In our previous article we discussed about the Obama administration’s warnings of the unfair practices that many Wall Street firms are engaged in when they advise retirement investors. In the Fact Sheet published by the White House titled Middle Class Economics: Strengthening Retirement Security by Cracking Down on Backdoor Payments and Hidden Fees, the Obama administration is said to be taking measures to “crack down” on these brokers who are reluctant to put the best interest of middle class families first. The firms are said to be selling investments with “high costs and low returns” rather than sharing quality investment advice. (Read: White House Warns of Backdoor Payments for Retirement Investments)

While last time we suggested retirement mutual funds that should be dropped from the portfolio (which however are not related to the unfair practices), this time we will focus on the IRA investment options. Also, we will look into the effects of conflicted advice on investment returns.

IRAs for Tax Benefits

IRAs are set up for the benefit of taxpayers or their beneficiaries, as this plan has lower long-term tax burden with the option for investors to withdraw money on reaching the retirement date. Simply, individuals can contribute money to IRAs, before tax deductions in most cases, and withdraw the capital with returns upon retirement. In 2013, the maximum IRA contribution was limited at $5,500 for investors below 50 years; while those above 50 could contribute $6,500.

However, an IRA plan is not an investment by itself. The money stashed into the retirement savings plan is diverted to invest in stocks, bonds, mutual funds and other assets. The asset allocation is thus a crucial step as investors would not want to lose money they are storing as a retirement plan.

Mutual Funds and IRAs are different financial instruments. However, their connection lies in the fact that money contributed to an IRA can be directed toward mutual funds. This gives a decent advantage for investors looking at tax advantage while investing in mutual funds. As mentioned earlier, IRAs are generally for tax-advantages and are regulated by the government.

However, the purpose of IRAs is lost if the investor is trapped in the unfair practices warned by the Obama administration. The fact sheet mentions that company officials operating 401(k) plans are legally required to prioritize the interest of investors. However, the same “fiduciary” obligation is not practiced in case of financial advisors for rolling the retirement plan to an IRA.

Conflict of Interests
A report from the President’s Council of Economic Advisers that the present regulatory environment allows the ‘misaligned incentives’, leading to losses worth billions of dollars for the American middle class families every year. The ‘misaligned incentives’ further let the brokers to influence investors to shift to high-cost IRA accounts from other low-cost plans.

The report enlists the following points:

“Conflicted advice leads to lower investment returns for working and middle class families. Working and middle class families receiving conflicted advice earn returns roughly 1 percentage point lower each year (for example, conflicted advice reduces what would be a 6 percent return to a 5 percent return).”

“An estimated $1.7 trillion of IRA assets are invested in products that generally provide payments that generate conflicts of interest. Thus, CEA estimates the aggregate annual cost of conflicted advice is about $17 billion each year.”

“A typical worker who receives conflicted advice when rolling over a 401(k) balance to an IRA at age 45 will lose an estimated 17 percent from her account by age 65. In other words, if a worker has $100,000 in retirement savings at age 45, without conflicted advice it would grow to an estimated $216,000 by age 65 adjusted for inflation, but if she receives conflicted advice it would only grow to $179,000—a loss of $37,000 or about 17 percent.”

“A retiree who receives conflicted advice on how to invest his IRA at retirement will lose an estimated 12 percent of the value of his savings if drawn down over 30 years compared to a retiree who receives unconflicted advice.”

Best Funds to Buy with IRA Benefits

The most profitable investment in funds would be the ones that would carry a low cost structure. Expenses have an inversely proportionate impact on the net return.

The funds discussed below will make good additions to a portfolio as they have a low expense ratio, carry no sales load and have a proven track record of impressive performance. In addition, the maximum management fee for these funds is 0.5%. The management fee is the annual percentage of fund assets paid to the fund’s investment manager as compensation for managing the fund. Often this fee is graded; that is, the percentage fee is reduced in steps on assets in excess of various breakpoints. Generally, the management fee will not exceed 1% of total net assets.

Most importantly, the funds carry a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy).
Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

All these funds have an inception year before 2000 and the maximum initial investment required is $1000.

T. Rowe Price Spectrum Growth (PRSGX - MF report) seeks capital growth over the long term with income being its secondary objective. The fund’s assets are invested in a range of T. Rowe Price mutual funds belonging to specific markets. The fund invests in both domestic and non-US equity funds and has exposure to several markets.

The fund carries a Zacks Mutual Fund Rank #1. The fund’s total return over 1, 5, 10 and 15 years are 7.8%, 13.3%, 7.6% and 6.1% respectively.

The minimum initial IRA investment is $1000, with minimum subsequent IRA investment being $100.

The maximum management fee is negligible and annual expense ratio is 0.8%. There is no 12b1 fee attached. For every $10,000 invested, the 10 -year expense projection is $990 as compared to category average of $1, 695.

Vanguard Balanced Index Investor (VBINX - MF report) assets are divided between indexed portfolios of stocks and bonds, with 60% of its assets in stocks and 40% in fixed-income securities. The fund's equity segment attempts to match the performance of the CRSP U.S. Total Market Index. The fund's bond segment attempts to match the performance of the Barclays U.S. Aggregate Float Adjusted Index.

The fund carries a Zacks Mutual Fund Rank #1. The fund’s total return over 1, 5, 10 and 15 years are 10.4%, 11.3%, 7% and 5.5% respectively.

The minimum initial IRA investment is $3000, with minimum subsequent IRA investment being $100.

The maximum management fee is 0.21% and annual expense ratio is 0.24%. There is no 12b1 fee attached. For every $10,000 invested, the 10-year expense projection is $306 as compared to category average of $1, 749.

American Funds American Balanced F1 (BALFX - MF report) seeks to provide conservation of capital, current income and long-term growth of capital and income by investing in stocks and investment-grade bonds.

The fund carries a Zacks Mutual Fund Rank #2. The fund’s total return over 1, 5, 10 and 15 years are 9.9%, 12.1%, 7% and 7.9% respectively.

The minimum initial IRA investment is $250, with minimum subsequent IRA investment being $50.

The maximum management fee is 0.24% and annual expense ratio is 0.66%. The 12b1 fee is 0.25%. For every $10,000 invested, the 10-year expense projection is $822 as compared to category average of $1, 749.