Alison Farrin of Innovative Pensions was kind enough to be our guest today on the Financial Impact Factor Radio. She explained to my co-hosts Dave Kittredge and Dave Ng of FinancialFootprint.com exactly what her role is in the 401(k) plan as a TPA or third party administrator. She offered some very helpful insights in how you should use the plans as well as the way small businesses should approach the process of providing retirement benefits to their employees.
Also on the show, a look inside the increasing financial debt faced by college students. Dave and Dave explain forbearance, deference and defaults.
Your ability to make the choice of which investment to purchase depends on who you listen to. You may think you are an independent thinker, willing and able to parse all information available to you in a way that complies with who you think you are. But psychological experiments prove otherwise. Faced with which investment in your 401(k) portfolio (we'll use this tax-deferred retirement account in part because most of us have access to them and only some of use them well) you will invest in what someone else has told you to invest in.
You may think you are acting independently. But experiments have shown that you will act against your own morals or perhaps better judgement) in many instances. Consider this: if you are a long-time reader of what I have written over the years, you have grown to disdain annuities and repel target date funds.
You know that I think annuities are a product that costs too much and despite the peace of mind it might offer you and yours, you could do better on your own in something just as conservative without involving an insurance company.
You know that I am not a fan of target date funds in part because they are not all created equally, do not have a good track record that suggests they can do as advertised and if they fail to do as advertised, you might have missed a decade or two of substantial portfolio gains because of it.
So as a non-fan of those two products (there are others but for the sake of this discussion, we'll keep to products you are most likely to confront at some point in your financial lives - target date funds in your 401(k) and annuities at the end of your career), you might think twice about what these offer and if they will do what they suggest they will or I have claimed they might.
Yale University psychologist Stanley Milgram measured the willingness of study participants to obey an authority figure who instructed them to perform acts that conflicted with their personal conscience. While some of his experiments seemed somewhat abusive, they drove home the point that once confronted by the voice of authority, you will not follow what you know is right.
Consider the Halloween experiment for a moment. A trick-or-treater is told by the person answering the door to take one piece of candy and after instructing them of that, leaves the room. 34% took more than one. But put a mirror with the candy and the number of children who took more than one piece despite being directed not to, dropped to 12%.
We are subject to influences even if the person who is influencing us is the person in the cubicle next door or the neighbor across the street. You have no idea whether either of these tow people are lying when they reveal their investment secrets - and most people understanding that fact do in part because there is no moral obligation to tell the whole truth (which might be that they have a great 401(k) balance but huge credit obligations). They speak with authority and looking for guidance, we gravitate towards their expertise.
Your level of intelligence has little to do with it. So what do you do knowing that you are susceptible to suggestions that may go against what you know might the opposite of what you think you stand for? Professor Milgram suggests the following (from Wikipedia):
The first is the theory of conformism, based on Solomon Asch conformity experiments, describing the fundamental relationship between the group of reference and the individual person. A subject who has neither ability nor expertise to make decisions, especially in a crisis, will leave decision making to the group and its hierarchy. The group is the person's behavioral model.
The second is the agentic state theory, wherein, per Milgram, "the essence of obedience consists in the fact that a person comes to view himself as the instrument for carrying out another person's wishes, and he therefore no longer sees himself as responsible for his actions. Once this critical shift of viewpoint has occurred in the person, all of the essential features of obedience follow".
Here is the difference between authoritarian expertise and common sense. If you are told by someone that such-and-such an investment is a good choice, that they have it and have been thrilled by the performance, their authoritarian tone will suggest that you need to do very little research because they have and they have given it their stamp of approval. You have absolutely no idea whether they are going to sell it tomorrow because whatever the investment was, it has run its course. And they have no obligation to tell you.
If a mutual fund suggests that it has a trillion dollars worth of investor dollars under its management, the perception is that there are a lot of people who trust the managers authority to do the right thing. But suppose that money - which we always think does the right thing even if the sell on the downside and buy on the upside - is doing only what the previous person has done. Think Ponzi. Think Madoff.
So what do you do? The morally correct choice is relatively simple when it comes to investments for retirement. You will one day retire and that means you are dreaming of a day when you will no longer work. You may live 20-30 years after that moment and you will need to finance that time. You will need to explore how you will spend that time and how you will pay for it.
You will need to put money away. I can say that you need to contribute the maximum amount the law allows to that 401(k) account, but you won't. You will feel bad because you haven't and in many cases simply work longer to make up the shortfall. But you know you need to invest more than you are.
Today on the Financial Impact Factor Radio show, we had as out guest, Joe Tomlinson of Tomlinson Financial Planning. Joe is no slouch when it comes to the world of finance, annuities and retirement planning products. He joined the host of the show Paul Petillo, Dave Kittredge and Dave Ng for lively discussion that traveled from a discussion about what planners/advisors/brokers were to annuities and other retirement planning products to a discussion about whether college was worth the enormous cost.
You should give it a listen. Better yet, click on the little iTunes button at the bottom of the player and never miss an episode (you will automatically be subscribed to each show as a podcast allowing you to take the show wherever you go).
Boomers plan on travelling in retirement, which is certainly a noble goal. But perhaps some of your investments should be gin the journey in advance.
First off, this is not the kind of thing you want to sink all of your investment dollars in. That might sound like a disclaimer, but the very idea that you could own a mutual fund that acted conversely to the way you want to react, a mutual fund that sold when markets were high and feasted when the markets were in trouble, and did so in many instances without so much as your normal hands-on knowledge, seems radical. You're an investor and you act like one.
Or you're an investor who knows that you aren't rational. And that is most of us. But a new study as uncovered that if you own a mutual fund far from where you live, you will allow it to do what it should do when the time is right. In other words, the farther away from your investment, as Miguel Ferreira of the Universidade Nova de Lisboa in Portugal, Massimo Massa of INSEAD in France and Pedro Matos of the University of Southern California found out, the more you agree with the hedge fund-like attitude the fund exhibits.
Hedge funds have long since known that you need a presence in the place you invest. It wasn't until a paper by Melvyn Teo of the Singapore Management University uncovered the fact that a geographic presence is key to investment success. This sort of "boots-on-the-ground" approach does make sense. If you know your marketplace, chances are you will know all of the nuances about that investment area. But this new study suggests that the farther you are away from that sort of investment, the better the investment does.
In a diversified portfolio, you probably own a few funds that you are taking a risk with - something in the emerging markets, an international fund or a hybrid of the two. Good advice has always suggested that some limited exposure to what occurs in far-away places adds some seasoning to an otherwise straightforward portfolio. Little did many of us know until recently was that this sort of investment will do better because it is so far out of our field of expertise.
Perhaps the worst thing that can happen to a mutual fund manager is the reaction of the herd or herd mentality. Once the herd begins to move in one direction or the other, hence the description, there is little anyone can do to stop the momentum from gaining speed. I don't need to tell you that the most recent example of just such a herd reaction was during the most recent downturn. Once the well-informed investors began to retreat, other investors, via the alerts from the media, began to follow.
For a mutual fund manager, this is the worst of all possible events. Keep in mind, most mutual funds don't keep a lot of cash laying around. When the occasional investor exists, they sell something and pay them off. But when an entire herd heads for the door, the selling simply opens the market wound wider and the bloodbath begins.
Hedge funds don't allow this to happen which allows them to take a position that might be contrary to what the markets are doing. In other words, they can buy what you don't want and sell what you think is hot and make money on either end of the investment equation. But the ability to do this is made possible by the knowledge that their underlying portfolio is not affected by the herd. That's not to say that their investors don't panic, but the lock-up keeps them from mucking up the plan - for the hedge fund manager and the other investors - by trying to head for the door when they probably should be buying more.
Now what Ferreira, Massa and Matos discovered was a sort of geographic lock-up. The farther away from the fund the actual investor was, the higher the likelihood that they would allow the fund, with the local address to do what it needed to do without interference. In other words, the less you knew about what was happening, the better the fund was likely to do. Distance turned these far-away funds into de facto hedge-funds.
In a nod to the hedge fund industry, they wrote: “This intuition is similar to the one proposed for hedge funds: Hedge funds take advantage of mutual fund investors’ fire sales. When mutual funds are forced to sell to meet redemption calls, hedge funds buy the assets liquidated at fire sale prices (Chen, Hanson, Hong, and Stein, 2008). The fact that mutual funds intermediate a way higher fraction of asset under management than hedge funds suggests that this effect represents a large-scale “limits of arbitrage” phenomenon, way more important for the economy.”
In other words, mutual fund managers who essentially swoop into a location, buy what they think is a good buy (not saying that their research is faulty) and fly back to the home office, lack the physical understanding that a geographic embeddedness offers. In other words, if you live there, you know better what is going on. Even in a global economy with the world seemingly wired to give you information in a split second, being somewhere is still better in terms of investments.
As I said when I began, this is not a recommendation to put whatever you have in places far away from where you live. But rather a shortfall of what we understand about where we invest. If there had been lock-ups in place for mutual funds, there is a distinct possibility that the downturn would not have been as severe. While hedge funds use lock-ups to prevent investors from forcing redemptions of what would be illiquid investments, mutual funds could use the same rule to control herd mentality and protect the patient, long-term investor in the process.
Everyone wants a piece of your business. You're a Boomer and you have needs - more like worries that you won't have enough to retire. So offers like the one we are about to explore are going to fly across the radar screen and you may be tempted to bite. After all, these are reputable companies offering what appears to be free retirement planning advice.
Vanguard has begun to offer you the opportunity to speak with a Certified Financial Planner. Based on what they refer to as extensive research supporting the need for contacting a professional, their new service focuses on those who are 55 years old or older. This is a worrisome group of late and the focus of a great deal of media attention. Being close to retirement is troublesome enough; close to retirement and worried that you will live longer than the previous generation (even if those stats rely on some very broad statistical factors) is even worse.
Being 55 years-old - which qualifies you for Boomer status - is close to retirement. But 10 years - by old school standards of retirement at 65 - is still a good amount of time to fix some problems, but not all. Vanguard studies have uncovered research that this group may be too overexposed to bonds (about 11% are totally into this fixed income investment) or too over exposed to equities (14% are 100% invested in stocks via mutual funds). This is not the idea behind asset allocation, a concept that keeps your money in a wide variety of investments in order to avoid sudden downturns that take the whole of your portfolio down in one quick swipe. Too much in stocks, as many investors were in 2008, resulted in a devastating blow to those portfolios. Too much in fixed income, some worry, could bring a similar event to these investors in 2011.
Asset allocation spreads the risk among different mutual funds within the retirement plan. For some, this suggests that you simply buy a target date fund with your retirement age goal and sit back and ride it out. But in many instances, the simplicity of this sort of investment suggests that you are not as focused (read: worried) as Vanguard would like you to be.
Target date funds are not everything they are sold to be. They can be expensive. They can be at the mercy of the basket of funds that make of the fund itself. they have managers who have never done this sort of seasonal readjustment over ten, twenty or thirty years. And not all target date funds do the same thing at the same time.
Vanguard's answer: your own personal financial planner. And Vanguard's solution to get you to use one: tell you its free. Trouble is, nothing is free including the advice, the readjustment to your portfolio or the ability of Vanguard to right decades of wrongs. the questions that this new programs suggests they will answer for you include some of the nagging questions they assume you have been asking yourself:
When can I afford to retire?
Will I have enough saved by retirement?
How much can I spend in retirement?
Which investments are best for me?
These are all good questions but basically all the same. A CFP can, according to Vanguard divine an answer following an online questionnaire that is followed by a 45minute phone call from a CFP where they will examine who and what you are. By the time you finish filling out the form, you will know exactly how much trouble you are in and why. You haven't contributed enough, you havent taken enough risk and you will have to work longer, hope for a robust marketplace and continued low fees and taxes and a hefty dose of good fortune along the way (i.e. good health).
The problem here is that for the vast majority of Vanguard clients, the advice is far from free. In fact, it can be quite expensive in a number of ways. Up front, the cost is free fro those who are considered Flagship or Voyager Select clients. To be considered on of these investors, Vanguard ranks your use of their services in the following way: "Membership is based on total household assets held at Vanguard, with a minimum $500,000 for Vanguard Voyager Select Services®, and $1 million for Vanguard Flagship Services®." And for that you get free advice.
The client with a membership in Vanguard Voyager Services® would need a minimum of $50,000 to qualify for the advice but the cost is $250. If you are like the vast majority of 401(k) investors, both with Vanguard and without, the service will cost you $1,000. And then, the decision is still up to you.
In a recent press release, they described the service and how it could be implimented: "After you review your plan's strategy with the planner, you can implement it on your own, ask us to help you get started, or simply use the plan as a second opinion for your current investment strategy. The ultimate direction—and the investment decisions—are completely up to you." There is no fee schedule should you decide to have them help you.
So here is some basic advice that seems based in common sense but still widely ignored: contribute more. You may have your asset allocation out of whack, you may be invested in target date funds, you may be paying too much in fees for what you have. But the bottom line is you still haven't made the toughest choice of all: allocating more of your paycheck to the problem.
Once you decide to sacrifice on the real life side of the equation, I firmly believe that you will take a more nuanced interest in the retirement side. No one makes sacrifices, particularly the monetary ones that your retirement plan demands without getting involved. The more money you invest; the more you will get involved in those investments.
Even as the news told us with the turn of the calendar that the first Baby Boomer was eligible to retire, all of us wondered if they did. Were their retirement accounts so much better than ours? Did they make promises that they kept? Were they able to dance between the raindrops rather than simply weather the storm? We may never know more than we know about ourselves. But what do we know about ourselves and our retirement plans? Does the answer lie in how we approach our New Years resolutions?
By the time you read this, your New Year's resolutions may already be broken. If not, in the next couple of days they will be seriously tested. This doesn't make you a bad person - in part because you have broken them so often in the past. But there is a pattern in your lapses and if you promised yourself to build a better financial plan, focus more of your income on your retirement accounts, and/or simply spend less, breaking those commitments can have longer range effects that simply gaining a few pounds.
Why do we break the resolutions in the first place? In large part, our resolutions are well intended. But they tend to be an all-or nothing type of promise to not do better so much as to change course. This might relatively easy to do if you are 20 years old. But the older you get, the longer it will take for that ship you call life to readjust its headings.
Which brings us to the second reason we fail to follow through: lack of patience. As much as I hate to bring up the dieting analogy, it does apply to the way you treat your finances. Nothing is instant. You can't will away years of bad habits and as soon as one of those bad habits creeps into your diet, its over. In the world of finance, it might be a purchase done outside of your budget that has the ripple effect of bringing the resolution down.
Statistics have shown that resolutions morph from something that is a need-to-keep promise to one's self to a nice-to-keep promise. This is another reason why, by the end of the first week in January, you have back-burnered the promise to increase your 401(k) contribution, put your credit cards away, talk to your children about money, talk to your husband about the course of your retirement plan. Even if the idea was to build a plan, something anything more than what you have haphazardly pieced together, you have already lost some of the goals you set forth.
Men have no problem breaking resolutions if they make them at all. Women often see it breaking a resolution as a sign of some weakness. Both are wrong. Here are five easy steps to make your financial promises stick in the new year - and if you haven't made any, this will help you make some commitment without the pressure of a change in the calendar.
1. Be patient. No retirement plan was hatched in a day or a week or a year. Most 401(k) plans have internet access available to their plan participants. Log on and find out where you are in terms of contribution. If it is less than 5%, change it to 5%. This is usually the threshold where your pre-tax contribution has no effect on your take-home pay.
2. If you are a couple, do this together. One resolution to keep is that retirement plans are best used if they are combined. Not physically, but on a decision level. One plan might be better, the other might be more generous in the match. One of you might earn more where a 5% contribution is actually a larger dollar amount. One plan might have better investment opportunities. If don't approach this together, you will not get the benefit of two plans as one.
3. Add 1% a month every month thereafter until you reach the 12% mark. This will be not-as-painful but will require you readjust your spending habits.
4. Educate yourself about risk and how much you can embrace. Women have been studied and most of those surveys have drawn similar conclusions: women are more pragmatic when it comes to investments. If men and women looked at what they want and how their plan could help to achieve it, they might find themselves much better situated 15 years down the road than if they chased the next-hot investment cycle.
5. Take a look at your beneficiaries. Your investments and insurances need to be specific. Your will needs to be clear. And if you do this, you will find that this forces you to look deep into the future at a time when one of you - most likely, the woman, will still be around.
Perhaps the best way to begin a prediction about 2011 is to see how I did in calling 2010, something I referred to as "Hope for a Decade Lost".
I wrote: "I wondered what economic nationalism would bring. Banks in major countries all were faced with unprecedented decisions, conundrums of epic proportions and no real template in which to test their theories of recovery." This played itself out in revelations about the Fed helping banks cover short-term losses and in doing so, helping to avert the potential for a major global crisis.
"In June of this past year," I wrote about 2009, "President Obama suggested that the Fed have greater power in regulation of more than just banks, proposing that the power of the Fed be extended to the whole of the financial system. With this expansion, the Fed would move beyond its control of interest rates and inflation (both of which were kept abnormally low and will begin their gradual uptick in 2010) to the role of financial police." This did happen but was softer than expected. I had hoped that someone responsible for the mess we are still in to be brought to justice - but that didn't exactly happen.