Believe it or not, now may be the best time for small investors seeking to build a retirement — ever.
Hyperbole? Maybe. But it might well turn out to be an understatement. Things might only get better for retirement investors.
Consider the recent interview Jason Zweig at The Wall Street Journal had with James Cloonan, founder of the American Association of Individual Investors.
Cloonan touches on powerful trends toward open markets and investor information since he started the group back in 1978. But the most compelling point, in my view, is the case he makes that costs have fallen almost continually.
By Zweig’s calculation, it was hard back then for an individual investor to avoid built-in trading expenses of 3% or more. Commissions were very high and the spread between bid and ask prices was 25 cents per share.
Now, Zweig figures, trades are 80% cheaper, or about half of 1%, vs. pricing in 1978.
But let’s not stop there. Consider the amazing changes in funds and retirement investing starting at about the same time and in the years soon after:
1974
Birth of IRA plans: Forty percent of households today include a wage earner who owns an individual retirement account. The ability to reduce current taxes has led to a balance at year-end 2012 of $5.1 trillion in IRAs of all types.
1975
Index fund revolution: John Bogle, founder of Vanguard Group, launches the first index fund, later known as the Vanguard 500 Index Fund. He was ridiculed at the time. Its performance since inception is a 10.82% annual return and today the fund controls $150.6 billion in assets. At the end of 2012 there were 373 index funds managing $1.3 trillion.
1978
Creation of 401(k) plans: The law that created the workplace 401(k) retirement plan was enacted in 1978. Counting all such defined-contribution plans, the system controlled $5.1 trillion in retirement benefits at the end of 2012. Sixty percent of U.S. households have them.
1993
ETFs are born: Investors seek to combine low cost with trading flexibility, leading to the creation of the first exchange-traded funds (ETFs). Total assets in ETFs now equals the total held by index funds, yet it’s a level ETFs reached in significantly fewer years.
1996
Online trading takes off: The technology that created electronic trading goes back to the late 1960s, but the brokerage industry played it close to the vest for years. Partly, that was a technology cost barrier but also an effort among brokers to maintain artificially high spreads. As the mass Internet took hold, the jig was up and both spreads and commissions began to plummet.
The confluence of these technologies and trends created a powerful mix of tax incentives, public market information and competition. It’s really a retirement investing nirvana.
There are some caveats. Investors in small company 401(k) plans still pay fees on the order of 2.5%. They are stuck, unfortunately, in 1978.
And retirement investors with the freedom to choose index funds and index ETFs still sometimes choose overpriced active mutual fund managers. Convinced that talent can beat the indexes, they too often end up far behind as a result.
Retirement investors win
Competition is good, and by no means should investors be forced to invest one way or another. But for the intelligent investor saving for retirement things have never looked better. A portfolio of index-tracking ETFs, trading largely commission-free and held inside a tax-deferred or tax-free IRA plan, brings one pretty darn close to frictionless investing.
Costs could always fall further still, especially if large numbers of retirees roll over money from workplace plans and choose to adopt low-cost, efficient portfolio planning. Certainly that’s the direction you see the major brokerages moving these days.
They see the writing on the wall. Retirement savers are likely to reward Wall Street firms that can keep up, and that’s a powerful force for continued, positive change.
