Help a Reader: Retirement Investments

Here's a question I recently received from a reader:

I have a 457 plan with my employer, to which I contribute $300 every paycheck.

Last week, HR gave us the opportunity to sit down with a representative from our 457 provider and get a "retirement check-up."  I have an asset allocation that I am pretty happy with across various classes, with money going into 8 funds, with no more than 25% into any individual fund.  The rep said I was doing well on asset allocation.

But the rep also said, "you might think about replacing small-cap fund A with small-cap fund B, and consider replacing bond fund C with bond fund D.  D and B have out-performed their counterparts considerably."  Here are the return stats:

Small -cap Fund A

• YTD return: -11.65%
• 1-year return: -2.12%
• 5-year return: 13.22%
• 10-year return: NA
• Expense ratio: 1.20%
• Inception: 06/25/99

Small -cap Fund B

• YTD return: -4.27%
• 1-year return: 10.44%
• 5-year return: 17.76%
• 10-year return: NA
• Expense ratio: 1.12%
• Inception: 02/14/02

Bond -cap Fund C

• YTD return: -4.99%
• 1-year return: -2.47%
• 5-year return: 2.57%
• 10-year return: 4.11%
• Expense ratio: 0.45%
• Inception: 09/01/94

Bond -cap Fund D

• YTD return: 3.01%
• 1-year return: 9.41%
• 5-year return: 4.23%
• 10-year return: NA
• Expense ratio: 0.90%
• Inception: 03/30/01

So the rep is essentially plugging a momentum strategy.  Switch to the fund with better recent performance, get better returns than my clearly-slower growing (or faster-crashing!) investments. I see some wisdom in that. In the back of my head, however, is the idea that with the larger declines in value of A and C this year, I am buying more shares of each per month through the laws of dollar cost-averaging.  As this is a 457 account, I'm not going to see the money for more than 20 years, so my time horizon is long, long term.

Would you make the switch the representative suggested for one or both funds? Why or why not?  How often do you make movements in your 401k/457/403b accounts with a long time horizon?  Thanks for any input you share!

What are your suggestions for this reader?

Comments

[Mark]

Without knowing the actual holdings within the fund, I would say stick with what you have because of the reasons you mentioned, you can buy more shares now while the prices are lower.

However, if it was possible to see what the top holdings were within the fund, that might influence your decison. If you knew that Fund A invested in established companies while Fund B was more aggressive, etc, that might make you want one over the other. If you're young maybe you want the more aggressive portfolio, etc.

My guess is if the savings plan has 2 types of funds in the same asset class, there have to be differences between them. The only reason I might agree with him is if you look at the longer term gains. Over a 5 year period both of his suggestions have done better...do they still have the same manager? If so it might not be a bad idea to switch if it looks like long-term it will have better returns.

[Jake]

A bond fund with 90 basis point expenses?!?!?!?!?!? Not a bond manager in the world that's worth that much.

[Robert]

Did they have any reason to suggest you switch other than performance? What are the bond funds made of? One could hold nothing but low rated bonds in emerging market countries and the other US government securities. You probably want the one(s) that would correlate the least with the stock market.

[NightBengal]

I would agree with the other readers that it is tough to make this kind of decision without knowing the investment strategy and associated risks of each fund -- especially when you're talking small caps. If the two funds are of different investment classes, say small cap value versus small cap growth, that could make the difference in the five-year-performance variation you're seeing there. Just from what I've seen, value stocks / funds tend to outperform growth stocks / funds, despite what the two terms may imply on the surface.

In general, though, momentum investing has to be done short-term, and even then it's usually destined for failure because chasing returns is hard. If the representative is looking at things other than the pure return difference, then that would give me more confidence. When looking at funds, you also have to consider things like management track record and tenure length, how often the fund switches investments, whether they tend to jump ship on good investments just because they are trying to meet their job's performance goals (happens quite often and is why a lot of funds underperform), etc. It's harder than it looks, sifting through all this.

On another note, though, I'm in total agreement with "Mark" that the representative will need a VERY good reason to justify the increase in expense ratio between C and D, as its annual compounding is equal to a FULL QUARTER of the fund's five-year total return (some nice perspective for you!). If that's an average return and not a total return, that's a LITTLE better, but still, egad.....

[Jake]

Another note on the bond funds, with performance history that is THAT different, they probably aren't even similar funds in terms of risk exposure. I.E. the first one looks like a US investment grade bond fund, and the second one looks like maybe an emerging markets fund or something.