Mutual Funds: investing in fixed income

Here is just one of the numerous articles I published on Answers. Please visit mutualfunds.answers.com Mutual funds are numbered in the tens of thousands investing in every conceivable investment opportunity. They range from equity (stocks) to fixed income (bonds) to money markets, commodities and beyond. And they break down even further to investments focused on domestic offerings to international, emerging markets to total global coverage. You can read the full article here.

Missing the Target: When Investing with This Sort of Goal is a Problem

Boomers who have shuffled out of their pre-2008 investments into target date funds did so because the promise seemed real. Conservative investments with some stocks and a sort of set-it-and-forget-it type of plan that would provide peace of mind. Younger people get them via auto-enrollment when they are newly hired. Either way, these investments have yet to prove their worth. Here’s the three main problems with target date funds.

One, they are funds of funds, a collection of mutual funds that do various things in different ways. Unfortunately, very few mutual fund families are rolling their best performing funds into these retirement tools. And in truth, why should they? If the investment public is buying a fund without too much effort, why throw it into a target date fund.

Two, target date funds are often found and the most heavily used in a 401(k) plan. They have been deigned the fund of the auto-enrolled, the new hire who for whatever reason doesn’t have a clue about how a 401(k) works, wouldn’t use it if they did (statistically, this is why these plans are underused and auto-enrollment has helped boost participation with few people opting out once they were in) and probably owns no other investment. If you have found yourself in this type of fund it is because your employer has done a little napkin math and determined when you will retire based on historic norms for retirement (i.e.65 years old). Those historic norms may not be all that accurate, but it is better than nothing.

Third, because 401(k) plans, at least the vast majority of them don’t allow you to do too much shopping around, you are stuck with the fund that your 401(k) is offering. And this is where we run into trouble.

These funds are designed, at least on that napkin, to do what most of us are not too well versed in doing: asset allocation over time. The idea is that we want to go from aggressively invested in our youth to a more conservative approach in our later years. This journey from capital growth to capital appreciation inside one fund has no real track record to speak of. So at any given time, a handful of target date funds with the same target date could be at different points on this aggressive to conservative investment journey.

Enter the Government Accountability Office or GAO. In a recent report, the GAO was asked (it does not say by whom) to answer the following questions about this investment: (1) To what extent do the investment compositions of TDFs vary; (2) what is known about the performance of TDFs; (3) how do plan sponsors select and monitor TDFs that are chosen as the plan’s default investment, and what steps do they take to communicate information on these funds to their participants; and (4) what steps have DOL and the Securities and Exchange Commission (SEC) taken to ensure that plan sponsors appropriately select and use TDFs?

Without going too deeply into the 59 page report, I’ll briefly answer some of the questions. The investments can vary wildly. In one fund they examined, 65% of its assets were still in common stocks in the year prior to the target date. If the goal is to get your money to a safer place over time, this fund failed to do what it promised to do. But they can’t be faulted for trying to get the biggest return for the investment dollar – and to do that you need to take risks – and hey, their are no guidelines to follow, just a sort of linear point A to point B path.

Performance is indeed an issue. We look back on mutual fund performance three, five, even ten years to glean some information about how the mutual fund performed in good markets and bad, how long the fund manager has been at the helm and how they have weathered the various storms that blow across the investment landscape. Target date funds have no track record to boast about – some have good returns, as much as 28% from 2005 to 2009. Others have lost more than 30% of their value in the same time period. Some have only been around for five years or less.

Chances are, because auto-enrollment put you in that fund and you have nothing to compare it to, in large part because auto-enrollment might make you an auto-investor, it doesn’t make auto-smart about investments. To their mutual benefit, plan sponsors are doing what they can to educate their participants. Some do better than others. But the worker is the one who has to show some interest in where their money is going in order for those educational efforts to work.

The last question the GAO attempted to answer about target date funds, the one about the involvement of the Department of Labor and the Securities and Exchange Commission in the process presents the most problems. A plan sponsor knows their fiduciary responsibility to offer good investments at the best cost accompanied with access to information. It comes down to all parties talking about you in the following way: You can lead a horse to water but you can’t make it a duck.

You have to take an active role in what your plan has to offer. Yes, the improvements in how target date funds operate will happen, and possibly without your knowledge. But this is your money that you are counting on in retirement. Do you really believe that anything in this day and age can be set on a path that lasts 30, sometimes 40 years and not need some attending to? 

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

Free is Not Free: An Offer of Retirement Advice

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.

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

Could Lifetime Income Benefit Boomer Women?

Boomers are faced with some immediate challenges.  Among those, after working for decades on "how much I can accumulate" for retirement, we are now asked to look at "how much lifetime income" those investments can generate.  This is not necessarily good news for Boomer women.

Those who have followed me on this site know that as a rule, I don't like annuities. For most of us, this sort of  - and I hesitate to call it such - investment is something you purchase to guarantee income.  Part mutual fund, part insurance policy and wholly too expensive on both counts, annuities, for whatever reason you purchase them, offer the buyer some peace-of-mind.  For women, annuities are particularly troubling and expensive. But the concept of guaranteed income for women in particular, is worth exploring.

When Amy Matsui of the National Women's Law Center spoke to the Senate Special Committee on Aging recently, she opened with the cold hard facts of retirement.  Women she noted tended to have smaller balances in their defined contribution plans or IRAs when compared to men ($34,000 on average compared to the $70,000 men had accumulated).

She strongly criticized the concept of these sorts of plans in part because of the self-directed nature of the plans, the feeble if inadequate investment selections available and the inherent risks these plans pose to the average, even experienced investor. Because women tend to stay in jobs for less time than men, the chances that any defined contribution plan asset accumulation would be less, even below the minimum required balance that would allow them to keep the plan at an old employer.  So they receive the lump sum payment, with the taxes and penalties and of course, the problem of starting over.

Ms. Matsui also points out that women are exposed to "longevity risk" more so than men. When a lump sum is paid by a 401(k) at retirement, the investor is left with managing that money so as to not run out. This can be a particularly daunting task for women - not because they are less savvy investors, many are more so than men - but because they will live longer and may outlive their spouses as well.

But this becomes even more problematic for the women looking to guarantee a lifetime income.  Annuities do not favor the women who need them most. When they shop for annuities, women tend to have smaller amounts to invest and therefore are subject to higher fees and lower effective returns than their male counterpart. Add to that, as Ms. Matsui points out, unlike defined benefit plans (pensions) which are not allowed by law to use gender as a factor in payouts, annuities use what she calls "gender-distinct mortality tables".  Women, because they live longer, get paid less than men even if they purchase the same product with the same dollar amount.

Because of that she fears that Social Security has become the retirement plan women can rely on, even if it isn't for much. Yet the solutions are relatively easy.

Among those solutions is the inclusion of some sort of lifetime income investment in all 401(k) plans. Tucked inside these plans, because of the law guiding how these plans are governed, women would benefit from the gender neutral handling of those options.

Rollover requirements on small balances could be changed as well allowing women to leave smaller balances in their former employer's 401(k). And, with the help of Congress, annuity products could be changed in how they treat women who live longer.

This could alter how women participate in the plans available to them. While it is widely acknowledged that only half the workers in the US have access to defined contribution plans at their place of employment, women lag behind their male counterparts in how they utilize them (only 40% of the women who have access to these plans use them). Is it because women want to know what these investments would be worth when they retire?  If they did, participation might increase.

Ms. Matsui points to the discriminatory process involved in purchasing an annuity.  She points out that a women, purchasing an identical product offered to a man, would receive over 9% less in monthly payments. With increased participation from employees inside a 401(k), the annuity it is believed would cost less and pay more as the risk is spread across a wider, more diverse group.  This doesn't occur when purchasing the annuity as a stand-alone product.

She admitted that she understood the administrative costs associated with maintaining these low balances in an employer's plan.  But Ms. Matsui argued that these low balances can add significant value to a low or moderate income woman at retirement.  The trend towards thinking of retirement in terms of income stream is gaining momentum and small balances should be considered as well.  Some is better than nothing, in other words, and when the post-retirement account can be enhanced even slightly, the quality of the retirees life increases.

The NWLC also wants spousal protection to be among the considerations when looking at the retirement plans of women. Because of the lump-sum payout of the 401(k), the protection in retirement of the spouse is left to the discretion of the retiree.  In a defined benefit plan, the spouse can receive benefits.

When the rollover occurs, the spouse may not receive what they may have gotten once the investment is reinvested and beneficiaries are chosen.  (Wills do not govern how IRAs are distributed leaving the chance that these retirement investment could go to children, even former spouses.) A change that would guarantee 50% to the spouse, unless waived would be a great stride toward improving the spousal benefit and income.

While some of these changes would provide only minimal changes in the lifetime income stream of low- to mid-income level, women, those incremental improvements could go a long way in increasing the quality of life, offsetting the total dependence on Social Security and promote the way we look at retirement from a total return on investments to how much will I get in retirement.

You can read Amy's testimony in pdf form by clicking here.

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

Annuities in Retirement

I have never been a fan of annuities.  The plain and simple truth to this belief rest on the fact that an insurance company should not be involved in your retirement future, past or present.  These businesses do have a role in protecting you from unforeseen problems and the possibility of those issue delivering a financial blow that could derail your plans.  Insure your life, your house, your car.  But insure your retirement?

First, an annuity is as I wrote, an insurance product with an investment aspect that offers to mask the true identity of what it is.  Now annuities have been gaining traction in the retirement discussion as a way to guarantee a lifetime income for those who feel as though they may run out of cash.  Just like every guarantee you are offered (on many items that at the time would be too expensive to repair on replace), the cost is built into the offer.  In other words, you are paying upfront for something that you may never use.

To read about this interesting subject more from Paul Petillo, managing editor of Target2025.com and a fellow Boomer, click here.

When it Comes to Wall Street...

Asking that questions seems odd in and of itself.  Of course they are you might answer.  And any Baby Boomer would be correct in this assessment.

But somehow, we seem okay with this. We seek retirement or at least profess we do, often making it seem like some scalable mountain we are in training to ascend. Advice on how to do this, a feat we would rather not attempt, instead taking the paved route with the rest of the tourists, comes from all angles. Invest more, take some risks, approach the effort with no emotion, live frugally, budget, diversify, and the take fewer risks, get healthy, worry, and finally try to outlive your money in retirement by taking no risks.

And lurking in the background, not caring one whit about you in the long-term and perhaps, if it is possible, caring less about your future in the short-term. As I said, when it comes to Wall Street, the odds are against us.

Read more...

Retirement is Not a Game of Horseshoes

After the 2008 investment season and early into 2009, there were only a handful of investors who could claim to have these elusive skills. As far back as Benjamin Graham, the skill that was needed to be a successful investor was widely believed to be a possession of the few.  It wasn't necessarily the wealthy either.  But a subset of the populace who, for some reason, understood the mechanism better than others.

This led more than few folks to look at target date funds as an investment that might hold the elusive key to investment success. Money poured into these types of funds and continues to this day.  This in large part because of the default option that new hires receive.

But Baby Boomers have an unique problem. Too conservative and there won't be enough money.  Too aggressive and there may be losses that are not welcomed.  But target date funds, while they have gained praise as they continue to underperform, are not the answer.

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

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.

The Weight of the Economic Recovery

Seems that there isn't a day goes past that I am not asked about the concept of buying a house.  These questions usually come from younger workers who may be barely into their thirties.  And the answer I offer them is not what they want to hear.  In fact, it flies in the face of everything they have ever heard about home buying, much of it now like the retirements of our parents: not something we can count on for us.

But what about Boomers who find themselves underwater in their homes? Can you walk away?  Will you know why?

For more on this topic, visit Target2025.com: Is Owning a Home No Longer Smart Money Management?

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

The Worrisome Nature of Less Risk

Ask any Boomer of a certain age what the meaning of life is and they will probably say retirement. So, if retirement is the goal, why would you handicap your chances of arriving when you imagined? Evidence of this shift has challenged those imaginations: Year-to-date (third quarter 2009), the US household sector is shown to have purchased $529 billion of US treasuries. Granted, a great deal of this was due to money flowing into more conservative 401(k) investments via mutual funds. This pace, the purchase of approximately 45% of what the Treasury was selling, is four times that of the previous year.

This sort of immunization has not gone unnoticed. The problem with many of these commitments to a more conservative approach may be creating a bubble of their own. These types of debt instruments are based on price and yield. As one goes up, the other goes down. The more someone is likely to pay for a bond, the lower the yield that is offered.

If this sort of pace continues, and it looks as if it may as the temptation to be able to even consider retirement strengthens as the economy gradually improves.

But with more people flocking towards these fixed income investments, the price paid will begin to become unattractive, in large part because inflation remains benign. That won’t last forever. And when those conservative investors begin to realize that the yield is now negative to inflation, the selling will begin.

The real paradox will then kick in. Now what?

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