Wednesday, December 30, 2009

Can 2010 be Better?

2010 will be the year of stabilization. A year where, if you have a job, you will probably still be working at the beginning of 2011 and if you are not, you may find employment; one where if you are prudent (and by that I mean not-so-conservative but cautious), you will find the equity markets still performing better (but not better than expected); one where we have learned lessons that should not be soon forgotten.

Read the full article from Paul Petillo, Managing Editor of Target here.

Thursday, December 17, 2009

When the 401k is Not an Option

Some of us may be entering a new job that does not have a 401k or has one that you do not feel is as good as the one you just left. And your employer won't let you keep your money where it was. What to do?

Rolling your 401k into an IRA is another matter. This is for the investor who has some concept of what lies before them. If I were to guess, this type of investor has had an active roll in how their former employer's 401k was allocated. They paid close attention to diversity, perhaps even following conventional wisdom of limiting risk as they aged.

For this retirement investor, the IRA rollover is viable option. It allows closer control of how this money is invested with a variety of considerations weighed with each decision. Not only will this investor spread their allocation over a number of funds, they will do so with an eye on fees and expenses, a consideration of performance of the fund under both good and adverse conditions, and clearheaded understanding of the risks involved.

IRAs cannot be borrowed against and restrict a penalty-free withdrawal of money before 59 1/2 years old. But the choices are the primary attraction. This investor knows, and you should as well, the risks of building a successful IRA portfolio also increase. The biggest concern is investments that crossover.

What 401k plans are supposed to do is provide the investor with a fiduciary responsibility to provide the right tools for their employees. You, as an IRA investor are on your own.

You must monitor the funds you invested in for a change in investment strategy, style drift (when a fund manager invests on the edges of what s/he was hired to do; such as when they invest in large-caps when mid-caps are the focus), and an increase in turnover (a cost for trading repeatedly that the shareholder pays for directly, often done in an attempt to boost returns in the short-term, like at the quarter's end). You bear the burden of this responsibility to your future.

The terms of disbursement are spelled out when you leave the job in the 402(f) notice. This explains your options for handling a 401k disbursement. Even if you want to stay, your old employer really doesn't want the continued burden.

Bottom Line: Once you receive that 402(f), begin to research your options. And even if you think that money will come in handy, never take the cash.

Paul Petillo is the Managing Editor of

Wednesday, December 16, 2009

What to do with a 401k from an Old Job?

Some of us may be entering a new job that does not have a 401k or has one that you do not feel is as good as the one you just left. And your employer won't let you keep your money where it was. What to do?

Rolling your 401k into an IRA is different that moving it to a new employer's 401k. In fact, it is wholly another matter. Given the option, keep the money in a 401k. But some of you will want to venture forth on your own even if your employer has a plan in place you could have used.

This is for the investor who has some concept of what lies before them. If I were to guess, this type of investor has had an active roll in how their former employer's 401k was allocated. They paid close attention to diversity, perhaps even following conventional wisdom of limiting risk as they aged.

For this retirement investor, the IRA rollover is viable option. It allows closer control of how this money is invested with a variety of considerations weighed with each decision. Not only will this investor spread their allocation over a number of funds, they will do so with an eye on fees and expenses, a consideration of performance of the fund under both good and adverse conditions, and clearheaded understanding of the risks involved.

IRAs cannot be borrowed against and restrict a penalty-free withdrawal of money before 59 1/2 years old. But the choices are the primary attraction. This investor knows, and you should as well, the risks of building a successful IRA portfolio also increase. The biggest concern is investments that crossover.

What 401k plans are supposed to do is provide the investor with a fiduciary responsibility to provide the right tools for their employees. You, as an IRA investor are on your own.

You must monitor the funds you invested in for a change in investment strategy, style drift (when a fund manager invests on the edges of what s/he was hired to do; such as when they invest in large-caps when mid-caps are the focus), and an increase in turnover (a cost for trading repeatedly that the shareholder pays for directly, often done in an attempt to boost returns in the short-term, like at the quarter's end). You bear the burden of this responsibility to your future.

The terms of disbursement are spelled out when you leave the job in the 402(f) notice. This explains your options for handling a 401k disbursement. Even if you want to stay, your old employer really doesn't want the continued burden.

Bottom Line: Once you receive that 402(f), begin to research your options. And even if you think that money will come in handy, never take the cash.

Paul Petillo is the Managing Editor of

Tuesday, December 15, 2009

Job Separation Investing

Keeping the money in a 401k has its advantages. For older workers, the ability to begin disbursement at age 55 is an attractive plus. Although it is generally ill-advised under almost every circumstance, keeping the money in the 401k retains your ability to borrow from the plan. Some of us will consider keeping this option open. It's an option albeit, not a good one.

Generally, the fees are better in a 401k. Institutions may get a much better deal from the plan sponsor and consideration of this is important in the rollover decision. A much larger plan may come with more options or simply less expensive ones. Fees are an important aspect of total return and a worthwhile item to focus on when making any decision to move.

But you may not have an option if the balance is less than $5,000. This means you are faced with the choice of taking the cash in the account (along with the 20% the account must hold for income taxes and the 10% penalty). The scariest statistic, two-thirds of you take the money and pay those hefty penalties.

The terms of disbursement are spelled out when you leave the job in the 402(f) notice. This explains your options for handling a 401k disbursement. Even if you want to stay, your old employer really doesn't want the continued burden.

Bottom Line: Once you receive that 402(f), begin to research your options. And even if you think that money will come in handy, never take the cash.

Next: rolling to an IRA.

Paul Petillo is the Managing Editor of

Friday, December 11, 2009

Dividends in Mutual Funds

We have been discussing dividends with Paul Petillo, a regular contributor on MomsMakingaMillion Radio for the last several weeks. As we continue or series, we have five questions:
Could you recap briefly for our listeners what we have already discussed?

Our discussion about dividends has offered a brief overview of what they are: profits paid back to the shareholder of record, and how you can buy them directly: through direct stock purchase of through dividend reinvestment plans or DRIPs. By far, the easiest way to take advantage of what these companies offer shareholders is to spread the risk and the time you might take looking for them by using mutual funds.

When we look at mutual funds that pay dividends, what are we looking for exactly?

This group of mutual funds is often referred to as 'equity income'. They are stocks that provide income and fund managers in this space are looking for good stocks selling for less than what they perceive which means they are hunting for value and stocks that pay a dividend. Keep in mind, this was much easier to do just a few short years ago.

Why is that?

There was a tax advantage to these types of funds and in the pre-bailout economy, many companies were increasing their dividends because of it. Since then, many companies, particularly those with a financial component (like GE and GM) or businesses focused on the financial sector (such as Citigroup) have either suspended or reduced their dividend in response to those changes in fortune. Currently, there are about 296 stocks that pay a dividend of some sort. In fact, holding an S&P 500 index fund will net you a dividend yield of about 2.5%. That 2.5% is what equity income funds use as the number to beat.

Are all dividend paying stocks the same?

Not at all. There is a term for it: dividend payout ratio. In the thirties, this ratio was about 90% - that's roughly ninety cents for every dollar made was given to shareholders. Now it is about 30% or less. This is a good rule of thumb for investors. If your stock is paying more than 30% of their profits back to shareholders, this might be a sign of trouble (if you consider that this percentage has gone up while the share price, a vote of investor confidence has gone down). If it is paying less the 30%, the company might be overvalued by the markets or simply in too much trouble to pay enough of the profits to shareholders.

Any last thoughts?

Keep in mind that dividends are backward looking, reflecting profits from the past year. If companies cut their dividends because profits were down, raising or reinstating them might not happen until next year. A lot of companies are going to buy back shares of their own businesses in large part because they are still cheap and because doing so, increases the price of the stock by making less shares available.

Look for companies that have been able to increase dividends over a long period of time (like McDonalds (dividend payout ratio: 52%), Pepsi (dividend payout ratio: 54%), Kimberly-Clark (dividend payout ratio: 55%) or a mutual fund that has beaten the S&P500 average payout of 2.5% (Columbia Dividend Income 2.47%, Nicholas Equity Income, yield 3.12%)

Paul Petillo is the Managing Editor of

Thursday, December 10, 2009

Retirement Planning: Where the Best 401k Plans Work

In a previous post, we introduced a rating system for your 401(k) offered by Brightscope. Now, they are offering a look at the best 401(k) plans.

Does your plan work as hard as you do?

The Top 30 401(k) plans as rated by Brightscope.

Paul Petillo is the Managing Editor of

Saturday, December 5, 2009

One the Edge of Losing Ground: Bankruptcy

The latest employment numbers are showing a slight increase in jobs. That's small comfort for the enormous group of folks who are still unemployed.

With over ten percent of us out of work, another eight percent of us no longer bothering and an estimated twenty percent of us contemplating the possibility that we might lose everything we have worked so hard for, the subject of who owns what as we consider our options in an economy that doesn't seem to be recovering fast enough to suit most of, the question of your 401(k) as part of a bankruptcy is worth asking.

The choice of bankruptcy is always the last option. When you consider this option, you will find your assets under the control of the bankruptcy estate while your case is pending. You still own these assets. Your home is protected providing you can make the payments and if your home is worth more than your mortgage, the bankruptcy estate will exclude up to $37,500 in equity from consideration. The same applies to any equity you might have in your car.

The concept for exempting these two items is relatively straightforward. How could you possibly hope to recover from bankruptcy if you were stripped of these items? Understanding the need for shelter and transportation is important. But does the most valuable asset protecting your future fall under the same consideration?

Although you will need a bankruptcy attorney to guide you through the maze of rules, the focus of such an action is to come to some sort of agreement with your creditors on how you will repay what you owe. In some instances, it might be the forgiveness of your interest obligation in favor of satisfying the debt. Repayments plans and schedules are worked out and as long as you follow those obligations, you can remain under the roof that you own and be able to get to and from work.

The question of your 401(k) however is not so clear-cut. And the answer depends on ERISA qualifications. Section 541(c)(2) of the Bankruptcy Code. Section 541(c)(2) provides: “A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable law is enforceable in a case under the Bankruptcy Code.”

This means that your 401(k) is safe from the actions of bankruptcy court and cannot be considered when determining the value of the estate. If you plan falls under ERISA protection, and generally this qualification applies to most larger company plans, your assets are safe. The exception however, effects the smaller business owner.

Among the exceptions to this rule is a retirement plans that has only one participant, such as single employee corporate plans, and some other plans originating in self employment. These plans may be property of the estate. They may be vulnerable to creditors. When you consider the number of small businesses affected by the economic downturn, this is an important exemption.

For those of you who do have a plan that is exempt, the ownership of this property has found its way to the US Appeals Court. The question posed by the case dealt with the loan that was borrowed from a 401(k). Although the person was obligated to pay back the loan, the loan payment was questioned.

Chapter 7 bankruptcy subjects the estate in question to a means test. This sorts out what is qualified and what is not in terms of "necessary expenses". The loan repayment to the 401(k) was challenged. The court, ruling in the case of Egjebjerg v. Anderson found that the repayment to the 401(k) was the same as a contribution to that person's plan. In other words, if you loan money to yourself, the repayment of that loan is not considered a debt under the law.

The plan has not right to sue for repayment of the 401(k) loan but can, according to the court, offset the loan against future benefits. But the court that while Chapter 7 proceedings did not cover the individual, Chapter 13 would consider the repayment as part of the debt owed. This subtle difference is important and makes the consideration of good representation a must for anyone considering such a drastic move.

It is important to consider all of your options before subjecting your finances to estate scrutiny. And secondly, borrowing from your 401(k) is still a bad idea. In a Chapter 7 proceeding, the losses to that important linger far into the future. And while Chapter 13, often referred to as the wage-earners plan, does allow for the repayment of that loan under the court's approved structure, the loss of earnings in the retirement plan will have lingering effects long after you emerge, finances revitalized.

Paul Petillo is the Managing Editor of

Monday, November 23, 2009

Yet Another Spotlight on Your Retirement Plan

A short while back, I wrote about a company that uses a series of benchmarks and mathematical equations to determine whether your 401(k) plan is doing what it should. Brightscope's product was designed to help plan sponsors find the problems in their plans and make an effort to correct them. As noble as that effort may be, the hurdles are numerous for plan participants to get their companies to make the necessary changes to their plans.

Now we have another entrant to the market place, this one offering the plan sponsor a look a their employee's retirement readiness. Fiduciary Benchmarks, based in Kansas will provide a snapshot look at a company's plan and the chances that their employee will arrive at retirement with enough cash to be considered adequate.

Using 100% as the retirement readiness benchmark, a number that represents different things to different income groups, the report, provided free in brief and at the cost of $100 for more detailed analysis looks at the average employee. From there, the report then analyzes various pathways that employee can take, and if they did, how well the plan allowed them to reach the optimum amount in their retirement accounts.

In a downloadable pdf, they suggest that a person earning $20,000 a year will need 94% of their pre-retirement income to survive. Although the plan does take into account conservative longevity predictions and the available investments in the plan, it does not look at the statistics for this particular group and their overdependence on Social Security benefits.

Their benchmark also suggests that someone earning three times that amount would need only 78% of their working income to hit the 100% mark in the company's index. Some industries fair much better than others. But this is not reflective of the whole of the employees in the plan, simply what the plan may do for you should you use it to its fullest.

And therein lies the rub. Most employees, no matter how good the plan, do not max out their retirement contribution, leaving them with a huge gap in what they will need and what they enter retirement with. Without full participation, there is little another tool for plan sponsors can do. The vast majority of plans are adequate even if they fall short on the educational side.

While there is emphasis on educating the participant through education of the plan sponsor, it is beginning to seem a little overdone, even as this type of spotlight is still in its infancy. Most employees wonder why their plans weren't improved sooner. And still more see the incremental improvements as a way to sustain the current level of contribution rather than an enticement to increase it.

The real improvement will come from the IRS. Once they fix the expected tax rate for retiree's plans when disbursement begins, and not leave the rate the big unknown, employees will see the future through a much clearer light. Not having any idea what those future taxes will be make it difficult to determine how much will be enough.

Thursday, November 19, 2009

Retirement Planning: Vacation Time and No Money?

We have found that 2009 was not so kind to those investing in their 401(k). Employers have reduced or eliminated their matching contribution and many recent surveys have suggested that this will be slow to return. What was once considered the competitive lure for many employees has no simply become a sidebar in the search for a job. For many, and employers know this all too well, just landing employment is benefit enough.

But what about those who already have a job? What if you are a long-term employee? Many of us, as we have noted numerous times in this blog (post about matchless strategies) and on, have taken the wrong path when confronted with this issue. Far too many of us reduced our contribution to our defined contribution plans when this occurred. Some have even determined that if the employer doesn't match, you shouldn't contribute either. And just as bad for your retirement future, you did nothing to help make up for that plan shortfall.

As we have noted, the best way to make up for this decrease in contribution is to increase the one you are making. For older workers, the higher salary they receive may make this possible. For younger workers, the decision becomes one of increased frugality, living well within their means and doing without some of the luxuries they may have built into their budget. If your employer contributed 3% and you contributed enough to make the match effective, your best move is to make up for the employer's shortfall.

Yet, there may be another way that your employer might be willing to allow. In an effort to get more people contributing more to these all-important accounts, the Obama administration has allowed retirement investors the option of rolling unused vacation pay or accrued sick pay into their plans.

This past year may have seen an increased workload at your job because of employee cut-backs. This may have forced you to defer a much needed vacation in favor of staying right where you were. Fear of seeming dispensable at a critical time, even though the need for vacation has been proven the best way to increase productivity. But this leaves you with an account full of unused vacation time.

Contributing this sort of payment to your 401(k) requires your employer to make some changes to their plan. Even as some have reduced the availability of their matching contributions, some have added this provision to their plans to allow exiting employees to have their unpaid time put into their 401(k) plan prior to rollovers and to allow those who did not use what they had, to use the time to contribute to existing accounts. The later can only be done if you have not maxed out your account (currently at $16,500 for those under 50 and $20,000 for those over that age).

Companies may find this incentive very alluring. Not only does it make them slightly more competitive (for one, employees are on the job more throughout the year) but it offer the illusion of a benefit increase without the actual pay increase.

If your company currently does offer this or is considering it, keep in mind that it will not come with or apply to any matching benefits the company offers. And they may also see it as a temporary offering rather than a fixed part of the plan. The only thing that is certain is the option must be nondiscriminatory.

Tuesday, November 17, 2009

Retirement Planning: The Dividend Difference

This week on MomsMakingaMillion Talk Radio we are discussing the art of dividend investing.

So what are dividends?
When a company makes a profit there are basically three things that can be done. Some reinvest it, which is what newer companies or growth companies do. They take those profits and channel them back into the company in the form of research or simply hold the cash for future mergers and acquisitions. Some companies use the money to buy back their own shares. This happens when the company realizes that its share price is below what they think it should be. Some use the cash to clear up their balance sheets by buying down their debt exposure. Others share it with the shareholders.

These are all good things to do with the cash they have made but nothing benefits the shareholder over the long run better than dividends do. Why is that?
Dividends are old school. I wasn't that long ago that Wall Street considered the act of dividends the most important aspect of an investment. Now we can look to dividends for one thing: to increase our wealth.

How often do companies pay their shareholders?
Dividends are decided by the board of directors. Then they set a declaration date, which is the day the dividend payment to shareholders becomes a liability on the company's books. This is followed by the shareholder of record date. If you are holding the stock on that date, you receive the payment. They refer to this point in time as the ex-dividend price for the stock. If you buy the stock before the dividend is paid, you get the dividend. But be careful, a company considers the shareholder of record a person who owns the stock four days before the dividend is actually issued. Buying a stock in this four day period means you will not get the dividend; the person who sold it to you will. And the other important date in this process is when the company actually pays you.

Do they always pay cash?
This is the most common way of doing it. A company will declare a dividend and that amount usually is split among four quarters. So if the business offers you a dollar dividend, each quarter you would receive 25 cents for each share you own. Sometimes they offer a one time special dividend which is a lump sum payment with no other date specified when they will do this again.

What do investors need to keep in mind when buying dividend paying stocks?
Three thing investors can keep in mind when looking a dividend paying stocks: they are less volatile because the companies who pay them tend to be far more stable in terms of share price than other companies, they outperform non-paying dividend companies by almost 3%, and the are easily reinvested providing the investor with additional opportunity to buy more stock which means more dividends.

Monday, November 16, 2009

Retirement Planning: It is Never Too Late to Start Investing

Chances are, the lesser your wage will working, the more dependent you will be on Social Security when you retire. While at first glance this might seem a sad state of affairs in terms of a retirement plan, it is not beyond your abilities to change this outcome before you retire. If you are aged 50-years, the ability to put together a viable plan is doubly difficult. But, even considering that, it is not impossible.

Several things need to be adjusted prior to that arbitrary date.

Retire when you can
Most of us have not been very successful with our retirement planning. We have begun late in many instances and have failed to utilize our options to the fullest. Many of us have not used these plans long enough to see the benefits. Long-term investing still needs thirty years or longer to work. The vast majority who have plans have used them less than 16 years.

During this time frame, often thrust upon us as your company changed from a pension plan to a 401(k) or you changed jobs repeatedly during that period, we experienced the shock of having to educate ourselves about what our options were and then set a plan that was previously managed for us to one that was defined by us.

For numerous folks, this meant doing the wrong thing first, then, as time passed, correcting those mistakes.

Default Investing
Up until several years ago, the default investment in your 401(k) could have been anything from a simple index fund to a money market account. The later simply parked your money, and while you never lost any of it, you never were able to take advantage of market ups and downs.

Now, new employees will be defaulted into target date funds (pick a retirement year or have one picked for you). And some, after the debacle that was 2008, have switched their retirement money to just such a fund in the hopes of recovering enough invested dollars to regain some of what you may have lost and preserve what was left.

The jury is still out on whether these funds will provide what you need to get where they say they will take you. Target date funds are navigating uncharted waters with a promise to do what never has been attempted. Unlike balanced funds (usually offering a 60/40 split between stocks and bonds), target date funds re-allocate your investment over time moving from more aggressive to less with the idea that this will protect your investment over time.

Over 50 Dilemma
If you are over 50, this strategy may prove to be the wrong one. In most cases, you are entering your largest income producing years. If you are contributing more as you earn more, you may be leaving a great deal of potential on the table as these funds try and protect those invested dollars instead of growing them.

While stocks are considered risky in this period, they should not be ignored. The best structured retirement plan will separate your investments into categories. If you are currently contributing 6% of your pre-tax income to your retirement plan (and this is not enough), you need to increase that amount to the point of causing you to rethink your daily budget needs.

Each pay raise should signal an increase in contributions. And each increase should go to a more conservative investment while leaving the initial 6% fully invested in stocks. This sort of self allocation will give some risk for old money invested and less risk for new. Shifting to a target date fund does not allow for this, taking much of the potential for risk off the table.

When and How
If you can wait to take a distribution from your 401(k), it will allow it to grow further. To do this, you will need to enter retirement without a mortgage, with your financial house in order (this means adequate savings, only the minimum in credit card debt and the all important emergency account). Your expenses will not decrease in retirement. The cost of maintaining insurances as well as your property will not go away. Your health could prove to be a factor as well and should be accounted for (and worked on while you are still employed) before you retire.

Many of these costs rely on projections. While these are difficult to make with any accuracy, they are not impossible to plan for. Inflation will increase by about 3% suggesting that each year, your expenses will go up, even the fixed ones (because inflation makes your dollar worth less). Insurances might increase on average 5-10%. And taxes will depend on how much income you have but basing your projections on current income rates might prove foolhardy. Add an estimated increase of 3% per year (this includes property taxes as well).

Arriving at retirement with any outstanding debt means one thing: you will have to continue to work just to keep up with the increases. The other option, of course, is to get used to these financial burdens while you are still working. Living a little bit more frugally now will offer you the opportunity to experience what life post-work will be like.

So the three basic tenets of investing apply: get your financial house in order, channel as much money as is possible into your retirement plan (without increasing the risk of creating more debt as you scrimp) and take some risks with your invested dollars. The first tow will offset any problems you might face with the last suggestion and allow your invested dollars to do some work that too conservative approach will not permit.

It's not too late. But the strategies are different.

Thursday, November 12, 2009

Matchless Strategies

For many us, the employer match to our 401(k) plans has gone, or in some cases reduced to a mere shadow of its former generosity. They are expected to return but it will take years before they return to their former levels - if they ever do.

This presents the person planning for retirement (perhaps predicting a retirement income would be a better description) with a dilemma. They are at first troubled by their own human nature.

Many of us have never made the attempt to increase our contribution to make up for the shortfall. Few of us max out these accounts, relying in the employer's match to give us three, possibly more, percentage points of pre-tax income contribution. If your employer stopped putting 3% (of free money) into your account, you risk missing your projections by up to $100,000 over a thirty year career.

To make up for this shortfall, we will need to increase our contribution by at least this much. In the short-term, this will mean taking home less. If your partner has a plan that continues to match, be sure they are contributing enough to receive it.

One or both of you could make up the increase by dividing the increased contribution. This might have a less of an impact on your take home pay.

This can also be done gradually, increasing your contrbution as you receive pay raises or bonuses (using them to offset any yearly income decrease as a result of your increased contribution). But it shouldn't be ignored.

This might also mean adopting increased exposure to more risky investment strategies. Many people are using a far-too conservative approach to their investments for retirement and often too soon. As I said "more risky". Adding a more aggressive fund or two and using the increased contribution to fund it might be the best option to recovering that lost ground quicker. Not always but in the long-term, it might be a risk worth considering.

And while you are making sacrifices, something that everyone seems resigned to do, start getting your financial house in order. A pay decrease shouldn't extend your credit balances on penny. In fact, a little austerity now could go a long way just ten-years down the road. Prepare your entire liability plan to be eliminated by the time you retire. A 30-year mortgage with fifteen viable work years left spells trouble in retirement.

I'm not saying there won't be debt scenarios that are unavoidable, but a mortgage shouldn't be one of them - and neither should outstanding credit debt. With no clear and concise picture of the cost of health care, the ability of Social Security to pay you what you think you have coming, and the performance of that 401(k) as you near retirement, carrying debt in light of this cloudy future can be the storm you were unprepared to deal with.

Tuesday, November 10, 2009

Is Roth IRA Investing Different?

Where to put your retirement money is always a problem. There is allocation, diversification and risk to consider. Expenses and fees, performance and tenure also come into play. If that is the case, is investing with a Roth IRA that much different than with a Traditional IRA?

Yes and No.

In a traditional IRA, the money you invest is done so on a tax deferred basis. Money you invest in a Roth IRA has been taxed, leaving only your earnings on those investments taxable at the date of your retirement. Because you paid taxes on the money you have put in, it is essentially yours to remove at any time. But once you do, although you will not face the tax or penalties associated with withdrawing invested dollars from a Traditional IRA, it still hampers the overall investment.

In both plans, the money is set aside (invested) for the future. It is not meant to be taken out before you retire - for any reason. Doing so will take potential growth off the table and this will change any projections you may have made based on assumed growth and potential retirement distributions, no matter how small.

The inside workings of these two types of IRAs is essentially the same. Although Roth 401(k) plans have surfaced recently, Roth IRAs have gained acceptance as a way for folks to continue to invest for their future in lieu of pensions and 401(k) plans. This makes the Roth IRA perfect for the investor who has maxed out every other form of tax-deferred investment.

Which makes the Roth IRA not so ideal for those looking to pay less taxes now by deferring those taxes until a time when their income will be less (most retirement planners will point to an annual income post-work of 75% of your current/future earnings as a benchmark for your retirement plan's success). Using a Roth may seem attractive at first glance, but unless you are swimming in invest-able dollars, it might be wise to keep the tax deferred plans fully funded first.

If you have, your current fund family, broker or bank will be a good first place to look. If you do, you should have a working knowledge of how to solve those nagging allocation and diversification problems (be careful to avoid buying funds that have similar investment goals in both your Traditional IRA and your Roth IRA - although they seem different, they still belong to you), fund expenses and fees (I'm assuming that if you have already committed to a group of funds in your tax-deferred accounts, they are already inexpensive compared to their peer group and in some instances, to the benchmark) and the overall performance of the offerings (look long-term, preferably longer than five years).

Once that is accomplished, you can invest in a Roth IRA with exactly the same discipline you would any other investment. You should understand your objectives, have a relatively decent grasp on your own investing behaviors and tolerance for risk, and do so with an eye on investing as inexpensively as possible.

Paul Petillo is the Managing Editor of

Monday, November 9, 2009

Retirement Planning: Rollovers and Other 401(k) Considerations

While the 401(k) plan you have access to at your place of employment is a a "better-than-nothing" retirement plan doesn't mean that you should ignore the benefits of investing for your future.

There are three basic problems with the retirement plan (and how you use it) known as the 401(k). You can read the full article here.

What to keep in mind about your 401(k) plan and rollovers:

If you have a 401(k) plan use it and if possible, use it to its fullest.

Get your financial house in order while you are working, especially if you have only been in your 401(k) plan for less than fifteen years.

Rollover your old 401(k) into a Traditional IRA within 60 days and be careful with the paperwork.

If you have more money to invest, open a Roth as well.

Thursday, November 5, 2009

Five 401k Questions

On Friday 11.06.09, I will be talking with Gina and Kat about 401(k)s on their popular radio show MomsMakingaMillion. Here is a glimpse of what we will be discussing about your defined contribution retirement plan.

"So you're looking at your 401(k) and suppose its just average. Not too large and not too small. Can you pick too many funds?"

Five would be about the optimum number to own. Because you have to begin somewhere, most of us opt for the index fund that tracks the 500 largest companies. This is good first choice and if the 401(k) is really small, a decent only choice.

To read the full article about how to build a 401k from scratch...

Wednesday, November 4, 2009

A Fiduciary Duty with Respect: Retiring with a Plan

Buried inside many 401(k) plans are fees charged by the plan sponsor that are often in addition to what many would consider the transparent information available. These fees are not often known to the 401(k) investor at a glance.

Fiduciary responsibility remains a difficult ideal to litigate. "Captive" investors may simply have to deal with higher fees in the short-term until there is some ruling supporting comparisons. Or, as many in the investment community hope, the markets will return and these concerned investors will simply forget how much they could have made with lower fees as higher return offset the losses.

Paul Petillo's full article on fiduciary responsibility can be found here.

Monday, November 2, 2009

Lower Bar Means Easier Results

If you were to open your third quarter 401(k) statements, and I hope that you do, you will find that your balance in your retirement plans has jumped significantly from its lows from the year ending 2008. This would, to the untrained eye, point to a recovery led by the stock market.

And the stock market has recovered - to a degree. Yet, expecting this to reflect into the economy that we experience day in and day out, is not there. And may not be for months. Why is this? The full article can be found here.

Paul Petillo is the Managing Editor of the

Monday, October 26, 2009

A Scary Halloween Retirement

Halloween is a something different for everyone and holds a fascination for most of us. In fact, Halloween might just be the best holiday to describe your retirement plan. A little scary, a little frightening, unknown dangers and hidden surprises and whatever is at the end of the darkened tunnel might just scare us more than we had imagined.

Retirement planning has become a very much a trick or treat landscape to navigate. Numerous products will be found in your 401(k) plans in the near future that might not prove to be the best solution for the investment dilemma your retirement accounts are in. And with Halloween just around the corner, perhaps we should look at some of the treats in your bag.

This is retirement planning the likes of what you may not have anticipated. Trick or Treat Retirement Planners!

Retirement Planning: Looking for that Moment

So How Much is Retirement Going to Cost?
Attempting to predict what your future needs in retirement will be is as easy as looking at your current spending and debts. How much of those bills will you be carrying into those golden years?

If you look at your retirement plan as a risky undertaking, something you can orchestrate to be in the right place at the right time - or better, diversified enough that no one place hurts the whole of your investment plan - then you will find yourself looking to stocks as a greater portion of your portfolio.

If you still want to add a conservative element to your plan, I suggest that any new investment contribution should be directed towards that, a move preferable to diverting funds away from another investment. The key isn't increased risk, it is maintaining levels of risk that allow portfolio growth and it is increased contributions.

More on this article from Paul Petillo, Managing Editor, can be found here

Friday, October 23, 2009

The Index Fund Conundrum Inside Your 401(k)

I do a popular radio show every Friday morning with Gina and Kat on MomsMakingaMillion. Each week, the topic progresses a little closer to a full understanding about your 401(k) – if that could ever fully happen!

This week, the ladies asked me: You talked about the risk of too little risk last week. This week I understand you want to take a look inside a 401(k) plan. A friend of yours was having a problem.

Yes we did discuss risk and the risk of too little risk. But the real risk might be lurking not in how you invest but in where you put your money in your 401(k). In fact, what your plan offers may be so limited that your choices boil down to good and not-so-good.

Let’s start with this: Most common, garden variety 401(k) plans offer index funds, lifecycle funds and if you are fortunate, actively managed funds. Plans can be big and small with thousands of options or just a few.

Life cycle funds represent a group of offerings focused on a particular target year that you would like to retire. These are essentially actively managed funds that shift, at least in theory, from aggressive to conservative investments over the course of your career.

Actively managed funds tend to pick a sector, such as large-cap stocks, and focus their investment prowess to the best possible return.

Index funds are designed to track an index of stocks (or bonds), ranging from the top 500 companies to indexes that track the smallest.

But before I tell you about how index funds can differ (which might seem odd, considering an index fund essentially attempts to mimic the published index) I want to talk about a person who wrote me last week. Although her email sounded panicked, she knew that there was little she could do about what her 401(k) plan was doing to her portfolio.

She told me she had chosen four funds in her 410(k) to invest in, the bulk of which was directed towards a small cap index and a mid-cap index run by Merrill Lynch. She believed, and rightly so, that this would be where the recovery would take place. These funds had always done well she told me, and when the markets turned sour and her funds were brutally beaten down, she kept her investment dollars streaming in.

Because markets do recover and her investments remained consistent, her portfolio value is now within a couple of thousand dollars of her year end balance in 2007.

Her concern was a change her plan sponsor was making in those funds, switching to another group of funds offered by Northern Trust. The reason according to a notice she received from her plan sponsor was the cost of fees.

Focused on Fees
In general, index fees should be as low as possible and here is why.
The idea is simple:
1.There is no trading to be done between the time the index is set and the next time it is adjusted;
2.There are no research fees;
3.And inside your 401(k), there should be no 12b-1 fees (the cost of advertising for new investors paid for by the current investors);
4. And lastly, because the company, in her case it was Kroger, the fiduciary responsibility (what a plan sponsor does is based on the assumption that it is best for the employee's future) demands the best deal.

That would be in a perfect world. Not to pick on her company's plan, but it doesn't fair very well when they are searched for using BrightScope, a retirement plan quantifier (information about their invaluable service can be found here) and this had her worried. Just because she has a plan, doesn't make it the best of all worlds, simply the one she has to live with.

Her plan was shifting her small cap index fund (with an expense ratio of 0.15%) to one that offered to track the same index but at 0.06%. At first glimpse, this seems like a good move. Lower fees are always good. Second glances however show how poorly the new fund offering has done compared to what she had before. Her new fund has a year-to-date performance of 12.52%; her old fund had chalked up a 29.83% return. Year-to-date, the Russell 2000 index of small cap stocks has racked up an impressive 22.43%.

Why would they do this, she asked? Other than being able to suggest that they are trying to do all they should for you, substituting one index for another based simply on fees, there seemed to be no clear answer. It is troublesome to be sure but not uncommon. It is also evidence that not all indexes are created equal or cost the same.

Index funds are subject to all sorts of influences. Fees run the gamut from absurdly low to ridiculously high. There is also the pesky probability of tracking error, a problem some fund managers get into as they try to outperform the benchmark. This tends to increase the expense ratio by forcing more trades and increased research. But it might also allow the index to outperform.

Keep in mind, your index fund does not buy every stock being benchmarked. An S&P 500 index generally has only about 75% of the stocks on the list in the portfolio. How much of each is often the reason for the disparity in returns. A Russell 2000 index fund has only about a third of the companies listed.

Most people think of Vanguard Group when they think of index funds. But their much-touted S&P 500 index fund carries an expense ratio of 0.15%. My friend’s small-cap index fund, the one that did so well, charged her the same as this less risky S&P 500 index fund cost.

Add to that, there is relatively poor information available to her even through her plan. A great many of the funds offered inside your plan are not offered to individual investors making information gathering difficult. Plan information is improving but comparisons are still hard to make. She was more upset that no one asked her if she would like to switch.

Not All Plans are Created Equal
Looking inside your 401(k) is never easy. For Boomers (and anyone focused on retirement), it can be especially difficult. You are torn in many cases between necessary risk and the fear of that risk. Your portfolio may not have recovered as quickly as my friend's did but consider the option of too little risk as one not worth taking.

There are basically only two ways of achieving the goals you may have set. You could increase your risk and/or increase your contribution. If you do the later, you can use the additional funds to purchase something more conservative while leaving your original contributions, the funds directed towards more risk, intact.

You should remember that if your plan offers only index funds and lifecycle funds (target-date funds), chose the index offerings. If your plan offers choices beyond index funds, choose the actively managed funds across a range of disciplines (large-cap, mid-cap, small-cap and international). In some cases, the fees might even be as competitive as the index fund that tracks them.

In the end, my friend did nothing. She had one of those not-so-good plans. Her only option was to increase her contribution to make up for the unrealized returns.

Paul Petillo
Managing Editor/

Thursday, October 22, 2009

Retirement Planning: Your 401(k) and Taxes

Writing for Boomer Retirement, I suggested that there could be some incentives added to the 401(k) plan that would make this all-important retirement vehicle much more attractive to those who under-invest or for those who fail to use their 401(k) at all.

As we all know, 401(k)s are not going away. But it is debatable as to whether this sort of defined contribution plan will be able to exist in the same form it has for almost three decades. Although, if you use it correctly, it can mean a much more secure retirement. So why haven't more people used it?

I suggest that it hasn't been around long enough, not enough people have been exposed to these plans to make the long-term effect work and the incentives are simply too small for the average investor to understand. Read the full article here.

Wednesday, October 21, 2009

Retirement Planning: Is It More Than We Thought?

is the anticipation of retirement clouding your vision? Do you make projections about your 401(k), how much it will be worth and how much of the optimistic balance will be available to spend? Do you know the difference between accumulation and decumultation?

Probably not. Today, writing for the Boomers Retirement blog, I discuss some issues that you may not have known about your retirement forecasts. It is as much about what you enter retirement with (liabilities) as what your 401(k) balance can support.

Read the full article here.

Tuesday, October 20, 2009

Pick Me Up, Dust Me Off: The More Tax Friendly 401(k)

William Bernstein writing for Barron's foresaw the future of the 401(k), this country's most ubiquitous retirement plan. “The 401(k) is likely to turn out to be a defined-chaos retirement plan.” And so it goes. Almost nine years after that comment was penned, the 401(k) has, for the most part, turned out to be a failure for most, a disappointment for some and far too much work for those who use it to its fullest.

This is based on numerous reasons, almost all dealing with our own, largely undefined and for the most part, beyond description approaches to investing. We are all over the place, trying to attach method to our madness and sound reasoning where there is none. This means that there is an investor class and the rest of us.

Unfortunately, we don't have to be exiled to the outside. But keep in mind, despite your best efforts, you will never be completely admitted to this elite group. Don't worry, many of those who are members are there by accident, something time will uncover and because of the nature of the class, they too will be kicked to the sidelines. In many respects, we are simply spectators.

Pensions are not dead although they are quickly becoming something of the past, relegated to the obviously smarter workforce, the union laborers. These folks admit to not knowing about where they should put their money, so instead of directing their own fortunes, many let trusts operate the investments.

(This is where a group of concerned folks gather, the employers and the union and determine where the best place to invest is. And statistics have shown, that in many instances, they do better than companies do when they hire "professionals". Also damning any chance at success is the interest the company has in the pension and how it relates to their balance sheet.)

This is sort of a forced retirement with the laborer giving up pay increases for pension contributions. And in the case of the trusts, it generally works like a charm. There are exceptions, particularly during labor disputes and troublesome negotiations when the welfare of the member is often second to the economics of the contract.

And in the three decades since its inception, we have proven the concept more or less incorrect. We are forward looking creatures that mistakenly attribute possibility to reality. In many instances, we have pre-determined how much we will need, how much we will need when we retire and how much we will need to save to get there. We have the whole plan sown up. That is until there is a bump, or in some instances, a really big bump jostles our fragile framework to the core.

Companies have shirked their fiduciary responsibility time and again. They enlist plan sponsors who are hellbent on squeezing every dime they can from every nickle invested. These fees, some hidden, some acknowledged are often higher than the individual investor might pay. And because the funds you choose form are locked inside a structured plan, shopping around is limited to what is on the shelf. In the land of choice, the plan that needs to have the most options is closed to competition.

The 401(k) appeals to our herd mentality, driving up our gains (at least on paper as we chase the hot funds and the sizzling picks our cubicle neighbor has chosen) and driving our losses further as we try and stop the bleeding. We look at these accounts as money saved (which it isn't) and add to the debacle and withdraw or borrow against these accounts.

And we like to blame. It is also in our natures. Which is why some feel as though the 401(k) hasn't been given enough time to work. Yet those who have a pension, what I have referred to as the great economic stabilizer for many Americans who have them, have seen their fortunes in their post-work years remain stable. You have to realize, these plans were designed for those who had nowhere else to go with their high level of earnings. This tax-deferred portion of the tax code was custom made for this group. And it would have been for us as well except that we don't have enough time in the plan to make it work the way it was designed.

We haven't contributed enough either. To reach the portion of pension payment using your 401(k), you would have to retire with three times your current balance, provided you took advantage of all the free (matching) funds and maxed the plan out. Now the matches have gone away and fewer people bother with the maximum contribution. The catch-up clause is just wishful thinking.

So can this thing be fixed? Yes and no. If 401(k)s are only worthwhile when you retire, why then do the changes to these plans, improvements that make it easier to keep invested and stay invested have to come from the government? Talk has been shifting towards some sort of government run pension plan or an exchange where employees can by some sort of guarantee (adding a new player to the retirement game, the insurance company). Neither of these is feasible.

Nothing says participate like less taxes and this sort of incentive offers some easily projected numbers that are easy for even the lay-est of investors to understand. Matching contributions may not have lured sideline investors because it meant money out of "pocket" or less in the budget.

The IRS could act to make all 401(k) plans more tax friendly.

Based on the fact that 401(k)s are essentially tax events, the wrong agencies are stepping in to try and fix an IRS problem.

Here is what I suggest: Consider making the tax deferred deduction on the 401(k) contribution twice what it currently is and you will, in essence, give the employee a raise. You could force a minimum contribution and surprisingly, it might not even be noticed. As many of you already know, 5% barely changes your take home pay. But getting an additional deduction would.

The IRS could take it one step further by then fixing the withdrawal tax table. Many of us don't know what we will be taxed when we retire because we don't know what we will be able to withdraw. The IRS could place a 5% cap on anything under $20,000 a year, 15% for all additional annual draw-downs. Upper tier investors would want to pile in and this would have the net effect of raising all investor boats. (To recover much of this lost taxable revenue, reducing the contribution limit by a thousand dollars to $15,500 would force those who could invest that sort of money to pay the taxes and put the money in a Roth. My roughest calculations show that it would add $10 billion a year to the coffers, offsetting the increased deductions.)

The IRS could also penalize those tax returns (in the nicest way possible) and tax any over payments in excess of $500. This would be directed to a group 401(k) that would be directed towards a state sponsored target date fund (even though I don't like them much, for this purpose, they may be custom made). When the person applies for retirement benefits, this fund would be added to their benefits and because it was already taxed, it would could not be taxed again. Applicable tax rates for 401(k)s would also apply on any interest gained.

Harsh medicine? Perhaps. But the end result would be more money to spend now, more money to spend later and more money that many would not have. All by changing the tax code.

Thursday, October 15, 2009

Can You see What They See?

It Should be Easier
There are numerous obstacles that keep us from building enough wealth in our 401(k) plans. The first is as simple as beginning to invest in your retirement future. This is stressed frequently and with good reason. The earlier you begin investing, the better situated you will be for retirement in the far-off future.

The second hurdle is how much to invest. I suggests that no matter how poorly a plan you have with your employer, setting at least 5% of your pre-tax income (a number that does not have much of an impact on your take-home pay) is better than not investing at all. For first time 401(k) investors, who may need as much of their paycheck as possible, this is a good start.

The third hurdle is the company match. This is used as an incentive to get you to put some money away for your future by offering to match the first couple of percentage points. Some companies do not do right by their employees when they match only with their own company's stock or if they have lowered or withdrawn the match due to the "economic downturn".

And the last hurdle to these beginners is where to put their money. Not all plans are created equal and not all investments in these plans are worthwhile. That doesn't mean you should ignore the opportunity to invest, it simply means that your choices are not as good as they could be. This is particularly troubling if you are an older investor who may have gotten a late start or if you have changed jobs and are now enrolled in a less than adequate plan.

Finish reading this post here.

Tuesday, October 13, 2009

Understanding Risk - The Risk of Too Little Risk

Last week, on the radio show I appear on as a regular guest, I suggested that instead of trying to determine what your risk tolerance was, you should instead think about what makes you anxious. This anxiety tolerance takes a more introspective view of who you are rather than what your investments might be doing. It requires, among other things, that you turn off the media.

Streaming into your living room is an after-the-fact representation of what the markets are doing. Even real time reports are not so much real time as a tool for edgy traders to plot their next move. If you really care about what your retirement accounts are doing, in terms of what they will provide ten, twenty or even thirty years down the road, looking at this type of data will force to re-examine what you may have previously thought was a good idea.

Although there is a science to investing, it is far less competent at coaxing the truth or any sort of conclusion fro the available data. The markets, pushed by human emotion (even if it is pre-programmed into a computer via modeling) fail to give you a true perspective, something that you would consider concrete, undeniable and/or truthful. This sort of representation is enough to make even the most savvy investor squeamish.

The knee-jerk reaction, the one a vast majority of investors are considering or have already begun is a move back to less risk. As banks fail, as markets gyrate, and as the recovery, albeit jobless, begins, some basic things should be kept, not in the back of your mind, but in the forefront.

No risk means saving. This is the traditional approach to keeping your money close at hand, for emergencies. It comes with risk as well. There is the inflation risk. Currently at or around zero, inflation strips the value of your dollar by making it worth less in the future. Without the interest that savings provides, each dollar saved will have less buying power. In an inflationary environment, that interest paid to you must beat inflation (even if you use the historic reference point of 3.5%).

And it must beat taxes. These will always rise, if not right up front, the increases will be felt through the products we buy, the business we conduct or the income we earn. No risk, in other words, has some risk and it is mostly on the downside. (That doesn't mean should abandon the emergency funds you are currently funding or stop you from getting one started.)

Your anxiety (or risk) tolerance may be forcing you to look for investments in your retirement accounts that take more risk than is desirable. Before we look at those types of investments, it is important to note that the reason you invest in your 401(k) is to provide income for a time when you no longer want to work (or work doing what you are doing).

For many of you, this has meant turning to the ever-present and often innocuous retirement calculator online. You enter into these tools, your current balance, which according to the latest Employee Benefits Research Institute report, is about $74,148 for the average 40 year-old. (The study reports data as of the year ending 2008.) While this down over 25% from the close of 2007, that figure represents a 35% increase for the investor in this age group since 2003.

The report also indicates that this was in-line with the stock markets performance over the same period. If you suffered less, it was due to diversification and the ability of the 401(k) to supply ongoing and consistent investment. This diversification was found using equity investments as the primary driver for the growth in these portfolios. In terms of asset allocation, 40% of this group allocated 80% or more of their assets to the equity markets, down only slightly from their years as a twenty-year old. (This group also owned about 11% of the remaining portion of their portfolios in their own company's stock.

These contributions are, as one might expect, greater in your investment youth. Or they should be. Investment returns (and sometimes losses) are the result of many of the changes in portfolio valuations. Even after the losses experienced in this age group's portfolios (28.5% in 2007-2008 and 5.8% in 2001-2002) the average account over a ten year period had increased 94%.

I have suggested that you should contribute at least 5%, company match or not. If you begin with that average balance of $74k, in 25 years you will have breached the $250,000 mark using a conservative approach which has about 50% of your portfolio invested in equities. Reduce your exposure to bonds in that portfolio to 15% or less, and the same time span could leave you with a balance of four times as much.

In terms of risk, 2008 was a game-changer. While 64.5% of those with plans in 1998 found equities the most desirable of investments, by 2008 this sentiment had shifted to 41.9% with the shift to a more balanced approach such as lifecycle funds (an increase of over 300% and to bond funds, which posted a 100% increase from a decade ago. Although we are looking at the forty year-olds, the sixty year olds made essentially the same moves as their counterparts twenty years their junior.

Using a retirement calculator, based on a generous 5% withdrawal when you retire, at age 40 or younger, will not produce the retirement income (based on a growth rate of 8% after you retire, beginning with zero and ending with a balance of $250,000 and an inflation rate of a modest 3.5%) you might imagine. If you can live on $14,446 in the first year (excluding Social Security and if you are fortunate enough, pension payments) then you are on track. This will however, draw your balance to zero in thirty years or less, if your investments fail to meet the 8% mark, year over year.

2008 also brought a dramatic increase in the number of loans on these plans (90% offer some sort of loan available). Eighteen percent of you tapped these provisions with, the report cites, an average outstanding balance of $7100. This may have been money you thought you needed at the time. But what it represents has a far greater impact in the future.

So why are so many individuals shifting to a less riskier (less anxiety inducing) form of investment? Perhaps they simply do not know what they are setting themselves up for in twenty or more years.

There is the argument that these more conservative investments utilized by retirement investors are not as risk free as previously imagined. This could put an additional drag on perceived outcomes you and your calculator have projected.

All bonds, essentially an extension of credit are compared to what the US Treasury issues. The difference between what a bond yields against this measure suggests the creditworthiness of the bond. In other words, the closer the bond to the US Treasury, the safer it is.

And as we say safe, we also remind you what we have previously discussed about safety. Without some risk, the chances that your money will grow are greatly diminished.

While this complicates the purchase of a bond individually, it makes bond funds much more attractive and some respects, slightly more risky. And in lifecycle funds, the employment of bonds lowers the risk of too much equity while possibly increasing risk where safety is sought.

What if, as Eric Fry of the Daily Reckoning suggests, the creditworthiness of the US Treasury comes under pressure? It is extremely important to bonds that it have a good benchmark to use. He writes: "Are foreign sovereign issuers becoming MORE credit-worthy or is the US government becoming LESS credit-worthy? Or is it a little bit of both?"

This type of risk may undermine the best intentions of the retirement investor and those who invest for them from a direction they will be mostly unprepared to handle. Not only will the return they are seeking be less than than they need to get to where they are going, there is a possible risk that they will receive far less than they anticipated. Fixed income may not be so fixed.

There is a risk to the equity markets because of this possibility. Yet it is still one worth taking. Even if your anxiety tolerance will not let you go beyond the simplicity of an index fund, you will fair better over the long run that those who shift gradually to a more balanced approach with an increasing amount of bond type investments. I'm not adverse to adding to your portfolio a fund that offers even more diversity (even a conservative choice) but in many instances, investors simply reallocate existing contributions when they should, for the best possible balance, increase their contribution and direct these increases to the more conservative product.

There is a distinct possibility that too little risk will not perform as planned.

Friday, October 9, 2009

What's Your Anxiety Tolerance?

For those of you may not know already, I appear on a radio show with Gina Robison-Billups from and Kathleen Bellucci of Pension Solutions every Friday morning. Lately we have been talking about how the listeners should approach their 401(k) plans.

Today's show will pose the following question (which you can hear here if you like) or simply read my answer below.

The question: How does someone choose the funds that suit their needs…risk tolerance???

Good question and something I have discussed at length on the website, in articles I have posted and commented on and at length in all of my books. In fact, I devote an entire chapter of my next book on the topic.

And still, after all of the academic papers, research, books and such, we still can’t pinpoint what risk is. We know that we try and figure out how much we can tolerate, hence risk tolerance. What we don’t understand is why it changes over time, with cultural shifts and economic upturns and downturns. If you knew how much risk you could handle – and get a good night’s sleep in the process – why would it change?

I’m thinking that a better term for it would be anxiety tolerance. We all know what makes us anxious. According to Robin Marantz Henig, writing for the New York Times magazine, “anxiety is not fear, exactly, because fear is focused on something right in front of you, a real and objective danger.” Investing is dangerous but not a danger. Ms. Henig suggests being anxious is “fear gone wild”.

This she says happens when we are confronted with novelty and threat. For many of us, this past year is unlike anything we have ever experienced and certainly threatened our investments and our retirements.

So how do we cope with anxiety tolerance or find out what ours is? I’ve given it a lot of thought and figured out that most of us are anxious about some decision or another. Investing is no different. Even savvy investors worry. Vanguard recently published their own worries suggesting that Investors not get too giddy with the recent market upswing.

My suggestion to you if you are feeling anxious: You should invest consistently, good times or bad, up market or down. If you have a broad selection of funds and you are feeling anxious, keep investing but for the time being, use a total market index fund. At least you will be capturing something.

So risk is hard to define. But what makes you anxious is not. Using the index fund when you are feeling worrisome will also lower you risk at the same time.

Wednesday, October 7, 2009

Adding Less Risk: The Safe Harbor Option

There is no easy answer for how much risk is too much risk or too little. In the aftermath of this past year, plan sponsors are looking for a way to insure that those close to retirement have the money they invested over their careers there when they need it. The key word is insure. And it is the industry that offers this sort of product that is being considered as a possible option. But are annuities the option worth considering?

One of the most difficult things to do is provide protection for already accumulated money in a defined contribution plan. Currently, even in what the industry refers to as megaplans, the options are limited to targeted-dated funds or some sort of option that offers fixed income protections. These types of options adjust the level of stock market exposure as the employee ages, shifting from more aggressively invested dollars to more conservative investments.

The reason for the increased popularity of these products is the result of a Congressional mandate. Target-dated funds were made the default investment for those entering the workforce replacing other less retirement oriented funds such as money market accounts. This allowed the worker to begin investing for their retirement in what the industry called the best option for those who do not know what to choose.

But now, with the focus on asset preservation rather than the typical asset accumulation, a particular concern for older workers nearing retirement, the pension industry is considering annuities. There are several problems with this, first and foremost being the involvement of the insurance industry.

Annuities are designed to be purchased as a stand alone product that provides guaranteed income. The insurance company makes certain commitments to how much you will receive in retirement from accumulated assets. The cost of this quasi-investment/insurance product is high in the first seven years of the purchase and the underlying investments made by the insurer are designed to provide the insured with a lifetime income.

The introduction of such a product in your defined contribution plan presents all sort of problems, not only for plan administrators but for the participants as well. According to Pensions and Investments Online, this would involve tweaking the already suspect target-dated funds. (I say suspect in large part because they have yet to prove they are able to do what they were designed to do.)

PIonline suggest that these target-dated funds could allow their investors to buy "slivers" of an annuity from several insurers. This would keep some of their money invested even after they retire and some of it as guaranteed income.

The second option and probably the most costly would be to offer a "guaranteed lifetime withdrawal benefit". This would essentially allow the investor to roll the assets they have accumulated in the annuity where the insurer would offer income based on a high water mark withdrawal based on a certain percentage. This would, insurers suggest, provide income even when the market moves in unsavory directions during retirement.

Robert Reynolds, chief investment office at the conservative Putnam Fund has been making noise since taking over the once powerful investment house. Among his proposals:

Mr. Reynolds would like to create "a national insurance charter and an FDIC-like fund to back up lifetime income guarantees". This will essentially force employers and employees to consider this option. The FDIC-like fund, not federally insured but instead insurance company guaranteed would offer protections for assets already accumulated.

Involving Washington is the trickiest part of his proposals. He would like Congress to add tax incentives to both employees that participate and employers who offer matching contribution "that would require "employers to offer a lifetime income option, either through annuities or other insured methods".

Of course for such a move to pass muster, the insurers would need to have set "caps on the equity exposure in target-date funds as they become mature". Such action would need the support of legislation that would "require employers to enroll all of their workers in 401(k) plans automatically and increase their contributions over time." This would put pressure on the smallest of firms to comply, a costly maneuver and force the largest firms to take away what some feel is the most important aspect of the 401(k) plan: choice.

This would also jeopardize the portability aspect of the plan. Few insurers would continue to cover an employee after they leave a firm and would probably not participate in a rollover to an individual retirement account (IRA). The reason: no former employee would continue to pay the outsized costs on an individual basis which could be spread over a large group inside a 401(k) plan.

“Usually after a tough period like this you're presented with an opportunity to make the system better,” Mr. Reynolds said in an interview. “We need to fix 401(k)s, which have become the retirement plan of this country. At Putnam, we want to get out in front of the issues.”

This is scary talk indeed.

Sunday, October 4, 2009

Risk: It is What You Don't Know that Matters

We speak often about transparency, how your 401(k) should be easy to understand, how the mutual funds in the plan should be up to the task of providing you with good options that cost as little as possible and how knowing these things will grow your investments. It is all about disclosure. And your retirement future.

I bumped into this anonymous morality tale about these topics, okay about how not revealing important information to those involved can place you in a compromising situation, one that we were all in just a year ago.

Consider the story of the naked wife.

A man is getting into the shower just as his wife is finishing up her shower when the doorbell rings. The wife quickly wraps herself in a towel and runs downstairs. When she opens the door, there stands Bob, the next door neighbor. Before she says a word, Bob says, “I’ll give you $800 to drop that towel.” After thinking for a moment, the woman drops her towel and stands naked in front of Bob.

After a few seconds, Bob hands her $800 dollars and leaves. The woman wraps back up in the towel and goes back upstairs. When she gets to the bathroom, her husband asks,…

“Who was that?” “It was Bob the next door neighbor,” she replies. “Great!” the husband says, “Did he say anything about the $800 he owes me?”

Moral of the story:
If you share critical information pertaining to credit and risk with your shareholders in time, you may be in a position to prevent avoidable exposure.

Thursday, October 1, 2009

The Risk of Less Risk

As Ben Bernanke, the Federal Reserve Chairman testifies before Congress, we will come to the conclusion that there is risk, we should do something about it and we still have no idea exactly what. Referring to the problem as systemic risk, both in the creation of firms seeking to reach, through acquisition, the "to-big-to-fail" status and the inability of one agency to oversee every player in this complicated, global game of finance, Bernanke admits that we are far from where we need to be but much closer than we think.

There is absolutely no doubt in anyone's mind, this is bigger than one agency. Even the ability to provide oversight to this sort of mechanism creates a risk in itself. The Fed will admit it has learned a great deal.

Top of those now known facts is that numerous other participants in the financial world, those whose regulation falls under the purview of other agencies/regulators who, because it was not previously needed, failed to look at the leverage and risk some of their charges were assuming. Insurance firms and lending institutions that fell outside of what the Fed was trying to watch, slipped through the regulatory cracks. It is now known that these firms provided just as much in terms of financial disruptions as did the banking system.

President Obama has suggested that the central bank be the primary torch bearer in this effort to provide stability. The ability to understand the complexities of this type of problem should fall to those who can make the best decision. But the question of how quickly the Fed can react, outside of increased regulation and policing of the regulatory follow-through, has never been an attribute of this agency.

While the world has never experienced this kind of downturn, one where risk was sold as predictable and eventually collapsed under its own promises, the aftermath of such activity does justify the need for some reaction.

So how does Mr. Bernanke describe the harness he has determined is needed: consolidated supervision. This allows the Fed to take the lead and offer some much needed protections.

Many of the decisions the Fed makes are reactive. The Fed has proven in numerous circumstances that its decisions take weeks, often months to find their way into the system. This time-lag can be costly in a marketplace that responds to news now. It also relies on the predictive powers of the central bank, the ability of these bankers to spot the problem long before it becomes a problem and to move without causing a panic. Not exactly in the Fed's wheelhouse.

I'm not seeing how this could be done to the benefit of everyone concerned. Mr. Bernanke shows his concern as well: "Unfortunately, the current regulatory and supervisory framework for systemically important payment, clearing, and settlement arrangements is fragmented, creating the potential for inconsistent standards to be adopted or applied." Consumers will ultimately find this sort adoption of rules to be expensive.

As banks begin to anticipate the future of what these agencies adopt, pass down costs will further restrict any recovery in the short-term. The stock market, suffering from "yeah, but" syndrome, an affliction that allows you to second guess every piece of good news and discount every piece of bad, will not be phased. The markets will instead see this much the way they see the continued unemployment, limited growth because of it, and tighter lending requirements: a bump in the road.

But will any of these proposals eliminate systemic risks? Risk comes from uncertainty and the Fed is too smart to try and wipe away this sort of activity. Investors have to believe, if wrongly so, that the markets offer enough risk to warrant their participation. "Yeah, but" not too much that they get blindsided by something they could not possibly have anticipated.

We tend to think of investors on a personal level, believing that our participation in these risky endeavors is acceptable, even encouraged. Even after all we have been through, we still want to believe that somewhere, someone is watching over us. It is the comfort of this regulation, humming in the background that let us down and now, retooled, it is supposed to revitalize that trust.

So how does this play out in the long-term? Probably better than we might anticipate. Most businesses have become as lean as they possibly can. Their ability to borrow still remains more costly than it should and new leverage and capitalization requirements by both borrowers and lenders will make the process of regrowing the economy slower. Which is probably a good thing.

We have gotten swept up in the speed of business without allowing us the opportunity to examine motives and risks. The slightly slower pace that another regulatory door will provide should make the long-term health of the marketplace more welcoming. Money is returning to markets because it has no place else to go. To create a healthy investment environment, this has to stop. Money has to want to be invested, not forced.

The risk of less risk is threefold: a slower moving system, a more expensive system, and lesser short-term rewards for participation. The glory days are behind us and had anyone been able to see the future, they most assuredly would have suggested "yeah, but". But in the long-term, we could experience less severe downturns, more or better prolonged gains and a healthier retiree (at least from a financial standpoint).

The "yeah, but" syndrome will carry us forward for quite some time. But as all long-term investors know, we will soon forget. Let's hope those in the position to be the regulators don't.

Monday, September 28, 2009

Rebuilding Your Wealth: What's Wrong with the 401(k)?

Your 401(k) is in trouble. While the concept of a self-directed retirement plan is, at least in theory a good idea, it was never meant to be all there is. So many components go into a the proper operation of such plans, it is hard to get a bead on which move is right and which might spell disaster.

So let's briefly examine some of the do's and don'ts of 401(k) investing:

Do: Participate. No matter how little your employer offers in the way of incentives, called matching contributions or even if they offer none at all, you need to be in the plan. Plan on a minimum contribution of 5%.

Don't: Believe that it isn't any good. There are a great many of these employer sponsored plans that are essentially worthless. They charge fees that are too high, offer too few good funds from which to chose, and lack good any real fiduciary responsibility (something the employer is required to do).

Do: Buy funds. There will, in almost every plan on the planet, be mutual funds to choose from in your 401(k). Mutual funds are essentially investors who feel as thogh the effort of pooling money spreads diversity and risk over a greater number of stocks than they would have been able to purchase individually. A fund manager is the person(s) you hire to make investment decisions for this group. The fund will charge fees for this.

Don't: Buy company stock. A lot of 401(k) plans are designed to force you to buy the company's stock. Some will do this by limiting any match to this purchase and prohibit you to sell those shares. This is still not a good reason to buy this stock or any other. When you put too much money into one stock (same goes for buying too specific of a fund in large quantities) you run the risk of jeopardizing your portfolio's overall performance. This is where many 401(k) plans got into trouble.

Do: Diversify. For many people, diversification is simply purchasing an index fund (a fund that tracks a particular sector be it the total market of the Standard and Poors 500 list of the top market capitalized companies. (Capitalization refers to the number of shares outstanding multiplied by the share price.)

Don't: Index funds/Target-dated Funds/ETFs. Index funds are very tax efficient and charge very low fees to manage. This is due to their passive nature. Once the index is bought, until the index is changed, there is no more trading. As money comes in from investors, it is simply used to purchase more stocks of the companies in the index. (Use index funds outside of your 401(k) and pay the taxes on them while the rates are still historically low). Target dated funds are a relatively new product and just about every 401(k) has something like this. They may call it a life style fund. These funds pick a date in the future when you would like to retire and the fund manager gradually alters the fund's focus from aggressive (although many are not too aggressive) to a conservative format as the fund gets closer to the target date (of your retirement). ETFs are not a good idea for 401(k) plans because they charge the employee each time they purchase more and in a 401(k), this happens every time you get paid.

Do: Pay attention. If you have built a portfolio that is diversified (some growth, some value, some international or emerging markets and further spread these funds to include large, mid and small cap areas) you will need to open your statement or check it online each month. Look for changes in fees, changes in the 10 largest holding and any statements that the fund manager might make.

Don't: Overreact. When markets rise, don't try to adjust your underlying funds to follow. When markets swoon, stay where you are. In a rising market, because of dollar cost averaging, you will buy less as the price goes up. In a falling market, you will buy more as the share price is discounted.

Think first. Your 401(k) is your future, directed by you. Never withdraw money from this fund either by loan or by any other means. This single action will take years to fix. If you leave a company, roll your 401(k) into an IRA.

Don't: Panic. Things will get bad but they never stay that way. Your 401(k) is not a cash account and should not be eyeballed to save you from financial bumps in the road - even those bumps seem like they will last for a long time.

Tuesday, September 22, 2009

The Beginning Investor's Dilemma

Where to begin? This question has stymied beginning investors since the time the market began. These days though, the question is twofold: why should I begin and where will I get the money?

Time remains the single best attribute to investing early and equally important, often. The powers of the equity markets are confusing unless you remember two basic rules:

There is risk;

And if you take no risk, there will be no reward.

That risk demands you put money somewhere. For the beginning investor, the best place is in a mutual fund. Your 401(k) at work is often a healthy list of choices. (Keep in mind, the number of choices available don't always signify the quality of the plan.) Among the most common types of funds in these defined contribution plans (so called because you define how much you will contribute) are index funds, growth funds, bond funds, balanced funds, and some combination of the lot.

Index funds track a broad index of companies in almost every instance, due to size. Growth funds may also be a type of index fund or one aimed at a particular group of companies. Bond funds invest in debt, which makes you a sort of lender (but in a mutual fund, without many of the problems associated with the transaction). Balanced funds look to provide some stocks and some bonds and usually tell you right up front how they allocate their investments.

The combination of the lot is represented by a growing sector called lifestyle funds or target-dated funds. These fund reallocate their holdings over the course of an investors career. The employee picks the date they would like to retire, say 2040 and the fund manager does the rest. As your holdings grow in tandem with your years in the plan, the fund gets more and more conservative.

Beginning investors are attracted to these because they are advertised as buy and forget. But they should be aware of the problems that may be associated with this type of investment. First, they don't have much of a track record. Even in the recent downturn, some very conservative funds (with short retirement dates targeted) did not beat the S&P500. Secondly, I worry that some fund families are using these new funds to prop up laggard funds that have done extremely poorly and lost many of its core investors.

While you are educating yourself on the subject, choose an index fund.

Now, where to get the money? If you set aside 5% of your income in a pre-tax situation (and 401(k) plans are just that), you will not feel a change in your take home pay. Do this even if your company doesn't match your contributions. (Some used to, some companies still do but to a much lesser degree and some never have added a contribution, usually dollar for dollar up to a certain percentage.)

If you have no defined contribution plan, use your tax refund (you know the one you plan on getting in about five months) to open an IRA.

No matter when you begin, waiting is no longer an excuse.