Morningstar Advisor - Spring 2008 - 96

Phillips Curve Back to the Garden By Don Phillips In his bestseller, In Defense of Food: An Eater’s Manifesto, journalist Michael Pollan asserts that the rise of nutritional science has caused modern eaters to switch from eating food to consuming food products. Where once we dined on bread made simply from stone-ground wheat, water, and yeast, we now eat bread formed from overly processed white flour and a host of additives designed to replicate the nutrients and freshness that the modern food industry has purged from our food. Turning bread into a collection of vitamins and micronutrients may allow food scientists to create breadlike products that are easier to mass produce and distribute, but it’s not clear that there are any health benefits for consumers, and there may well be unforeseen consequences. The same might be said of the modern financialservices industry. For our grandfathers, investing was simple. They bought either the equity or debt of established companies or the debt of government entities. For convenience, they might buy into an investment company or mutual fund that prudently invested, for a reasonable fee, in a balanced portfolio of these securities. Nearly all of the dividends and capital appreciation generated from the stock and bonds flowed back to shareholders in a pure, straightforward process. Today’s fund investors are far more removed from the basics of their underlying investments. Funds are still called bond or stock funds, but they may be composed entirely of synthetic ingredients, such as collateralized debt obligations or stock market futures. An investor’s connection to the basic nutrients of stocks and bonds, namely dividends and capital appreciation, is tenuous at best. The hedge fund community has taken the process even further, decomposing investment returns into alphas and betas, much like nutritionists have broken down food into a simple combination of proteins, carbohydrates, and fats. Rather than deploying “whole” investments, today’s investors are apt to use a set of genetically re-engineered investment products tailored to create desirable product characteristics. It’s clear that this process has benefitted the producers of financial services. It’s easy to charge a premium price for fancy engineering—just look at the expense ratios of the new 130/30 and market-neutral mutual funds. But synthetic securities also introduce new risks and uncertainties to the market, as seen in the damage done by products used to repackage subprime debt. Moreover, even when these products do work, it’s rare that their merit— after all fees and taxes are deducted—results in a better investor experience than the plainvanilla products they were designed to improve upon. How many of the sexy asset-allocation or target-risk balanced funds have produced a better result than good old Vanguard Wellington Fund VWELX in recent years? Not many. Investors would be wise to remain skeptical about the benefits of financial engineering when it comes to the topic of this issue’s spotlight, retirement income. For our grandfathers, retirement income would likely have come from a pension that had been invested in bluechip stocks and investment-grade bonds. In essence, the whole benefits of stock and bond ownership would be harnessed to meet the retiree’s income needs. In today’s non-definedbenefit world, the logical means of recreating this income stream would be to buy dividendpaying stocks and investment-grade bonds. Unfortunately, investors are likely to start too late and save too little in planning for retirement, thus making such conservative investments insufficient to meet income needs. The problem is made doubly difficult because most of today’s mutual funds have shifted their distribution fees into their expense ratios. The rise of 12b-1 fees and high distribution costs now embedded in expense ratios undermine the industry’s ability to pass along income. Mutual funds must pay all of their expenses out of their investment income stream before they tap into capital gains; thus, increases in expense ratios generally mean a drop in income for retirees. A portfolio of stocks and bonds that collectively yields 4% would return only 2.5% in a fund with an expense ratio of 1.5%. That’s a crippling 37.5% loss of potential retirement income. This math puts pressure on both fund investors and companies to find ways to stretch for yield. When firms offer yield-stretching funds that can overcome investors’ savings and expense gap, it’s the investment equivalent of food marketers promising overweight people that they can lose weight without diet or exercise if they just purchase some new chemically altered potato chip. Both parties are pleased with the immediate perceived benefits, but the longer-term consequences aren’t always clear. A healthier approach to retirement income will be to focus on the basics: increase savings, make wise asset-allocation decisions, assemble a diversified portfolio of stocks or low-cost mutual funds with strong, growing dividends, and incorporate appropriate annuity products, if needed, into the mix. It won’t dazzle the portable alpha crowd, but it’ll do wonders toward ensuring a long, happy retirement. Sometimes, the simplest solutions are the surest. K Don Phillips is Morningstar’s managing director, corporate strategy, research, and communications. 96 Morningstar Advisor Spring 2008

Morningstar Advisor - Spring 2008

Table of Contents for the Digital Edition of Morningstar Advisor - Spring 2008

Morningstar Advisor - Spring 2008
Contents
Letter from the Editor
Inbox
Do You Use Annuities with Living Benefit Guarantees?
Managers Who Actively Enrich Shareholders
Staying Out of the Silos
Investment Briefs
Let’s Not All Become Fundamental Indexers Just Yet
Volatility Potential
Adding the Income Dimension
Do’s and Don’ts of RMDs
An Attractive Yield is Only Skin Deep
Mutual Funds Get in the Game
Beyond Target Date
The Last Holdout
A Bird of a Different Feather
First-Class Thinker
Sleep Like a Baby
Is Health Care Immune to a Recession?
Anatomy of a Mutual Fund Disaster
Embrace Your Inner Contrarian
Risks Worth Taking
Mutual Fund Analyst Picks
Undervalued Stocks
Most Popular Variable Annuities
New at Morningstar and on MorningstarAdvisor.com
Back to the Garden
Morningstar Advisor - Spring 2008 - Intro
Morningstar Advisor - Spring 2008 - Morningstar Advisor - Spring 2008
Morningstar Advisor - Spring 2008 - Cover2
Morningstar Advisor - Spring 2008 - 1
Morningstar Advisor - Spring 2008 - 2
Morningstar Advisor - Spring 2008 - Contents
Morningstar Advisor - Spring 2008 - 4
Morningstar Advisor - Spring 2008 - 5
Morningstar Advisor - Spring 2008 - 6
Morningstar Advisor - Spring 2008 - Letter from the Editor
Morningstar Advisor - Spring 2008 - 8
Morningstar Advisor - Spring 2008 - Inbox
Morningstar Advisor - Spring 2008 - Do You Use Annuities with Living Benefit Guarantees?
Morningstar Advisor - Spring 2008 - 11
Morningstar Advisor - Spring 2008 - Managers Who Actively Enrich Shareholders
Morningstar Advisor - Spring 2008 - 13
Morningstar Advisor - Spring 2008 - 14
Morningstar Advisor - Spring 2008 - Staying Out of the Silos
Morningstar Advisor - Spring 2008 - 16
Morningstar Advisor - Spring 2008 - 17
Morningstar Advisor - Spring 2008 - Investment Briefs
Morningstar Advisor - Spring 2008 - 19
Morningstar Advisor - Spring 2008 - 20
Morningstar Advisor - Spring 2008 - 21
Morningstar Advisor - Spring 2008 - Let’s Not All Become Fundamental Indexers Just Yet
Morningstar Advisor - Spring 2008 - 23
Morningstar Advisor - Spring 2008 - 24
Morningstar Advisor - Spring 2008 - 25
Morningstar Advisor - Spring 2008 - Volatility Potential
Morningstar Advisor - Spring 2008 - 27
Morningstar Advisor - Spring 2008 - 28
Morningstar Advisor - Spring 2008 - 29
Morningstar Advisor - Spring 2008 - 30
Morningstar Advisor - Spring 2008 - 31
Morningstar Advisor - Spring 2008 - Adding the Income Dimension
Morningstar Advisor - Spring 2008 - 33
Morningstar Advisor - Spring 2008 - 34
Morningstar Advisor - Spring 2008 - 35
Morningstar Advisor - Spring 2008 - Do’s and Don’ts of RMDs
Morningstar Advisor - Spring 2008 - 37
Morningstar Advisor - Spring 2008 - 38
Morningstar Advisor - Spring 2008 - 39
Morningstar Advisor - Spring 2008 - An Attractive Yield is Only Skin Deep
Morningstar Advisor - Spring 2008 - 41
Morningstar Advisor - Spring 2008 - Mutual Funds Get in the Game
Morningstar Advisor - Spring 2008 - 43
Morningstar Advisor - Spring 2008 - 44
Morningstar Advisor - Spring 2008 - 45
Morningstar Advisor - Spring 2008 - 46
Morningstar Advisor - Spring 2008 - Beyond Target Date
Morningstar Advisor - Spring 2008 - 48
Morningstar Advisor - Spring 2008 - 49
Morningstar Advisor - Spring 2008 - 50
Morningstar Advisor - Spring 2008 - 51
Morningstar Advisor - Spring 2008 - 52
Morningstar Advisor - Spring 2008 - The Last Holdout
Morningstar Advisor - Spring 2008 - 54
Morningstar Advisor - Spring 2008 - 55
Morningstar Advisor - Spring 2008 - 56
Morningstar Advisor - Spring 2008 - 57
Morningstar Advisor - Spring 2008 - 58
Morningstar Advisor - Spring 2008 - 59
Morningstar Advisor - Spring 2008 - A Bird of a Different Feather
Morningstar Advisor - Spring 2008 - 61
Morningstar Advisor - Spring 2008 - 62
Morningstar Advisor - Spring 2008 - 63
Morningstar Advisor - Spring 2008 - First-Class Thinker
Morningstar Advisor - Spring 2008 - 65
Morningstar Advisor - Spring 2008 - 66
Morningstar Advisor - Spring 2008 - 67
Morningstar Advisor - Spring 2008 - Sleep Like a Baby
Morningstar Advisor - Spring 2008 - 69
Morningstar Advisor - Spring 2008 - 70
Morningstar Advisor - Spring 2008 - 71
Morningstar Advisor - Spring 2008 - 72
Morningstar Advisor - Spring 2008 - 73
Morningstar Advisor - Spring 2008 - Is Health Care Immune to a Recession?
Morningstar Advisor - Spring 2008 - 75
Morningstar Advisor - Spring 2008 - Anatomy of a Mutual Fund Disaster
Morningstar Advisor - Spring 2008 - 77
Morningstar Advisor - Spring 2008 - Embrace Your Inner Contrarian
Morningstar Advisor - Spring 2008 - 79
Morningstar Advisor - Spring 2008 - Risks Worth Taking
Morningstar Advisor - Spring 2008 - 81
Morningstar Advisor - Spring 2008 - 82
Morningstar Advisor - Spring 2008 - Mutual Fund Analyst Picks
Morningstar Advisor - Spring 2008 - 84
Morningstar Advisor - Spring 2008 - 85
Morningstar Advisor - Spring 2008 - 86
Morningstar Advisor - Spring 2008 - 87
Morningstar Advisor - Spring 2008 - 88
Morningstar Advisor - Spring 2008 - Undervalued Stocks
Morningstar Advisor - Spring 2008 - 90
Morningstar Advisor - Spring 2008 - 91
Morningstar Advisor - Spring 2008 - Most Popular Variable Annuities
Morningstar Advisor - Spring 2008 - 93
Morningstar Advisor - Spring 2008 - 94
Morningstar Advisor - Spring 2008 - New at Morningstar and on MorningstarAdvisor.com
Morningstar Advisor - Spring 2008 - Back to the Garden
Morningstar Advisor - Spring 2008 - Cover3
Morningstar Advisor - Spring 2008 - Cover4
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