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June 15, 2009

The Swedish Experience

ATT00261If you are like most Americans, you enjoy having choices.  Today, we have more choices than ever.  From the variety of cars we drive to the differing number and sizes of candy bars.  Choices abound.

In the arena of investments and 401k allocation possibilities, the number of choices has exploded in the last ten years.  What used to be a fairly simple choice of allocating between stocks, bonds, and money markets is now more complex than ever.

A careful review of The Swedish Experience can help shed some light on the difficulty associated with complex investment decisions.  In 2000, Sweden privatized their government-run pension plan.  This private plan was designed to provide “maximum choice”.  Each participant was allowed to form their own portfolio by selecting up to five privately-managed funds from an approved list.  If someone failed to pick a fund, however, the government would put them into a very low risk, low return fund.  This default fund was not recommended.  The government’s activity encouraged people to choose more appropriate funds.

Any fund meeting certain fiduciary standards was allowed to enter the system.  As a result, by the start of the program, participants had over 456 fund choices.  As of August 2007, that number grew to 783.  Information on the funds was provided in book form to all participants.  It listed fees, past performance, and the risk of each fund.  Fund companies were allowed to advertise to attract accounts, and did so with great fan fare at the start of the program.

So what happened?  As you have probably guessed, making such a decision was a difficult experience.  Most did not have the expertise or training to make an informed decision.  About one-third ended up with the low return default fund, making it the largest fund choice.  Faced with so many choices, one-third chose not to choose, despite the government’s encouragement to invest elsewhere.  As time went by and fund managers stopped advertising, more and more new participants ended up in the default fund.  By 2006, only 8% selected their own portfolio.

Did active choosers make better choices?  Active choosers tended to take far too much risk in their portfolio.  The average active chooser’s portfolio was comprised of 96.2% stocks.  They were also far more likely to follow trends.  Armed only with a book of funds and little knowledge, participants picked the funds that performed the best over the immediate past.  During the peak of the technology bubble, many active choosers picked the Robur Aktiefond Contura fund, which invested in primarily technology and healthcare stocks.  4.2% of all participants’ monies went into this account alone.  The reason was simple… the fund had produced a 534.2% return over the previous five years.  What could go wrong?  In the three years after the launch, the fund lost 69.5% of its value and has continued to be very volatile.

Lesson learned?  Faced with numerous choices, many participants did not know what to do so they ended up in the default fund. Others looked at the one piece of information they understood (returns), and made their decision based upon it.  It is not clear how many participants made their decisions based on clever ads, but that is certainly not a good method.  There were some who invested wisely and outperformed the default fund, but they were in the minority.  Part of the problem can be chalked up to bad timing.  The
program was launched right before one of the four worst bear markets ever! But more could have been done to help people choose wisely.

The more complex and difficult a decision is, the more people need personal assistance.  Add to that poor feedback, and few opportunities for learning, it is no wonder participants did not do better.  People needed the help of an independent financial advisor.  Unfortunately, these participants did not have one.  They could have called a representative of a fund, but that advice is hardly unbiased.  The two most common mistakes were doing nothing or taking on too much risk.

What does this mean for Americans?  We have 100 times more investment choices than the Swedish participants.  This huge number often leads to inertia.  People simply stay where they are or take on too much risk without realizing it.  What investors need is a relationship with a financial advisor or mentor who will provide answers both now and in the future. Investors must be aware of possible conflicts of interest.  If an advisor works for a firm that makes investment products, will their advice be unbiased?  Understanding what you are buying before making any investment decision is critical.  Insist on getting the investment policy, fees and risks of every possible investment beforehand.  Carefully review the prospectus of each investment vehicle.  Becoming a knowledgeable investor
takes time, but the dividends are well worth it!

Contact your Money Concepts’ financial advisor today for unbiased financial planning advice.  We have the tools, knowledge and experience to help you make an informed, thoughtful decision.

Please feel free to pass this on to anyone you feel might benefit.  We appreciate all of your referrals.