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 BlueCollarDollar.com

DB(k): Not a 401(k), Not a Pension, Not a Bad Idea

It is rare to find this writer wrapping himself around anything that came from the mislabeled Pension Protection Act of 2006. I have criticized it at length and continue to find traces of this poorly written, business friendly piece of legislation that does little, if anything to protect pensions and a lot to shift the blame and the responsibility onto the employee.

But tucked away inside of the PPA is a little known, and possibly little cared for opportunity for small businesses to attract a higher quality worker through the benefit of a DB(k). What could this be?

In short it is a hybrid of sorts, a combination 401(k) plan and pension plan wrapped into one. Here's how it works (at least on paper):

Initially, you have to understand that part of the problem with retirement stems from the fact that 401(k) plans, the self-directed retirement plan that replaced the pension (defined benefit plan) were never designed to be the be-all-end-all retirement option. This is at the heart of our current problem. People were unprepared to become investors in many instances and refused in others to learn what they needed to know to become better at using the stock market to increase their wealth.

This (invested) wealth was supposed to shore-up retirement futures by investing in what appeared to be, even over the long-term, a sure thing. Although everyone was aware that stocks do not rise endlessly, over time, they rose enough to pique the interest of even the least savvy among us. You didn't need to be a rocket scientist to know that the act of simply putting money away in a tax-deferred account was all that was needed. Ignoring the rules of good investing was easy when you thought if your 401(k) plan as a savings account that provided bigger than life returns.

Although these folks failed to understand that these retirement accounts were actually investment accounts and not savings, the realization came too late. (Savings is what you put in a bank or CD, essentially money that is safe from loss and at the same time, earning interest.)

This doesn't mean that pensions were immune to the downturn. The people in charge of making sure that these plans were stable and low-risk, found the temptation to invest that money in greater amounts in riskier investments proved to be too much as well. What was supposed to be an economic stabilizer faltered. Because pensions were also hurt in the downturn, the PPA revealed its uglier side with rules that made many of these plans difficult if not cumbersome to continue. Less than 50% of the businesses now offer these plans.

We quickly came to realize that no corner of your retirement future it seemed was safe. There was no safe harbor.

So where does that leaves us now? Because "now" is a movable target, reliant on the strength of the economy and the recovery of the stock market, investors in their retirement future were left with two options: less risk or ignore the risk and get back in. Unfortunately, many are opting for less risk.

The DB(k) can change all of that by offering a stable side to the retirement picture while allowing the worker, specifically those at businesses with less than 500 employees, the chance to take risks they might not have taken otherwise.

The DB(k) is part pension giving the employer the opportunity to offer 1% of an employee's salary for every year up to twenty as a defined benefit. While this may not seem like the pension plans of yore, it is better than nothing and for the business itself, doesn't require them to shift funds to cover promises made.

The DB(k) is also a 401(k) plan. It has an automatic enrollment rule (which can be opted out of) that automatically stashes 4% of your pre-tax income in the plan. To encourage the employee without placing an outsized burden on the employer, matching contributions can be offered up to 50% of the employee contribution with a maximum set at 2%. Theoretically, the employee's participation in their retirement, including the employer match could be 7% of their income.

There is another part of the plan that could attract employers: work for three years and you are guaranteed a pension and the plan itself is not skewed towards the workers who make the most.

The added incentive for adopting such a plan is the ease of adoption and the low costs associated with it. If the employer opts to offer a plan that has lower costs (administrative fees) as well, the employee could see as much as 2-3% more money invested.

The only hold-up: the economy. As long as the recovery remains jobless, the incentive to change plans, which can officially be adopted beginning in 2010, will be slow. But once competition for new hires, particularly those looking for the best benefits possible increases, you can expect these plans will find a solid niche for employers.

The 401(k) Returns... Almost

Your 401(k) is still in trouble. As the stock market rallies (although some think that September and October, historically bad months for the stock market will correct this), as the economy recovers (although consensus agrees for the most part that the recovery is not so much a bounce as a leveling off) and as unemployment remains the lagging indicator (along with housing), the effort at funding your future through your 401(k) languishes. Why? The employer is seeing that incentive to invest, the 401(k) match as not worth reinstating to pre-2008 levels.

For those of you who may not be aware, the 401(k) replaced the pension decades ago as companies divested themselves as guardians of your future. Pensions were the repayment for loyalty, human capital and profits. The 401(k) on the other hand was directed by the employee. Business used the incentive of the company match, a dollar for dollar investment up to a certain percentage as a way to encourage loyalty, human capital and profits.

Then the economy turned sour. And in the process of cost cutting, many companies eliminated or greatly reduced their company match. The question is: will matching of employee contributions ever return?

The short answer is yes. The long answer is: they will no longer resemble the employer contributions we have all become used to receiving.

Businesses face two problems when they decide to cut their 401(k) match. Neither is very appetizing and may even cost the company more than they bargained for.

For most plans, reinstating their 401(k) will not happen until 2011. Because of what is known as a safe harbor rule, reinstating the company match needs to be in the books by November of the previous year. To take effect in 2010, companies will need to feel as though the economy is on stable footing. This is not yet clear and may not be clear by the fall.

If the economy recovers at a faster pace than anticipated and jobs begin to return before 2011, the competition to get and in many cases retain good employees by offering these incentives will be missed. This could be a costly mistake for businesses looking to get and keep quality workers.

If the economy merely levels off, these employers will have time to see if some new techniques, currently being offered by Starbucks, might be the way of the future. Starbucks is breaking the mold for 401(k) plans by changing the incentive to profit based contributions. In other words, the company does better and in return, you get something for your retirement besides what you invested.

Will it work? Will other businesses follow? Possibly yes to both. The current corporate thinking is leaning towards less incentives believing that their plans were too generous in the first place. If your company has struggled through these tough economic times, particularly if you are associated with the automotive industry, those incentives, many experts agree, will never return.

A great number of other industries are planning to ease back into the incentive by offering substantially less in matching contributions and promising to raise those levels once they are assured the economy has recovered.

Some may simply be waiting to see of the Starbucks model works.

Does this mean the end of the 401(k)? No. Instead, you will have to earn more, put away more and invest with slightly more risk than you would like to assume. This means keeping your money out of staid index funds and target-dated funds in favor of investments that could do better. For some, this will be re-entering a high-risk investment model that did not pay off previously, evidenced by the cutting many nest eggs by a third or more when the market soured.

The next year will prove to be among the most interesting of the recovery.

Which Recovery is Good for Your Retirement?

We are at or near or nowhere near a recovery. No one knows. But that doesn't stop the speculation and with good reason. Most investors try and position themselves near where they feel the seeds are planted - the green shoots if you will. But this recovery, which had devastating long-term effects not only on retirement plans but the investors who use them to secure the future, is different than previous returns to normalcy.

In the recent past, we have had three major blows to the economy. 1973 was a good example of an oil driven recession. Most Americans were caught completely by surprise. For many people, it was the first time they had ever felt globalization in their paychecks. And more than just the long lines at the pumps brought this realization to their front door steps.

The recession that began in the third quarter of 1973 was not initially inflation driven. In fact, it was the nominal interest rate of 10.2% and inflation rate of 7.4% (if they seem high compared to our current rates, they are), the collapse of investments, consumer withdrawal and the overall lack of spending that pushed the unemployment rate to almost 10%.

The recovery was spurred forward by a huge tax rebate engineered by Alan Greenspan. And while inflation seemed to come under control, albeit briefly, unemployment rose as some industries that are traditionally hurt during a recession - housing, manufacturing - took longer to recover. By 1980, the trouble with banks (deregulation led to riskier lending practices, higher federal deposit minimums) only added to the problem. By 1982, the prime interest rate was at 20%.

Banks failed, Savings & Loans collapsed and the corporate tax increase and the deficit spending by the government instituted by the Reagan administration all contributed to the length of the recession. But it was the contraction of available money (money supply) by the Federal Reserve that caused the downturn. And helped its recovery by 1984. By that point, inflation was down to 3.2% and two million Americans had returned to work.

The next recession hit the world as consumer confidence (which had soared, declined) and consumer spending (spurred on by unrealistic optimism) became global players. We had developed into a nation of consumers and the world was now our producer. When we stopped spending with the first Gulf War and the rise in oil prices, the rest of the world's economy (the exceptions were Japan and Germany) fell.

The recession that began in 2008 is well documented and still lingering. But the signs of recovery are beginning to poke through. The problem is, what and when will it end and when it does, what will the new post-recession economy look like?

The credit shocks that the economy has felt are still reverberating. Bondholders will be offered riskier high yield bonds to help alleviate this debt burden. Current bondholders will be asked to lengthen the maturities on the bonds they currently hold and job creation will be the last piece of the puzzle needed to see any meaningful recovery.

Business are still testing their limits, stretching what few resources they have in an effort to position themselves for their shareholders. This pressure will keep job regrowth to a minimum as businesses figure out what to do next. Just as many investors have removed risk from their portfolios, so have the businesses we invest in (whether it be directly through stock purchases or indirectly, through mutual funds).

This makes planning for a retirement in this environment doubly difficult. Those close to retirement will have little time to bring their portfolio losses back to pre- 2008 levels quick enough to make a significant difference (the economy needs retirement in order to create jobs for people entering the workforce).

Those looking at a retirement ten-years and beyond have lowered their risk significantly as well, opting for index funds and indexed ETFs or by lowering their investment contributions. Both of these will force retirement further into the future.

Although consumers won't see raises for many years to come, the slowdown is allowing many banks the opportunity to work through the bad loans still on the books. Businesses will begin capital spending but only barely in the next year.

The key to benefiting from this recovery involves more than increasing your savings (which is considered an economic inhibitor) and getting your financial house in order (refinancing during these low lending rate events and realigning spending). The key is still investment and a healthy dose of investment risk. Confidence in the fact that you may not lose your job, you will keep your house and possibly even build that emergency savings account for the first time leaves the average person with a risk gap that only stocks can fill.

If you do not maintain at least a 5% contribution level and keep it in actively managed funds, those looking to pick stocks in this sort of market, you will miss out on some unusually attractive opportunities at rebuilding what you may have lost.

In other words, 90% of Americans will feel the recovery long before any other part of the economy will. They just won't realize it.