Earlier this year, T. Rowe Price banned more than 1,300 participants in the American Airlines 401(k) plan from trading in some of its funds. The majority of these participants were following trading recommendations published in a newsletter. The Wall Street Journal, meanwile, reported on the emergence of a 401(k) trading account newsletter industry. This is not a welcome development for plan sponsors. Here’s why:
1. Traders never prosper in the long run. All market traders use “systems” based upon factors, algorithms or key data elements to generate purchase and sale recommendations. These systems may allow followers to prosper for a while, but there has never been a trading system that has been successful over the long run. Markets change, data elements lose their relevance and traders are rarely able to successfully adjust their models to keep pace.
Can you name a successful market trader? None really pop to mind. However, if I ask you to name a successful market investor, you might think of many names (Warren Buffet comes to my mind.) Participants who follow these trading systems may end up with significant losses.
2. The mutual fund families are watching. Expect these trading newsletters to become more popular as their proponents become more skilled at marketing. All of the mutual fund families have programs in place to monitor for frequent trading. They have consistently said that frequent traders hurt all investors in a fund by driving up costs and lowering returns.
The mutual fund families will penalize participants who trade frequently in their accounts by assessing redemption fees, locking up their balances in certain funds or prohibiting them from making transfers. Participants who trade their accounts are generally unaware that the fund companies can take these actions.
3. Trading advice is different from allocation advice. My firm, like many others, provides help to participants with regard to their 401(k) accounts. When I talk with a participant, I provide suggestions about how they might consider allocating their account balance for the long term. I never suggest trades and actively discourage trying to time the markets. Market traders take a different view. They encourage participants to trade in their accounts and actively embrace market timing as a wealth creation strategy.
Many participants can be seduced into following a trading strategy by a promise of large increases in their account balance. Right now, these newsletter publishers appear to fall between the regulatory cracks and are not subject to any sort of oversight. Consider including cautions to employees in your education sessions to help them avoid these promises of easy money.