Yield Disparity

The understanding of investing returns in the US is that anyone can attain the same returns as someone else. This fiction is what drives moderate income people to invest in the stock market. Research has shown that this is not accurate.

What Is It?

Very simply yield disparity is the difference in the yield or return on investment received by different investors in an asset category. In this case I am discussing the yield disparity in the stock market. Yield disparity that is random would be expected, however, research shows that the difference in returns received by different investors is highly correlated to their assets. Higher income individuals receive higher returns and lower income investors receives not only lower, but significantly lower returns. What this means is that there really is no “average” return for a stock. When an investment professional says to you that the return on an investment was 10%, the return you can expect is very much dependent upon how wealthy you are. This is because of wealthier investors have better information and probably some better skill at investing than less wealthy investors. Furthermore insiders such as executives have extremely good information about the state of the company’s financial situation and can sell shares they have accumulated before changes in the companies status are known by the general public. This timing aspect to investing is extremely important and makes the difference between a very good return, or a low return or a loss.

What this means is that the better off are pulling out the returns from stocks for themselves, and leaving less for less wealthy investors. Therefore, a quote of a return on a stock return is not what any one investor can expect to receive from the investment, but rather changes depending upon who that investor is, their wealth, and their access to inside information. The statement of average return without declaring the importance of the yield disparity overstates the return to the vast majority of investors.

Why The Yield Disparity is So Important

Yield disparity is real and significant, but barely discussed. No investment firm will touch the subject or admit that it exists. This demonstrates to the control over information that the financial industry exerts over the mass media. I learned of this myself not from a university or government study, but from a single individual who worked for decades as a retirement program consultant.

Brooks Hamilton was the subject of a PBS FrontLine episoe which can be seen here.

http://www.pbs.org/wgbh/pages/frontline/retirement/view/

The program was entitled “Can You Afford to Retire?” It is excellent and should be required viewing for anyone who seeks to understand the retirement system. He noted the yield disparity in this interview which shows substantial differences in investment return by income level. According to his research which looks over 50 years of 401k returns the group with the lowest 20% of income earned about 4% per year in gains. The group with the highest 20% of income earned about 25% returns.

The sample size was 50,000 people out of a population of maybe 30 million people in 401k plans at that time..scattered in every zip code of the country.

I know John Bogle…I have an enormous respect for him…he testified before the Senate in November of 2003 (details here)….It should be required reading…He basically said..from 1984 to 2002 when the stock market did a 12 percent annual return, the mutual fund industry credited 9 percent..The average investor according to [mutual fund data collector] DALBAR did 2.7 percent. – Brooks Hamilton

However according to Brooks Hamilton the problem is even broader than that.

In a 1000 person plan, probably over 900 contribute too little too late…And of the 200 that join the plan and contribute materially…150 of those 200 underperform the market. – Brooks Hamilton

The many problems of 401k programs are listed at http://www.brookshamilton.com/401k_pitfalls.htm

At this link the tables of the different yield disparity for different income levels is apparent.

http://www.brookshamilton.com/pdf/PressPakFork.pdf

Forcing Average People to be Professional Investors

One of the major problems with the 401k program is that it places every individual in the position of having to be their own investment professional. However, not all people are knowledgeable in investing, and consequently, many do a poor job of managing their 401k. Another issue is that the 401k is voluntary, and many contribute to little to their 401k. These were all aspects that were taken care of by pension programs. That is the pensions were professionally managed, and they were obligatory, all employees contributed a prescribed amount through their employer. Books Hamilton has the following to say about the interests the average person.

We examined five plans, Citigroup, Hewitt, Merrill Lynch, Morningstar and Prudential, for the period of 1995 to 1998. None of the five came close to matching the performance of the stock market, or an index of 60% stock and 40% bonds. If employees at Merrill Lynch and Morningstar can only manage below average returns, is is reasonable to hope that most American workers, the majority of whom according to USA Today don’t know the difference between a stock and a bond, will be able to properly manage the investment of their retirement funds? – Brooks Hamilton

Face reality, some people don’t care about investments and don’t want to learn. Expecting them to learn is like asking all employees to master classical piano in their spare time at home. That means that employers need to give employees a managed account option. – Brooks Hamilton

What is interesting is that the US retirement system has been completely transformed in the past few decades with literally no research into the results of the efficacy of 401k programs and the transformation has been make primarily because it is beneficial for companies. However, the 401k has been universally negative for workers.

The following table is from Books Hamilton’s research. As can be seen returns in this table variate with the income of the individual.

Return by Income Level

This was during an up year, during the boom. An average year will have a smaller discrepancy. The government knows exactly how these numbers play out per year as they have the IRS returns. All the major financial companies know as well, however, will not release the information to the public.

How Pensions are Managed

Companies seem to much better manage the pension than the 401k. Could this be because non-professional investors are making investment decisions? Isn’t this the logic behind the 401k, that more choice leads to better outcomes and that every individual must “take charge” of their investments?

Conclusion

The story of the movement to the 401k is a story of corporate control over the government bodies that should be regulating retirement systems. Due to the yield disparity, individuals by different levels of wealth receive different returns based upon the timing of their investments. Brooks Hamilton brought to light a large database of investors, none of which were particularly wealthy, and showed significant benefits of to those who were better off. This shows that the “average return” is meaningless. However, Brooks Hamilton did not show how much better the very wealthy do, and how much they pull out of the returns for the rest of investors. However, there has been significant research to show that when insiders begin to sell shares, those shares subsequently decline. More research is needed in this area, but because of corruption in the financial sector, I would not expect any.

References

Q: The reason so many Enron employees lost so much is that they forgot the first Step of investing—diversify! Isn’t diversification the key?

A: You are correct that history shows that diversified investing provides the best opportunity for success. But it But it does not guarantee success. My research, and that of others, addresses this issue directly. If the amount attributed to Social Security by a median-income worker had been put into a diversified portfolio, and id if that individual were to live 20 years into retirement, and the economic outcomes (real wage and stock market growth rates) of any 10period during the 20^th century were applied to that portfolio, only the into 1990s would result in higher retirement income from the portfolio than the existing Social Security system. If that person were to live longer than 20 years, even the decade of the 1990s would not have outperformed Social Security. The only reason that anyone is willing o look seriously at private accounts is because of the aberrant behavior of the stock market during the 1990s. Today, most retirees relying on 401(k) plans have significantly lower retirement income than those who were able to hold on to their old defined-benefit pension plans. It is not only workers at bankrupt companies like Enron who have been hurt; Enron highlights the level of risk imposed upon all workers by private accounts. We’ve been told repeatedly that if we diversify our holdings in private accounts sufficiently, we don’t face much risk. But when the stock market goes down significantly (45% in 2001-2002), diversification does not provide much protection. Bush Social Security advisor Sylvester Scheiber, who works for the corporate benefits consulting firm the Wyatt Group, wrote an article in 1994 predicting that the financial markets are likely to lose as much as half of their value as the baby boom generation retires and starts to sell its financial assets to pay for food and rent. This is why he has been advising his corporate clients for decades to replace their real defined-benefit pension plans with 401 (k) plans. It shifts the cost of a financial collapse from the corporation to the employees.  Dr. Douglas Orr – Real World Banking – Dollars and Sense

Tagged as: DollarsandSense.org