The investment industry could help you become a better investor. Will it? I think so, but it may take some time. To gain trust, the industry needs to get better at delivering usable information – the kind that helps you make smart choices – not the kind of sales literature that no one understands. Here are five things I’d like to see the industry do:
1. Report returns over rolling time periods. Do you invest Jan. 1, and take your money out Dec. 31? I don’t know anyone who does. Yet that is how mutual fund companies typically report returns. Even if those companies report returns over the most recent 12 months, does it have any relationship to the returns the fund might deliver over the next 12 months? No.
It’s natural to look at what did well last year. If you see one fund that was up 19 percent last year and another that earned only 1 percent, of course you want to move more money into the one that did well. But first, ask yourself, “Do I know why one fund was up 19 percent and the other wasn’t?” The answer is probably no. If you don’t know why, you shouldn’t be making the changes.
The mutual fund industry could help you make better decisions by reporting returns differently. How? By using an average of numerous 12-month rolling time periods. Sound confusing? Let’s look at an example.
Suppose last year the fund you are considering investing in was up 15.96 percent, as measured from January to December. You decide to look more closely, so you look at the returns from the year before last, but by measuring from February to the following January, then March to the following February, then April to the following March, and so on. You would then average those various 12-month time periods together to get a better picture of what you might expect as an investor.
For a mutual fund to employ this, it would state its average one-year return based on the last 60 rolling 12-month time periods. This would keep investors from chasing last year’s top performers, which is a horrible but common way to choose investments.
2. Use more descriptive terms. Unless you’re a UFC fighter, it is unlikely your goal is to be aggressive. Investors I know have a goal to retire by a certain age, or maintain a slow, steady increase in account values. And what exactly does conservative, moderate or moderately aggressive mean? Many investors who read these terms in their 401(k) literature have little idea what they mean.
If investing isn’t your business, even the terms “growth and income” are confusing. Of course you want growth and income – who doesn’t? A better idea: Pick terms that describe the investor experience, such as “slow and steady” or “fast and bumpy.” Such terms describe the speed at which your account values may change – either up or down.
Or perhaps funds could use terms people are familiar with, such as “the sprint, the one mile, and the marathon,” or “school zone, city street and highway.”
I’d love to see an aggressive fund say something realistic in its literature such as, “This fund will make you cry in a bad market and dance in the street in a good one.”
If no one wants to be that creative, how about being direct? Such as a stock fund stating, “This fund has 10-year growth potential. Your probability of having a successful experience with the fund will go up if you plan to contribute to and own it for at least 10 years, and will go down if you plan on moving your money in and out of it.”
It is too much to ask for this kind of straight talk?
3. Provide better guidance. A mutual fund or 401(k) plan is a tool to help you accomplish a financial goal. What is that goal, and will your current savings rate and investment choices help you get there? The investment industry could do a better job of helping you answer these questions.
Some 401(k) plans are using platforms (online software tools) that help you see how your 401(k) money fits into your overall financial picture and how much retirement income it may provide to you one day. I’d like to see more of this.
Too many people look at their investment choices and feel overwhelmed. They feel as if they should roll the dice, they need to be actively monitoring their investments or they simply don’t know enough to even begin.
Better education programs (especially ones incorporating videos) could help. These materials need to explain things in simple terms without using investment jargon. After all, if you don’t even know what a stock is, or what a mutual fund is (and many people don’t), how are you supposed to feel comfortable putting money into your plan?
4. Offer a guaranteed-rate fund. I’ve met plenty of people who don’t know what a growth and income fund is, but I’ve yet to meet someone who didn’t know what a five-year certificate of deposit was. Employer-sponsored plans ought to be required to provide a guaranteed-rate fund – like a CD of sorts. Some plans do provide such a choice, called a Guaranteed Investment Contract, or GIC. I wish all plans provided such an option.
It doesn’t seem fair to offer a slew of investment choices when a certain segment of the population won’t understand any of them. Banks and insurance companies can do a better job of providing safe and understandable choices that can be used inside a 401(k) plan, and employer-sponsored plans should start requesting such options. Only offering market-related choices (money market, bond and stock) should not be acceptable.
5. Explain risk differently. A picture is worth a thousand words, sure, but to educate, it needs to be the right kind of picture. Many funds offer a line graph that shows you the growth path of $1,000 invested 10 years ago, and they compare that to a related index. For example, a large-cap stock fund will graph its performance relative to the Standard & Poor’s 500 index. That doesn’t help the average person without any usable knowledge as far as volatility and risk go.
To understand risk, you need to see several different options graphed together. How about graphing your conservative, moderate and aggressive choices all in one picture? Then you would clearly see the “slow and steady” line compared to the “fast and bumpy” line, or the “school zone” compared to the “highway lane.”
Now, combine this graph with pop-up terms. For example, if you hovered over the “fast and bumpy” line, a pop-up box might explain why this fund has a better probability of working for you if given 10 years, by pointing out the big dip you see in 2008, and then showing the subsequent recovery.
I’m sure there are many other things that could be improved. Have an idea of your own? Leave it in the comments. Maybe someone will listen.
Dana Anspach, certified retirement planner, retirement management analyst, Kolbe Certified Consultant, is the founder of Sensible Money, LLC, a registered investment advisor with a focus on retirement income planning based in Arizona. She is the author of “Control Your Retirement Destiny” (Apress), writes for About.com as its Expert on MoneyOver55 and contributes to MarketWatch as a RetireMentor.