Thursday, December 31, 2009

What will 2010 Bring?

2010 will be the year of stabilization. A year where, if you have a job, you will probably still be working at the beginning of 2011 and if you are not, you may find employment; one where if you are prudent (and by that I mean not-so-conservative but cautious), you will find the equity markets still performing better (but not better than expected); one where we have learned lessons that should not be soon forgotten.

Read the full article from Paul Petillo, Managing Editor of Target and a fellow Boomerhere.

Thursday, December 17, 2009

The IRA Option

Some of us may be entering a new job that does not have a 401k or has one that you do not feel is as good as the one you just left. And your employer won't let you keep your money where it was. What to do?

Rolling your 401k into an IRA is another matter. This is for the investor who has some concept of what lies before them. If I were to guess, this type of investor has had an active roll in how their former employer's 401k was allocated. They paid close attention to diversity, perhaps even following conventional wisdom of limiting risk as they aged.

For this retirement investor, the IRA rollover is viable option. It allows closer control of how this money is invested with a variety of considerations weighed with each decision. Not only will this investor spread their allocation over a number of funds, they will do so with an eye on fees and expenses, a consideration of performance of the fund under both good and adverse conditions, and clearheaded understanding of the risks involved.

IRAs cannot be borrowed against and restrict a penalty-free withdrawal of money before 59 1/2 years old. But the choices are the primary attraction. This investor knows, and you should as well, the risks of building a successful IRA portfolio also increase. The biggest concern is investments that crossover.

What 401k plans are supposed to do is provide the investor with a fiduciary responsibility to provide the right tools for their employees. You, as an IRA investor are on your own.

You must monitor the funds you invested in for a change in investment strategy, style drift (when a fund manager invests on the edges of what s/he was hired to do; such as when they invest in large-caps when mid-caps are the focus), and an increase in turnover (a cost for trading repeatedly that the shareholder pays for directly, often done in an attempt to boost returns in the short-term, like at the quarter's end). You bear the burden of this responsibility to your future.

The terms of disbursement are spelled out when you leave the job in the 402(f) notice. This explains your options for handling a 401k disbursement. Even if you want to stay, your old employer really doesn't want the continued burden.

Bottom Line: Once you receive that 402(f), begin to research your options. And even if you think that money will come in handy, never take the cash.

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

Tuesday, December 15, 2009

Leaving a 401k behind?

Job separation can come for any number of reasons. But a late in life job change comes with additional considerations. What to do with that 401k you left behind?

Keeping the money in a 401k has its advantages. For older workers, the ability to begin disbursement at age 55 is an attractive plus. Although it is generally ill-advised under almost every circumstance, keeping the money in the 401k retains your ability to borrow from the plan. Some of us will consider keeping this option open. It's an option albeit, not a good one.

Generally, the fees are better in a 401k. Institutions may get a much better deal from the plan sponsor and consideration of this is important in the rollover decision. A much larger plan may come with more options or simply less expensive ones. Fees are an important aspect of total return and a worthwhile item to focus on when making any decision to move.

But you may not have an option if the balance is less than $5,000. This means you are faced with the choice of taking the cash in the account (along with the 20% the account must hold for income taxes and the 10% penalty). The scariest statistic, two-thirds of you take the money and pay those hefty penalties.

The terms of disbursement are spelled out when you leave the job in the 402(f) notice. This explains your options for handling a 401k disbursement. Even if you want to stay, your old employer really doesn't want the continued burden.

Bottom Line: Once you receive that 402(f), begin to research your options. And even if you think that money will come in handy, never take the cash.

Next: rolling to an IRA.

Paul Petillo is the Managing Editor of and a fellow Boomer

Thursday, December 10, 2009

A Look at the Best 401K plans

In a previous post, we introduced a rating system for your 401(k) offered by Brightscope. Now, they are offering a look at the best 401(k) plans.

Does your plan work as hard as you do?

The Top 30 401(k) plans as rated by Brightscope.

Paul Petillo is the Managing Editor of

Wednesday, December 9, 2009

Investing is Never Simple

Mutual fund investing should be a simple process. It should be straightforward and easy to understand. Unfortunately, once we get involved, we bring our own set of behaviors to the process. And Boomers as a rule, should know better.

In our first discussion about performance comparisons for mutual funds, we looked at the downside of simply comparing side-by-side an actively managed fund with one of the indexes that are published. These indexes span a wide variety of categories in order to help investors understand how the broader market has done in relation to the fund they own.

Which leads us to a discussion about fees.

Paul Petillo is the Managing Editor of and a fellow Boomer

Tuesday, December 8, 2009

Not too Late: Dividends, Boomers and Growing Wealth

Boomers should pay attention. As our portfolios age, common wisdom is to transfer our wealth to more conservative investments. Nothing is more conservative in the world of equities than companies who pay dividends. Not only is the return historically better the companies who pay, such as those in the Dow offer older and more stable investments allowing you to skip the middle man and buy directly.

Dividends offer the investor an opportunity to not only own a share of a company but also to share directly in that company's profits. As you may recall, when a company makes a profit, they have numerous options. Many businesses simply reinvest the money into the company. Some buyback shares with the profits or reduce their debt. But older, more established companies distribute those profits among shareholders.

Some even offer a dividend reinvestment plan or DRIP. And many of these plans allow you to receive the dividend in the form of more stock. These plans are an inexpensive way to increase your portfolio's value and do so without much in the way of effort on your part.

The best part of these types of plans is the cost. Not only is the purchase automated but buying stocks directly from the issuing company is also, in most cases, free of brokerage costs. Add to that, most companies allow you to begin the process with as little as $10. The automated feature of these plans also allows you to invest via automatic deduction from existing accounts you might own.

Involvement in this type of program allows you to purchase individual shares rather than taking a cash disbursement. This reinvestment can be set up in a variety of ways: full reinvestment (where any and all dividends are used to purchase more stock), partial reinvestment (designates how much of the dividend goes to buying additional shares and how much you want to receive in cash), or as a cash payment.

To enroll, you need to own at least one share in your name (if you are buying them for a minor, your name must be entered as the custodian). You can do this using an online brokerage or similar discount broker.

There are over 300 companies listed on the S&P 500 list that offer these sorts of options. All of the companies on the Dow Jones 30 offer either a direct stock purchase (DSP) which eliminates the need for a broker or a DRIP, which requires ownership of at least one share to begin the reinvestment plan.

Last week, Gina asked me what would an investor do with $25. Although I suggested opening an IRA directly with a mutual fund company (in large part because at least there are tax advantages in doing so), that same amount, invested every week could generate enormous amounts of profit for the investor as well. Keep in mind dividend payments create a tax event (although some allow them to be tucked inside your IRA).

Yet, considering the fact that dividend paying stocks generally outperform the overall market by 3%, this is an opportunity that has so much potential, you shouldn't pass it up.

Below is a list of the Dow 30 companies with dividends, direct stock purchase plans or dividend reinvestment plans.

3M Company (MMM) DRIP
Alcoa Inc. (AA) DRIP
American Express Co. (AXP) DSP
Bank of America Corp. (BAC) DSP
Boeing Co. (BA) DRIP
Caterpillar, Inc. (CAT) DSP
Chevron Corp. (CVX) DSP
Citigroup Inc. (C)
Coca-Cola Co. (KO) DRIP
DuPont (E.I.) deNemours (DD) DRIP
Exxon Mobil Corp. (XOM) DSP
General Electric Co. (GE) DSP
General Motors (GM)
Hewlett-Packard Co. (HPQ) DRIP
Home Depot, Inc. (HD) DSP
Intel Corp. (INTC) DRIP
International Bus. Mach. (IBM) DSP
J.P. Morgan Chase & Co. (JPM) DRIP
Johnson & Johnson (JNJ) DRIP
Kraft Foods Inc. Cl A (KFT) DRIP
McDonalds Corp. (MCD) DSP
Merck & Co. Inc. (MRK) DSP
Microsoft Corp. (MSFT) DRIP
Pfizer Inc. (PFE) DSP
Procter & Gamble Co. (PG) DSP
United Technologies Corp. (UTX) DRIP
Verizon Communications Inc. (VZ) DRIP
Wal-Mart Stores, Inc. (WMT) DSP
Walt Disney Co. (DIS) DSP

Paul Petillo is the Managing Editor of and a regular contributor to MomsMakingaMillion Talk Radio. He is also a fellow Boomer.

Sunday, December 6, 2009

Small Comfort

This past Friday, we received some great unemployment numbers. They are showing a slight increase in jobs. That's small comfort for the enormous group of folks who are still unemployed and for Boomers who may have seen a late-in-the-game brush with unemployment. And that may have strained our personal economies.

With over ten percent of us out of work, another eight percent of us no longer bothering and an estimated twenty percent of us contemplating the possibility that we might lose everything we have worked so hard for, the subject of who owns what as we consider our options in an economy that doesn't seem to be recovering fast enough to suit most of, the question of your 401(k) as part of a bankruptcy is worth asking.

The choice of bankruptcy is always the last option. When you consider this option, you will find your assets under the control of the bankruptcy estate while your case is pending. You still own these assets. Your home is protected providing you can make the payments and if your home is worth more than your mortgage, the bankruptcy estate will exclude up to $37,500 in equity from consideration. The same applies to any equity you might have in your car.

The concept for exempting these two items is relatively straightforward. How could you possibly hope to recover from bankruptcy if you were stripped of these items? Understanding the need for shelter and transportation is important. But does the most valuable asset protecting your future fall under the same consideration?

Although you will need a bankruptcy attorney to guide you through the maze of rules, the focus of such an action is to come to some sort of agreement with your creditors on how you will repay what you owe. In some instances, it might be the forgiveness of your interest obligation in favor of satisfying the debt. Repayments plans and schedules are worked out and as long as you follow those obligations, you can remain under the roof that you own and be able to get to and from work.

The question of your 401(k) however is not so clear-cut. And the answer depends on ERISA qualifications. Section 541(c)(2) of the Bankruptcy Code. Section 541(c)(2) provides: “A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable law is enforceable in a case under the Bankruptcy Code.”

This means that your 401(k) is safe from the actions of bankruptcy court and cannot be considered when determining the value of the estate. If you plan falls under ERISA protection, and generally this qualification applies to most larger company plans, your assets are safe. The exception however, effects the smaller business owner.

Among the exceptions to this rule is a retirement plans that has only one participant, such as single employee corporate plans, and some other plans originating in self employment. These plans may be property of the estate. They may be vulnerable to creditors. When you consider the number of small businesses affected by the economic downturn, this is an important exemption.

For those of you who do have a plan that is exempt, the ownership of this property has found its way to the US Appeals Court. The question posed by the case dealt with the loan that was borrowed from a 401(k). Although the person was obligated to pay back the loan, the loan payment was questioned.

Chapter 7 bankruptcy subjects the estate in question to a means test. This sorts out what is qualified and what is not in terms of "necessary expenses". The loan repayment to the 401(k) was challenged. The court, ruling in the case of Egjebjerg v. Anderson found that the repayment to the 401(k) was the same as a contribution to that person's plan. In other words, if you loan money to yourself, the repayment of that loan is not considered a debt under the law.

The plan has not right to sue for repayment of the 401(k) loan but can, according to the court, offset the loan against future benefits. But the court that while Chapter 7 proceedings did not cover the individual, Chapter 13 would consider the repayment as part of the debt owed. This subtle difference is important and makes the consideration of good representation a must for anyone considering such a drastic move.

It is important to consider all of your options before subjecting your finances to estate scrutiny. And secondly, borrowing from your 401(k) is still a bad idea. In a Chapter 7 proceeding, the losses to that important linger far into the future. And while Chapter 13, often referred to as the wage-earners plan, does allow for the repayment of that loan under the court's approved structure, the loss of earnings in the retirement plan will have lingering effects long after you emerge, finances revitalized.

Paul Petillo is the Managing Editor of and a fellow Boomer

Tuesday, November 24, 2009

Ready or Not is Not the Question

Are you ready? It seems that something as simple as a question like that, particularly when it pertains to your retirement could never be answered. 'I hope so', or 'as I will ever be' all see like the answers most of us would give when asked that question. When in fact, a new tool hopes to pinpoint your potential for retiring well by putting your plan's ability to do what it should under the microscope.

A short while back, I wrote about a company that uses a series of benchmarks and mathematical equations to determine whether your 401(k) plan is doing what it should. Brightscope's product was designed to help plan sponsors find the problems in their plans and make an effort to correct them. As noble as that effort may be, the hurdles are numerous for plan participants to get their companies to make the necessary changes to their plans.

Now we have another entrant to the market place, this one offering the plan sponsor a look a their employee's retirement readiness. Fiduciary Benchmarks, based in Kansas will provide a snapshot look at a company's plan and the chances that their employee will arrive at retirement with enough cash to be considered adequate.

Using 100% as the retirement readiness benchmark, a number that represents different things to different income groups, the report, provided free in brief and at the cost of $100 for more detailed analysis looks at the average employee. From there, the report then analyzes various pathways that employee can take, and if they did, how well the plan allowed them to reach the optimum amount in their retirement accounts.

In a downloadable pdf, they suggest that a person earning $20,000 a year will need 94% of their pre-retirement income to survive. Although the plan does take into account conservative longevity predictions and the available investments in the plan, it does not look at the statistics for this particular group and their overdependence on Social Security benefits.

Their benchmark also suggests that someone earning three times that amount would need only 78% of their working income to hit the 100% mark in the company's index. Some industries fair much better than others. But this is not reflective of the whole of the employees in the plan, simply what the plan may do for you should you use it to its fullest.

And therein lies the rub. Most employees, no matter how good the plan, do not max out their retirement contribution, leaving them with a huge gap in what they will need and what they enter retirement with. Without full participation, there is little another tool for plan sponsors can do. The vast majority of plans are adequate even if they fall short on the educational side.

While there is emphasis on educating the participant through education of the plan sponsor, it is beginning to seem a little overdone, even as this type of spotlight is still in its infancy. Most employees wonder why their plans weren't improved sooner. And still more see the incremental improvements as a way to sustain the current level of contribution rather than an enticement to increase it.

The real improvement will come from the IRS. Once they fix the expected tax rate for retiree's plans when disbursement begins, and not leave the rate the big unknown, employees will see the future through a much clearer light. Not having any idea what those future taxes will be make it difficult to determine how much will be enough.

Paul Petillo is the Managing Editor for and a fellow Boomer.

Friday, November 20, 2009

Turning Time into Retirement Investments

It is getting towards the end of the year. And while this past ten months has been a scary ride for those that are still employed, it might be possible to turn it into a boon for Boomers close to retirement. Chances are, you have worked harder this past year than you have in any within recent memory. Chances are, this included not taking vacation time or tapping any of that sick pay your employer might give you.

Is it possible that this could be your chance to max out your 401(k)?

We have found that 2009 was not so kind to those investing in their 401(k). Employers have reduced or eliminated their matching contribution and many recent surveys have suggested that this will be slow to return. What was once considered the competitive lure for many employees has no simply become a sidebar in the search for a job. For many, and employers know this all too well, just landing employment is benefit enough.

But what about those who already have a job? What if you are a long-term employee? Many of us, as we have noted numerous times in this blog (post about matchless strategies) and on, have taken the wrong path when confronted with this issue. Far too many of us reduced our contribution to our defined contribution plans when this occurred. Some have even determined that if the employer doesn't match, you shouldn't contribute either. And just as bad for your retirement future, you did nothing to help make up for that plan shortfall.

As we have noted, the best way to make up for this decrease in contribution is to increase the one you are making. For older workers, the higher salary they receive may make this possible. For younger workers, the decision becomes one of increased frugality, living well within their means and doing without some of the luxuries they may have built into their budget. If your employer contributed 3% and you contributed enough to make the match effective, your best move is to make up for the employer's shortfall.

Yet, there may be another way that your employer might be willing to allow. In an effort to get more people contributing more to these all-important accounts, the Obama administration has allowed retirement investors the option of rolling unused vacation pay or accrued sick pay into their plans.

This past year may have seen an increased workload at your job because of employee cut-backs. This may have forced you to defer a much needed vacation in favor of staying right where you were. Fear of seeming dispensable at a critical time, even though the need for vacation has been proven the best way to increase productivity. But this leaves you with an account full of unused vacation time.

Contributing this sort of payment to your 401(k) requires your employer to make some changes to their plan. Even as some have reduced the availability of their matching contributions, some have added this provision to their plans to allow exiting employees to have their unpaid time put into their 401(k) plan prior to rollovers and to allow those who did not use what they had, to use the time to contribute to existing accounts. The later can only be done if you have not maxed out your account (currently at $16,500 for those under 50 and $20,000 for those over that age).

Companies may find this incentive very alluring. Not only does it make them slightly more competitive (for one, employees are on the job more throughout the year) but it offer the illusion of a benefit increase without the actual pay increase.

If your company currently does offer this or is considering it, keep in mind that it will not come with or apply to any matching benefits the company offers. And they may also see it as a temporary offering rather than a fixed part of the plan. The only thing that is certain is the option must be nondiscriminatory.

Paul Petillo is the managing editor of and a fellow Boomer

Thursday, November 19, 2009

A Boomer Look at Similar but Conflicting Investment Tools

There is a great deal of conversation going on about whether the ETF is a better than the mutual fund. Both have advantages and one, as you will find out, has more disadvantages than the other. Because we are basically discussing the approach to retirement, the concern among investors as to which would be better is relevant.

The argument is never clear. When we compare mutual funds to ETFs, we often miss the differences between the two in large part because we are discussing two different types of investments, how they should be used and what they are. Folks on the ETF side of the disagreement point out a variety of plus while conveniently leaving the minuses out of the conversation. People who argue for mutual funds are looking for something other than a simple index fund.

The Pluses of ETFs (with the minuses)
The tax benefits that are often touted by the ETF camp rely on the buy-and-hold strategy that index funds offer. It should be noted that when comparing these two investments, one should drop the vast majority of mutual funds from the argument and concentrate only on the index mutual fund.

With any investment, capital gains are a consideration. The only way these two can be compared on a tax basis is when there is a sale. While funds held outside of a 401(k) or other retirement account distribute capital gains on a regular basis, ETFs do so only when sold. An actively managed mutual fund (which is what numerous ETF supporters believe is a fair comparison) can generate a capital gains even if the fund losses money. Actively managed mutual funds shift the holdings in the fund during the course of the year and this does present the possibility that you will need to pay taxes on those transactions. But like index funds, ETFs only shift holdings when the index fund it tracks shifts holdings.

So in this argument, ETFs and index funds are similar in tax efficiency. But when ETFs are compared to actively managed funds, ETFs seem the better choice.

Are ETFs a more simple investment?
While you buy an ETF at a set price (which can also be done with index funds, the main difference is the when the price is fixed - in mutual funds it is at the four o'clock close; ETFs reprice throughout the day depending on how well the underlying portfolio has done) that price can gyrate wildly throughout the day. In fact, much of the last minute swings in the overall market are due to ETF positioning and may offer you a false picture of the underlying worth of the ETF.

Those for ETFs suggest that this one price, one trade principle makes these investments better. But the cost of that one trade can be much higher than the purchase of a mutual fund (actively managed or indexed) and that trade, which is whatever your brokerage account charges, is also a factor in the sale. If you add those two transaction to the cost and the fact that many mutual funds do not charge for the purchase of their shares, the argument about simplicity falls flat.

So in this argument, on the surface, ETFS seem less expensive but only as long as you buy and hold which is not what professionals do with this investment.

Perhaps ETFs are more cost-effective
Once again, ETFs cost you dollars to trade. While this is a fixed cost that can be calculated, mutual funds charge expenses against portfolio balances. This makes any mutual fund purchase, even index fund investments, subject to fee considerations. The lower the fee, the greater the cost-effectiveness. With ETFs, you do pay an underlying fee which when compared to index funds is often higher and you pay commissions on the purchase and sale.

One percent is one percent no matter who charges it but if you can buy one for nothing compared to the cost of a brokerage fee both in and out, the ETF argument runs into problems.

The ETF option
While there are numerous types of ETFs available there are also numerous types of mutual funds tracking essentially the same markets. Mutual funds offer sector investments just as ETFs do. Here ETFs are probably better. The simple reason is the ability to allow you to get in and out of a hot sector without any pain other than the cost of the trade. But for the vast majority of investors, their style is passive. They really want to do the research, make the decision and then let the money and the investment ride.

ETF investors crave action even if they do it under the guise of flexibility. They are essentially chasing the next hot corner of the market while mutual fund investors leave the pursuit up to the professional manager they hired.

So in this argument, ETFs play nicely to the investor who wants to move quickly in and out of a hot sector.

Are ETFs easier to transfer
Of course they are easier to transfer. Held in your brokerage account, the shares are yours to take wherever you want. Transferring assets in a mutual fund (index or actively managed) does require a bit of work and there may be a slight charge for the effort but this argument also falls flat. When moving a fund, those shares must be sold and there is a cost in doing so. But most mutual fund investors spend a great deal of time researching their investments (manager tenure, fees, performance and underlying holdings/investment style) and if they desire to move, it is because something has gone wrong with the fund. In this instance, moving a fund is worth the cost incurred. ETF investors move based on price value alone. And they move to another ETF.

So in this argument, the better research you do the more likely you are to buy an index fund and hold it or buy an actively managed fund and monitor it. Owning an ETF is always a temporary investment and the investor is always looking for another ETF to suit their needs.

Paul Petillo is the managing editor of and a fellow Boomer

Wednesday, November 18, 2009

Social Security How Long Will It Last?

Money How long can Social Security last?

At the current rate, the system could be operating in the red in just a few years and exhaust its trust fund by 2037. Meanwhile, reform seems more difficult than ever.

As the boomer generation reaches retirement age, many are facing the harsh reality of a less-than-cushy nest egg. Some put their kids through college at the expense of long-term savings. Others simply didn't save enough. Can they live on Social Security alone? Will
Social Security still be available 30 years from now on?

Building Wealth with Dividends

Every Friday morning, I discuss different aspects of investing and retirement planning. The hosts of MomsMakingaMillion Talk Radio believe that if women were paid what men are paid for the same job, poverty in this country would decrease by 50%. This week, on 11.20.09, we will be discussing the art of dividend investing. (The format for my segment is broken down into five questions.)

So what are dividends?
When a company makes a profit there are basically three things that can be done. Some reinvest it, which is what newer companies or growth companies do. They take those profits and channel them back into the company in the form of research or simply hold the cash for future mergers and acquisitions. Some companies use the money to buy back their own shares. This happens when the company realizes that its share price is below what they think it should be. Some use the cash to clear up their balance sheets by buying down their debt exposure. Others share it with the shareholders.

These are all good things to do with the cash they have made but nothing benefits the shareholder over the long run better than dividends do. Why is that?
Dividends are old school. I wasn't that long ago that Wall Street considered the act of dividends the most important aspect of an investment. Now we can look to dividends for one thing: to increase our wealth.

How often do companies pay their shareholders?
Dividends are decided by the board of directors. Then they set a declaration date, which is the day the dividend payment to shareholders becomes a liability on the company's books. This is followed by the shareholder of record date. If you are holding the stock on that date, you receive the payment. They refer to this point in time as the ex-dividend price for the stock. If you buy the stock before the dividend is paid, you get the dividend. But be careful, a company considers the shareholder of record a person who owns the stock four days before the dividend is actually issued. Buying a stock in this four day period means you will not get the dividend; the person who sold it to you will. And the other important date in this process is when the company actually pays you.

Do they always pay cash?
This is the most common way of doing it. A company will declare a dividend and that amount usually is split among four quarters. So if the business offers you a dollar dividend, each quarter you would receive 25 cents for each share you own. Sometimes they offer a one time special dividend which is a lump sum payment with no other date specified when they will do this again.

What do investors need to keep in mind when buying dividend paying stocks?
Three thing investors can keep in mind when looking a dividend paying stocks: they are less volatile because the companies who pay them tend to be far more stable in terms of share price than other companies, they outperform non-paying dividend companies by almost 3%, and the are easily reinvested providing the investor with additional opportunity to buy more stock which means more dividends.

Paul Petillo is the Managing Editor for and a fellow Boomer

Monday, November 16, 2009

Retiring when You Can

Chances are, the lesser your wage will working, the more dependent you will be on Social Security when you retire. While at first glance this might seem a sad state of affairs in terms of a retirement plan, it is not beyond your abilities to change this outcome before you retire. If you are aged 50-years, the ability to put together a viable plan is doubly difficult. But, even considering that, it is not impossible.

Several things need to be adjusted prior to that arbitrary date.

Retire when you can
Most of us have not been very successful with our retirement planning. We have begun late in many instances and have failed to utilize our options to the fullest. Many of us have not used these plans long enough to see the benefits. Long-term investing still needs thirty years or longer to work. The vast majority who have plans have used them less than 16 years.

During this time frame, often thrust upon us as your company changed from a pension plan to a 401(k) or you changed jobs repeatedly during that period, we experienced the shock of having to educate ourselves about what our options were and then set a plan that was previously managed for us to one that was defined by us.

For numerous folks, this meant doing the wrong thing first, then, as time passed, correcting those mistakes.

Default Investing
Up until several years ago, the default investment in your 401(k) could have been anything from a simple index fund to a money market account. The later simply parked your money, and while you never lost any of it, you never were able to take advantage of market ups and downs.

Now, new employees will be defaulted into target date funds (pick a retirement year or have one picked for you). And some, after the debacle that was 2008, have switched their retirement money to just such a fund in the hopes of recovering enough invested dollars to regain some of what you may have lost and preserve what was left.

The jury is still out on whether these funds will provide what you need to get where they say they will take you. Target date funds are navigating uncharted waters with a promise to do what never has been attempted. Unlike balanced funds (usually offering a 60/40 split between stocks and bonds), target date funds re-allocate your investment over time moving from more aggressive to less with the idea that this will protect your investment over time.

Over 50 Dilemma
If you are over 50, this strategy may prove to be the wrong one. In most cases, you are entering your largest income producing years. If you are contributing more as you earn more, you may be leaving a great deal of potential on the table as these funds try and protect those invested dollars instead of growing them.

While stocks are considered risky in this period, they should not be ignored. The best structured retirement plan will separate your investments into categories. If you are currently contributing 6% of your pre-tax income to your retirement plan (and this is not enough), you need to increase that amount to the point of causing you to rethink your daily budget needs.

Each pay raise should signal an increase in contributions. And each increase should go to a more conservative investment while leaving the initial 6% fully invested in stocks. This sort of self allocation will give some risk for old money invested and less risk for new. Shifting to a target date fund does not allow for this, taking much of the potential for risk off the table.

When and How
If you can wait to take a distribution from your 401(k), it will allow it to grow further. To do this, you will need to enter retirement without a mortgage, with your financial house in order (this means adequate savings, only the minimum in credit card debt and the all important emergency account). Your expenses will not decrease in retirement. The cost of maintaining insurances as well as your property will not go away. Your health could prove to be a factor as well and should be accounted for (and worked on while you are still employed) before you retire.

Many of these costs rely on projections. While these are difficult to make with any accuracy, they are not impossible to plan for. Inflation will increase by about 3% suggesting that each year, your expenses will go up, even the fixed ones (because inflation makes your dollar worth less). Insurances might increase on average 5-10%. And taxes will depend on how much income you have but basing your projections on current income rates might prove foolhardy. Add an estimated increase of 3% per year (this includes property taxes as well).

Arriving at retirement with any outstanding debt means one thing: you will have to continue to work just to keep up with the increases. The other option, of course, is to get used to these financial burdens while you are still working. Living a little bit more frugally now will offer you the opportunity to experience what life post-work will be like.

So the three basic tenets of investing apply: get your financial house in order, channel as much money as is possible into your retirement plan (without increasing the risk of creating more debt as you scrimp) and take some risks with your invested dollars. The first tow will offset any problems you might face with the last suggestion and allow your invested dollars to do some work that too conservative approach will not permit.

It's not too late. But the strategies are different.

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

Wednesday, November 11, 2009

401(k) Fair Disclosure for Retirement Security Act of 2009

This is interesting for its content. The only trouble I see is the lack of fiduciary responsibility that has, in part, infected the 401(k) plan itself. These fiduciaries are often not well trained in their responsibilities and some firms are simply too small to put the effort in to finding the best 401(k) plan for their employees.

These plans, as you will hear in this video dated 04.22.09 in support of the 401(k) Fair Disclosure for Retirement Security Act of 2009 and presented before Congress by Alison Borland, Retirement Strategy Leader for Hewitt Associates LLC are incredibly complicated. If they are difficult to manage in a large firm, you can only imagine how troublesome these plans must be to smaller enterprises.

Representative George Miller (CA - D) introduced the 401(k) Fair Disclosure for Retirement Security Act of 2009 that would require:

* 401(k) plan administrators to provide advance notice identifying each of the plan's investment options, along with its risk level, investment objective, historical returns, a fee comparison chart and other information

* quarterly benefit statements to disclose certain account activity information including fees assessed during the quarter

* 401(k)-style plans to include at least one lower-cost, balanced index fund in order to receive protection against liability for participants’ investment losses under ERISA Section 404(c)

* service providers to disclose to plan sponsors:
- fee information broken down into four prescribed categories
- any financial relationships or potential conflicts of interest
- the existence of different share classes and the basis for the differences
-in situations where free or discounted services are provided to the plan, the extent to which and the amount by which the service provider or its affiliates are otherwise compensated

* the DOL to provide model notices and review compliance with these requirements.

The bill is on its way to the House ways and Means Committee and so far, has not been scheduled.

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

Monday, November 9, 2009

Time, Transfers and Temptations: The Overcomplicated 401(k)

While the 401(k) plan you have access to at your place of employment is a a "better-than-nothing" retirement plan doesn't mean that you should ignore the benefits of investing for your future.

There are three basic problems with the retirement plan (and how you use it) known as the 401(k).

First, for many of us, it has not been around long enough for us to take full advantage of what this type of investment scheme can offer. A full thirty years or more would be considered the optimum amount of time - which makes this a young investors game. The older investor probably has had less than fifteen years to date to grow a plan that they believe will provide enough post-work income to allow them to retire well.

People who do not have that much time should be attempting to max out the plan (either the most you can contribute or the most the IRS will allow) and keep more than what those sage financial planners suggest in stocks. Even if the equity exposure is spread across a variety of index funds, moving too much into a conservative investment such as fixed income too early will drive the available balance and potential earnings down.

For people who are in this age bracket, the focus should shift to getting your financial house in order while you have the time. Set your mortgage up for payoff as soon as possible. This can be done a number of ways: refinancing or paying down the mortgage in advance of the scheduled payoff date. While a refi is good, unless you are getting an interest rate reduction of one percentage point of better, the cost of a new loan and the ability to get one in this sort of slumping economy might not be the best way to spend those dollars.

Instead, begin a prepayment plan that is both safe and easy and has the most flexibility. For instance, did you know that if you pay one extra month a year (divided over twelve months payments - $1200 a month mortgage payment divided by twelve would allow you to make a $1300 payment) would shorten the length of the loan by eight years? A fourteenth month payment would bring the total length of the loan down to about sixteen years. This is without costly refinancing and allows you to do what you can if you can afford it. Avoid the lenders offer of a twice-a-month payment plan and secondly, be sure that when you do this, mark the extra payment as "for principal".

Do I need to tell you to do what you can to eliminate any and all outstanding credit? If you cannot payoff what you have borrowed at the end of each month, you have borrowed more than you can afford.

Secondly, your retirement account is not a savings account. It is an investment for your future. Not one single dime should be withdrawn for any other purpose than your retirement. When you are transferring a 401(k) due to a job loss or a new job, make sure you roll it over into an IRA and name a Trust or Trustee. Failure to do so will result in taxes charged against you as if you had simply withdrawn the money.

And lastly, you will not be able to invest as much but the opportunities are greater. IRAs will not provide you with as great of a pre-tax advantages as your 401(k) did, but the choices you will have as result of getting out of not-so-good plan are incredible. Shopping on the open market for a mutual fund or funds allows you to move your move across the full breadth and depth of the market, control the expenses and fees and allow you to set your goals (in terms of risk) far better.

Many 401(k) plans force employees to purchase company stock which make them less diversified. Getting out from under this type of plan will stand to be the best thing that changing jobs could offer. Granted, if your company matched contributions (some still do and many more will begin to do so again in the next several years) this will no longer happen. This is a big loss of free money. Use this as a criteria for your next job and insist it be part of the benefit package.

You can still set up an automatic payments withdrawals from your checking or savings account but there are limits. In 2010, the limit for your IRA, which is what your new rollover plan is called, will be $5,000 for individuals and $6,000 if you are over fifty. You could, if you can afford to do so, open a Roth IRA as well (a rollover into a Roth will prompt a tax penalty because Roth plans are after tax accounts). This will allow you an additional $5,000 contribution.

Keep in mind that you only have a sixty day window to do this. Your old employer may allow you to stay in your old plan. The 60 days begins when you start the action or they tell you they want you out.

What to keep in mind about your 401(k) plan and rollovers:
If you have a 401(k) plan use it and if possible, use it to its fullest.
Get your financial house in order while you are working, especially if you have only been in your 401(k) plan for less than fifteen years.
Rollover your old 401(k) into a Traditional IRA within 60 days and be careful with the paperwork. If you have more money to invest, open a Roth as well.

Paul Petillo is the Managing Editor of and a fellow Boomer

Wednesday, November 4, 2009

When Your Retirement Plan Goes to Court

In 1970, Congress took to task the responsibility of mutual funds to offer a fair price for their services. This "fiduciary duty with respect to ... compensation for services" suggests that investors should know how much a fund is charging. But these fees are not always as transparent as we would like.

Buried inside many 401(k) plans are fees charged by the plan sponsor that are often in addition to what many would consider the transparent information available. These fees are not often known to the 401(k) investor at a glance.

Is Any Fee Fair?
On Monday the Supreme Court heard arguments in the case of Jones v. Harris Associates. Harris Associates was accused of charging higher fees for 401(k) investors than they charged for similar investments made by pensions. The trial was heard in the 7th District Court and the ruling suggested that the fees, while almost twice that charged for institutional investors was not out of line with what is considered the industry standard.

The question remains, what is fiduciary responsibility? The late Justice Benjamin Cardozo, writing in the widely cited case Meinhard v. Salmon, believed that "partners in a business have a fiduciary duty to inform one another of business opportunities that arise." He wrote: ""a fiduciary represents the punctilio of honor, and that is contrasted with the morals of the marketplace operating at arm's length."

This would suggest that the business partner relationship extends to the investor, who is essentially locked into the plan offered by their employer. They do not, as in other business dealings, have the ability to walk away from the investment and choose something else. This lack of portability, the old "money walks" notion of how free markets conduct themselves does not apply in this situation.

When Higher Fees are Noticed
These fees are particularly troublesome in light of the recent downturn. What would be considered reasonable fees when the stock market is outperforming become a glaring slap in the face when fund returns are down. The belief that fees whittle away the potential of greater returns is well founded.

As an example, consider the 45 year old, gender neutral investor who has a household income of $50,000. With an 8% contribution rate and an 8% return (after fees) over the remaining 20 years this person plans on working (a beginning balance of $100,000 and a potential of inflation, which is currently running in negative territory but historically runs around 3%). This person would have enough cash on hand, provided that the 8% return remained in place on the investments accumulated throughout their retirement, to not run out of money until they were 87 years old.

In the case heard before the Supreme Court, the additional half percentage point levied against the investor in the 401(k) would remove almost two years of income from the plan. The Court was asked to determine whether these fees were excessive in light of what other investors paid for similar products.

In an overview of the argument: "Open-end investment companies – more commonly known as mutual funds – are often created and managed by investment advisers. Although the funds and advisers are separate entities, the overlapping nature of their relationship can create conflicts of interest. The petitioners believed that Harris Associates did not "provide full and accurate disclosure of all material facts related to the transaction; and (2) ensure that the transaction is fair to the shareholders."

Does Your Plan take Responsibility?
The Investment Company Act of 1940 was designed to keep the role of advisor and client separated by a board, which would determine fees the advisor would like to charge. Prior to this, the relationship without the board made the practice of who paid what. But the advisor hires the board making the threat of firing the advisor much less of a possibility than if the board was independently elected. "Justice Scalia, for example, speculated that even if a board could not directly fire an advisor, it could set the advisor’s fee so low that the advisor would quit."

But the argument came down to an apples and oranges comparison of which fees were reasonable. The Court has numerous options including doing nothing. Yet, as long as investors focus on the fees charged, the argument should continue if only as an act of dissent voiced by the participants in the plan. Forcing the plan sponsor to shift to a more fee friendly environment, possibly with a new advisor would be a step in the right direction. But that could lead to a less focused fund manager who may not try as hard.

Fiduciary responsibility remains a difficult ideal to litigate. "Captive" investors may simply have to deal with higher fees in the short-term until there is some ruling supporting comparisons. Or, as many in the investment community hope, the markets will return and these concerned investors will simply forget how much they could have made with lower fees as higher return offset the losses.

Paul Petillo is the Managing Editor of and a fellow Boomer

Tuesday, November 3, 2009

Mutual Funds have Taxes Too!

Most of us who write about retirement planning and investing all focus on getting in as soon as possible and staying invested as long as you can. I lean towards staying in equities as long as possible; while some advocate a gradual shift as you get older to a more conservative investment portfolio in an effort to protect what you have gained.

And while I also like the idea of wealth preservation, it should be done not with your initial investments in the stock market but with an increase in overall contributions. In other words, as you grow older, add more conservative offerings to the mix rather than shifting current equity exposure.

Lump Sum Investing
Generally though, we often offer this advice on retirement accounts. But what if you have maxed out your 401(k), contributed as much as possible to your Roth and still have money to invest? What if you have decided to get into the markets now with a large sum of money (401(k) plans use a defined contribution model: invest each paycheck, a specific amount or percentage; tax-deferred), be it from a bonus or unexpected windfall?

Mutual funds offer the average investor the opportunity to do three things: spread the investment over a vast number of stocks - or at least more than you might be able to buy individually, use the expertise of the fund manager to ferret out the best investments and to do so without costing too much.

Mutual Fund Pitfalls
We all know that mutual funds have their faults. Some drift in style exposing us to the possibility that we will hold too much of the same underlying investment. Some simply charge too much compared to their peer group. And others simply cannot find the right investments to boost their performance and keep the investors they already have, interested in staying for the long-term.

Attracting new investors and keeping legacy shareholders happy is the real key to the success of the mutual fund. You do not have to be represented by a large mutual fund company to be a very good mutual fund. Not only does the availability of invest-able funds grow, making growth opportunities increase, but the potential for the worst possible problem for a fund, redemptions, stay at a minimum.

Redemptions cause two things to happen. First, the fund manager is forced to sell some of the fund's underlying holdings to satisfy your fellow shareholder's exit. A lot of these types of transactions makes the fund vulnerable and adds to the grief experienced by fund shareholder who believe that the fund is a good one, even if the markets as a whole are suffering.

The second thing it does is force a taxable event. Whether you defer the taxes in your 401(k) or hold the mutual fund outside in a taxable account, this is perhaps one of the worst things that can happen to a future or current shareholder.

Mutual Funds and Taxes
Taxable events are unavoidable in any investment. In fact, it acts as a confirmation that you have made money - in most instances. But in a mutual fund, the tax event might come as a surprise even if the fund will or has posted a loss.

You can be taxed for a capital gain even if your mutual fund has lost money. The fund manager may have been forced to sell long-held and profitable investments in order to keep the share price higher and the returns better in difficult markets. Often, the shares held in the fund pay dividends and these are also taxed. In a taxable fund, this can happen at scheduled times of the year. But no matter when, taxes will need to be paid even if you reinvest the gains (and eventually they will be paid when you take a distribution).

So what can you do? As I said, in a 401(k), there isn't much you can do and it probably shouldn't even be very high up on the list of considerations. But if you are buying a fund that is taxable, it will pay to do a little bit of homework.

Doing Your Homework
Find out from the fund if they are about to make a capital distribution. These often come at scheduled times of the year and it can vary from fund to fund. And it come whether the fund has had a loss or not. Lump sum investors are better off waiting until after the distribution to make the investment.

Avoiding this can be difficult if you have been in the fund for a while. It might be a good idea to sell the fund before this event and move the money into a similar ETF that represents the same type of investment exposure. This avoids a wash sale, a taxable event in itself that increases the owed taxes (from capital gains rate to ordinary income rate) if you buy the same investment within thirty days of the sale.

Reinvested gains change what tax people like to call the cost basis (important when calculating the actual share price against the selling price) of the cumulative total. This doesn't lessen the chances for taxes but does decrease them somewhat.

Keep in mind, this isn't a tax avoidance strategy so much as it is a method to avoid paying for taxes on events that occurred before you invested. Selling the fund and buying an ETF, even in the short-term can create taxes as well if the fund did well. Selling the ETF and moving the money back into the fund can also create a tax situation.

Another thing to consider: move the fund to a much more conservative investment in the same fund family for a brief time (until after the distribution) and then move it back to the original investment. In many instances this is done without any costs at all to the investor. If you don't move in a timely fashion, you will be forced to pay the taxes on the sale.

According to Fairmark, "If you move money from one fund to another within the same family of funds, you're selling one fund and buying the other. If the first fund went up before you made the move, you have to report a gain and pay tax on it. Consider the tax consequences before moving money to a different fund, even within the same family of funds!"

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

Monday, November 2, 2009

When Analysts Get it Right, They Might be Wrong

If you were to open your third quarter statements, and I hope that you do, you will find that your balance in your retirement plans has jumped significantly from its lows from the year ending 2008. This would, to the untrained eye, point to a recovery led by the stock market.

And the stock market has recovered - to a degree. Yet, expecting this to reflect into the economy that we experience day in and day out, is not there. And may not be for months. Why is this?

The Norm
When markets recover from their bottom, they do so based on what many of us like to feel is a fundamental improvement in the businesses that our retirement plans invest in. Those businesses offer forecasts to analysts who in turn predict how what the company expects its future to be, how they plan on growing or simply maintaining market share, and how they see the consumer's reaction to their efforts.

These analysts then parse this information. In doing so, they offer clients of their firm an outlook on what these companies are most likely to do and whether their positions reflect the strategy. Using terms such as overweight (meaning that more of a particular company's stock should be owned relative to their total portfolio), underweight (a suggestion that exposure to the stock should be had but not so much so that it could jeopardize the overall holdings), neutral (a reference to keeping a company's stock would neither hurt or benefit the client any better than if they didn't own the company at all, suggesting that it be balanced based on a variety of measures such as overall risk) and of course the buy/sell that signals you should, if your were a client to move in a specific direction regardless of your current position.

For the most part, analysts have been right about the stock market. Of the 344 companies that have reported their earnings so far, 85% have handily beat expectations that these analysts have reported. Is it simply the result of a command performance or is it the result of pessimistic outlooks provided these folks?

In all likelihood, it is the later. Businesses have begun to recover but are doing so without the help of the workers they would have needed in the past. Taking advantage of extremely low rates for borrowing, they have shored up their books to give the appearance of profitability, they have cut costs across their businesses and have done so without hiring workers to meet demand.

Better is Not Best
This cash hoarding has done wonders for the balance sheet. In fact, Standard and Poors company has found that the industrial companies in its index of the 500 largest cap companies has increased to by $684 billion as of June 30th. Using low interest lows to refinance debt is not the same as using low interest money to increase spending. This is also reflective in the ratings many corporate bonds have received, driving the risk of default lower.

And this is driving your retirement plan balances higher as a result. The question is: can it go on? The short answer is yes. The analysts are still giving investors false hope with lower estimates of performance in the near-term. Even without domestic hiring, companies are beginning to expand overseas. Labor is cheaper and many see the demand for consumer goods increasing offshore at a faster pace than here at home.

The long answer is no, it can't go on indefinitely. The American economy is still driven by consumers. How much of it will be in the future remains tied to the ability to borrow (still low despite the historic low rates available to even the smallest borrower, although with higher than expected requirements to access that credit remain problematic), the unemployment rate (which is expected to top the 10% mark, with even more people dropping form the ranks of the measured as their search for employment simply stops being recorded), and the bottoming of overall prices (a relative measure of how well a company can sustain profitability in the face of lower overall sales).

The Better Idea
For now, staying invested seems like a better idea than not. The problem is whether the economy's recalcitrant attitude will prevail over the business plans and the analyst's forecast. You can expect mid-caps to remain a focus in the coming months as small caps still struggle with funding their operations. Many in this space rely on research and development money to stay on track and some even look to the merger and acquisition markets to help. Neither seems very promising at the present.

Does that mean we are headed for another correction? Yes and no. Yes, we will see some result of the weak dollar having a negative effect on our investments, both equities and fixed income. No, in that it will not be as bad as the one we just experienced. The only way to take advantage of this volatility is to stay invested and doing so in a steady stream of contributions, the way your 401(k) provides, will end up in a better result than following the gyrations of the market that are bound to take place.

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

Wednesday, October 28, 2009

The Aha! Moment

There is no doubt that an enormous amount of confusing information is still floating around about retirement planning. Folks are trotting out old mares, suggesting that slow and easy is still the best approach. Some a taking the rider off the horse altogether, instead putting them in a wagon - you know, for safety's sake. Others still are suggesting that if you don't whip this beast more than you currently are (I am in this camp) you will run out of money when you retire. That is, unless you keep working until you are so old, retirement lasts only a decade or so.

How do you sift through it and come up with a feasible plan, one that takes into consideration all of the threats and possible missteps that can occur? How do keep the plan rigid enough that you can make better-than-probable predictions about what you might be able to live on and how not to outlive your money?

Risk is in the Spotlight
Judging from what I have encountered, it must be very difficult indeed. Risk has jumped to the forefront of conversations. Many investment advisers are falling back on this thinking: If you lose less than you thought you would, then you can give us credit for suggesting the low-risk approach to your retirement investing. On the other hand, who will get the blame if what you projected your retirement accounts to hold comes up a decade short of where it should be?

We have spoken about the risk of too little risk. We have discussed the effects of only looking at upside potential, ignoring the downside (diworsifying) as an indication of future returns.

We Want New
Yet there are still those that think protection of assets is what your tax-deferred accounts should be. This is understandable. We want fast fashion as economist Juliet Schor describes it. If what we had no longer seems to be working, then something new, something better might work. For many of us who have never tried it, the something new often means less risk, not more, fewer opportunities to grow your money by slowing the potential to a trickle. This approach relies on a much heavier stake than many of us are accustomed to doing: increasing our contributions.

The gradual shift from stock exposure to bond exposure over time is a sort of false diversification. Yes, there was a ten-year period when bonds did better than stocks. And there was a twenty year period when stocks did better than bonds. In either instance, the differences were almost insignificant. Neither has outperformed the other so indisputably that you should go with one or the other.

Which is why so many suggests a mix of the two. But this ignores innumerable possibilities, allowing what could be beneficial to fall by the wayside. It encourages single index investing (if you do it outside of the popular target-date funds) and relying on a mutual fund manager to do it for you (inside a target date fund).

Doing this, you pass up the international and emerging market exposure that global investing has become. Tying your fortunes to one country, no matter how you structure your investments is no longer diversification.

There is the lack of investor acknowledgment that commodities drive a great deal of our marketplace and invested by the right hands, can add some protection over long periods of time. This cannot be accomplished inside funds that promise to decelerate your risk exposure over time using what would appear to be conventional techniques. Not to mention the fact that these funds have not been around long enough to have any provable track record, and now, their exposure to stocks has found the concept worthy of SEC scrutiny.

You can add a great deal of the risk you need simply by keeping your 401(k) actively involved. This is where you should harbor the risk you need to undertake the difficult goal of creating enough wealth. This will come at a cost that many are suggesting is not worth paying. Increased fees can be problematic, but some exposure to these markets through index funds that track smaller and more specific areas often harbor competitive fees and far better returns than their large company counterparts.

Index funds that track the largest companies or mutual funds that mimic indexes should be kept on the outside of your tax-deferred retirement accounts. (I make this argument here.)

So How Much is Retirement Going to Cost?
Attempting to predict what your future needs in retirement will be is as easy as looking at your current spending and debts. How much of those bills will you be carrying into those golden years?

If you look at your retirement plan as a risky undertaking, something you can orchestrate to be in the right place at the right time - or better, diversified enough that no one place hurts the whole of your investment plan - then you will find yourself looking to stocks as a greater portion of your portfolio.

If you still want to add a conservative element to your plan, I suggest that any new investment contribution should be directed towards that, a move preferable to diverting funds away from another investment. The key isn't increased risk, it is maintaining levels of risk that allow portfolio growth and it is increased contributions.

Paul Petillo is the Managing Editor or and a fellow Boomer

Monday, October 26, 2009

Retirement Planning Trick or Treat

Retirement planning has become a very much a trick or treat landscape to navigate. Numerous products will be found in your 401(k) plans in the near future that might not prove to be the best solution for the investment dilemma your retirement accounts are in. And with Halloween just around the corner, perhaps we should look at some of the treats in your bag.

Inside Your 401(k)
Let's start with the easiest one to talk about, the index fund. This investment offering is in your 401(k) account and offers low fees, which is good, they offer of low volatility, which is attractive after last year, and the promise of steady returns. They mimic a published index and they follow those stocks to meet or beat that index all while providing you with enough of a risk return relationship that will get you to retirement. They are not your favorite trick or treat sweet; the one you will eat after the good stuff is gone kind of investment.

Fees can vary widely in 401(k)s and some of them are hidden from view for good reason. It is one thing to be charged fees in a fund, it is wholly another matter to charge them for managing the plan. So many plan sponsors are finding funds for their participants that charge lower fees but at the cost of returns.

But wait, index funds are created equal. After all, there is the index they must follow. Not quite follow. Only about 75% of the stocks in the index are actually held in a S&P 500 index fund, and a third of the available companies are in a fund that tracks the Russell 2000. That leaves room for besting the index. And some do, particularly in the small-cap space where index funds can beat the index by eight to ten percentage points and do it with fees that are the same as some popular S&P 500 funds.

And fees in those funds can be all over the map. Why? Perhaps tracking error as they trade and research more than a similar fund. Perhaps because your index fund may be wishing it were an actively traded one. Reasons vary and so do the fees.

As Good As They Are
Index funds, as good as they are, should be kept outside of tax deferred retirement plans. This will allow you to control the fees and potential returns/risk those funds are taking much better. And in the current tax environment, it might well be worth paying for them now. Consider the three years worth of losses you would have been able to write-off after the downturn.

In 2010, tax rates will change for dividends (to that of ordinary income rates) and capital gains (to 20%) which is still a good deal - at least for the next couple of years. Dividend payouts are down and not likely to begin to increase soon making that tax reasonable. Twenty percent is not 15% but still not a bad deal.

(I realize that this sounds as if I'm advocating for the more expensive actively managed funds in 401(k)s. I am although I am just looking at it from a time frame point of view. Without a doubt, early investing is best. But many folks have entered the fray of 401(k) management with less than fifteen years until they would like to retire. Even if this group maxed out their contributions, it would take a solid 8% return year over year to get even close to enough to draw $15,000 a annually from the account and not run out of money. Risk inside a tax deferred account. Less risk outside. Your 401(k) plan unfortunately is your "mad money account"!)

Some Confusion Remains
People still confuse savings with investing too often and that, I believe, is one of the real problems with how folks recently readjusted their retirement accounts. Savings is not investing. As a result of this misdirected thinking about what those accounts really were, they have assumed so little risk, they put their "planning for retirement" at too long term a pace.

Retirement planning has become a very new and tricky landscape. People switched, sold or borrowed from their 401(k)s at the exact time they should have been rebuilding them. Had they stayed put and if they were fortunate enough to be able to continue their contributions, the vast majority of them would have seen balances in those accounts close to what they were at the 2007 year-end. What scares me now, is that there are new products on the shelf to add even less risk (at least in the sales pitch of loss) that investor/consumers might find attractive.

The Next Disaster
Disaster planning, which may comes as a shock to almost no one, can effectively derail any well-laid out plan. Kids, parents, jobs and a host of other problems can make deciding which move is best to for you doubly hard as you try to construct their plan.

Building a retirement that is financially predictable, growing savings that is stable and accessible and using your 401(k) plans to guide your future is no easy task. You will be assailed in the coming months and years with products that promise to protect your gains with products that are essentially insurance. Compared to index funds, these are like the neighbor who gives you a toothbrush. Good idea but the wrong treat

Retirement planning needs to be earthquake proof. That means considering new and innovative ways to get the 50 year old investor back in position to retire while s/he can. Less risk is not the path.

Paul Petillo is the Managing Editor of and a fellow Boomer.
Further reading on index funds in your 401(k)

Thursday, October 22, 2009

Could a Change In Tax Law Save the 401(k)?

William Bernstein writing for Barron's foresaw the future of the 401(k), this country's most ubiquitous retirement plan. “The 401(k) is likely to turn out to be a defined-chaos retirement plan.” And so it goes. Almost nine years after that comment was penned, the 401(k) has, for the most part, turned out to be a failure for most, a disappointment for some and far too much work for those who use it to its fullest.

The Investor Class and The Rest of Us
This is based on numerous reasons, almost all dealing with our own, largely undefined and for the most part, beyond description approaches to investing. We are all over the place, trying to attach method to our madness and sound reasoning where there is none. This means that there is an investor class and the rest of us.

Unfortunately, we don't have to be exiled to the outside. But keep in mind, despite your best efforts, you will never be completely admitted to this elite group. Don't worry, many of those who are members are there by accident, something time will uncover and because of the nature of the class, they too will be kicked to the sidelines. In many respects, we are simply spectators.

Pensions are not dead although they are quickly becoming something of the past, relegated to the obviously smarter workforce, the union laborers. These folks admit to not knowing about where they should put their money, so instead of directing their own fortunes, many let trusts operate the investments.

(This is where a group of concerned folks gather, the employers and the union and determine where the best place to invest is. And statistics have shown, that in many instances, they do better than companies do when they hire "professionals". Also damning any chance at success is the interest the company has in the pension and how it relates to their balance sheet.)

This is sort of a forced retirement with the laborer giving up pay increases for pension contributions. And in the case of the trusts, it generally works like a charm. There are exceptions, particularly during labor disputes and troublesome negotiations when the welfare of the member is often second to the economics of the contract.

The Retirement Calculation
And in the three decades since its inception, we have proven the concept more or less incorrect. We are forward looking creatures that mistakenly attribute possibility to reality. In many instances, we have pre-determined how much we will need, how much we will need when we retire and how much we will need to save to get there. We have the whole plan sown up. That is until there is a bump, or in some instances, a really big bump jostles our fragile framework to the core.

Companies have shirked their fiduciary responsibility time and again. They enlist plan sponsors who are hellbent on squeezing every dime they can from every nickle invested. These fees, some hidden, some acknowledged are often higher than the individual investor might pay. And because the funds you choose form are locked inside a structured plan, shopping around is limited to what is on the shelf. In the land of choice, the plan that needs to have the most options is closed to competition.

The 401(k) appeals to our herd mentality, driving up our gains (at least on paper as we chase the hot funds and the sizzling picks our cubicle neighbor has chosen) and driving our losses further as we try and stop the bleeding. We look at these accounts as money saved (which it isn't) and add to the debacle and withdraw or borrow against these accounts.

And we like to blame. It is also in our natures. Which is why some feel as though the 401(k) hasn't been given enough time to work. Yet those who have a pension, what I have referred to as the great economic stabilizer for many Americans who have them, have seen their fortunes in their post-work years remain stable. You have to realize, these plans were designed for those who had nowhere else to go with their high level of earnings. This tax-deferred portion of the tax code was custom made for this group. And it would have been for us as well except that we don't have enough time in the plan to make it work the way it was designed.

We haven't contributed enough either. To reach the portion of pension payment using your 401(k), you would have to retire with three times your current balance, provided you took advantage of all the free (matching) funds and maxed the plan out. Now the matches have gone away and fewer people bother with the maximum contribution. The catch-up clause is just wishful thinking.

Fix what is Broken
So can this thing be fixed? Yes and no. If 401(k)s are only worthwhile when you retire, why then do the changes to these plans, improvements that make it easier to keep invested and stay invested have to come from the government? Talk has been shifting towards some sort of government run pension plan or an exchange where employees can by some sort of guarantee (adding a new player to the retirement game, the insurance company). Neither of these is feasible.

Nothing says participate like less taxes and this sort of incentive offers some easily projected numbers that are easy for even the lay-est of investors to understand. Matching contributions may not have lured sideline investors because it meant money out of "pocket" or less in the budget.

The IRS could act to make all 401(k) plans more tax friendly.

Based on the fact that 401(k)s are essentially tax events, the wrong agencies are stepping in to try and fix an IRS problem.

Here is what I suggest: Consider making the tax deferred deduction on the 401(k) contribution twice what it currently is and you will, in essence, give the employee a raise. You could force a minimum contribution and surprisingly, it might not even be noticed. As many of you already know, 5% barely changes your take home pay. But getting an additional deduction would.

The IRS could take it one step further by then fixing the withdrawal tax table. Many of us don't know what we will be taxed when we retire because we don't know what we will be able to withdraw. The IRS could place a 5% cap on anything under $20,000 a year, 15% for all additional annual draw-downs. Upper tier investors would want to pile in and this would have the net effect of raising all investor boats. (To recover much of this lost taxable revenue, reducing the contribution limit by a thousand dollars to $15,500 would force those who could invest that sort of money to pay the taxes and put the money in a Roth. My roughest calculations show that it would add $10 billion a year to the coffers, offsetting the increased deductions.)

The IRS could also penalize those tax returns (in the nicest way possible) and tax any over payments in excess of $500. This would be directed to a group 401(k) that would be directed towards a state sponsored target date fund (even though I don't like them much, for this purpose, they may be custom made). When the person applies for retirement benefits, this fund would be added to their benefits and because it was already taxed, it could not be taxed again. Applicable tax rates for 401(k)s would also apply on any interest gained.

Harsh medicine? Perhaps. But the end result would be more money to spend now, more money to spend later and more money that many would not have. All by changing the tax code.

Paul Petillo is the Managing Editor for and a fellow Boomer.

Wednesday, October 21, 2009

Outwit, Outlast, Outplay: Surviving Retirement

It was bound to happen. Most of us have been predicting it for years. Retirement. That long awaited event which bridges the days of wealth accumulation with the moment of wealth draw down. All of your hard work, your scrimping and saving, your investing and financial wrangling all come down to this moment.

And as the first wave of Boomers begins to eyeball retirement, how it will be accomplished is not as certain as it was just five years ago. Optimism has been replaced by skepticism as folks look at depleted 401(k) balances and wonder if anything they had planned for, any retirement dream they had dreamed, will come true.

There are several things you have to consider as you stand at the foot of that bridge. Do you want to cross? Do you need to or worse, do you have to? Retirement, the time you have been waiting for, planning for, investing for may not be the dream scape you had once believed it would be.

In our thirties, if we looked far enough ahead and were wise enough to begin investing, envisioned retirement as a time of rest a relaxation, funded by wads of discretionary income generated from decades of smart money moves.

In your forties, you saw the end of the line a little clearer and realized that discretionary spending might not be the primary focus of those golden years but a benefit after essential spending was done. You are more mature and have a better grasp on what things costs, how much money it takes to maintain the lifestyle you are comfortable with and how hard you have to work to maintain it.

In your fifties, you have a better grasp of the bookend pressures that life often is. Your parents have needs, some of them financial that cannot go without consideration. Your children have needs that might be beyond the cost of college. They may have started a family, bought a house or simply moved back home. Each of these may have been an unplanned financial drain changing your estimations of where you had hoped to be.

All through this, you struggle to prioritize your investments, trying to justify your contributions to your 401(k) plans as budgetary pressures weigh in. And then, as if you needed it, the markets decide to add their own bit a pressure to your plan. These are all well expected events, something prudence and wisdom should have warned you about. Problem was, you were still busy living.

Now the time for retirement is within reach and you wonder how well you did. Did you outwit the markets? Was your investment strategy the right one? Will you have enough to survive?

If you began your retirement journey early enough (which most of us haven't), you have given your investments the opportunity to grow. But few of us have used our 401(k) plans long enough to achieve the results we had hoped we would. The 401(k) simply has not been around long enough (just over 25 years since its introduction) to consider this a career long investment.

Rather than thinking about how much longer you might have to work, think of your situation as "how much longer do I need to keep investing". To get the maximum from your retirement plan, you need thirty or more years of steady investments to achieve the kind of wealth accumulation that would allow you to begin to draw down (decumulate) those accounts.

We tend to, even after the market correction that damaged many balances, still be overly optimistic about how much we will need in retirement and how much those post-work accounts will earn. Optimism points to a steady return of 8% on those accounts or higher. Fixed income accounts, those primarily invested in bonds will need almost 6% year over year.

And then there is the income that these accounts will generate. Do you pick 4% a year, adjusting for inflation as the target number? A $250,000 account balance at retirement will provide about $15,000 a year and at that rate, will deplete your account in thirty years - and that is based on a very optimistic and we now know, uncertain 8% return. To achieve a $50,000 a year income, you must have a balance of $1.25 million at the time of retirement.

What if you are nowhere near that account balance? Aside from working longer and keeping your investments in a greater share of the equity markets than most suggest, the best way is to enter retirement with as few of the "essential" bills hanging over your head.

Will you retire with a mortgage? This was not something your parents had to contend with. As one of the single greatest drains on your working income, taking your mortgage into retirement is simply not feasible. Taxes and insurances will, without a doubt, increase faster than you anticipated. Upkeep on property (homes, cars) will add an additional drag on your plan.

Making that post retirement income work may require you to divest. Is this part of your plan? The more liabilities that you enter retirement with, the greater the pull on your assets. Rather than look at retirement as a "how much will I need", a change in focus to "how much does it cost me to live" might be a better way to look at the possibility.

If your balance sheet shows more than 25% of your current income going towards your liabilities, you do not have enough money to retire. While you should keep investing and contributing to your retirement accounts, you should also be drawing down the cost of your lifestyle to match those assets. This is something within your control.

The less debt you enter retirement with is perhaps a better determination of how much money you will need to survive this important game of strategy. It is not how much you need to retire, it is what will you need it for.

Paul Petillo is the Managing Editor of and fellow Boomer.

Tuesday, October 20, 2009

Subtle Changes in Your 401(k)

While we can discuss risk and the risk of too little risk, the real risk might be where you put your money in your 401(k). In fact, what your plan offers may be so limited that your choices boil down to good and not-so-good. Most common, garden variety 401(k) plans offer index funds, lifecycle funds and if you are fortunate, actively managed funds.

Life cycle funds represent a group of offerings focused on a particular target year that you would like to retire. These are essentially actively managed funds that shift, at least in theory, from aggressive to conservative over the course of your career. Actively managed funds tend to pick a sector, such as large-cap stocks, and focus their investment prowess to the best possible return. Index funds are designed to track an index of stocks (or bonds), ranging from the top 500 companies to indexes that track the smallest.

Before I tell you about how index funds can differ (which is odd, considering an index fund essentially attempts to mimic the published index) I want to talk about a person who wrote me last week. Although her email sounded panicked, she knew that there was little she could do about what her 401(k) plan was doing to her portfolio.

She told me she had chosen four funds in her 410(k) to invest in, the bulk of which was directed towards a small cap index and a mid-cap index run by Merrill Lynch. She believed, and rightly so, that this would be where the recovery would take place. These funds had always done well she told me, and when the markets turned sour and her funds were brutally beaten down, she kept her investment dollars streaming in.

Because markets do recover and her investments remained consistent, her portfolio value is now within a couple of thousand dollars of her year end balance in 2007.

Her concern was a change her plan sponsor was making in those funds, switching to another group of funds offered by Northern Trust. The reason according to a notice she received from her plan sponsor was the cost of fees.

Focused on Fees
In general, index fees should be as low as possible.
The idea is simple:
1.There is no trading to be done between the time the index is set and the next time it is adjusted;
2.There are no research fees;
3.And inside your 401(k), there should be no 12b-1 fees (the cost of advertising for new investors paid for by the current investors);
4. And lastly, because the company, in her case it was Kroger, the fiduciary responsibility (what a plan sponsor does is based on the assumption that it is best for the employee's future) demands the best deal.

That would be in a perfect world. Not to pick on her company's plan, but it doesn't fair very well when they are searched for using BrightScope, a retirement plan quantifier (information about their invaluable service can be found here) and this had her worried. Just because she has a plan, doesn't make it the best of all worlds, simply the one she has to live with.

Her plan was shifting her small cap index fund (with an expense ratio of 0.15%) to one that offered to track the same index but at 0.06%. At first glimpse, this seems like a good move. Lower fees are always good. Second glances however show how poorly the new fund offering has done compared to what she had before. Her new fund has a year-to-date performance of 12.52%; her old fund had chalked up a 29.83% return. Year-to-date, the Russell 2000 index of small cap stocks has racked up an impressive 22.43%.

Why would they do this, she asked? Other than being able to suggest that they are trying to do all they should for you, substituting one index for another based simply on fees, there seemed to be no clear answer. It is troublesome to be sure but not uncommon. It is also evidence that not all indexes are created equal or cost the same.

Index funds are subject to all sorts of influences. Fees run the gamut from absurdly low to ridiculously high. There is also the pesky probability of tracking error, a problem some fund managers get into as they try to outperform the benchmark. This tends to increase the expense ratio by forcing more trades and increased research. But it might also allow the index to outperform.

Keep in mind, your index fund does not buy every stock being benchmarked. An S&P 500 index generally has only about 75% of the stocks on the list in the portfolio. How much of each is often the reason for the disparity in returns. A Russell 2000 index fund has only about a third of the companies listed.

Most people think of Vanguard Group when they think of index funds. But their much-touted S&P 500 index fund carries an expense ratio of 0.15%. My friend’s small-cap index fund, the one that did so well, charged her the same as this less risky S&P 500 index fund cost.

Add to that, there is relatively poor information available to her even through her plan. A great many of the funds offered inside your plan are not offered to individual investors making information gathering difficult. Plan information is improving but comparisons are still hard to make. She was more upset that no one asked her if she would like to switch.

Not All Plans are Created Equal
Looking inside your 401(k) is never easy. For Boomers (and anyone focused on retirement), it can be especially difficult. You are torn in many cases between necessary risk and the fear of that risk. Your portfolio may not have recovered as quickly as my friend's did but consider the option of too little risk as one not worth taking.

There are basically only two ways of achieving the goals you may have set. You could increase your risk and/or increase your contribution. If you do the later, you can use the additional funds to purchase something more conservative while leaving your original contributions, the funds directed towards more risk, intact.

You should remember that if your plan offers only index funds and lifecycle funds (target-date funds), chose the index offerings. If your plan offers choices beyond index funds, choose the actively managed funds across a range of disciplines (large-cap, mid-cap, small-cap and international). In some cases, the fees might even be as competitive as the index fund that tracks them.

In the end, my friend did nothing. She had one of those not-so-good plans. Her only option was to increase her contribution to make up for the unrealized returns.

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