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 BlueCollarDollar.com 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 BlueCollarDollar.com, 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 BlueCollarDollar.com 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 BlueCollarDollar.com and a fellow Boomer

Wednesday, November 18, 2009

Social Security How Long Will It Last?

Money How long can Social Security last?

Source: http://articles.moneycentral.msn.com/RetirementandWills/default.aspx
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 BlueCollarDollar.com 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 BlueCollarDollar.com 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 BlueCollarDollar.com 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 BlueCollarDollar.com 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 BlueCollarDollar.com 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 BlueCollarDollar.com 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 BlueCollarDollar.com and a fellow Boomer.