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.

The All ETF 401(k)

Exchange Traded Funds, like many new products that have hit the investment market in the last ten years or so, have made steady inroads among hardcore investors looking to use these often specifically indexed funds to "park" money as a hedge against other trades or as way to take advantage of a broader market bet. These are professional maneuvers that come with costs and are probably not good for the average investor.

First off, let me explain what an ETF is. Exchange Traded Funds are basically index funds. Index funds are basically passive in nature, mimicking a published list of the stocks grouped together, such as the top 500 companies (published by Standard and Poors) allowing the investor to purchase a fixed group. They can also be broken down further to include numerous other indexes from mid-cap, small-cap and indexes of stocks from around the world. These funds, like their mutual fund counterparts have sliced and diced the world into segments.

For instance, if you think India is the next big hot spot. There is an ETF that buys the broad market along with some smaller regions in that country. Do you believe that Latin America will recover first? There is an ETF that allows you to play that economy. Perhaps you feel as though a stake in a commodity such as oil or gold is the next best place to invest. There are ETFs for that as well. Even bonds are covered.

ETFs, because they fall outside the realm of mutual fund regulation, also offer some savvy investor the ability to short (borrowing shares in the hope that the price will fall and then, buying the less-expensive shares) or leverage (using some stocks as collateral for purchasing more shares) or buy real estate without the REIT.

And while that sounds like a world we should all play in, for most of us it simply won't work.

Because Exchange Traded Funds are traded throughout the day, investors using them can buy and sell a position without waiting for the 4pm close that mutual funds have. The downside: ETFs also create brokerage charges in and out of the position and because of that, do not give the impression that this is a park and hold investment. The double downside: this create volatility that rattles the market in the hour before the close.

There is also a transparency and a legacy issue. Despite the publicized passivity of the fund, there is not always a good indication of just what the index represents at any one given moment. They also have not been around long enough to compare to mutual funds. New ETFs pop up everyday as the world gets chopped up into increasingly smaller chunks. And this creates a problem as well. Index funds stick to the index they track or the index they claim to mimic. ETFs can have some style drift within the fund making them difficult to pinpoint with any real accuracy.

ETFs are index fund cheap as well. An upside for any investor looking to keep the overall expenses of investing at a minimum. They rarely mention the cost of trading these funds, just the convenience.

The question is: do they belong in your 401(k)? Sharebuilder thinks so and has announced their launch of a new program for advisers to sell. Designed to make the interaction small businesses have with these registered investment advisers (RIAs) easier and more seamless, low cost ETFs will make up 100% of what these plans offer.

According to ShareBuilder these "investment offering consists of a preset line-up of 16 ETFs from popular funds offerings like a S&P 500 ETF to important fixed asset categories like treasury inflation protected securities (TIPs) not common today in most plans. ShareBuilder 401k also provides five model portfolios to help make it easy for participants to get off on the right foot."

Once again, is this right for your retirement portfolio? While we have discussed how fees can eat up a great deal of the potential profits an investor might expect. And if they are hidden as they so often are (the fees I am referring to are more from the adviser end of things) as little as a one percent increase over what a small business is paying could impact returns over the course of a working career as much as 17%. Sharebuilder promises that this new plan will be less expensive to operate with features such as auto-enrollment and auto-rebalancing thrown in for good measure.

But by making the plan completely ETFs, the risk level drops considerably. The average employee will relinquish more control to index funds than is needed to raise your portfolio's earning potential. Small plans will have a limited number of the these index-type offerings narrowing the potential for better-than-average results. In fact, your results using only ETFs will be average.

ETFs can be used as a tool for investors. But to have them solely as a tool for those planning on retiring, seems to serve the adviser more than the client.