Bob’s Journal for 7/7/22
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Rollovers to IRAs Cost Investors Thousands of Dollars
The most common retirement plan transaction is the rollover.
Quite often when an employee leaves an employer, the employee rolls over the 401(k) or other retirement plan balance to an IRA. These rollovers could be costing many investors thousands of dollars, according to a new study from Pew Charitable Trusts.
Many employer retirement plans allow participants to buy “institutional shares” in mutual funds and other investment funds. These shares have lower expenses and fees than the standard “retail shares” of the funds.
Someone with a very large account balance can buy the institutional shares through an IRA, but that’s a small percentage of individual investors. Most people, after rolling over money from an employer plan to an IRA, have to buy the retail shares.
The cost difference between the two share classes seems very small, but the total additional cost mounts over time. The study found that many investors don’t realize how much the shift from institutional shares to retail shares costs them over time.
Hybrid mutual funds (typically balanced or asset allocation funds) had the lowest cost difference between retail and institutional shares at 0.19 percentage points. Even that small difference mounts.
Using the total amount rolled over from IRAs to 401(k)s in 2019, the expense difference cost investors a total of $980 million in that one year alone, according to estimates in the study. Stock and bond funds have more significant cost differences between the two share classes, so the loss to investors is much higher.
Over periods of 25 years or more, the cost really compounds. One estimate in the study is that after 25 years an investor who rolled over $250,000 would have paid more than $10,000 in additional fees and savings reduced more than $20,000.
The study recommends what I’ve long advised in Retirement Watch. Before rolling over money from an employer plan to an IRA, compare the fees and expenses between the two options. Some employer plans have average to high fees, while others work hard to reduce the costs to their participants and are good deals.
How the Stock Market Decline Increases Inflation
The stock market decline puts pressure on “unicorns” and other young companies, and that increases prices on consumers.
It is an interesting example of secondary effects in the financial world.
Many young companies don’t worry about making profits or even projecting being profitable in a few years. Their goals are to provide an attractive product or service and build customer bases.
They rely on funding from investors, usually private equity funds, to cover losses, and investors are willing to do that as long as there is a plan to sell the stock in a few years either in an initial public offering or to another company.
That’s a viable strategy as long as the stock market is strong and there isn’t talk of a recession. But the change in the investment and economic environment in 2022 upends the strategy.
For many companies that are losing money, it’s less likely they’ll be able to sell shares at a profit any time soon. The result is the companies now are under pressure from their investors to generate positive cash flow.
That’s why various young companies are raising prices, reducing services and taking other actions. Uber raised prices and is reducing some services. Netflix is likely to introduce advertising to a lot of its programming. Those are only two prominent examples.
Some analysts refer to this as the end of the “millennial subsidy.” They say millennials are the target consumers of many of these companies and benefit the most from the goods and services of the money-losing companies.
Whether or not that’s a fair characterization, there’s no doubt investors have subsidized customers of some companies. That’s ending and leading to higher prices for goods and services.
It Was an Ugly Half Year
Any way you look at it, the first half of 2022 was bad, except for commodity investors.
The old saying on Wall Street is “Sell in May and go away.” The idea is that stocks have good returns early in the year and then lag from June through November.
This year has been different. It is one of the few years the stock indexes had a negative return for the first six months. It also was the worst first half of a year for stocks since 1970.
Bonds didn’t do much better. In fact, the most widely followed bond index declined 11%, its worst first half of a year ever.
The digital currencies and related assets also had a terrible start to 2022. Many of the companies in the digital currency business went from expanding rapidly to laying off employees.
Commodities were the only major asset class that had positive returns for the first half, and they had significant gains.
What does all that mean for the second half of 2022?
In the past, in the few times when stocks were down more than 15% in the first half of a calendar year, they had positive returns in the second half.
I don’t recommend counting on such data mining to manage your portfolio. As long as the Fed continues to tighten monetary policy, stocks and bonds are likely to decline. The Fed tightening could even slow economic growth enough to bring down commodity prices in the second half.
Financial assets will start to generate positive returns once investors believe an end to tighter monetary policy is near.
The Data
The ISM Manufacturing Index declined in June to 53.0 from 56.1 in May. A level above 50 indicates growth, and June was the 25th consecutive month the index was above 50.
But June’s number does indicate the rate of growth in manufacturing was slower than in May. In fact, June’s reading was the lowest since June 2020.
But the PMI Manufacturing Index increased slightly in June to 52.7 from 52.4 in May.
Personal income increased 0.5% in May from April’s level. Consumers reversed recent behavior in that they increased spending less than income increased. Personal consumption expenditures (PCE) rose only 0.2% in May. That’s the lowest monthly increase in PCE in 2022.
The Fed’s favorite inflation measure, the PCE Price Index, increased 0.6% in April and 6.3% over 12 months. That means real wage increases were negative in May, because inflation for the month exceeded the income increase.
The 12-month increase in the PCE Price Index in May was the same as in April. March was the recent peak in the measure at 6.6%.
Excluding food and energy, the core PCE Price Index increased 0.3% in April and 4.7% over 12 months..
The ISM Services Index for June was 55.3. That’s down a little from 55.9 in May.
The employment market showed its first signs of weakening in a while during May, according to the JOLTS (Job Openings and Labor Turnover Survey) report.
The number of job openings decreased a bit to 11.3 million. But the number of hires, separations and quits remained about the same in May as in April.
The PMI Composite Index for the economy was 52.3 in June. That’s lower than the 53.6 in May and the lowest level since January.
The manufacturing sector declined significantly. The PMI Manufacturing Index fell to 52.7 in June from 57.0 in May. The PMI Services Index declined to 52.7 from 53.4.
New unemployment claims were down 2,000 to 231,000 in the latest week. Continuing claims decreased by 3,000 to 1,328,000.
The Markets
The S&P 500 rose 0.34% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.12%. The Russell 2000 increased 0.23%. The All-Country World Index (excluding U.S. stocks) lost 2.69%. Emerging market equities fell 2.25%.
Long-term treasuries gained 4.32% for the week. Investment-grade bonds increased 2.32%. Treasury Inflation-Protected Securities (TIPS) added 1.05%. High-yield bonds gained 0.65%.
On the currency front, the U.S. dollar gained 2.01%.
Energy-based commodities fell 9.82%. Broader-based commodities lost 10.00%. Gold declined 2.84%.
Bob’s News & Updates
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