Managed Mutual Funds and Retirement Income How Economic Literacy Pays Big Dividends

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David W. Rasmussen James H. Gapinski Professor of Economics Florida State University Dean Emeritus, College of Social Sciences and Public Policy Affiliate: Pepper Center on Aging and Public Policy Affiliate: L. Charles Hilton Center for the Study of Economic Prosperity and Individual Opportunity

The Main Story How to achieve a solid investment strategy for retirement assets Preview: about 70 percent of all financial retirement assets are getting a lower rate of return than they should This amounts to tens of thousands of dollars for even modest savers

Is There a Natural Tendency to be Financially Illiterate? People are generally: Myopic Ignore the power of compound interest Do not understand risk Psychologically we may be wired to be economically illiterate

Where Retirees Get Their Income Earnings Based Wealth* Housing** Other Wealth*** Work < $5,000 $1,902 $8,004 $156 $259 $10,321 $5,000-9,999 6,757 7,572 139 448 $14,916 $10,000-14,999 11,337 7,548 101 535 $19,521 $15,000-19,999 15,948 9,408 191 830 $26,377 $20,000-29,999 21,247 11,304 686 2,475 $35,712 $30,000-39,999 27,064 12,768 1,236 5,597 $46,665 $40,000-49,999 28,936 13,848 2,220 12,503 $57,507 $50,000-69,000 32,998 15,300 3,904 20,870 $73,072 $70,000 + 38,737 21,684 12,584 73,309 $146,314 *Social Security, private and government retirement **monthly rental value of owned *12 *** interest, dividends, rental income, and other property income Source: Consumer Expenditure Survey, U.S. Department of Labor Statistics, August 2016

Fundamental Insights for Future Retirees Social security and defined benefit pensions will provide less income in the future Continuing to work will be critical for more households Some households can tap housing equity for emergency situations Saving by individuals will be more important as will continuing to work Economic literacy is required for household decisions

Pitfalls in Saving 70% of the $13.7 trillion in 401K Retirement Funds are in high cost managed funds that the Economist calls a “rotten deal” Consumer Reports headlines “Mutual Fund fees skim big bucks from 401(K)s: A household of two median –income earners will pay about $155,000 over 40 years” The Consumer Federation of America reports that a “Review of 25 major brokerage firms and insurance companies find all posing as fiduciaries, misleading consumers

A Comparison of Investments in Managed Funds vs an Indexed Mutual Fund Fee Level High* Medium** Low*** Investment Amount $20,000 Estimated Return 7.00% Holding Period (years) 15 Fund Value After 15 years $39,910 $48,068 $53,872 Profit/Loss $19,910 $28,068 $33,872 Total Fees and Expenses $9,337 $4,417 $820 *Virtus Enhanced Core Equity Fund Class **Dreyfus Appreciation Fund, Inc. Class Investor ***Vanguard 500 Index Fund Investor Class Source: Financial Industry Regulatory Authority, Fund Analyzer, apps.finra.org/fundanalyzer/1/fa.aspx

Why are Returns to Managed Funds Lower than Index Funds? Distribution fees Sales commissions Bid/ask spreads Cash drag

Lower Fees Make a Big Difference Lower Fees Make a Big Difference Comparing Returns: Index vs Managed Funds Age Annual Savings 7% Return 4.8% 30 $600.00 $642.00 $628.80 40 $9,470.16 $10,133.07 $8,435.54 $8,840.44 50 $26,919.11 $28,803.44 $20,957.77 $21,963.74 60 $61,243.82 $65,530.89 $40,969.95 $42,936.51 70 $124,473.77 $133,186.93 $68,891.41 $72,198.20

Why do Smart People Make Dumb Financial Decisions? Brokers benefit from selling high fee managed funds while “serving” us We want to believe self-interested brokers that we can beat the market The Illusion of control

The Challenging Task of Increasing Financial Literacy An easy message of financial literacy: low fee index funds pay better In principle, a nudge towards a responsible broker How to combat myopia in decisions regarding work, home equity, and saving

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