ETFs: Are These Investments Needed in Your Retirement Plan?

Boomers are often faced with a decision that will be framed in such a way as to make it seem the only logical choice. As the mutual fund verses ETF debate begins to gain steam, some truths need to be considered.

Mark Twain suggested: "The reason we hold truth in such respect is because we have so little opportunity to get familiar with it." This will be the selling point for exchange traded funds: you will hear that they are less expensive, that they are better than the mutual funds - many of them indexed, and that you should own them in your 401(k).

They will suggest you overlook the cost of trading them, the fact that they tempt you to trade them more frequently than ou would a mutual fund and in doing so, allow you to follow the herd on any given day, a behavioral no-no for every investor. So what exactly is the attraction that they want us to see? Are mutual funds better or worse than ETFs?

The answer depends on who you are. If the sort of investor who believes that they can make small moves to harness big gains, then you should probably avoid the lure of ETFs. Exchange traded funds are mutual funds that can be traded just like stocks. They tend to have lower fees than their comparable cohort the mutual fund but the commissions that brokers charge for these trades tend to erase the advertised returns you might get.

If you are the sort of investor who buys to hold, then the surprising choice would be ETFs. Yet you will need to harness the inner trader in you that wants to succumb to the temptation to trade. This sounds easy. But in truth, is no easy feat.

So let's run some numbers comparing a total stock market ETF sold by Vanguard and a total stock market index sold by the same company. The ETF (trade as VTI) carries and expense of 0.07%. The mutual fund version of the same thing (bought as VTSMX) levies a 0.18% fee on investors. The former has no minimum investment,; the later wants $3,000 to begin. So we'll start there and propose a hopeful return over 10 years of 4%.

In the first calculated example, the investor made no additional contributions to the investment. Vanguard does suggest that they charge no brokerage fees but they do charge a $20 annual fee for the account. This might be much higher when accessing these funds through your 401(k) and there may be additional brokerage fees. So we'll assume a $10.00 brokerage fee - as I said, yours might be lower and in most cases, the brokerage charge is on both ends of the transaction.

Based on the above numbers, the ETF, once purchased and held begins to creep past, in terms of raw returns by the third year. By the 10th year, you will have saved about $19.41 in fees giving you a net gain for your ETF of $32.82. 

But begin adding to the security on a regular basis (say $200 a month) and the differences are much more notable. To add to the ETF in equal proportions over the same 10 year period would cost you $1021 in commission costs and with this money not working for you, the sacrifice in what each would be worth at the end of the 10-year investment period used in our example in addition to the trading cost would leave you with over $1200 less in the ETF account.

Inside a 401(k), where regular contributions rule the way you invest, ETFs can give the average investor less of an opportunity than proponents suggest they will. In a taxable account, bought without commissions such as Vanguard offers and purchased in large lump sums, ETFs slightly trump their mutual fund siblings.

Will you take the time to learn the truth about yourself before making the decision on which investment is better? You are the debate. 

Paul Petillo is the managing editor and founder of Target2025.com/BlueCollarDollar.com and a fellow Boomer.

Pensions and 401(k)s: A Shotgun Marriage?

As Boomers, we witnessed the placing of the pension plan on the endangered list, a relic of the past, a dinosaur left to the fate of its size and lack of adaptability. I personally miss them.

Is the pension plan, the dinosaur retirement plan of times gone by the answer to getting the older worker to retire at the historic retirement age and the answer to all of the economic problems facing the country right now?Possibly. Monique Morrissey, an economist and Ross Eisenbrey, the vice president of Economic Policy Institute recently offered their thoughts on why the pension offered the older worker the kind of security that is mostly absent in the 401(k).

Are pensions dinosaurs?

The idea has legs but not based on how they believe it could be achieved. While the authors suggest: "workers with only 401(k)s are better off than the nearly half of full-time workers with no retirement plan at all. The impact extends beyond older workers, their families, and younger workers waiting in the wings." They believe that adjustments made at the legislative level to make health insurance more affordable would be enough to give older workers the needed nudge to retire on time.

If, as many people I have spoken with admit, we'll never go back to pensions, perhaps we should instead look to some sort of hybrid idea. The 401(k) had the net effect of shifting risk to the worker, allowing for worker mobility and giving the employer a cost savings not present in the pension plans many were managing. Now, we pine for the days of the pension.


The birth of the 401(k)
Not that this was how it actually happened, but you can picture the backroom thinking: we'll shift the burden of retirement (and risk) on our workers and force them to buy into the stock market. The market will boom (see the bull market that coincided with the advent of the 401(k)) and everyone will be happy. We'll have a mobile and disposable workforce that can take their money with them when we no longer need them. No pensions, no loyalties, no ties that bind for decades, no human capital trade-offs in the early years. Genius. As I said, not that this actually happened. And furthermore, I believe that when Ted Benna, the father of the 401(k) and discoverer of the line in the tax code introduced the notion, this wasn't what he envisioned.


Fast forward three decades
And then the housing crisis crippled the mobility part. Too many people want to move to another city for another job but won't or simply can't. Older workers who have work are focused on being sure that they can retire and as a result are clogging the system of job turnover, necessary to accommodate the growing workforce.

Rather than shift the burden on the government by making benefits more accessible, why not use a pension trick. If employers offered an incentive like the five best, older workers might be willing to move on. Here's how it would work. In most instances, older workers earn the most in the final years of work. Why not reward them for their loyalty and expertise by offering a double or even triple contribution to their 401(k) if they also max-out their contribution. Rather than pushing the burden of catch-up onto the employee, the employer would also step-up their matches as well. It would probably require a tweak of two to current law to allow it. But the change would be worth it.


Three things would happen.
The older worker would get this massive incentive to save more in the final years and although they wouldn't be forced to retire, the contribution bonus could end at 65. The worker could stay on but the catch-up period would be over. This would allow the older worker to see the advantages of saving more sooner and capitalizing on the contribution bump. And the employer would see an offset in cost with a new hire, often employed for far less than the older worker.

The best of pensions combined with the self-direction of 401(k)s and the incentive to retire seems to be a simple tweak, a proverbial gold watch and a more secure older worker entering retirement. And the job cycle would, at least in theory, get moving again. And while Washington is legislating, how about requiring index funds in all 401(k) plans and annuities (which are forbidden to consider sex when tucked in these plans - which is a benefit for women in particular and men as well).

Paul Petillo is the managing editor of BlueCollarDollar.com/Target2025.com and a fellow Boomer.

Playing Worry: Approaching Retirement with Dread

Baby Boomers and those that follow you age-wise through the workforce all seem to very concerned about a single thing. You can't escape it.  You are having your choices about retirement and your plan diced and splayed and discussed in any number of forums.  None of the outcomes from these conversations are suggesting what you want to hear. So here's a flash: you're worried.

Insured Retirement Institute President and CEO Cathy Weatherford recently wrote "Unfortunately, as the promise of Social Security continues to be on unsure footing, working Americans are coming to realize that they will need more than just that paycheck to sustain them throughout their retirement." Even when the Employee Benefits Research Institute released its most recent report, concerns about retirement were, as they could only be expected to be, were the top concern.
And with that comes the numbers.  Now I tend to agree with Steven Strogatz, professor of applied mathematics at Cornell and the author of "The Calculus of Friendship when he suggests that although we are easily duped by words, numbers "brook no argument," he writes suggesting that they "are the best kind of facts."  he describes them as cold, hard, and objective. So when the EBRI reports that 69% of those recently surveyed believed that retirement accounts were extremely important, most of us agreed. Three out five the EBRI concludes from their question don't believe in Social Security and almost two-thirds say they lack confidence in the program enough to begin saving more.

Now to Ms. Weatherford's defense, she sells annuities.  So when she adds that "Increasingly, they [the working folks] are looking for ways of securing their retirement income through annuities, retirement savings accounts and other insured retirement strategies. Employers can play an important role in helping to connect employees with available benefits that can lead to a financially sound future."  I am left to ask the question: wasn't it the employers who got us to this point?

Although as the report, which was commissioned by Project 2010 suggests that 94% of the employers offer a plan of some sort, the less than surprising number is the actual participation.  With three-quarters of the employees that have access us them, it is the fourth that don't is the more troublesome number. And tucked inside these numbers is the fiduciary fib that these employers have done everything they could do to get their employees involved.

Employers are directly responsible for encouraging their employees to invest for their own futures.  Some incentivize their plans with matching contributions. Matching contributions do not have to be high in order to get their workers to participate in the plan.  In fact, studies have shown that a more modest matching contribution might actually spur the employee to put additional funds into their accounts. In the latest economic downturn, companies dropped or greatly reduced their matching contributions and are slow in returning to them.

The matching contribution does a great deal in getting the employee to do right by their own future.  But more important is the period of time between initially beginning the job and the actual beginning of their participation in the plan.  Some employers hold their matching contributions for a longer (than is necessary or even in some cases, realistic) vesting period giving the employee less incentive to invest if they feel as though they don't expect to remain at the job that long.

Some employers do offer plans that are both robust but well-supported with information and educational materials. But no plan is the be-a;;-to-end-all offering that would create the perfect scenario for everyone: employers, employees or the plan administrators. And also included in the report was the fact that 17% of the plans now offered annuities. Is this just an attempt at getting to that perfect "everything" plan?

This lack of what the investment industry refers to as a holistic approach, or decumulation, has professionals practically drooling in anticipation of of what these products can hold for their industry.  I don't really worry that my opinion about annuities will alter simply because this product has begun to emerge as the next big element in your retirement plan.  An annuity will always be an annuity and because of that, will always have more unanswered questions that concrete evidence that it is a better product as a whole instead of its parts.

Annuities are hybrids, born in the insurance industry as part insurance and part investment.  They are costly and unwieldy, ripe with fees and special ta situations for your heirs, hard to get rid of if you change your mind and don't necessarily do for women the way they provide for men.  That last part about women versus men is an actuarial adjustment for the longer lives women have. No other "investment" makes such a distinction.

Then there are the idea of guarantees. Annuities make certain promises, the largest of which is that they will never go out of business. Never is a really long time. And depending on the potential you might have for living longer than you anticipated, it would be nice to think that a company could never falter, never be affected from some unforetold expectation and never consider closing its doors for good. But it happens. It doesn't happen with your equity mutual funds and some bonds might default in your bond funds, but insurers are not forever. This is risk that is grossly understated.

What makes people so fearful about Social Security is the very thing that makes it work.  Whenever you can pool risk, you eliminate more than you create.  The fixes to Social Security are rather simple and even if you are decades from retirement, the program has the legs to continue on even in the face of the Boome onslaught (a wave that may effectively be not much more than swell in this post-recession economy). Annuities can't do what Social Security does and for good reason: there is no money to made.

In the name of fiduciary responsibility, plan sponsors will be begin to offer this sort of product with questions on cost, viability and suitability all left unanswered.  Even a simple CD could do the same sort of thing an annuity would, come with FDIC insurance and promise to never lose a penny.  A well paid CD tucked inside a retirement portfolio but outside the tax-deferred plan would help ease those fears just as well.

But the biggest fear is that when they do become available in your 401(k), they won't be one annuity, but a succession of small, mini-products, each with differing contracts. So far, no retirement plan has been able to answer the question of liquidity and security. Until those can be answered with any certainty the annuity will languish as an option, even with government support.

Paul Petillo is the Managing Editor of Target2025.com and a fellow Boomer

The Boomer Bummer: Many of Us are Still Not There

Boomers take note: we still aren't at the enviable position of having enough money in our retirement plans to allow us to outlive those reserves. Should it come as a surprise that our retirement plans have not made us comfortable enough to suggest that we won't run out of money?

In the July 2010 EBRI Issue Brief, written by EBRI Research Director Jack VanDerhei and senior research associate Craig Copeland detail the travails of various cohorts in the pursuit of outliving your retirement nest-egg.

What they found was a "don't-feel-bad-for-yourself" moment we should all take note of: the rich can become less so in retirement, just like us. Okay, most of us have a greater chance of outliving our money as compared to the highest income brackets.  But the thought does have some comfort but few lessons.

The EBRI Retirement Readiness Rating™ is based on EBRI's Retirement Security Projection Model® (RSPM), which the institute first used in 2003 to evaluate national retirement income adequacy seeks to portray where we are in terms of retirement in the hope that we can make the changes we need to our plans (such as 401(k)s) while we are still working.  It is also designed to show advisers which steps to take to protect their clients.

The latest version of the survey includes auto-enrollment and auto-escalation of contributions in 401(k) plans, which have come as a result of changes on the legislative level.  It also includes updates for financial market performance and the often chaotic state of employee behavior.  The report is based on a database of 24 million 401(k) participants.

By simply looking at how much has already been accumulated across this wide swath of workers, they were able to determine when the money will run out.

The results after 10 years of retirement:

Lowest-income quartile: 41 percent are likely to run short of money.

Next-lowest quartile: 23 percent.

Third income quartile: 13 percent.

Highest-income quartile: 5 percent.

After 20 years of retirement:

Lowest-income quartile: 57 percent are likely to run short of money.

Next-lowest quartile: 44 percent.

Third quartile: 29 percent.

Highest-income quartile: 13 percent.

But what does "running short of money" actually mean?  The ERBI study used a combination of basic expenses based on information obtained from the Bureau of Labor Statistics' Consumer Expenditure Survey.  This also includes the biggest unknown but the highest projected retirement costs: health care.  By adding the cost of some health insurance and out-of-pocket health-related expenses, plus expenses from nursing home and home health care expenses, at least until the point they are picked up by Medicaid, the nest-egg most of us have will be under serious stress in a relatively short time.

While there have been some improvements in how much money we have currently accumulated, the group referred to as the early Boomers, those aged 56 to 62, the likelihood of running out of money has improved since the survey began.  But it still sees 46% of this group with less than adequate assets to cover the basic needs in retirement.  Late Boomers are only slightly better prepared with 44% likely to run short.

In short, we haven't put enough money to work for our plans to be successful.  We haven't allowed the plans to use the risk available to grow the plans the way they need to be nurtured.  And we have not harnessed our own budgets in such a way as to alleviate the pressures that accumulated debt takes away from our ability to save and invest more.

Paul Petillo is the Managing Editor of Target2025.com and a fellow Boomer.

Your Retirement Plan Directed by You

Today we are going to tackle the self-directed IRA. We all know what an Individual Retirement Account or IRA is. Briefly, it is the retirement tool for those of us who may not have access to a 401(k) that defers taxes for retirement. The deferring part is not really as complicated as it seems. In a 401(k), you have your contribution taken out before you pay taxes; in an IRA, you pay with after-tax money and then take the deduction when you file, basically subtracting the taxes from your contribution to be paid later.

How is a regular IRA different than a self-directed IRA?
The differences are not as obvious as the title of these products sounds. An IRA is an investment chosen by you and you direct the funds to it for your retirement. It seems like this should be called self-directed but in reality, it is very different from what the IRS views as a self-directed IRA.

In a self-directed IRA, you become the manager of the whole process. Rather than simply sending money to a mutual, fund company, the most common sponsors of IRAs, you direct the underlying investments. In the previous example, the institution is the middleman. In a self-directed IRA, the institution, whomever or whatever one you chose, does what you tell them to do.

To learn more.

Is it Too Late to Start Over?

Boomers are faced with a double whammy of sorts.  First, they have limited time in which to take risks and when they did, they didn't take enough of them.  But there are still some things that can be done.

A great number of investors reacted in a very predictable fashion as the Great Recession took hold.  They sold their holdings on the way down, in large part because no one could predict how far down would actually be and stopped contributing to their 401(k) plans.  Employers, as we have discussed here, suspended their matching contributions for several reasons (no need to spend money where it didn't need to be spent and there was no longer any reason to offer this as an incentive to keep or hire new employees).

Adding to the mad dash to protect dwindling balances, target date funds and bond funds swelled with new contributions. This was, in many instances, akin to stuffing money under the mattress.  Not that some these funds did poorly or had mediocre performance, although many did, investors felt protected or at least safe from the chaos and volatility of the open markets.  It was a flight to risk-free, or at least, invest-and-forget investments.

Once-Bitten

Historically, the bad news of a falling stock market lasts about six months.  This quick, fall-off-a-cliff drop to the bottom is often followed by a market where investors find innumerable bargains. Over the last decade, unlike all of the previous data on the equities market, recent recoveries, this one included have come at record speed.  Five years in-between market drops and recoveries is not the norm.  But possibly, could be.

This may have something to do with a much larger segment of the investment market coming from 401(k) investments. Although these plans have been around for thirty years, they have not really caught on until recently and even that trend is not fully employed by those who have access to these types of plans.  Pensions may have gone away but 401(k) plans have not fully replaced them with the working public.

That fact leaves many investors vulnerable to their emotions and to the forces that promote the marketplace.  A recent study done by Hewitt Associates found that the vast majority, or what they termed typical, investor under the age of forty had moved some or all of their retirement funds into target date funds.  Those over the age of forty found the move to bond funds more appealing.  Both of these investments, albeit conservative in nature, were forgivable. They were doing what any "once bitten" investor would do.

Read more here.

Paul Petillo is the Managing Editor of Target2025.com and BlueCollarDollar.com and a fellow Boomer.

Will More Plan Participants Ruin Your Retirement?

It was often thought that the laws of scale would solve everything.  The more the merrier so to speak.  When applied to your 401(k) plan although, the opposite might be true.


Auto-enrollment in 401(k) retirement plans was mandated in the Pension Protection Act of 2006. The PPA saw the idea as a way to help ensure that employees at least had a jump start at retirement. By enrolling new employees automatically, the theory of getting more workers involved in the plan sooner would them an opportunity to grow their future right from the first day (in some cases). At the time, it was thought to solve the under-use of these plans by a great many workers.

Is a lower company match going to impact your retirement future?  Will you increase your contribution to offset the lower match or do as some have historically done, reduce your contribution in kind?

Read more about the high cost of autoenrollement on your retirement plan.

From Paul Petillo, Managing Editor of Target 2025.com and a fellow Boomer.