Thursday, December 4, 2008

AARP mutual fund costs

This Bloomberg story isn't directly Social Security-related, but it reminds me of a few interesting issues from the Social Security debate from a few years back. Bloomberg reports that health and auto insurance purchased through AARP often costs far more than seniors could buy simply by calling up an insurance company on their own. Understandably, some AARP members were upset, thinking they would receive discounts by purchasing through the organization. They story didn't have extensive responses from AARP and they may well have good explanations for how they price their insurance products, so I don't want to hit that issue too hard.

But it does remind me of some research I did back in 2005. At the time, the personal accounts debate was going strong and AARP posted an online cartoon (download the file and open in Internet Explorer) in which supporters of President Bush's proposal for voluntary personal accounts are portrayed as greedy financiers with telescoping arms seeking to separate unwary workers from their retirement checks. You would take the risk, the cartoon says, while they would collect the profits. (The fact that accounts would have been handled by a low-cost government agency similar to the Thrift Savings Plan, and that estimated administrative costs were only 30 basis points, was apparently lost on them.)

This got me thinking: how much did AARP charge for their mutual funds, which they offered through a co-branding with Kemper Securities? Given their rhetoric regarding fees that would be charged for Social Security accounts, as well as their general mission of providing low-cost products and services to seniors, one would assume the admin charges on AARP branded mutual funds would be at least as low as those charged to someone who walked into an investment company off the street.

As it turned out, that wasn't really the case. For instance, consider funds that track the S&P 500 index. AARP's annual charge for their index fund in 2005 was 0.45 percent of account balances, or "45 basis points" in investors' jargon. This was almost twice the industry average of 25 basis points for products that are, by design, identical. Of the 10 largest S&P 500 index funds, 8 had lower expenses than AARP's.

Since I invest through Vanguard, I compared fees on a range of AARP funds to comparable funds offered through Vanguard. The table below shows what I came up with (remember, these were fees as of around April 2005). Averaging nine typical funds, AARP's fees to its members were 2.6 times higher than Vanguard's. I believe the minimum investment requirements were lower for AARP than for Vanguard, which could make the AARP funds a better deal for very small investors. But for a typical person, AARP's fees were definitdely higher than Vanguard's. Over long periods, this can make a big difference in what you end up with.

Annual fees on sample of 9 similar mutual funds (as percentage of fund assets) as of April 2005.







Tax Free Money Fund


Tax-Exempt Money Market Fund


US Treasury Money Fund


Treasury Money Market Fund


S&P 500 Index Fund


500 Index Fund Investor Shares


Emerging Markets Growth Fund


International Explorer Fund


Global Discovery Fund


Global Equity Fund


Balanced Fund




Global Fund


Global Equity Fund


Small Cap Growth


Explorer Fund Investor Shares


Development Fund


U.S. Growth Fund Investor Shares


I believe AARP has changed its co-branding from Kemper to another company and its current fees appear more reasonable. The net admin cost for each of the three stock funds is 50 basis points. Each fund is composed of index funds of domestic and international stocks and corporate bonds. AARP's aggressive mutual fund is similar to Vanguard's LifeStrategy Moderate Growth, which carries an annual administrative cost of 23 basis points. However, the $3,000 minimum investment for Vanguard is higher than for AARP's fund, where the minimum is only $100. That said, if you have more than $3,000 – and I'd guess that most AARP members would – then it's not clear that AARP's funds offer better value than you'd get from Vanguard or some alternate provider. The lesson: shop around.

One final note: you could argue that while you'd pay more for an AARP mutual fund than from some other companies, AARP takes that extra money and puts it to good use through its policy advocacy and services to seniors. However, you'd still come out ahead if you bought the cheapest mutual fund available then donated the savings to the AARP Foundation, for which you would receive a charitable tax deduction.


Anonymous said...

Why does being a hypocrite mean you are wrong? maybe because they are greedy bastards they realize just how greedy the bastards who run your private accounts will be.

More insight, less hackery, please

Andrew G. Biggs said...

Anon: For some reason, I don't find your comment particularly persuasive.

But if you want more insight, how about this: AARP charges an average of 50 basis points administrative charge for their mutual funds, which (apparently) many people willingly pay. The average administrative charge for mutual funds is even higher than that; I believe it's around 150 basis point. It's a little hard to argue that a 30 basis point admin charge for a personal account is excessive when millions of investors happily pay multiples of that for mutual funds. If 30 basis points is too much, what would be the right compensation for the service provided?

Anonymous said...

How about the fact that to do a true comparison between fund families you have to keep them the "same". AARP's funds now are Fund of Funds with a total cost of .50 basis points. Compare that to other Fund of Funds and you'll get a much higher cost across the board than .50 basis points all in.

You also forget to mention that it includes auto rebalancing - no small account fee - which most big shops have as well as salaried professional advisors - who don't work on commission. Lastly, check out performance more than expenses...because over time performance and return on your money is more important than expenses...i'll gladly pay more if you'll pay me back more than the other folks "supposedly" charging less.

Please don't argue with me about funds as I have worked in the fund industry for more than 20 years at many different fund shops.

Tell the whole story...
By the the research a great many - millions of our seniors are not in a position to invest thousands of dollars..

Andrew G. Biggs said...

The point of searching out comparable funds was to do exactly what you suggest. The Vanguard Fund I linked to is also a fund of funds, made up of several of their index funds. It's also auto-balanced. In terms of fund allocation, it's very close to AARP's and would have similar performance. The only difference I can see is the minimum investment and the fees. If you're in a position to make a $3,000 investment with Vanguard, which I expect most AARP members could (they're older and better off than average) then the Vanguard fund seems an unequivocally better deal.

Anonymous said...

No offense but your wrong. Again, it has to do with performance not fees.

Vanguard Fund of Fund Lifestyle is down -24.75 year to date through December 1st. The AARP Conservative Fund is down -11.81 during the same time period. They both claim to have 75/25 in equity verse bonds...but both have the ability to "change" allocation upon their judgement. Again, i reinformce fees are completely overrated...tell me what you've made for me...again...I'll pay 200 basis points if you outperform by 300.

Anonymous said...

the ticker for the comparative vanguard i quoted above is vscgx - morningstar and others put this fund in the same "category" as the aarp conservative fund.

Andrew G. Biggs said...

Anon: You may be right that Vanguard's conservative growth fund matches AARP's aggressive stock fund more closely in its asset allocation. But in the context of index funds, which both AARP's fund and the Vanguard funds are composed of, fees matter much more because there's very little in the way of active management. Can AARP or Vanguard alter the composition of the mutual fund? Sure. But are they likely to? Not very. In which case, fees matter a lot.

Anonymous said...

I gave you the returns for the AARP Conservative Fund and it's competitor in the Vanguard's conservative Fund of Fund. It's apples to apples.

Explain to me how you think that additional .25% of fees is incrementally that much more detrimental than a return of -24.75 verse -11.81 during the same time period. I'll make it easier....Which fund would you have rather been in during the past 11 months? -

Anonymous said...

One other thing to think there has been a significant amount of articles recently about how "Conservative" fund or funds in general identifying themselves as something and truly not being the in the Vanguard Conservative Fund - it has a much higher equity exposure than some of it competitors so - it has suffered tremondously more (return vs. AARP Conservative Fund) than most "Conservative" investors should have. This is the same cateogry that the majority of AARP members should be in...conservative...i doubt you would find many that suggest a loss of -25% through december is conservative..

Andrew G. Biggs said...

Comparing this year's returns is silly, since the returns are purely a function of the asset allocation. In other words, let's say I found a Vanguard fund with exactly the same asset allocation as AARP's. In that case, the net return would have been 0.26% higher this year and every year. The point of my post was to find roughly comparable funds and then compare the fees. Moreover, returns in any given year aren't very significant since they're one draw out of many. If all you care about is returns, then the average return on Vanguard's fund is surely higher than AARP's since it's more stock heavy. But again, that wasn't the point. But since I suspect you're missing the point I made, I think I'll call it a day here.

Anonymous said...

Your wrong and your missing my point --- on a 10,000 investment the difference between the 2 funds YOU mention is 26 bucks.

My point is that your comparing expenses between 2 funds and I'm saying that if your going to do that then compare the returns of the funds as well - don't take your analysis half way. Compare expenses and then compare performance of the funds your are mentioning. But as i suspect you are missing my point.

Anonymous said...

I'm wife anon - no two funds are managed exactly the same andrew. I dare you to find funds that are managed identical...they don't exist. Some rebalance monthly, some bi monthly, some decide not to depending on the market - some have small bets(becuase they are allowed to) in different investments to try and raise their returns. Some could go totally defensive and go all cash. The point, I suspect, that anon is trying to make is that no two funds are the same and the returns are at least a point of comparison to use when comparing funds...fees are baked into those returns.

Just one man's opinion.

Anonymous said...

Sorry....I'm "with" anon. little slip there with the mind.

Anonymous said...

How did the AARP Funds do at their 3 year track record and ranking from Morningstar? I'll help...5 stars across the board...ask the folks that paid 26 dollars per year less in expenses for the vangard competitor fund and see if they would have preferred to be in the AARP funds instead of the vangard one over the past 3 years?

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