deal of investment into mutual funds, from individuals to professional investment managers to institutional investors.

What the Journal found was that of the funds Morningstar rated 5 stars, only 14% were 5 stars five years later and that there were more of them rated 5 years later as 1 star than 5 stars. They quoted Morningstar as saying that the star rating was never intended to be predictive. But, it would be hard to argue that they are not used that way or intended to be used that way.

So, how should we take that? Is Morningstar worthless? Worse, does it actually increase the chances of faring poorly?

First, I have noticed myself the tendency for funds that carry high performance through the current year to stumble the next year. For that reason, I consider short-term data to be not that useful.

But, the Morningstar database allows advisors like myself to get a great deal of data about a fund. It tells us how volatile it is likely to be, how consistent it has been in the past, what style the fund has, how it tends to correlate with different factors, whether there is a new manager, if the manager is significantly invested in his own fund, the stewardship of the fund family and a number of more esoteric bits of information that I find useful.

Here’s a chart in that WSJ article that I think is very instructive.

Yes, funds from every rating tend to on average converge in future performance, with most of the convergence happening by the 3rd year. But, just as importantly, the average rank of each star rank group stays the same. The 5-star group remains the top group and the 1-star group stays the lowest group on average. Amazingly, the same is true for all five groups.

Second, the 1 through 3-star group tends to keep dropping in relative performance but the 4-star group not so much and the 5-star group tends to keep its relative outperformance.

Those who have seen how performance converges to the mean are not surprised by all this. But, the study actually vindicates the ranking system. The only thing it really says is that the confidence in how every fund will perform in the future has been too high for many investors.

This is why I so value consistency of returns, both in actual results and in style. The group of funds that stays consistently better than its peers is not a large group, hence the strong move toward indexing, especially with ETFs.

I have my own ideas on how best to predict that. I would like to see more studies that look at factors like team management of funds vs star managers and the effect of lower expenses on predictability. The frequency with which a fund has stayed in the top two half for fees and performance should be another positive factor. The effect of being bought by another firm or having a manager change, especially in a star manager system, should be generally negative if past performance had been very good.

Bottom line – the Morningstar rating system is still relevant, though not as predictive as people not paying close enough attention might have believed. Morningstar data has also greatly improved transparency and lowered fees. Future study would be very helpful on determining what other factors help predict good future performance. And, since the star groups as wholes keep their relative rankings, you are usually better off with a 4 or 5-star fund than the others.

This entry was posted on Tuesday, October 31st, 2017 at 2:48 pm

Plan Fees Make a Huge Difference in Your Retirement

So many smaller 401ks (under $10 million in assets) don’t pay enough attention to 401(k) fees. But having total fees that are 1% higher can make a huge difference in your retirement funds.
For example, if you currently have $50,000 in your 401(k), earn $50,000 a year and put in 6% of pay that your company matches, in 30 years you will have $2,189,082 if you compound at 10%. But if your plan expenses are 1% higher than they should be, you will have $1,769,436 instead. Your company not being diligent enough about fees cost you $419,646! And, you are only one participant.
The Dept. of Labor has said they want plan sponsors to review and benchmark their fees on a regular basis. Many don’t do it, especially smaller plans.
One way to check your fees is to look at the annual fee disclosure they are required to give every participant once a year, sometimes called a 404a(5). Send it to a 401(k) specialist like me and have them look it over.
Another way is to go to Brightscope.com, an independent data source on 401(k) plans. Look at their rating of your plan’s costs. If they rate them as High, you really need to take action and call a retirement plan consultant like me. It could make a substantial difference in the size of your retirement investments.
This entry was posted on Thursday, August 3rd, 2017 at 11:24 pm

To Do List for Emergencies and End of Life

The most popular course I ever taught was called Finishing Well. I taught people how to get everything together so that their executor, or perhaps themselves as executor of a parent’s estate, would not find themselves in “executor hell.” The tasks also work well just preparing for emergencies like an accident or heart attack.

Probably no one other than someone that has been through it, knows how much time and work is involved in being the executor of an estate, especially if it is one of the vast majority that did not get things sufficiently organized beforehand. There are so many unclear things and the feeling that you have left something out is always there, especially when you consider that around $60 billion sits in unclaimed accounts in this country. Some time spent in cross-generational conversation and getting things organized is enormously helpful.

If you would like a copy of the to-do list, email me at DaveH@CornerstoneInvestment.com and I’ll send it to you.

This entry was posted on Wednesday, March 8th, 2017 at 12:15 pm

Pres. Trump’s Hold on the Fiduciary Rule

Well, there is a whirlwind in the oval office these days, and one of the recent actions was to put the new DOL fiduciary rule on hold as part of a review ordered on the reasonableness of provisions in the enormous Dodd-Frank bill passed in 2009.

The fiduciary rule was only finalized in 2016 and was only indirectly tied to Dodd-Frank. The bill had mandated that the S.E.C. look at conflicts of interest among financial institutions as they related to clients and come with up solutions. When the S.E.C. could not get it done due to internal conflicts, the Dept. of Labor stepped in and issued a fiduciary rule that affects retirement accounts, like different types of IRAs.

I am 100% in favor of the spirit of the rule and if I were king, I would have it take effect in April as scheduled. The fact that insurance companies, brokerage firms and banks fought it with everything they had says all you need to know about the trustworthiness of their business models.

I remember being shocked as a young broker at Merrill Lynch back in the 1980s and discovering that the firm tracked commissions by the hour but did not bother to track client account performance at all. That is precisely why I left the brokerage industry in 1995 to be an independent fee-only advisor working in the sole best interest of clients from day 1.

Having said, the rule’s requirements for documentation are as typical Washington – more difficult than they should be and creating unnecessary paperwork burdens that are difficult and expensive to comply with, especially for smaller firms. If the rule is held up and/or changed in some way, one hopes it will be to correct those issues.

The specter of the new rule has prompted a good deal of change for the better in the industry and much of that will stick one way or the other. One example is Merrill Lynch changing all accounts to fee-based accounts rather than commissions. Across the industry, firms have recently told advisors without experience or a reasonable number of retirement plans to work in partnership with those who do, though that doesn’t necessarily mean that the bigger advisors know what they ought in order to properly advise companies sponsoring retirement plans.

I continue to see much evidence to the contrary and I continue to see nearly everyone but me continue to charge plans a % of assets in plans under $25 million. That is a terrible thing for plan fiduciaries and participants because plan fees grow just as fast the plan does, often 7% to 10% per year, for the same flat level of service. That service provided is sadly low and inept in the vast majority of those smaller plans.

If fees are taken out of plan assets, which they typically are, it is a dereliction of duty for plan sponsors to allow fees to grow 7% to 10% per year for any static level of service. It is almost criminal to pay it for the level of service most small plans receive, which is a trustee meeting or two a year, usually no participant education, rarely a change to under-performing funds and no advice to plan sponsors on how to properly monitor vendors or plan investments and document it.

I just did a presentation to a very small plan, under a million dollars in assets, in which my flat fee was currently about $5,000 less than than their current fees. Since the plan was being charged a % of assets by the other company, the difference in money saved by participants over the next 10 years was projected to be over $50,000 and in 20 years over $200,000. That’s the power of a flat fee. And, the service I will provide is in a whole other league from what they had been getting.

That’s putting the client first. The other firm was more interested in an additional $200,000 in compensation from one small plan. That’s the problem, and unfortunately, the new fiduciary rule does not even address it. Still, it is time financial firms were required to act in the best interest of clients. We can then work on little issues like excessive compensation and poor service.

This entry was posted on Friday, February 10th, 2017 at 9:41 am

Investing Strategy in Light of Trump’s Election

It’s been two weeks since the election and it is pretty clear what the stock and markets think will happen under President-elect Trump – faster economic growth from spending on infrastructure and significant cuts in the corporate income tax rate, as well as making it more attractive for companies to bring home the $2 trillion in cash they have parked overseas.

The bond market is also pricing in the broadly hinted at December increase in rates by the Fed, a growing indication that inflation is starting to increase slightly and that inflation will be given a significant boost if President-Elect Trump follows through on promises to raise tariffs significantly on some goods and to renegotiate the NAFTA and TPP trade accords. We can only hope that what he does is less than he promised on foreign trade, as it would be both inflationary and harm U.S. manufacturing growth as countries retaliate by raising tariffs and shop elsewhere for foreign-manufactured goods.

Of the bond market sectors, long treasury bonds, mortgages and municipal bonds have sold off the most, and it has been a very sharp move for a two-week period. High yield bonds have held up well, as they benefit from better economic growth. How much higher rates go largely depends on the changing market forecast for what Trump actually gets done.

The stock market moved up suddenly with the election results, up 4% the first week and 1% last week and is starting off the new week well. Thanksgiving week tends to be stock-market friendly.

One stock sector that jumped a great deal was financials. Bank of America jumped roughly 20% in a few days. That was is based on the hope that some of the enormous Dodd-Frank bill and attendant regulations will be negated and that higher rates will lead to higher spreads (profits) on lending. Near-zero rates have been killers for bank profits and the cost of complying with Dodd-Frank has been huge.

Out-of-favor, deeply cyclical companies like Caterpillar also had a great last two weeks, mainly on improved forecasts for world economic growth. Rolling back many Obama-era regulations as promised (a stroke of the Trump pen will wipe away a stroke of the Obama pen) would help businesses of all kinds. However, raising tariffs could really hurt some of these. Value-oriented funds, which often look for out-of-favor companies have done best, especially those investing in midsize and smaller companies.

So, the question is, will these trends persist? You will see what institutional investors think simply by watching the markets, both stock and bond.

The bond market is hard for most people to follow because there are so many sectors. The simplest broad proxies for most investors are large, broadly invested funds like PIMCO Total Return (PTTRX) and Metropolitan West Total Return (MWTRX). A falling share price normally means rising interest rates, or at least an increasingly confident forecast for that. Be aware that some funds may have a big one-day drop in price if they make a year-end tax distribution before year-end.

My personal opinion is that President-Elect Trump will get the cut in corporate taxes and reducing the penalty on bringing overseas cash home. Infrastructure spending will also likely get done. While that will take time to hash out, the Democrats are receptive to increased spending on infrastructure, although more conservative Republicans will push back based on the effect on the nation’s debt.

Tariffs are less predictable. We don’t know how much is pre-negotiation bluster, whether tariffs will actually rise, exactly which ones, how and when. It does appear that China is already seizing the opportunity generated by all the talk from Trump by moving on trade deals with Asian countries. China has considerable advantages in speed from a more authoritarian decision-making process and receptivity from not attaching required reforms as strings like the U.S. does.

The fly in the ointment is Trump’s insistence on spending so much early political capital on immigration issues. The more he concentrates on those, the less likely other things get done and the more likely that they get delayed. The next 3-4 months should continue to be very interesting.

This entry was posted on Monday, November 21st, 2016 at 12:57 pm

Jack Bogle, Vanguard Founder Agrees – Lower Stock Market Returns Ahead

For a while now, I’ve been using lower forecasts for stock and bond market returns over the next 10 years than the long-term historical averages. I think financial planners, advisors and brokers do their clients a disservice by using the Ibbottson average returns since 1929 when stocks are currently valued well above average, profits peaked a couple years ago and have been lower for the past six quarters in a row and the tailwinds that drove the increase in stock and bond prices since 1982 have one by one largely evaporated or become less of a factor.

I think 5%-7% on stocks is a more realistic assumption over the next 10 years and 2%-4% on bonds. That’s one reason you have heard me talk to clients more about alternatives, especially real estate. If you run a 401(k) it should have you considering some alternatives, though liquid alternative funds on the whole have been disappointing in their performance.

It should also make a difference in what you assume you’ll have for retirement and should prompt you to prudently consider upping your 401(k) and other retirement contributions.

So, when I read Morningstar’s Christine Benz interview Jack Bogle, the founder of Vanguard Group, I was interested to see that he agrees with me and is actually even a little more pessimistic. I have excerpted some comments from that interview below. You can read or watch the entire interview at http://news.morningstar.com/Cover/videoCenter.aspx?id=772785


Christine Benz: Hi, I’m Christine Benz for Morningstar.com. I recently had the opportunity to sit down with Vanguard founder Jack Bogle. We discussed his return forecasts for the major asset classes. Jack, thank you so much for being here.

Jack Bogle: Always good to be here, an annual occasion, Christine.

Benz: It’s an annual privilege for me. Let’s talk about your return expectations for stocks and bonds starting with equities. I think you have a really intuitive formula for forecasting equity market returns over the next decade. Let’s talk about how you get there and where you arrive.

Bogle: Sure. It’s very simple, easy to explain. Everybody knows this, but I don’t think anybody else has ever put it down in the way I have. I’ve been using it for 25 years and it’s worked beautifully for the full period. Every once in a while a decade is off by a good bit and then it’s made up in the next decade. But it places stock returns into two categories: investment return, that’s what you’re earning on the stock. That’s your dividend yield when you buy in–a crucial number–and the earnings growth that subsequently follows. And the other is speculative return, which is change in valuation of stocks generally, easily measured by the change in the price/earnings multiple. And for example, which happened in the ’80s and again in the ’90s, the price/earnings multiples roughly doubled twice from 10 to 20, and that doubling is a 7% per year increase in valuation, and it did the same thing the ’90s, that’s a 7%.

Benz: Sent us into bubble territory at that point.

Bogle: Yeah, it got us into bubble territory. So in those two decades the markets had returns of about 17% a year. But if you had even the most general idea that having gone from 10 to 20 to 40 times earnings, the next decade would have to go to 80 times earnings to continue those returns, you’d realize there was just a lot of air. That’s what valuations can get to in bubbles. So, putting all that together, we’re looking ahead–we’ll deal with stocks here first–we’re looking ahead to some challenges compared to what we’ve had in the past. So, today the dividend yield is 2%, the previous 50-year average or so is like 3.5% dividend yield, and that’s a dead-weight loss of 1.5% in return. You can make it up in other places, but you can’t make it up there.

Benz: Relative to past history.

Bogle: And the growth in earnings over the past 50 years has been about 6.5%. I don’t think it’s going to be that high. So I use 5% for earnings growth and that gives me roughly a 7% investment return on stocks. Those are pretty anchored, because we know the dividend yield, and earnings growth is such that you know we could have a 2% earnings growth and we could have a 10%, but we are highly unlikely to have zero and we’re highly unlikely have 20%. So there is a sort of centrality to earnings growth. So the problem is in the valuations. And today the stock market is selling at about 23 times earnings and the long-term norm is 17 times earnings, a little bit below that actually. And that would cost you 3% if the market ended this decade–I don’t do this for anything but decades; it doesn’t work at all year-by-year, but that would mean you’d lose 3% of that return.

This entry was posted on Monday, October 3rd, 2016 at 9:02 am

High Fees on Target Date Funds

Target date funds are wildly popular in 401(k) plans and are found in almost 80% of plans today. The little-known secret? They can be among the most expensive funds among the investment options. According to Morningstar, quoted in today’s Wall St. Journal article on target date funds, the average operating expense ratio (OER) of the 2,200 target date funds in existence is 0.903%.

Now, most sophisticated plan investment committees want expenses on funds to average below 0.65% if that includes actively managed funds and much less if the plan lineup is heavy on index funds. Yet target date funds on average are almost 50% higher than that.

Even worse, some fund families like American Funds, a very popular provider of 401(k) plans, have some target date funds with a higher expense ratio than the individual funds that make it up! Say what? The difference is pure gravy, more money in the pocket of fund companies and less money for plan participants, especially since target date funds are likely to be the most popular choices of plan participants.

I can build a custom target date fund from index funds and come in at 0.25% or less, depending on the mix.

You may not think saving 0.65%/year on expenses using custom target date funds amounts to much. Well, over 30 years, for a person starting with a $10,000 balance and contributing $5,000/year including the employer match, the difference is nearly $80,000 more at retirement (assumes 7.65% vs. 7.00% return). If that’s the average experience, multiply that by all the people participating in the plan and you are soon talking about millions of additional dollars for your workforce at retirement. That’s the tremendous value of lower fund expenses translated into better performance.

Don’t even get me started on the fact that many plan participants are pretty far off on what they think the allocations are in the target date funds near the target date. When they think they know what they have and are wrong, that’s a potential disaster in another big market downturn.

Consider having me replace your target date funds with custom target date funds using the best funds of each category rather than settling for off-the-shelf target date funds with high expenses. It can make a tremendous difference in how well your employees retire, including you.

Dave Hoshour AIF, MBA, MA
Cornerstone Investment Services
A Fee-Only Investment Advisor Specializing
in Company Retirement Plans
10800 Sikes Place Suite 300
Charlotte, NC 28277
704-698-1040 Phone

Note: This is part of my series on the biggest problems facing 401(k) plans today.


This entry was posted on Monday, October 3rd, 2016 at 8:51 am

High Fees in 401(k)s – Avoiding a Lawsuit

I recently covered what I thought was the biggest problem in 401(k)s today – advisors who don’t specialize in qualified retirement plans. This is the first of several parts addressing other problems in 401(k) plans.

High fees are a risk to both employer and employees – employees because they reduce the growth of their investments and harm their retirement readiness, assuming fees are deducted from participant accounts, which is the norm.

High fees are a risk to the employer because they invite lawsuits and Dept. of Labor (DOL) civil actions. In both cases, the company will have to pay tens of thousands in attorney fees. If found liable, which is usually the case, it will have to pay back 5 years of what was deemed to be the excess fees, plus interest, and if it is the DOL, probably excise taxes as well. There is also the tax on employee morale as they see management forced to pay back money to the retirement plan from mismanagement or _____ you fill in the blank with what employees are likely to think. Hint: it’s not good.

That would never happen in your plan, right? First, let’s see if you have a good handle on what your fees actually are. Big problem if you don’t think you’re paying any fees. You are. Always.

Have you had a consultant like me look to find both disclosed and hidden fees? By “consultant,” I don’t mean the hordes of junior smile-and-dial “advisors” that harass your HR Dept. with endless calls. I mean an experienced retirement plan specialist.

Do you have a copy of your required annual fee disclosure document (408(b)(2) from your plan provider(s)? Have you compared it to the ones from the last two years? If you do, and your plan is under $25 million in assets, your are probably in the 90% whose fees went up 5% – 10% each year. That’s because 90% of plans are charged an asset-based fee, and as the plan grows with investment growth, contributions and matches, the fee grows just as fast – exactly as fast. A dollar to a doughnut says you don’t let your other expenses grow at that rate in these low inflation times. Plus, it’s only partly your money. Fees typically come out of participant accounts based on what percentage of plan assets their account makes up. So, if you are a CEO, CFO or HR director and you have 10% of plan assets, 10% of the plan fees come out of your account and 90% from your coworkers.

The DOL says plan fees must be reasonable in light of services performed. How can service stay the same and fees grow 5%-10%/year and still be reasonable? The only way is if the service you are getting is at such a high level that you were underpaying before. If you have typical 401(k) service, which amounts to a meeting or two each year and not much else, and you are paying, say 0.5% in costs not related to the fund choices, you are paying $5,000/year per million in plan size. For what?

Do you know exactly what you’re paying? Not if you don’t know all the fees and whether the fund expenses are as low as possible. Many times I’ve seen fund options that are not in the lowest cost share class. WalMart paid many millions because their funds weren’t and quite a few other household names have too.

Are your fund expenses as low as they should be? Probably not. But you won’t know for sure unless I look at it carefully with you.

This is something you really need to be on top of. It doesn’t cost anything for me to look at your plan costs. You owe it to your employees and to protect yourself. The average award in a DOL civil action last year was well over $200,000, not counting attorney fees and the hit to employee morale. Protect yourself and your retirement as well as your employees’.

This entry was posted on Wednesday, August 17th, 2016 at 11:10 am