Mutual Funds for the Utterly Confused

If you were to try and calculate where we will be as investors in twenty years, you might find a wholly different place. If you were to try and base this future view of the world on what the past has told us, you might even be somewhat optimistic. You may have realized that what happened in 2008 and into 2009 was an event unlike any other that preceded it and the lessons learned were indeed good ones. You might even say sometime in the near future that what happened then lasted longer than any recession has since.

The investment landscape for many individual investors has changed and for all intents and purpose, will continue to evolve. But what will the average investor look like twenty years from now? Will they have realized that buy and hold, the mantra of the investing past completely betrayed them over the last ten years? Will they redefine their own personal wealth as the sum of not what you might be worth but instead what you have amassed in cash? Will the future unveil a land of savers?

We have gone from an abysmal savings rate of zero - and often less than zero - to a quest for at least three percent. While this is healthy and important, the savings is not coming from the squirreling away of cash from spending, but from a shift in risk in numerous retirement accounts. Will this leave a whole generation of investors on the sidelines? Will we take what is long overdue and in the process take it too far?

Your professional money manager is now offering his/her clients a mirror of those feelings. Allowing you to put valuable dollars away in fixed income and cash focused investments - as of February, this has become so prevalent that almost half of all retirement accounts have gone super-conservative - is simply not responsible. I have been crusading for years on the platform that you can do whatever it is you pay your financial adviser to do. You can make bad decisions with similar outcomes. You can become conservative without paying someone to tell you what you already feel. You can miss the mark again and again without the aid of a third party aiding and abetting that decision.

There are three things you need to know to avoid this type of advice. We are in a bear market because folks have lost faith in equities, capitalism and the power of American and global growth. That will pass. Secondly, the market is in a bear type situation because, in short, credit became suspect and the lenders who offer credit to companies big and small became self-conscious of their poor investment decisions, under-capitalization and liberal leverage rules. Changes are in the pipeline to dissuade similar behavior in the future. And lastly, bear markets demand our attention.

Instead, we have turned away at the very instance that we need to refocus that attention. Your financial adviser should have known better than to allow you to continue to invest in stocks when the prudent move would have been to move to a balanced position of bonds and stocks. But that kind of move would have found him/her on the perimeter during the run up and not exactly someone whose services you considered invaluable. To do this, advisers would have had to be less mirror-like (telling you what you wanted to hear) and more devil’s advocate.

And now, just a few long months later, what have they learned? To keep your business, they are continuing to mirror your attitudes as you shift into somewhat more dangerous waters en masse. Because many 401(k) plans do not offer money market accounts, the next best thing has been chosen as the conservative tool for this skittish, once-bitten-twice-shy group: guaranteed investment contracts or stable-value funds. So what exactly are these super conservative investments?

According to StableValue.org, this $300 billion market can be summed up as follows: Guaranteed Investment Contracts or GICs come in three basic forms. The traditional, separate account and synthetic all rely on crediting rates and are supported by a variety of different investments. These contracts can be held in a constant state with the rate “set at the beginning of the contract or reset periodically to reflect the performance of an underling security, portfolio or investment manager”.

I am positive that you are aware of all of this. But for those of you who have yet to be thoroughly confused by this insurance product (that’s right, the credit risk you will find in traditional and separate account GICs is controlled by insurance companies), there is more. GICs contain an amortization feature that looks at the payout in the future and adjusts itself accordingly. Hence, the involvement of the insurance company.

Traditional GICs offer a specific rate of return for a predetermined period of time. Separate accounts shake things up a bit by offering varying strategies to achieve their fixed income objectives. The later GIC is primarily offered to plan administrators of pension funds.

Synthetic GICs offer a more direct ownership and control of plan assets. Synthetic GICs are divided into two additional categories: maturing (offering a portfolio containing a single security or one that holds securities that are similar and because of that strategy, which tends to resemble the traditional GIC, this often the most sought after type for average investors under the advice of their advisers) and evergreen (which have no set date of maturity, can be actively managed and may contain those securities of infamous renown, mortgage backed securities, CMOs and other non-Treasury securities). Synthetic GICs along with traditional and separate account GICs can be pooled into another GIC that taps some of each of the aspects of the other.

These are not toys for the uninitiated investor and while offering safety they do not guarantee much of anything. The “guarantees” in these contracts come from insurance companies, which you would assume would be conservative by nature (AIG?). Add to that, they are not guaranteed by the FDIC (as many bank sold CDs and money market accounts tend to be), are not backed by the full faith and credit of the government (in the way Treasuries are), they barely beat inflation if at all (resembling short-term bonds in overall return), and unlike all of the aforementioned investments, come with substantially higher fees (essentially wiping any realized gains before you have a chance).Not to mention the fee your adviser will skim as they reflect what you are feeling at the moment. Your need for sleep, your inability to accept and embrace any risk at all, and your eventual change of heart somewhere down the road when equities begin to rebound (probably in the fourth quarter) should be at the center of their concerns for your portfolio’s health. While some have switched to high-yield bonds for safety, those that choose GICs will be sadly disappointed in their decisions by the year’s end. And most of that disappoint will not come from loss of cash but from money lost in protecting it.

By that time, it will be too late.