Borrowing to Build Retirement?

Over the years I have written about the topic of retirement planning, I have witnessed some incredibly crazy thinking. Many of those thoughts have come home to roost often too late for the investor to do anything to fix the situation. We plan, we tell ourselves, to retire at a certain age with a certain amount of money based on a certain withdrawal rate.  But those plans are often dashed by unforeseen events that, in hindsight we should have anticipated.

Recent reports have pointed towards an increase in employee contributions to their 401(k) plans. These upticks, however slight lead many to conclude that we are starting to get the message. But which message are we holding on to? Is it the need to simply save more because we know the chances are we will need more or is it the result of some other encouraging news? I'm inclined to go with the second choice.

Retirement planning is a whole package endeavor. In other words, simply putting money away for retirement is not enough. Numerous other pieces of the puzzle come into play and this is what is often ignored. The effort is noteworthy only if you have developed a budget that is actually less generous, forcing you to face the reality of an income in retirement that is not the same as the one the you had while working.

This income reduced budgeting is practiced by too few close-to-retirement planners. At no time in the history of retirement planning - and I'm going way back to the generous days of the defined benefit plan or pension - was the payout at retirement designed to replace 100% of what you live on now. The number was actually closer to 70% replacement and that was only if you had worked within the confines of that pension for thirty years or more (and it was not impacted by changes from the company). The remainder was to be supplemented by Social Security.

But with advent of the defined contribution plan (401(k), 403(b)), with the responsibility for funding your retirement placed squarely on your shoulders, we were forced to face the possibility that 70% of our current income would not be replaced. In order to get those kinds of post-work rewards, we would have had to invest 12-15% of our pre-tax income, every year without fail, in good markets and bad. For too many people with this plan, that sort of budget-busting restriction was simply too much to embrace.

We are to be forgiven for our human-ness however. We make mistakes and follow the herd - when they sell, we sell and when they pile in, we follow. In both instances we turn our backs on the whole concept of retirement planning: steady and ever-increasing contributions without consideration for what the overall market is doing.

Our employers didn't help much either. They gave us matching contributions, took them away or reduced them, and when they re-introduced them, they were far smaller. And we misinterpreted this as a sign that they knew something we didn't and mimicked their actions: we reduced our contributions when the matches were lowered and increased them when they were raised. As I said, we can be forgiven this tendency but we won't be absolved of this sin of remission when we begin thinking about retirement.

One of the other keys to the seemingly good news about an increase in contributions in 2011 is backlit with some additional news. Auto-enrollment helped to raise the account balances of the overall plan (and as employment improves, so will the news that we are using the plans in a more robust way). But those auto-enrolled new hires were placed squarely in the plan's target date fund of choice.

Long-time readers know about my reservations with these funds. New readers should note: target date funds are often less transparent than stand-alone funds, the underlying portfolio can be suspect, the target date may not be far enough in the future to be realistic and to date, the rebalancing implied in the fund is not determined by any specific guidelines. In other words, those who are put in a target date fund via auto-enrollment would be wise to get into an index fund (or four raging across a variety of markets) as soon as possible.

Those folks, the youngest among us who are the most likely candidates for these auto-enrollment options can make changes that will get them much closer to the goal. Older workers, however don't. And they know it. But they have some advantages, at least in their mind that the younger worker doesn't: equity.

And that equity in their homes, combined with the historically low interest rate environment has given many Baby Boomers a second option: to borrow against their homes and take the refinanced money and put into their retirement accounts. Is it a good idea or one that is bound to backfire?

Three things make it risky. One the equity in your home may not recover. Older homeowners who tap their home's equity are doing so at the risk of increasing their mortgages at a time when additional debt, no matter how inexpensive is not prudent. Two: They are eliminating a safety valve that could be used if retirement got too rough: the reverse mortgage. And third, if they are forced to or simply want to sell, the equity in their property is not there to give them a downpayment for new housing.

Leveraging your home to finance your retirement account does come with some tax advantages though. Just because one account increases as one is leveraged doesn't necessarily give you a balanced approach. In other words, there are "veiled risks".

You will still need to allocate your portfolio to perform better than the cost of the new loan and the interest rate you pay. This means that year-over-year, you will need to do much better than you may have calculated. A four percent mortgage added into the cost of the refinance (another one percent) added to the rate of inflation (another three percent if it holds steady) means your portfolio will need to return north of eight percent year over year - without fail.

The only way to give your retirement income any sort of sure footing is to increase your contributions by a much wider margin than what has become known as the average - 8% - and pay down your mortgage.

Fifteen percent is still the optimum contribution rate and even that number will give you only 75% of your current income in retirement - provided you saved for twenty years or more. Paying down the mortgage reduces your overall cost of debt service while increasing your equity.

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

The Retirement Recipe

There are numerous analogies floating about concerning what retirement is. For each of us it represents something different. Perhaps it is only a dream, distant and more or less unfathomable. For others, it might seem close and still too far enough away to embrace the concept that one day you might actually do something different. And for Baby Boomers, the path is much clearer, the distance is much closer and the journey much easier to define.

But one thing that is certain: the retirement you envision is a recipe, a cooking lesson of sorts that follows some basic concepts and some self-determined experiments in taste. The degree of cooking you actually engage in when it comes to concocting this plate of retirement options is dependent on the desire and the passion you bring to the process.

Consider the effort it takes to make spaghetti. Everyone has made this at one time or another. Noodles are the prefect vehicle for a meal, sustainable and filling and without adornment, plain and simple. Spaghetti is like an index fund. 

It does a great deal but is not a stand alone ingredient. It needs enhancement, flavors and improvements to make it whole. Building a retirement portfolio with an index fund as the backdrop is an excellent place to begin.

The sauce can be that enhancement and once again, your degree of involvement in the process will make the dish much more vibrant and appetizing. Simply opening a store bought jar is fine for when you are inexperienced, but the concept of all of these ingredients pre-determined by someone else in a production plant somewhere other than your own kitchen is much like the target-date fund. These funds offer a combination of investments already mixed and stirred to the proportion dictated by your age.

For some of, this pre-mixed sauce of investment choices is flavor enough. Like many pre-made food products, the salt level is too high and these manufacturers do this for a good reasons. Salt is the ultimate flavor enhancer, and the perfect seasoning to make unappealing ingredients more so. Store bought jar recipes are quick and easy and for those who have taken the time and effort to make their own sauce (or as my Italian household refers to it: gravy) know the difference a little time and energy can provide to the plate of pasta.

But who has the time to make a great sauce/gravy? When it comes to your retirement plan or simply your investment strategy, we want convenience. But this isn't always the best strategy. A little effort, such as making a sauce/gravy recipe from scratch can make all the difference to the end result. The making of your retirement plan may seem complicated but in truth, it isn't as difficult as we often perceive it to be.

As I mentioned earlier, the index fund is a great foundation and is the pasta in this dish. The sauce enhances the meal's appeal and you can do the same thing with your retirement. We are by our nature prone to certain biases. We fear many things (such as loss) and we tend to follow what others have done (herd mentality). We think we know what we like and dislike but the bottom line is, we gravitate towards what we have been taught to like. In many instances, this is risk.

Risk is a necessary ingredient but it doesn't have to be risky. A portfolio of index funds or similar exchange traded funds can offer some spice to an otherwise risk-free and rather plain approach to your retirement plan. How do you add risk? The simple answer is diversification. Creating a portfolio of index funds (or ETFs) that spread the risk over large swaths of certain sectors can increase the risk without embracing too much risk. In other words, index funds provide seasoning in melodious way, adding flavors that are harmonious.

The subtle blend of not only an index funds that tracks the largest companies (an S&P 500 fund) can add nuanced flavors. Index funds that track mid-cap, small-caps, international offerings, emerging markets and bonds can create the broadest of opportunities for even the most conservative palates. And it can do so with low expenses.

But some have worried that using just indexes leaves the portfolio simply mimicking the cycles of the market. In other words, your attempt to get good flavor may achieve little more than what opening a jar of sauce might provide your spaghetti will. This is where the actively managed fund enters the equation.

While actively managed funds are continuously maligned in the press and by index/ETF advocates everywhere, they can add a kick to a portfolio in the right dose. Like many overpowering flavors, used in moderation can increase the enjoyment of the dish. I suggest moderation (which is another term for diversification) because too much can overpower; too little can make the process boring.

This sort of dish, once created and joined together, spaghetti and sauce, provide nourishment and satisfaction. And like your retirement plan, depends on how much is on the plate to get to that point. Few of us put a couple of strands and spoonful of sauce on the plate and expect to be satisfied. Your contribution, kept at a minimum is somewhat like that: not enough to quell the appetite. But if you pile it on, as many do, you will have a filling meal even if you don't eat it all. Your contribution to your retirement has similar results: more money when you do finally retire than you can consume.

Yes, the analogy is a stretch but the concept is clear: your retirement is dish made with care and served in heaping portions. What sort of retirement meal are you cooking?

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

The Laws of the Cartoon World

Remember Saturday mornings, cartoon, pajamas and a bowl of cereal. We entered into a world of animation that had rules in play we knew only existed there. Boomers may have forgotten those laws and have grown up thinking that was then, this is now. But perhaps...

It all seems so otherworldly these days. As if everything that seems familiar isn’t and the laws the govern rational – and often irrational behavior no longer apply. Markets are up then down and then post the worst third quarter in recent memory – and we’re not sure what that means. Does it indicate something wicked this way comes or perhaps the end of the episode? So I turned to some laws that explain the world of finance, retirement and just getting-by in a world gone wacky.

Cartoon Law I.

“Any body suspended in space will remain in space until made aware of its situation.” We basically have two things to focus on: our future and what will happen next. We are continually being told to invest, max-out that 401(k), do everything you can now, pain equals pleasure which has replaced risk equals reward. That is until we chance to look down. And you know what happens next.

Cartoon Law II.

“Any body in motion will tend to remain in motion until solid matter intervenes suddenly.” Our retirement goals have experienced this law firsthand.  Hitting the cartoon telephone pole at full speed is, as this Law II suggests, the only way to stop forward motion with any success. There is the comic slide down the pole immediately following the impact which can only mean two things: we will sit as the cartoon stars whirl around our collective heads, trying to regain our reason for moving forward. Once our heads are cleared, Law II is waiting with the next pole a little further down the road.

Cartoon Law III.

“Any body passing through solid matter will leave a perforation conforming to its perimeter.” If you follow the markets, any markets, no matter how much information you think you have, now matter how timely it seems to be, the person in front of you will create their own cookie-cutter hole, exit, leaving you to get ahead of the problem that no one, including you is sure is a problem.  So instead of leaving by the door, they exit through a wall, evidently not a solid enough surface to allow Cartoon Law II to come into play.  We are at the mercy of speculators it seems who apparently have little regard for laws of supply and demand but understand two things: your predictable behavior and the ability of cartoon physics to protect them.

Cartoon Law IV.

“The time required for an object to fall twenty stories is greater than or equal to the time it takes for whoever knocked it off the ledge to spiral down twenty flights to attempt to capture it unbroken.” This is my favorite axiom of all.  Who among us has not seen the Federal Reserve try and do this?  We are watching this occur as we speak as Fed chairman Ben Bernanke races down the stairs with his latest effort in Operation Twist. Only Cartoon Law IV is a waste of time.  The priceless nature of the economy, the object hurtling through global space in this instance, falls victim to the inevitable comic result: it might be too big to fail but the attempt to catch it will prove unsuccessful as well.

Cartoon Law V.

“All principles of gravity are negated by fear.” I offer last quarter’s frenetic trading as proof that investors can spin their feet so quickly that they do not touch the ground while any news good or bad propels most of them straight up a flag pole. These days many average investors are left scratching their heads as they realize that just the sound of the unknown can change the direction of the market dramatically.

Cartoon Law VI.

“As speed increases, objects can be in several places at once.” You know this one as the cloud of dust and debris brawl, to be witnessed as the candidates begin their battle for the White House.  With the economy hanging in the balance or at least by their telling of the tale, the next year should provide numerous occasions of spinning and throttling as no candidate so far can pinpoint where the nation is right now and offer a plan of where we should be.

Cartoon Law VII.

“Certain bodies can pass through solid walls painted to resemble tunnel entrances; others cannot.” This inconsistency has played itself out to great effect in housing.  The folks who stand at the helm of the economy have painted an imaginary tunnel and allowed millions of Americans to pass through but when those that needed help the most attempted to follow, the surface was once again solid. This trick surface has left many wondering why something cohesive can’t be done. Housing may never recover if recovery is gauged by where it was. Yet so many people are wondering why the supposedly smart financial people who aided and abetted in this financial crime won’t simply understand that they have an option – and it isn’t achieved by raising ATM or debit card fees.

Cartoon Law VIII.

“Cartoon cats have more than the traditional nine lives.” They become like water snapping back to whatever they were prior to their mishap, even assuming the shape of the container if they happen to find themselves in one.   Seems that we alone know this to be true and no matter how many times the economy can be “decimated, spliced, splayed, accordion-pleated, spindled, or disassembled, it cannot be destroyed.” It becomes the equivalent of a cartoon mulligan. Someone please tell those in Washington. They think that what the economy needs is simple: more self-regulation and perhaps a little agency consolidation, a trillion dollar cut in spending here and an entitlement cutback there. We’ve seen it before and it gives us hope. We know that after the economy regains its shape, these set-backs (weak dollar, global slowdowns, market volatility and commodity speculation) will prove there are lessons we haven’t really learned and why should we have. We are pretty confident as a group that we will have another life to do it over again. At  least we hope that this cartoon law is real.

Cartoon Law IX.

“Necessity plus Will provokes spontaneous generation.” This opens the door to the “controversial pocket theory” which  “suggests objects can be drawn from unseen recesses of a character’s costume, or from a storehouse immediately off-screen” or can be borrowed directly from what you will owe at some point in the future.  And then, as if by magic, this future they tell us will just show up as if it “merely defers the question of how any absolutely apt object is instantaneously available”. Of course, you do need to believe in magic and if magic is the suspension of disbelief, saving will help – a lot.

Cartoon Law X

“For every vengeance there is an equal and opposite re-vengeance.” This is the one law of animated cartoon motion that also applies to the physical world at large. The bottom line is that we are not to blame. Each time I talk to an expert on my radio show we are told is our behavior that is the reason we are in the mess we are in. Every nuance we have is examined and studied and plans for re-vengeance are hatched. It has become us versus them. Instead of financial products getting simpler and more easy to understand, they ultimately become more nuanced, more layered with possibilities and as they get less expensive, they don’t become less expensive. It seems that all we want is to fall on the right side of cartoon law.

These laws were borrowed liberally from “Elementary Education” by Mark O’Donnell (Knopf (1985) in the hope that when you encounter these situations, you may fall on the right side of cartoon law.

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

Boomer Retirement: You probably have the solution

Yes, you can retire to which you answer: "how?" All of the pundits from every corner of the planet suggest that this is simply not possible, you continue adding that the retirement you envision will simply not be possible. And I listen intently looking for signs of your willingness to compromise. Oddly, you don't mention anything of the sort despite having accustomed yourself to years of doing just that.

Granted, the compromises you made throughout your life were, at best minor ones. You may have come to grips with numerous economic realities that gave way to great stories at the Christmas dinner table or perhaps among friends and family that shared those experiences. Many of these financial tales do not begin with 'remember when we had money' but more like 'no one knew how poor we were'. That's because pulled by the bootstraps stories are far more interesting to the listener and the teller of the tale when there is some drama, some obstacle to overcome.

So we are beginning to tell a tale of woe long before the story is finished. The vast majority of us did not begin our financial journey with money. We may have been given a little bit of a boost by parents who spent their hard-earned money, money they probably could ill-afford to spend, to help us. But the quest for more money would become the only job many of us will have ever had. What we did should have been the great modifier of how far that quest could have taken us. But access to credit sort of screwed that dynamic up; not permanently.

So when I hear forty-year olds tell me that they know they will never retire, adding to the chorus of those who really have a problem as the approach sixty, I wonder whether they aren't telling the tale too soon. And if that is the case, are they listening to the story they are telling?

Here is the problem and the solution in three steps:

One: You probably have the resources available to live on less. I'm not suggesting you go frugal by any stretch - that would probably take some sort of intervention. Instead, understand what your money is going for and how long it took for you to get it. In the good old days, folks saved for the things they wanted. Suppose you approached each item over one hundred dollars with the same thought. Suppose you work 2000 hours in a  given year and you net about $50,000. That's about $25 an hour. So each purchase in excess of a hundred dollars would cost you four hours of labor.

In all likelihood, you throw out about one-fifth of the food you buy either as leftovers or simply because you failed to consume it. You may have worked about an hour or two for nothing, depending on your grocery bill. Each month, you probably work ten hours to pay for your cable (TV, internet, phone), a possibly ten to fifteen to pay for utilities. And that is based on $25 an hour for your work, which is above the national pay-per-hour median and mean average salary reported by the Bureau of Labor Statistics.

Now the answer to this dilemma resides in imagining you earn less. The rich do this quite often and bank the difference. It is often called a cushion, such as when there is more money being brought in but less dollars relegated to the budget, more or less forcing more austere measures on the household.

Two: The what-to-do-with-the-extra-cash basically solves the retirement puzzle. But only in part. Most of us have access to retirement plans but the quality and the cost of those plans varies widely or should I say wildly from one plan to the next. If you are married and don't work for the same employer, you have the ability to pick and choose the better of the two plans.

While many 401(k) plans have been making strides in reducing the cost of the funds being offered in their plans, they have turned around and raised their administrative costs. If you are married, fully funding the best of the two and picking and choosing with the second best plan. This is good couple time and a chance to review how your tale is beng written.

If you are single, the choices are more narrow but not without benefits. You have no co-author for your story and therefore, you are the sole writer of the ending. Even if you have never written a word, you probably have read. Good writers give you several subplots, characters you want to know and a conclusion that both satisfies and amazes.

Your subplots are already in place (kid perhaps, college debt, etc.) and how you handled each one developed your characters (were they handled well or are they going to be redeemed) and as you head towards your conclusion, will the person reading your financial life empathize, sympathize or simply suggest that had you done this or that along the way, the story could have been better.

Three: You are your own critic. Churchill once said: "Criticism may not be agreeable, but it is necessary. It fulfills the same function as pain in the human body. It calls attention to an unhealthy state of things.” being critical of your work thus far is essential in negating the pain and getting to healthy. Once you resign yourself to hear only the downside of possibilities, you entertain no hope of redemption. If you were reading your life, would you be thinking that this particular tome is not worth the time or effort.

Good writers seed this despair with hope. If you suggest that retirement is simply not possible, for instance, what is the ending going to look like? Are you the reader anxious to read further? Probably not. So you think about the positive endings that could take place, list them out and how plausible they might be and choose one. You have all of the information to finish this book by the half-way mark of your working life. You can look at your parents and grandparents and project the potential for your own life expectancy. You can look at how far you've come and know how far you need to go. All that's left is the plan to get to the end.

Yes you can retire. Yes you should retire. Yes, you have the money. This is the ending, you the reader wants.

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

Baby Boomers: Are Your Denying a Time when You will be "Old Old"?

Baby Boomers face all sorts of challenges when it comes to retirement. Are we ignoring the most obvious of those challenges when we refuse to think that we will one day be old - not just older, but old old.

It is a relatively well known phenomenon amongst the soon-to-be retired. You are jettisoned from your 401(k) with a large chunk of money, a lifetimes' worth of hard earned cash. You are forced to make a decision about what to do with it. Kept in its present form would require you pay taxes on it as it is. Rolled into an IRA allows you to hold off on distributions, possibly until you are 70 or begin to take money out. But some folks fall into the annuity trap.

This choice, the annuity, in whatever flavor you are sold by the insurance company is often picked when the newly retired person does so in the midst of what would be a bear market.

For those not versed in that term, this a period of lower stock prices; the reverse of which would be a bull market. Most folks fall back on the same logic, perhaps not fully tested or vetted, that retiring in a down market is hardest on your retirement account because you have far less than you might have has had you retired when the market was on the upswing.

On paper it might look bad. But the bear market might be your friend, especially if you are the counterintuitive type not prone to believe the conventional wisdom. What is the conventional wisdom? To be upfront, something I disagree with in most cases in large part, because I don't think pat formulas work. We evolve and so does our thinking. Why, if that is true of us and we are the markets, do we insist on being harnessed by stringent parameters?

Because they provide comfort, a point of reference, a goal. No matter what name you assign them, they are prevalent and with so many personal finance and retirement "gurus" saying the same thing, you tend to fall lockstep into the same thinking. Withdraw 4% you chant and you will never run out of money.

I've disputed this notion in the past as not very wise or thoughtful. Two things helped me arrive at this conclusion. Long before Susan Jacoby wrote her new book about old age (Never Say Die: The Myth and Marketing of the New Old Age, Pantheon Books), which provides a no-hold-barred look at the distinct, perhaps inevitable slide the human body takes on its path to death, I was suggesting that we might live longer but what will living longer mean. Oh, we may live to 85, but our arrival signals the end of cognitive independence for more than half of us.

She blames the baby boomer, the reinventor of what life is as the culprit in this thinking. We may have changed the way our youth unfolded and we may have upset the norm throughout our working careers. But when it comes to old age, it doesn't matter whether you have some sort of can-do attitude, you won't be able to change what is going to happen to you. You may envision a life of vigor and vitality, volunteerism and travel. We all need something to keep us moving forward. But Jacoby says we are ignoring the hard facts of life. We'll still get old. And with age comes the maladies of that time. Still there and still the same unsolvable mysteries.

So we will reach a point somewhere in the future - and the odds are in favor of this thinking - when you will no longer be the person you are right now. The years that you believed would be full and vital are now gone and you are collecting in the form of equal - possibly inflation adjusted - income that you can't spend. You scrimped in the early years of your retirement, downsized, even counted every penny. And then later in life, it doesn't matter. My suggestion was to start out big and taper back. Perhaps gradually easing back from a 6-7% withdrawal rate in the first ten years of retirement to a paltry 2-3% by the time you are 80 years old.

The result would be more or less the same with you using the money in the early years to do what you thought you could do and scaling back as your new sedentary lifestyle takes hold, an inevitability we can't avoid. "Young old" is easy to imagine. "Old old", not so much.

But the choices we make right at the moment of retirement may have a greater impact on how well that retirement is financed than we may have previously thought. Those bear market retirees, the ones who graviate towards annuities more so than their cohorts who retire in the midst of a bull market, may end up doing better over a longer period than their more optimistic cohorts.

I am of course referring to the studies done by Wade Pfau, an associate professor at the National Graduate Institute for Policy Studies in Tokyo who has suggested that retiring during a bear market is actually the best case scenario. His thinking is that a bear market provides more upside potential than a bull market would. On this point, he may be right. Our penchant to follow the herd during a bull market gives the impression that markets will always go up.

And there is some proof that for a time, they will. There is also proof that if you retire during a robust bull market, you will be more inclined to believe that you possess some sort of powerful ability to manage your money better. But bull markets fall and this causes confusion among those who may have deluded themselves into thinking they were more skilled than they were.

Professor Pfau thinks that a 60/40 stock split is optimal and if you invest over the course of 30 years at a rate that is close to 17% of your pre-tax income, you will be able to have 50% of your pre-retirement income, inflation adjusted, throughout your retirement. Staring earlier will mean less needed to get to the same mark. And of course this excludes any other money you might receive in retirement.

You are probably saying to yourself, 'that's a lot of income to sock away' and you'd be right. But this is one thing that hasn't changed: if you think you haven't been putting enough away, you are probably right. If you think old age is something that will resemble the first day of retirement for the next 30 years, you would be wrong.

Baby Boomers should be thinking about spending more when they are healthiest. Because 'old old' doesn't give you the chance to revise your planned 'young old' retirement.

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

Is Dollar Cost Averaging Old School?

There is a school of thought circulating that dollar cost averaging is not smart investing. For those of you unfamiliar with the term, it is how your 401(k) plan works and why it works so well. You essentially make a contribution determination - usually a percentage of income which is taken before taxes ore levied - and each paycheck, you buy share of whatever investment you have chosen in your retirement account.

The concept is basically simple enough for most every investor to understand, even embrace. One, the investment is steady and in many cases affordable and painless. Because of its automatic nature, you need only check your statement every quarter to make sure the money went into the account and went where it was supposed to go.

DCA also benefits the average retirement investor with some control over the numerous errors that plague most investors. By doling out money evenly, your investments are bought based on affordability and not on the decision of the herd. Herd decision making relies on following the rest ofthe investors as they sell or buy and experience with this sort of mentality suggests that they usually buy when the markets are on the way up and sell as they descend.

DCA does something unique. It allows the investor to buy less as the herd buys more and to buy more as the herd sells. Imagine a share of a mutual fund costing a dollar. You allocate one dollar of your paycheck and you buy one share. But the market goes up and the share now costs $2. DCA restricts your enthusiasm at joining the herd and allows you to only buy one-half a share. the shares you already own have increased in value so you aren't missing the upswing. You just aren't throwing more money at something that may be over valued.

Now imagine the opposite happening. The share falls in value to 50 cents. Your dollar buys two shares and while it is true, your other shares have lost value in the process, the investment thinking here is that over the long-term, there will be more upsides than downsides. This means that you will be buying the same share at a discount.

Are there any downsides to this investment strategy? Some think so. One gentleman I was discussing this with suggested that folks using a 401(k) plan should never forget that this is investing. I couldn't agree with him more on that point. He went on to say that even the most passive investing requires some diligence and dollar cost averaging takes that diligence away. That is a downside but not an insurmountable one.

He thought that all of the money in a given year should be sent to the most conservative fund available in the employee's 401(k) and then redistributed to funds that are doing better. While this may work for some people, few of us know how mutual funds operate, whether the markets are favorable or not and often we find out after the markets have made the decision for us, and lastly, our 401(k) do supply the rapid response some of this thinking implies.

It does require a skill level and command of all of the emotions and biases that plague even seasoned investors. It obligates us to be better educated - but for most of us, we need time to get to that point. It is always my hope that we do attempt to become better acquainted with the way our money is being invested. But in the mean time, the concept of dollar cost averaging serves far too many of the average investors too well to be discarded.

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

Our Paul Petillo on Financial Impact Factor: The Annuity Show

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).

Listen to internet radio with

Paul Petillo of Target2025.com/BlueCollarDollar.com

and Dave Kittredge and Dave Ng

of FinancialFootprint.com

on

The Financial Impact Factor

at Blog Talk Radio

Boomers Plan on Travel: So Perhaps Should Your Investments

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.

Paul Petillo is the managing editor of Target2025.com/BlueCollarDollar.com, radio show host of Financial Impact Factor 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.

Boomer Women may Want to Work Longer: But will they be Allowed?

Boomer women, faced with lesser time in the workforce are increasingly looking at the option of working longer. The question is: will their employer see this as beneficial? And if they do, how far are they willing to go to permit this extended work career?

We know two things in this post or almost post-recession era we are currently in: One, older workers are returning to work or not leaving the workforce at all and two, younger workers who traditionally made up the bulk of the workforce, are being crowded out by this newer pool of older workers. Delaying retirement due to economic concerns that have stymied our financial well-being has been news for quite some time. But what if the new face of the workforce is slightly wrinkled and framed in grey?

According to a study conducted by WorkplaceFlexibility.org and authored by Richard W. Johnson, Senior Fellow at The Urban Institute: "As the U.S. population ages and the number of Americans reaching traditional retirement ages increases, employers may need to attract and retain more older workers, many of whom are highly experienced, knowledgeable, and skilled." Basing the study on well-known assumptions, Mr. Johnson explores the shift in the workplace to accomodate the older worker who is increasingly choosing to hang on to their employment longer.

Among those assumptions is a longer life. As the older population reaches retirement age, they are finding the ability to continue working a possibility in large part because the work these folks tend to do is less physically demanding that many jobs were just a decade ago. While financial concerns are most likely to enter into the newsworthy conversations, the study seems to suggest that this trend is centered more on women than men.

The result is increased complications both for the company, the worker and the benefits they might or should be receiving at that age. The result is an experiment unlike any conducted prior to this where the lines blur between what is full-time work and what is full-time retirement.

Phased retirement, the new buzzword in this process involves reduced hours and responsibilities that include some perks normally reserved for women and men in the workplace who temporarily leave because of families. Among those phased perks are "flexible work arrangements, including part-time employment, flexible schedules, telework, contract work, and job sharing."

For the employer, the fringe benefits often accessible to the older workforce, such as traditional pensions could open the door to age discrimination. And this could hurt women more than men. Even as women have made great strides over the last several decades in pay, benefits and workplace populations, it is this group that is most likely to continue, or want to continue working beyond the traditional age of 65. Men, despite the reports of longer and healthier lives, choose to retire more now than when the jobs they engaged in were more physically demanding and strenuous.

Because the focus of this report is on the effects various policies and practices surrounding this transitional time of a workers life, Mr. Johnson points out some of the incentives and disincentives for working or not. Social Security has been gradually pushing back the retirement age and will probably continue to do so in the coming years. Defined benefit plans or pensions further complicate this trend by penalizing the annuitized payment should the worker continue to be employed.

The shift over the last three decades to defined contribution plans (401(k)s, 403(b)s) are much more accommodating to this segment of the workforce that wants to work longer. They can continue to contribute to a DC plan long after the traditional pension retirement age has been reached, adding the potential for greater lifetime incomes in the process. Because of these types of plans, workers reaching retirement age are more likely to work at least two-three years longer than they may have previously anticipated.

The study also revealed that if the employer provides health benefits for early retirees. of which according to a 2009 study conducted by the Kaiser Foundation only 29% of the employers do, that person is more likely to retire. Take them away or not provide these benefits and the worker will stay on the job longer.

Because Social Security benefits are calculated on a 35 year work history, one that favors men who have never had any interruption in their work history, this group is more likely to take their leave from the workforce. For women, each additional year worked eliminates a zero earnings year that may have come due to family leave because of children or the need to take care of aging parents.

The question facing employers is whether to retain these workers. In most instances, the older worker is at the top of the pay scale and poses a greater cost on the health benefits provided. Mr. Johnson notes: "Another study found that employers were less likely to call back older job applicants than otherwise identical younger applicants (Lahey, 2008). And it takes laid-off workers age 50 and older much longer than younger workers to become reemployed, even though older unemployed workers appear to search just as intensively as their younger counterparts (Johnson and Mommaerts, 2010)." Even if the desire to work longer is there, the opportunities may be limited.

Employers have acknowledged that the pool of potential retirees in the coming years will have a negative impact on the skill level of their employees. Yet few have done anything to address this shortfall of talent and skill. "For example, in the Cornell survey only 26 percent of employers allowing phased retirement would provide the same health benefits to workers after they reduced their hours. About two-fifths of employers allowing phased retirement in the Cornell survey, but only 9 percent of employers in the Ernst & Young survey, would allow in-service pension benefits."

The problem will need to be addressed by Congress at some point. Women Boomers face the greatest challenge in the coming years as they attempt to make up earnings shortfalls and look to adjust their schedules to a more flexible arrangement.

Employers will also need to address the issue as well. they may say that the talent looking to retire is worth retaining. But their current policies don't suggest they are doing much in the way of providing incentives. They may say they desire the older workforce. In practice, they have yet to make substantive moves to permit this choice.

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

Are you planning for retirement when you should be managing it?

Boomers know all too well what it's like to be close to retirement. But I have always been concerned with the phrase. Just saying it make the whole process seem like a carrot on a stick, always within sight; never quite reachable. Why does it have to be like that? is I there perhaps a better way to planning for retirement? Possibly the key is in the management.

From the minute you put your first dollar to work for you in 410(k) or an IRA, you were close to retirement. Age suggested you were closer but we soon learned that it wasn't so much a date on a calendar that determined the retirement scenario. It was the date plus the money you had invested.

Unfortunately, this is sort of backwards. The approach can be forgiven in part because we are constantly exposed to planning as the key to getting from that first dollar to that toes-in-the-sand-drink-in-your-hand place called retirement. Planning offers us some solace that we are doing something. What we find out too late is that "something" in more prone to failure than we had previously anticipated. So we back-off, give-up, resign ourselves, or worse, make the same mistakes again.

Why would we, knowing what failure tastes like continue to make the same mistakes? We are groomed to do what we have always thought was the right thing to do: plan. Fredrich Hayek, the Nobel prize winning economists suggested that you can't possibly know everything at once - there is simply too much data and it is happening too fast. Trying to collect in one place to make a decision is only asking for trouble. There is an African proverb that suggests only a fool test the water's depth with both feet. So why do we think we can jump into retirement using only one tool?

We are conditioned in our business dealings to think that we can control various aspects of the world around us, bending it to our will. But these are simply reactions to what has already passed. And that further conditions us to accept failing as long as, according to Francois Gadenne, CFA, who is the current co-founder, chairman and executive director of the Retirement Income Industry Association in Boston: "To succeed we must fail, early and often -- and cheaply."

Writing in a recent edition of AdvisorOne, Mr. Gadenne sought to reverse the planning of retirement by suggesting that it should be a management of funds. By building what he calls a funded floor, you are essentially unable to make big bets about an uncertain future. He blames the current state of retirement on the idea of central planning. Central planning becomes rationale on top of failed rationale and that is not based on what could happen but rather who is in charge when it did.

He writes: "Retirement income advisory processes should work like market prices rather than like central planning because, once we move beyond didactic examples, central planning cannot be smart enough or large enough or coercive enough to overcome the knowledge problem in the real world." In some ways, he seems to be deflecting the blame, something we are very comfortable doing when it comes to our money. Planners should merely advise and review that advice annually.

This seems to give advisors some distance between what you are doing and what you should be doing it. That chasm can become incredibly wide and because you are mostly conditioned to react to after-the-fact events, it is now you, not those who advise you, who are responsible for your failure to manage while trying to make a plan succeed.

Because retirement planning - or management - is often so far away and the people involved in the earliest stages of this process have probably drifted away, it is a wholly "you" process. You bring the mistakes that you have been conditioned to bring. When things get risky and when the risk costs too much, you take fewer of them because you know that they are less expensive. And because the retirement pundits also suggest that the earlier you start, the better opportunity you have to weather the downturns that await us, we accept them, regret them and learn to move on. And often repeat them.

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

The Okay Retirement is Not So Okay

Boomers are particularly vulnerable to suggesting that things are okay. In this post we will look at the okay retirement plan and suggest that your 401(k) may be trying to accommodate you with okay choices.

To see the word okay (the form I prefer over the simpler OK or the punctilious O.K.), without intonation or judgement doesn't do the word justice. Hearing it adds meaning and nuance. You need to experience it roll off of someone's lips lazily, dropped in an aggressive acquiescence or simply thrown out there for fun . It is a word, or phrase that simply is.

This is the prevailing feeling you get from hearing someone say 'I'm okay' when asked about their retirement plan, or their day at work, or their time spent in school. It becomes an answer ladled over falsehoods. Why is that? Okay is value-neutral. In fact, for it to have any real meaning, it must be spoken. What happens when okay is, well, okay?

For the last year, we have seen the markets kind of recover (I would not suggest watching the regular gyrations of the stock market these days for anyone but those strong of stomach) as they continued to deal with news from around the globe.

True, the markets are notably higher than several years ago but the structure seems rickety, unstable. This applies to more than just equities; bonds are troublesome too. Commodities have weighed in with gold becoming bubble-like in the wake of low inflation, the opposite of what usually happens. And yet, if asked about your retirement plan, you would probably answer: "It's okay."


What is happening in your 401(k) has offered the a look at what okay is when it comes to investing. Some of this is your fault. Some of it the fault of those whose definition of fiduciary responsibility has shifted. Perhpas there is no better evidence than that offered by Prudential Retirement. They have introduced okay investing to its 3.7 million customers using 401(k)s the manage. By doing so, they extend the risk avoidance to a new level: an FDIC insured bank account in your 401(k).

There are basically three things wrong with this, two are obvious, the other is speculation based on years of experience ferreting out the moves most financial institutions make.


The first has to do with risk, or better yet, lack of it. The average investor is still recoiling from the meltdown now over two years old. In all my years, I have never seen a lingering fear last so long or an industry do what it can to enable it. By this time in usual times, what happened to your investments would have been long forgotten.

A bull market somewhere would have been outed and it would start anew. This is a different era. Lingering unemployment, continued global financial strife, housing, and all the rest have made forgetfulness more difficult.

But this pendulum swing to conservative is a bit surprising.Risk is inherent in the investment world. Without it, as I have mentioned on numerous occasions, you have savings, vanilla and plain and safe.


You can get to retirement with savings. But you will have a greater opportunity to get there with more money if you invest. Trying to get folks to change this vernacular, from retirement savings to retirement investing has been a Sisyphean task. We want to think of it as savings so most personal finance and retirement writers and pundits continue to use the phrase. 401(k) plans have become the new bastion for low to no risk, offering target date funds and index funds as the go to investment for all of their participants.

I have many reservations about target date funds (from promoting set-it-and-forget-it investing, the inability of these funds to beat the market, a good target date index, and the fact that so many of these funds are simply a halfway house for orphan funds) and index funds (yes they are cheap but they are also too tax efficient for a 401(k)). Making them the default investment for new hires or advising older workers to use them and you have a recipe for an underfunded retirement - in part, because the vast majority of people who use them don't fund them with enough money to make up the low risk sacrifice they are making.

I mentioned that you could get to retirement with savings. It's possible but not within the purview of the average worker. You would need to save using a wide variety of stable vehicles like money market funds and CDs, all of which are offering so little in the way of interest that it hardly beats inflation. Bonds may seem like they offer a safe haven and in some instances they do. But that safety is accompanied by risk and one of those risks is beating inflation. Did I mention that you would probably never stop working in order to make the "savings-only" plan work?


What about annuities? This is where I am speculating. Prudential Retirement is an arm of Prudential Insurance which sells annuities. Although the vice president of Prudential Retirement Carlos Mello makes it known that his company doesn't give investment advice, the seed will have been sown with the new product.

Billed as a place to ponder your next investment move or even an account whereby those close to retirement can have access to cash when they do, putting a savings account in a 401(k) will be used as a sales tool for annuities. Insurers know that most people look back on the performance of their 401(k) in the short-term (about six months) and base their decision on whether to buy annuities at retirement or not. A market that has done well turn newly minted retirees away from the product. While with a down market in the months leading up to retirement, the purchase of an annuity is much higher.

Now imagine someone close to retirement stockpiling cash in one of these FDIC insured offerings. They are already (or will be at least) accustomed to little or no return. The upsell to annuitize that cash upon retirement, and the pitch is rather charming, may be too hard to avoid. To hear retirement planners talk, you would think they are reinventing the pension. Which in some respects they are. Without the employer's contribution.


If you were employ a three thronged approach, which is an okay way to go, you might use savings for emergencies, building up a six month reserve - a year would be even better. But do so knowing that you will need to fully fund your 401(k) in the process - not just a comfortable 10%. And you will need to hedge both of those bets with a Roth IRA held outside your 401(k) - this is where your index funds belong.

While etymologists tell us that the O and A long vowel sounds, separated by the hardness of the K is nearly universal and used in almost every language, it shouldn't be used to describe the state of your retirement plan.

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