Cut Risk? Maybe Not
As I follow the debate about financial regulation, I'm struck by a couple of things. To paraphrase Newton's third law of motion: For every regulation, there's an equal and opposite reaction -- generally unintended and often costly.
The much-ballyhooed credit-card legislation, for example, triggered an avalanche of new fees and rate hikes as issuers raced to beat the effective date. Guidelines intended to protect home buyers from inflated appraisals are delaying sales and frustrating borrowers. Restrictions designed to make money-market funds more liquid have cut yields. Wall Street guru Burton Malkiel has argued that a proposal to tax stock and derivatives trading by speculators would raise transaction costs and lower returns for all investors.
It also strikes me that trying to regulate financial transactions is a lot like playing Whac-A-Mole -- something new and unpredictable always pops up. We at Kiplinger's think the next big disappointment could come from investments that promise to reduce risk and generate positive returns no matter what the market environment -- the investor's holy grail. Those returns may not pan out, or they could come at a steep price.
Fresh air. I'd like to see investment companies preempt regulators and tell investors what they're getting into. Take, for example, target-date mutual funds: You pick a fund with a date close to your anticipated retirement or other goal, and as the date approaches, the fund adjusts its portfolio to become more conservative. We are fans of these funds -- see Target-Date Funds Reset Their Sights. But they have come under fire because they turned out to be riskier than anticipated. On average, the 2010 funds lost 34% of their value during the 2007-09 bear market (they gained 44% in the subsequent market rebound).
Each family of target-date funds chooses its own mix of assets, and that's fine with me as long as I know what that mix is and why the company has chosen it. Full disclosure: I own the T. Rowe Price Retirement 2020 Fund, which invests more than 70% of its assets in stocks. Price managers make no apologies for their aggressive approach, which they believe defends against long-term inflation and the risk that you'll outlive your money. But investors need to know upfront that such funds aren't intended to be drawn down in the first year of retirement.
Annuities are another investment category that could benefit from a lot more fresh air and plain English on the part of issuers. Annuities can be useful retirement tools. But investors often confuse immediate annuities, which convert a lump-sum payment into a steady stream of income (similar to a traditional pension), with more-complex deferred annuities, which have an investment component that can be coupled with protections against market losses. The latest deferred annuities come with higher fees and lower guarantees than in the past, so we present an alternative annuities strategy that could make more sense for you: combining low-cost investments for the early years of retirement and longevity insurance for the later years.
Bottom line: No matter how appealing the guarantee or well intentioned the regulation, there's no such thing as a free lunch -- or a risk-free investment. Count on us to keep whacking away at those moles.
P.S. We couldn't be prouder that Kiplinger's has won the General Excellence award for large magazines from the Society of American Business Editors and Writers. That's a real honor from a jury of our peers. Thank you, SABEW.