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Dear ___(plan administrator or trustee):
As a
participant in our company’s retirement plan, I have been studying what it
takes to be a successful long-term investor. As you know, many of my fellow
employees and I are depending heavily on this plan to ensure our financial
futures. After reviewing the investment options available in our plan I have
reluctantly concluded that the plan fails to give us some of the tools we
need to do the best job of investing our savings effectively over the long
term.
Because so
many people, perhaps including you personally, are counting on our plan, I
hope you will give this topic a few minutes of your time. I believe our plan
could be significantly improved with the addition of a small number of new
investment options. While I am not an expert in plan administration, I
believe the costs and risks of doing so should be quite reasonable.
I have
enclosed a few articles that I hope you will read and consider. Here’s a
summary of what my research has shown:
Nobel
prize-winning experts have concluded that the overwhelming majority (over 90
percent) of long-term investment results are determined by the asset classes
represented in a portfolio. Therefore, having the right types of assets is critical.
The research indicates that over time:
- Small-company stocks outperform
large-company stocks. According to Dimensional Fund Advisors, a large
investment and research firm in Santa Monica,
California, from 1927 through 2004, U.S.
small-cap stocks had annualized growth of 12.4 percent. That compares
with 10.4 percent over the same period for the Standard & Poor's 500
Index.
- Value stocks outperform growth
stocks. DFA figures indicate that from 1927 through 2004, U.S.
large-cap value stocks grew at an annualized rate of 11.4 percent,
compared with only 9.5 percent for large-cap growth stocks.
- International stocks often
outperform U.S.
stocks, and because U.S.
and international markets typically move up and down at different times,
combining them can stabilize a portfolio. Here are some interesting
comparisons of annualized returns for the period from 1970 through 2004:
U.S. large-cap
stocks, 11.2 percent vs. international large-cap stocks, 10.4 percent; U.S.
small-cap stocks, 13 percent vs. international small-cap stocks, 16.5
percent.
- When these four asset classes are
combined and rebalanced each year, the resulting “smart diversification”
(described in one of the enclosed articles) gives the portfolio higher
returns. Using the four asset classes from the last example, it is easy
to calculate that their average annualized return was 12.8 percent. When
they were combined with annual rebalancing, the resulting annualized
return was 13.4 percent.
- Even more important, especially to
conservative investors, is risk reduction. Measured by standard
deviation, the average risk of these four individual asset classes from
1970 through 2004 was 20.8 percent. When they were combined, they
produced a standard deviation of only 16.9 percent. That 16.9 percent is
lower than the figure for any of the four individually.
It is easily
possible to divide the universe of U.S. stock funds into large-cap
stocks, large-cap value stocks, small-cap stocks and small-cap value stocks.
You can do the same with international stock funds and wind up with terrific
diversification via eight mutual funds. I also believe that an emerging
markets fund would give us exposure to the long-term growth potential in
developing nations such as China. Using an asset class that is not highly correlated with stocks, such as a Real Estate Income Fund (REIT), also makes sense.
On the fixed income side of the portfolio I believe that using short-term, intermediate-term, and inflation protected bonds provides the capital preservation that retirement plans require. I believe every one of these asset classes should be available to
us in our plan. Most of them can be accessed with low-cost index funds, and I
think our plan should have them.
Merriman, an independent investment firm and registered investment
adviser in Seattle,
has a free educational Web site, FundAdvice.com, where it has posted several Model
Portfolios. Merriman also suggests these as good
funds to include in 401(k) and similar retirement plans.
One example of these Model Portfolios would be at Vanguard using the following funds:
Vanguard 500 Index Fund, Vanguard Value Index, Vanguard Small Cap Index, Vanguard Small Cap Value Index, Vanguard REIT Index, Vanguard Developed Markets Index, Vanguard International Value, Vanguard FTSE All-World ex-US Small Cap Index, Vanguard Emerging Market Index, Vanguard Short-Term Treasuries, Vanguard Intermediate-Term US Treasuries, and Vanguard Inflation-Protected Securities.
I hope you
will seriously consider my request for the addition of one of these Model Portfolios. I am not
proposing that any of the present options in our plan be dropped, and certainly
every participant is free to make his or her own selections. By making these
funds available in our plan, you will give serious investors more effective
tools to make our money work harder for us. Is this too much to ask?
I appreciate
your time and look forward to your response.
Articles to enclose with this letter:
The
Ultimate Buy-and-Hold Strategy
The
Perfect Portfolio
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