March 24, 2023

Strategies: Tremors From the Fed’s Grand Experiment

Using traditional methods, as well as some that have never been tried on so large a scale, the Fed managed to nudge down a broad range of interest rates to extraordinarily low levels for a very long time. But earlier this month, Mr. Bernanke indicated that the time for winding down the grand experiment might be growing closer.

That has vexed the markets, and no wonder: the Fed’s adjustments have been affecting the wealth and the livelihood of millions of people.

Bond yields had begun rising at least partly in anticipation of Fed action, but they soared after Mr. Bernanke explained that if economic conditions kept improving, the central bank might begin to pare down its voracious bond-buying and eventually start to raise short-term rates. His words appeared to spill over into other asset classes: the stock market and gold prices fell sharply. Volatility returned to what had been quiet markets.

Last week, after several Fed officials said the markets had overreacted, some of the damage was undone, but not nearly all of it. “The reaction in the markets has been violent,” said Steven C. Huber, a portfolio manager at T. Rowe Price. “It’s caused a lot of people real pain.”

That interest rates have started to rise isn’t in itself surprising, he continued. “Many of us have been saying that would happen for a long time,” he said. “But the speed of the recent rise — that was startling, and the volatility has been rough. And it’s not clear how all of this will play out in the markets. In the short term, it’s meant real losses for many, many people.”

Bond mutual funds, which usually can be counted on for modest if unspectacular gains, have been dipping into negative territory for the year. Some investors have been selling their stakes. The probability that many fund investors will endure full-year losses “is probably as high as it’s been in a very long time,” said Francis M. Kinniry Jr., a principal in Vanguard’s Investment Strategy Group.

Through Thursday, the Vanguard Total Bond Market Index fund, which tracks the performance of the Barclays Aggregate Bond index, had a total return of minus 2.6 percent for the year, according to Morningstar. The T. Rowe Price Strategic Income fund, which Mr. Huber manages, was down 1.7 percent, and the Pimco Total Return fund was off 3 percent.

The markets have generally been reacting like addicts facing a possible cut-off of their favorite drug, said Michael Hartnett, chief global equity strategist at Bank of America Merrill Lynch Global Research. “The opiate of investors has been central bank liquidity,” he wrote in a note to clients last week, adding, “We believe liquidity withdrawal will not be painless and will create higher volatility.”

And in an e-mail, Mohamed A. El-Erian, the chief executive of Pimco, said that while there might be some pockets of value in the Treasury market, “investors should also note that markets remain vulnerable to technical overshoots and, thus, quite a bit of volatility.”

None of this looks very reassuring right now, yet in the long run, rising bond yields and an end to the Fed’s unconventional policies could be very good news. After all, yields have been so low mainly because the economy has been weak.

A continued climb in rates — either because of action by the Fed and other central banks or simply because of the markets’ internal dynamics — would presumably reflect market participants’ belief that the economy was strong enough to withstand higher rates. That could imply more jobs, rising productivity and, depending on how the larger economic pie is sliced, maybe even higher real incomes for working people.

What’s more, for several years, low rates have been extremely painful for people living on fixed incomes, making it harder for them to save enough for retirement, and increasing the risk of using up their nest eggs. I’ve written about that quandary in recent columns.

Eventually, higher rates could be a balm for many people. As James W. Paulsen, chief investment strategist at Wells Capital Management, put it: “We’ve got to remember that returning to some state of ‘normalcy’ is the goal of every economic recovery we’ve ever been through. That’s what’s beginning to take place. Getting from here to there will hurt, sure. But, frankly, the economic data has looked stronger, and the Fed has just been following the data. I think we can look at this as a celebratory milestone rather than as some kind of a scary event.”

Mr. Paulsen says that he expects the stock market to be stuck in a trading range for a while, but that he sees a good chance for the Standard Poor’s 500-stock index, now near 1,600, to close the year well above 1,700.

WHERE will bond rates end up? Virtually everyone agrees that the long-term trend is upward. But it’s not at all clear where rates will be going in the near future.

Mr. El-Erian says he believes that the Fed has been overly optimistic about the economy’s strength. “If the forecasts prove correct, which, unfortunately, we question given current economic realities, the Fed would have a positive reason to exit gradually from its prolonged highly experimental monetary policies, “ he said. “It is also apparent that the Fed is getting more concerned about the ‘costs and risks’ of its policy experimentation.”

Even discussing an eventual revision of its policy has been disruptive, he said. Managing an end to its grand experiment is likely to be even harder.

That’s why any effort to time the market — to truly anticipate the Fed’s moves, and the shifts in interest rates — is inherently dangerous. “Bonds are intended to be a buffer in a balanced portfolio, along with stocks,” Mr. Kinniry said. Holding on to bonds while yields rise and prices fall may be very painful, he said, but it’s still worthwhile. “Even at times like these,” he said, “it’s important to stay the course.”

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Second Quarter

A Mutual Fund Ruling Remains a Head-Scratcher

In the last year, mutual funds have done little to adapt to a Supreme Court decision that defines a fund’s board, not its management company, as the ultimate authority for its operations.

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Your Money: In Search of an App to Monitor Average Bank Balances

Just 45 percent of checking accounts that don’t earn interest are free, according to the latest survey of the largest institutions in each big city. That’s down from 65 percent in 2010 and 76 percent the year before.

Forget your outrage for the moment. On one hand, many of these institutions received federal bailout funds or other assistance. On the other, your representatives and others imposed new overdraft and debit card rules that made checking accounts less profitable. And if you invest in mutual funds, you’re probably one of the shareholders whose implicit pressure is pushing banks to raise fees to maintain profit margins.

Instead, consider the practical implications. The average minimum balance to avoid a monthly checking account fee rose to $585 last year from $249 the year before, according to the Bankrate survey. That’s a whopping 135 percent increase.

Banks do the balance math in several ways, using different minimums and fees and waivers, dangling carrots and wielding sticks. Many of the biggest banks will take figures from each day of the month and average them out.

Here’s the problem with that approach, though. Few if any banks give you a running total of your average balance for that month. Instead, they do the math at the end of the month and you find out then if you qualified for free checking. If you want to know how close you are in the middle of any given month to being assessed an $8 or $10 or $20 fee when the month ends, you need to do the math each day yourself.

The resulting effect is this: Many banks have built free-checking scoreboards for people who want to avoid fees, but they’re not putting the numbers up until the monthlong game is over.

Here’s what would be ideal: An online banking widget on the banks’ Web sites that tells you what your average balance has been that month. This could go in the same place on the page where you see your transactions and current balance. Even better would be a second figure that tells you what you need to average for the rest of the month to avoid a fee. A mobile banking app should provide the same information, too.

One reason that banks haven’t produced something like this yet is because of the constraints of their existing technology, according to Robb Gaynor, co-founder and chief product officer of Malauzai Software, which creates apps for financial institutions.

“Most core software products that banks and credit unions use don’t allow you to look back,” said Mr. Gaynor, who has also worked full time at banks. “If we ask a bank, give us a balance from four days ago, a lot of their systems can’t do it.”

So what often happens, he said, is that at the end of the month, some separate system that has been pulling and storing daily balances does the math to compute the average for the month. Then, it assesses monthly fees accordingly.

Why don’t banks just fix this and give us all running tallies? “Most banks are focused on your budget and expenses and looking backwards,” said Jacob Jegher, a senior analyst at Celent who specializes in online banking and has tracked consumers’ interest in third-party sites like Mint that help people manage their finances.

As for a more forward-looking feature that would tell you the balance needed to avoid fees, he said that he had not seen it on any list of financial institutions’ priorities. “Banks have historically tried to make money on fees, and they are desperate for fees,” he said. “Would it be in their best interest to offer it?”

Whatever you may think of banks’ motivations, there are some big institutions that make it easy to avoid fees without daily entries on a home-brewed spreadsheet.

Banks are quick to note that if you use direct deposit, there are in many cases no fees and thus no need for any average balance calculation. That is nice, except that unemployed people and many others don’t collect and store their income that way. Even people on a salary don’t always have access to direct deposit or use it. A survey in 2010 by the electronic payment specialists Nacha found that just 72 percent of full-time and part-time salaried employees received their pay through direct deposit.

All that a Wells Fargo spokeswoman, Richele Messick, would tell us is that a “majority” of checking account customers manage to avoid monthly service fees through direct deposit. The bank, which is still sorting out all the accounts it inherited when it took in Wachovia’s customers, has three ways of calculating the minimum balance: taking 31 daily snapshots and dividing by 31; looking to see if you’ve fallen below the stated minimum on any given day and levying the fee the first time you do each month; and taking just one snapshot at the end of the month.

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Mutual Funds Report: Third Quarter


It’s Small Consolation, but Big-Company Funds Fared Better

Many investors suffered in the last quarter’s sell-off, but losses in large-cap stock funds weren’t as bad as those for riskier, small-cap portfolios.

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Bucks: The Risks You Can Control

Paul Sullivan, in his Wealth Matters column this week, writes that a stock market dive or the debt debate in Washington are events you have no control over. But he says there may be risks in your portfolio that you can control.

And those risks may be ones you don’t usually consider. Do you, for example, know the primary investments in your various mutual funds? You may be surprised to find out that the same companies are playing the dominant roles in all your mutual funds. Or are you working with several financial advisers who do not know what the others are doing?

In a time of market volatility, controlling your own risks may be the way to give you more peace of mind.
Tell us your thoughts below.

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Your Money: On the Hunt For a Better 401(k) Plan

If you work for a large employer, there are often people in human resources with their own ideas about what the investment choices should be and how everyone should share in the costs. And there may be a committee, too, that helps govern things.

Then again, the stakes are often a little lower. Larger employers, thanks to plans that are stuffed with thousands of workers’ life savings, tend to have better investment choices and lower costs. Smaller employers, with little leverage and few or no assets, routinely end up with expensive plans and subpar investment choices.

And then there’s Alan Wenker, the controller for Feed Products North, a small company in Maplewood, Minn., that sells minerals to animal feed mills. Armed with a pretty good understanding of the markets, he still spent an entire decade engaged in stop-and-start efforts to find a better plan for himself and the 25 or so colleagues he has today.

Yes, you read that right. Ten years. It should not take that long, and the marketplace for retirement plans for smaller employers has improved a bit since Mr. Wenker set out on his quest.

Still, anyone at a smaller company who would like to cut costs in half while also improving the investment choices, as he did, would be wise to consider the hurdles he had to clear and the obstacles in his way.

So why are all the details so important? Most people starting their careers now will spend 45 years trying to save enough so they can stop working someday. But if the investment costs and fees inside your 401(k) or similar fund average, say, 1 percent of your assets each year instead of 0.25 percent, the difference can cost over $100,000 by the time those 45 years are up.

And that’s just the fees side. Most actively managed mutual funds, which try to pick investments that will do better than an index of similar securities, often don’t actually outperform that index over long periods of time. Even so, many employers, out of ignorance or blind faith, don’t provide a full menu of index funds in their retirement plans.

Mr. Wenker was only beginning to understand all this in 2000, when he went to work for Feed Products North. He’s 47 years old now, but he’d spent the bulk of his adulthood paying off his student loans and hadn’t paid much attention to the details of the 401(k) plan he had access to at a previous job.

His new company had no plan at all in 2000, so he decided to start one. And he took the path of least resistance, signing up for the 401(k) plan that his company’s payroll processor, ADP, offered. When Feed Products North switched to Paychex a couple of years later, Mr. Wenker moved the plan as well.

All along, however, his opinions about investing were evolving. He’d read Andrew Tobias’s book “The Only Investment Guide You’ll Ever Need” and became a fan of the public radio show now called “Marketplace Money.”

As Mr. Wenker became more aware of the importance of diversification and low costs, he said he realized that his Paychex plan had no index funds and was costing him and his colleagues about 2 percent of their balances each year. (Paul Davidson, director of product management at Paychex, said the company had done some research and discovered that the high costs resulted from Mr. Wenker getting assistance from an outside broker. Mr. Wenker countered that his Paychex representative had urged him to use a broker but that no broker even called him for two years to help with the plan until he urged Paychex to intervene.)

After his realization, Mr. Wenker started shopping around, even picking up the phone when the cold callers rang. “But you always end up at the same place that you already are,” he said. “which is a set of mutual funds and a nice guy with a glossy brochure. But the funds are essentially all the same. They tend to have higher expenses, because they have to pay for the guy in the suit with the glossy brochures.”

As Mr. Wenker got wise to the sales pitches, he often found himself dumbfounded. “I once had a stockbroker nearly yell at me that there was no such thing as a no-load mutual fund,” he said, referring to the front-end and other fees that mutual fund companies sometimes charge and that the broker was insisting were mandatory. “I stared at him in utter disbelief. There are people that believe that humans and dinosaurs walked the earth at the same time. So I can’t convince you to believe something you don’t want to.”

Why such ignorance? Jessica Weiner, who spent years working at insurance companies that pitched plans to small businesses before starting a consulting group called the Value Quotient, has an explanation. “One of the realities you have in the smaller market is that the brokers who get involved with a plan are typically benefits experts,” she said. “I call them incidental brokers.”

As in, 401(k)’s are incidental to them. An afterthought. Where they really make their money is pushing health, life and other insurance, especially policies aimed at senior executives and company owners.

At one point in his search, Mr. Wenker thought to call Vanguard, since it had the broadest selection of index funds and the lowest costs at the time. But Vanguard does not administer 401(k) plans for small companies.

Here is what is supposed to happen today if someone like Mr. Wenker calls Vanguard, according to Gerry Mullane, a principal in the company’s institutional investor group: The representative should refer the caller to a local financial planner or smaller administrator who can help set up a retirement plan that includes Vanguard funds.

Mr. Wenker did not receive a referral when he called several years ago, so he continued his hunt. “Maybe I should have called Vanguard back 25 times until I understood it completely,” he said. “But that’s not all I have to do. A sense of practicality jumps in there as well.”

And therein lies one of the biggest challenges for anyone like him. If you run the finance operation of a small company, you have hundreds of tasks to take care of. Fixing a middling 401(k) plan is something you end up doing on your own time, if you can even make the time when you’re also a father, as Mr. Wenker is.

His breakthrough came in 2008, when he stumbled upon an article about Dimensional Fund Advisors, a mutual fund company that does not attempt to pick stocks but constructs its low-cost portfolios in a way that often ends up outperforming index funds by a bit.

Mr. Wenker called the company for help. Generally, it only lets people invest in its funds through financial advisers. So it put him in touch with Stephen Varley in Minneapolis, and within a year, Mr. Wenker and his colleagues had a new plan with better funds, personalized advice and an overall cost that was more than 50 percent less than what they had been paying before.

Tales like these don’t always have happy endings. The company owner may be a friend or a relative of the person making money by servicing your retirement plan. Or you may have delusional colleagues in charge of the retirement plan who think they can pick market-beating investments with their third arms when they’re not doing their day jobs.

But if you’re like Mr. Wenker, whose boss let him make the call, there are some options available now that can help. Many, in fact, are cheaper than using funds from Dimensional Fund Advisors while also paying for a financial adviser’s time.

I’d start with administrators like Employee Fiduciary, the Online 401(k) and Invest n Retire. They should all be able to provide a plan with low-cost mutual funds or other investments. The ShareBuilder 401(k) plans are also worth a look, as is Charles Schwab’s new initiative to set up plans that include only exchange-traded funds.

If those five don’t work for you, or if you decide, as Mr. Wenker did, that you want an adviser on call, you can phone Vanguard at 1-800-841-7999 and ask for the referral that Mr. Wenker didn’t get several years ago. Dimensional offers referrals, too.

This sort of pursuit will require a bit of baseline knowledge on your part. If you don’t have a head for numbers or lack confidence in your analytical skills, draft someone who does and reel in other allies if you can.

“You have to be a nerd like me to even care about this,” Mr. Wenker said. “For me, it was a labor of love.”

And if it isn’t love for you? Just think about the $100,000 you stand to lose and see if that inspires your inner nerd.

Twitter: @ronlieber

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