Your Retirement Plan in 2012

This article originally appeared at BlueCollarDollar.com and was written by Paul Petillo

"Time is free, but it's priceless. You can't own it, but you can use it. You can't keep it, but you can spend it. Once you've lost it you can never get it back." Harvey MacKay

One of the key elements in any financial transaction is time. If you want to retire, you must consider the amount of time. If you want to borrow, how long you have to pay it back can be translated into dollars and cents. Investing; timing they suggest can't be down but is important nonetheless.

If you are twenty, time is on your side. If you are thirty, there is time left. If you are forty, time is of the essence. If you are fifty, time is running out. If you are sixty, where has the time gone. And older than that, time is no longer on your side. It accompanies us through life like some dark passenger. It reflect back on us from the mirror. And when we look at our retirement plan, it stares at us without guilt or shame. Time is the truth.

When I first began writing these predictions, and I've been churning out these year end ditties for over a decade, many were laced with optimism, some with an urging that we learn the lesson and move forward armed with knowledge of past mistakes, and still others were exercises in reality. In 2012, we have some opportunities and some problems awaiting us, left on the table as we symbolically turn the calendar wiping out 2011. But it won't leave quietly.

So I have a few thoughts about what you can do - resolutions of sorts but not the drastic sort we make and break almost within hours of promising ourselves at midnight.

Increase your contribution I start with this obvious chant for two reasons: you aren't making a large enough contribution and two, I would be remiss in not telling you this right from the start. And I'm not just speaking to those with a 401(k).

There are the millions of you who are forced to (and because of that are not likely to) finance your own retirement through an individual retirement account. We lament at the worker who literally only has to sign up at his workplace and doesn't. And far too often, we say little about the person who has to sign-up (after finding a fund), commit with a fortitude that is somewhat lacking and to contribute some of their paycheck via direct deposit every week or month. That effort, it seems is a much more involved hurdle.

In 2012, the investment world will be little changed. It will roil and confuse and gyrate and possibly even nose dive - just as it has for decades. It will react to news - if not from Europe form China or even the presidential elections (which ironically tend to be excellent years to invest). This will have you second-guessing your investments. But this will only apply if you have no idea how much risk you can take.

Pay attention to diversification You may not be capable of rebalancing, the act of making sure that your investments are directed evenly across many investments. This is much harder than it seems. As long as you are involved - and that is YOU in capitals - the struggle to keep balance will not get any easier.

For the vast majority of us, mutual funds will be the investment vehicle of choice. These investments will see more movement towards fee reductions. Which is a good thing. Fees will and always have been a subtraction of gains. This makes an excellent argument for indexing.

Choosing six index funds across the following cross-sections of the markets will not solve the problem of rebalancing (some will do better than others) but it will provide diversification. Index the largest companies (an S&P 500 fund), a mid-cap fund (the next 400 companies in size), small-caps (the next 2000), an international fund (an index of the largest countries (those with established banking systems even if they are currently troubled and will continue to be so in 2012), an emerging market fund (after international funds, the most risky) and a bond index (one that covers as much fixed income as possible).

Some of you will wonder if exchange traded funds (ETF) wouldn't be just as good if not better than simple indexing. In 2012, ETFs will continue to drill down ever deeper into sectors of the markets that add risk along with the illusion of an index. ETFs will become more actively managed in 2012 offering you more risk at a lower cost. Cheap doesn't mean better. 2012 will be year of the ETF. If you are unsure what these investments are, consider this conversation I had with David Abner of Financial Impact Factor Radio recently to help explain what these investments are and how they work.

Focus on your financial well-being This refers to your credit score. It continues to impact your financial future and will become increasingly harder to ignore. A new credit rating service agency will add to the difficulty in 2012 and not only will the current scoring impact costs such as insurance, it will seek to trace the breadcrumbs of your financial life more thoroughly that the big three do.

There is little likelihood that the job market will increase as many of our returning troops will flood the marketplace, taking numerous jobs from your kids just out of college. Which means another year with your kids at home. The only answer to this problem is to continue to tighten down your budgets in 2012. As I mentioned earlier: "If you are forty, time is of the essence. If you are fifty, time is running out. If you are sixty, where has the time gone."

And you must do this understanding that inflation - not the reported number but the real number in your grocery bill - will still chip away at your wealth. This means you will move in two opposite directs in 2012: saving and investing more for your fleeting future (at least 6% but 10% would be best) and spending less in the present (easy of you don't use credit).

And the housing market will improve for those who have repaired any damaged credit or who have saved enough of a down payment to buy a house. people are still buying and selling. These people have found that while the market is not accessible to all, it is for those that have done right by their personal finances.

Do all of that this may not seem like a new year - but it will be a better year!

Retirement Planning: The Danger of Opting for Lazy

The Pension Protection Act of 2006, quite possibly the worst piece of retirement legislation to ever take hold, has some employees allowing their employers to do what they are too lazy to do: diversify their accounts, select the right age-appropriate funds and move allocations. Your contribution might stay the same. It is where that money is going that creates long-term and possibly adverse problems for workers who believe they are on the right path.

The PPA is a business-friendly bill that gives employers new abilities. Some of these changes, which can be blamed on a more economical plan for the employer, do not always translate into a better option for the employee.

An employer can look at the cost of their current plan and deem it too costly to maintain. When this decision is made, the funds that were currently chosen by you are shifted into similar types of funds. That is, if you do anything at all.

When there are changes in your plan, you receive notification, often twice before the event. Failure to react to these changes within the given time frame (often thirty days) allows the employer's new plan sponsor to make changes it deems best for your age. The problem with this kind of power is threefold: One - only on the rarest of occasions does the employer have enough information about your finances to make a good decision; two - the new group of mutual funds in the plan may not resemble the allocations you made previously; three - the default options often do not take into account your personal risk tolerance.

In other words, lazy now has a price.

This can have the most devastating effect on younger workers. They often have the poorest understanding of the age appropriateness of their investments. Some have simply under-invested in equities, preferring to avoid what they have witnessed with older co-workers and their parents. In other words, they do not want to lose money. In other words, they are avoiding risk.

Your employer can change that. New plan sponsors can offer to switch funds on you, to allow you greater exposure to equity risk while switching older workers to less risk exposure. They do this by enrolling unsuspecting (although, as I said, notified in advance) employees into target-dated funds.

I have raised suspicions about these types of funds, their ability to perform better than a simple index fund, and the possibility that these funds (more like a fund full of funds from a particular family and not all of them good) will do better over time. Target-dated funds have no track record and more importantly, no guarantee that the manager at the helm will be able to mix and blend the right investments to achieve growth and capital preservation.

Michael Malone, managing director of MJM401k, a 401(k) consulting company in Phoenix suggests that this is still only a possibility. He said, “There is a degree of paternalism associated with it. If we look at the allocations that employees have, there have been more cases than not that those allocations and selections of funds aren’t necessarily the best things for them.” He warns against doing nothing: “But if you want to maintain your existing elections, you can move back into any elections you want.”

The bottom line for any investor, whether they be independent or enrolled in your company's defined contribution plan is to be aware of any shift. While you can change these fund allocations after the fact in many instances, why would you allow the fund sponsor to do the thinking for you.

If your company has a new 401(K) provider with a new group of funds, try to mimic your investments from the previous sponsor's offerings. This may be a bit more difficult because many of the changes are to plans offering less investment options, not more.

But opting to do nothing could cost you thousands of dollars of potential earnings over the course of career.

Why Investors Do What They Do: Diversification

In his classic book "Portfolio Selection" co-Nobel prize winner Harry Markowitz describes his topic as something other than securities selection. He suggests that a "good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies."

Diversification often involves numerous human emotions and misuse of it is often the result of some of the topics we have already discussed (loss aversion, narrow framing, anchoring and mental accounting with herding, regret, the impact of the media and optimism all as yet discussed). But diversification is a way to avoid being wrong. It is a way to avoid regret. And when you are wrong, you tend to be really wrong.

These feelings of "wrong-ness" are often the result of events beyond our control. Non-economic influences can derail the best efforts of an investor along with weather, military actions, even the health of the President. As Markowitz suggests: "Uncertainty is a salient feature of security investing".

In order to avoid too many economically obscure references to diversity we will boil the discussion down to two theories: the expected utility theory and the case-based decision theory. The first theory suggests that if the investor is indifferent to an investment, in other words they are so similar that she/he doesn't care either way, that this actually becomes a form of risk aversion and hardly ever produces good long-term satisfaction with those choices.

In the instance of Case-based decision theory, Mohammed Abdellaoui offers the following from his book "Uncertainty and Risk": "it is assumed the decision-maker can only learn from experience, by evaluating as act based on its past performance and on the performance of acts similar to it." This leads to chance decisions.

But what is often overlooked is that not only do you decrease your chances of being wrong, you by default increase your chances of being right. Diversification will spread the risk and as a result of that, may allow you to miss the next hot stock or mutual fund. Because it is impossible to pick the future based on the past - recall the reminder that past performance might not play a role in future results - diversification makes the chances of getting some of the hot property but not all of it.

Consider this simple question: if Rome is located between 41°54' North Latitude, which American city lies at a similar latitude - Boston, Atlanta or Miami? Most folks when asked this question go with either Miami or Atlanta and do so with more than reasonable assurance that they are correct. But Boston, with 42° 21' 29" N is actually the closest by comparison.

Unfortunately, as Robert Hagin author of "Investment Management" points out that people when people make investment mistakes - something that can afflict both professionals and non-professionals, they fail the old adage of "a problem is not what up don't know; it is what you do know."

The most difficult part of investing is removing guesswork and the wishful thinking you may have for the act. Not easy by any means. But much easier if you don't overthink the act of spreading your risk.

Next up: Herding

Retirement Planning - D is for Diversity

D is for Diversity

Diversity creates more problems for retirement investors than we have space here to count. More than one study has revealed that fear of making the wrong choice stops us from making any choice at all. It is no different when you need to make a choice about which mutual fund to put in your 401(k). The problem is, which fund is the right fund?

Many mutual funds often have default investments for new enrollees. This is a way to get you participating without too much effort. But your employer doesn’t always hire the best fund families to run the plan and the choices might be limited. No problem.

The single greatest way to gain immediate diversification is with an index fund that tracks the S&P 500 index of the largest companies. This Goldilocks index – never too hot, never too cold, but just right – is the perfect investment to use as you begin your retirement journey. Once you learn more about how to make your plan work, you will need to diversify to include an index that tracks the rest of the market.

A is for Asset Allocation

B is for Balance

C is for Continuity