Is a Million Dollars Enough?

As long as I have been writing about financial topics, the million dollar mark has been the goal that most every retirement planner suggested was necessary to leave the workforce and have enough to live comfortably for the rest of your life. And then, not coincidentally, the post-2008 landscape changed that configuration, in many instances, actually lowering the goal.

Keep in mind that goals are backward looking even as they are forward reaching. You need one they suggest to know what you need to do to get there. The question that lingers is how much is a goal worth having if the goal creates stress on your well-being, your family dynamic and your overall health? In fact, the answer may eventually answer the question of how long will we live in retirement?

Is a goal worth having?

Yes and no. First it identifies what needs to be done to achieve whatever it is you dream of doing. You want to go to the movies, the goal is to produce the twenty bucks or so it will cost. This is a fixed goal with real tangible numbers to accompany the desire. You know the real cost of going: tickets, concessions, babysitter, etc. You also equate exactly how many hours you may have worked to achieve that goal. Retirement unfortunately is much different.

You don't know what anything will cost. Folks throw out inflation as a concern, healthcare as an untenable cost and your longevity is the long-term savings reducer rather than the concept that it will give you more fruitful lives. 

You do know that you don't want to be newsworthy. You don't want to be headlines: "woman says death preferable to living in poverty" or "man says I didn't plan on being poor". So you do two things that enable what might seem inevitable. You worry and you don't save.

So what is the number?

There is no number. There is just you trying to figure out the day-to-day while ignoring the future. Keep in mind that no retirement plan was ever designed to replace 100% of your current income. Eight-five percent is considered good and seventy percent of your current income would be do-able. You can subtract your projected Social Security Income and you have some sort of idea how much you will need based on how much you need now.

In survey after survey, you have answered with comments that suggest you are no where near where you should be. Of course you aren't. Even if you haven't invested/saved all that much, time will make it somewhat better. Compounding still works. The investments you make now will be better off in the future, even if only slightly so. And the budget you keep now will help you stomach living on less in the future.

In survey after survey, the folks who look at the data, construct the questions and parse the info the answers supply see a landscape littered with dispair and angst. They see people lamenting that they will work until they die. They see people complaining that they will do worse than their parents and suggest that they will do worse than any generation prior to this one. They find that people are unwilling to adjust their dreams and use that as the goal, even if it is wholly unrealistic.

Is the answer your 401(k) plan sponsor's responsibility?

Russell Investments thinks this may be the key. They did a study recently that suggested two things: higher income wage earners will be better prepared for any problems they may encounter in retirement (healthcare costs, market volatility, inflation, etc.) while lower income wage earners will struggle with the day-to-day expenses prohibiting them from finding any available cash in which to save. The study does suggest that Social Security plays a lesser role in the higher pre-retirement income wage earners plan (about 36%) as compared to the lower income worker (about 51% of current income could be replaced).

But where the study differs from other reports on the dire state of this affair is helping the plan sponsor reconstruct their role in the process. Without citing the cost to businesses for retaining older workers (some numbers have put the cost as high as an $50,000 per worker past normal retirement age), focusing on the near-term expenses by making the plan better may be the best way to move this worry into the realm of manageable.

I'll give you the link to the whole study (here) but the element that intrigued me the most was the suggestion that the defined contribution side of the equation, the fiduciary responsibility of the company, could play the role that has been often overlooked. It is easy to say save more without offering the employee any hope of finding the right investments in which to do just that.

The way they suggest it would work is first to induce the employee to use the plan. Rather than a dollar for dollar match up to a certain percentage, they suggest that the employer match 75% of the first 5% contributed. Five percent has long been considered a sort of break even point for the employee providing some contribution without impacting the take-home pay needed by the lower income earning group.

If you were to see it written as a math sentence, it would look like this: A 75% match of first 5% of income creates a savings rate of 8.75% or 5% plus (0.75 x 5%) = 8.75%

But they think the best option would be to not stop there with the incentives. They think a secondary match should kick in once the employee taps the 5% mark. Companies could offer a 25% match on the next 5% contributed.

If you were to see this next stage of the plan, it would look like this: 8.75% plus (0.25 x 5%) = 15% savings rate.

The study goes a bit further suggesting that auto-enrollment and auto-escalation (essentially forwarding pay raise to the plan instead of to the paycheck) would get these hesitant savers on board sooner rather than later. It would also require the plan administrator to refocus on the core demographic of the employees, tailoring the underlying investments towards that group and controlling expenses better in the process.

And that would change the question of whether a million dollars was enough to "aren't we in this together?"

On the Radio with Author Mike Egan

Monday on Financial Impact Factor Radio, we had Mike Egan, author of "Your Stronger Financial Future: The Eight Essential Strategies for Making Profitable Investments". This book takes the time to rearrange your thinking about the world of finance around us and in doing so, arrange it so that we can systematically confront fear and presumption and get on with our plans for retirement.

Listen to internet radiowith

Paul Petillo of Target2025.com/BlueCollarDollar.com

and Dave Kittredge and Dave Ng

of FinancialFootprint.com

on

The Financial Impact Factor

at Blog Talk Radio

Is it Magic?

I wanted to talk a little bit today about illusions and our brain. No doubt most of you are familiar with magic. We call falling in love with the right person magic. We think of good fortune as magical. Yet, magic is based on three key principles and these are best illustrated with the simplicity of a card trick.

Although I am not a magician I do know that every kind of magic hinges on the ability of the magician to create something your brain wants to believe. And this precarious attempt to fool you depends on you wanting to be fooled. In fact, every magic trick is based on this belief: that the magician can fool you. But noted magician Penn Julliette of Penn and Teller fame also is quick to point out that any sort of illusion, designed to fool the brain is a disaster waiting to happen. Surprisingly, attitude has everything to do with the success of any trick – not you attitude, but that of the magician.

Mr. Julliette explains that in a simple card trick, the key is for the magician to act as if he doesn’t care. He could care less whether or how much you shuffle the deck and his attitude portrays exactly that. Then, when you return the deck of newly shuffled cards to the magician, he or she then offers you a card, any card. You do and this also doesn’t matter. But where you put the card upon returning it after memorizing of course, it does.

Now the magician’s job isn’t finished. He or she does care where you put the card and uses any number of techniques to get the card back to the top of the deck. But your brain believes that it has controlled everything up until this point. In effect, the unwilling suspension of disbelief has taken over our thought processes. Even when the magician offers to have you re-shuffle the deck, you won’t.

Now I have been writing about the state of personal finance for over thirteen years. Which means I have spent a great deal of time with people who are looking to achieve the same financial success in their post-work life as they may have in their pre-retirement life. But our brains are working and I fear that we aren’t doing a very good job talking to those brains.

As financial educators, we are well aware of what the people we focus on do with the information we have. In fact, most of us find some sort of information, latch on to it and actually look for confirmation of that thought. In 2007, researchers at the University of California – San Diego found that once we expose ourselves to information, it becomes an acquired memory. Not permanent mind you. Your brain doesn’t work that way. Instead it seeks out information that permanently fixes it in our heads. This is what brain folks call spaced repetition. Given the right info your brain performs impressively. Given the wrong information, and your brain still performs impressively.

Another bit of research points to what is called retrieval. Seems your brain performs better if the memory you have stored there is pulled and examined. Each time we do, the memory gains some importance. We as financial people fail here as well. We do make those we deal with think about what they want and how they think it should be once they get it. But inevitably, we add to the problem by giving them something they hadn’t considered. The memory of what we thought we knew is still there. But now we have something else to remember.

The last problem we encounter is as financial educators is the act of dumbing down. We fail to do what some educators have found is the most important of functions: interleaving. We try to explain things in so simplistic a way that we actually confuse more than teach. We tend to piecemeal our lessons, a bit about debt here, something about insurance there and perhaps a little estate planning antidote thrown in for good measure. Yet we define them as parts of a whole instead of a whole. They are intertwined and we make the mistake of suggesting all too often that they are somehow pieces to be taken at their own worth, an approach that doesn’t seem to help according to the journal Applied Cognitive Psychology.

Those we are hoping to help, according to this august publication would do better if we lumped it all together, somehow tying it up in a neat bundle of problems and issues instead of giving the whole process a linear feel. It can’t be helped in books, as as any editor or writer knows. One thing needs to lead to another.

And far too often, we break that linear explanation of money into something like this: hope, fear and confidence.

Unfortunately, hope for something better is dashed by the fear of what we don't know and ultimately, your confidence begins to wane. This is problematic for anyone who attempts to try and describe what they know, How do you parse the necessary information amongst the thousands of messages out there and make it meaningful across all readers?

Perhaps boiling it down, removing the illusions, forgetting the magic might work. Personal finance is no magic trick. It involves challenging what you know; not simply believing what you need to know. You need to save and invest and yet, even as you commit to those hopes, you are challenged by what you hear and this creates fear. Fear that perhaps you haven't done all you could do. Perhaps confidence stems from doing what you can with what you have to achieve what you are capable of. Lofty goal setting aside, you are the magician looking at the trick. Tell yourself what the magician tells you.

You are probably better off than you realized. You are probably capable of fixing the small things which in turn lead to the bigger solutions for the problem. Be the magician against the markets. All you need to know is how to your card on top.

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

Overestimating Your Retirement Needs

A million dollars sounds like a nice round number to shot for when you discuss retirement planning. But the goal might be self-defeating for most folks as they check their quarterly balances in their 401(k) plans. In all likelihood, you contribute (but not enough) and your 401(k) plan is adequate (even a smallish 401(k) will have at least fifteen mutual funds, some of which will be passive type investments such as index funds). And even if you are average - average 401(k) balance of $20,000 and an average household income - around $50,000 - you can achieve enough wealth in retirement to do just fine.

And you can do it on a quarter of that sum, a much do-able number. But there are caveats, as there are in all things and not something you should ignore. First of which, we have briefly addressed is your expectations. Retirement savings, including Social Security is not really designed to replace 100% of your income. In fact, even in the heyday of the pension, and amongst those that still exist, the average payout is normally about 70% of what you can expect.

So working in round numbers: $50,000 in income/35 years until traditional retirement/10% contribution/4% return invested passively in index funds we have come up with the following future profile.

In retirement, you will need $35,000 a year in income. (Because of inflation, in 2046, that will be equivalent to $98,485. Inflation has the net effect of making what seems like a small amount look far larger. The flip side of inflation is that money will buy the goods at an equally inflated cost.)

Part of that income will come from your Social Security and/or pensions. To produce the rest, you should build up your nest egg (including your 401k, IRA and other savings accounts) to $251,110 by the time you retire. (In 2046, that will be equivalent to $706,590).

To save $251,110, your investments need to gain an average of 4.28% from now until retirement. If we are calculating this right, it is a safe estimate (about 99.78% chance) of this happening. But not without some effort on your part.

Even beginning at 30 can be considered young or starting early. With all of the rhetoric surrounding our longevity, the normal target age of 65 can be expected to be pushed back making 30 the new 20.

By passively investing, you have assumed as much risk as is considered advisable and even under the most modest of circumstances projected at 4% or slightly higher, the low cost of this type of investing will give you bigger gains than if you had assumed more risk at a higher expense.

And although inflation will inflate your net total, taxes based on the $35,000 a year income should remain relatively stable. And by using index funds across several markets (an S&P 500, a mid-cap and a small-cap domestic equity, an international index and a bond index) you have chosen the most tax efficient method of investing ever invented.

The remainder of the plan relies on you contributing 10% of your pre-tax income and staying out of debt. This means you will have to adhere to some sort of budget from now until the end.

The bottom line: a million might be too lofty a target for most and may spur some folks on to achieve more. But for the vast majority of us, comfort and security is enough to give us hope. More than that - strongly encouraged by the way - will simply be icing on the retirement cake.

Paul Petillo is the managing editor for Target2025.com and a fellow Boomer

Can You Be A Savvy Investor With Index Funds?

We are a fickle bunch. We think of ourselves as savvy investors, although there is a great deal of room for improvement among all investors to which degree of savviness. Yet we are in almost every instance our own worst enemy. Victoria Holt is quoted as saying: "Never regret. If it's good, it's wonderful. If it's bad, it's experience". Yet still, after several decades of behaviorists studying our actions in the marketplace like so many mice in a lab, we still do the same predictable things time and again.

And perhaps the first emotion we feel once we begin to second guess each of our "investment" decisions is regret. And if the recent selling of actively managed mutual funds by investors over the last year or so is any indication, regret for past decisions is in full swing.

Adding to the chatter that actively managed mutual funds and by default the managers who stand at the helm, is John Bogle, chanting the mantra he has carried since the late seventies. Why, he has asked, would anyone choose to look for more than what an index fund can provide? And as we begin to acknowledge the pull and tug, feel the most susceptible to such cost savings as a lower fees, which is always good, index funds begin to come to the front of our thinking about which investment is best.

But once you begin to believe that getting mediocre returns in the equity markets is the "new" goal, the attempt at saving some money in terms of the fees charged by actively managed funds in exchange for the smaller returns that index funds offer becomes the overall focus. And if that is the sight path you choose, index funds are definitely the right fund to use.

In a recent report in the NYTimes on the subject of this exodus from highly regarded performers over decades to index funds in search of lower fees, one thing stands out in the numbers. This is simply a beast feeding upon itself.

Consider this: You own X amount of shares in an actively managed mutual fund and you sell. But rarely do investors act alone. They are signalled by some change in the wind, some report drilled over and over or perhaps, it is from the suggestion of a colleague. Suddenly, fear sets in and you begin to think that you have the wrong investments. The fees are too high, you think and then anything that resembles a stick snapping alarms you and your fellow investors and you run.  And then you regret.

The selling prompts the redemption of shares, which when enough investors sell simultaneously, and enough shareholders accounts need to be made whole as they leave, markets move. And if the movement is great enough, the equities drop. And so do the indexes. So you sell at a loss only to buy shares in a fund you just, via the herd, lowered.

In many instances, the outflows are no reason to believe that the actively managed mutual fund world will implode. In fact, according to Brian Reid, the Investment Company Institute’s chief economist, 93% of the investment assets stayed right where they were as the remainder moved to other investments. Among those investments - more than just index funds reaped the benefit of this change in loyalty to actively managed funds - overseas funds gained as well as funds focused on commodities. Bond fund outflows also helped boost the index fund profile.

And what did this sell-off net the exiting investors? What were they looking for? Believe it or not, index funds that are actively managed. This surprising move has some folks, including myself, scratching our collective heads.

True, the fee structure of index funds is far cheaper that that of the actively managed fund (index funds average about .16% while actively managed funds average about .97% - with many load and closed end funds added into that average and increasing it as a result). But once you let a broker enter the mix, the fee structure changes, coming closer to the cost of the actively managed fund and at a lesser overall return.

Index funds because of the tax efficient structure belong in taxable accounts - as long as the capital gains tax remains historically low. Inside a tax deferred account such as a 401(k) or an IRA, the effect is lost. This is and should be the domain of the actively managed mutual fund. And while you should never lose sight of the role fees play in the long-term performance of your investments, believing that fees are the only driver in achieving steady returns is misplaced.

And while I have nothing against index funds, the growing number of funds  that slice and dice the markets do not always lead to lower fees for investors. But talk about index funds enough, and investors won't notice nor take the time to compare one index to another.

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

Your Retirement Ex-Social Security

Bring up Social Security to just about any American, Boomers included and you will get one reaction or the other. And it doesn't really matter whether you are young or old. You feel something is bound to happen to the program and although you may have no idea how it works, you believe that the way it currently does can't go on. Now opinions differ on the health of the program and the long-term sustainability of it but few argue that there aren't problems looming in the future. Is there?

The first reaction most feel is that the program can't continue on the way it has for decades to come. Bankruptcy, running out of funds, too many Baby Boomers, all get the blame for the demise of this important program. Whomever lit the match to this topic (someone on Wall Street I suspect with a keen eye on the potential windfall privatization would provide his/her business) has got to be pleased. A simple tinder of an idea has caught the public's attention and now we have a full-on brush fire.

So here's the rub: I'm not going to argue with those who have their mind's set on the end of the Social Security program as we know it. Let them think that it will not be around.

Let them believe that what is essentially a program to provide insurance that poverty won't grip those less fortunate, the disabled, the children who have lost parents or spouses who have lost loved ones, and those who did not have access to any additional cash to invest or save for retirement won't be penniless is worth tossing to the curb. Lawmakers seem to think that their suggestion that by simply telling the average American to save and invest more, work harder and longer, and in the process, feed their fear of not being able to retire in a lifestyle that is not sustainable on a single dollar less than they are currently making, that they are moving the country into a more prosperous future. They are not.

The bottom line is that the program will continue to exist. And so will the talk of its end. Why that conversation persists is puzzling. Even as fewer people contribute into the plan, those few actually contribute almost more than eight times as much as the post-WWII generation did. As Merton C. Bernstein, the Walter D. Coles Professor Emeritus at Washington University in St. Louis School of Law recently suggested, it is because of production. Workers are not only producing more output than previous generations, the work they are doing is better compensated. And that increased compensation according to Bernstein has closed the gap sufficiently. Is that simple equation likely to improve in the coming generations? Without a doubt. Yet little consideration is focused on that economic anomaly.

That's not to say that the program couldn't use a few additional tweaks. But preparing for the worst is not worth considering. And recent attempts by the GOP would actually create more debt not less should they try and change the program. It's a complicated and sort of odd way to think about it. The reality of what some of these proposed changes would bring about point to a flaw that cannot be overlooked: changing Social Security in the name of dealing with some future debt obligation we would leave our children would actually increase the debt limit we leave those kids.

Without getting into the vitriolic debate about the cost of government, the ridiculous ideas for reining in costs while two, possibly three wars are under way (and no talk of slowing spending down there) all while a recovery is under way, seems absurd. The bottom line still falls back on your ability to have enough to feel comfortable in retirement. If you exclude Social Security from your retirement calculations, then the onus of financing your retirement is on you. While I do not like the idea of a back-up plan (it suggests that the original plan has the potential to fail), Social Security not only acts as one, it is one that cannot be touched.

And surprisingly, despite all of the talk about its end, it will still be there for my grandchildren. Perhaps snot as robust. But doing the same thing it does now: providing insurance against poverty.

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

The Insurance Most Boomers Overlook

Is this the insurance Boomers and pre-Boomers overlook the most? Quite possibly. Last week, we talked about the idea of disability policies in your personal finance framework. This week, we're going to take a look at some of the add-ons that you might consider when buying a policy.

Shoppers know what a value is. Except when it comes to buying cars and insurance. Then, we often lose sight of what value is by adding stuff to the purchase which can increase the cost. Want the spoiler on the car? It’ll cost more. The upgraded sound system? More. Leather, sunroof, alloy wheels? More, more and more money out of pocket. And most shoppers know they can add these extra items on after the purchase. But few seldom leave the show room with the stripped down version of the car, the basic model, with the intentions of adding on the features we think we need.

Our conversation about disability insurance also has the same sort of stripped down version – the basic coverage that replaces some, not all of your income should you not be able to work. Now, we're going to take a look at the seriously upgraded policy that most of us find not only enticing, but worthwhile. These add-ons are referred to in insurance jargon as riders. Are they worth it or can we do it alone with less?

Let’s discuss what you can add-on to these basic policies and what they may cost you for this peace of mind.

The first of these add-ons is often the Cost of Living Adjustment or COLA. We know how our money can erode over time with inflation. So it can be suggested that if you have agreed to a set benefit, that benefit, the longer it is in place will be worth less with each passing year. The COLA rider is intended to protect you from this risk and usually kicks in after first full year the policy is play or even after the first year of your disability. They offer an enticing increase, sometimes as high as 6% every year that you are disabled and receiving benefits.  Sounds good but could cost you about 40% more than the basic coverage.

Most people who use a disability policy do so because they can’t work. But when an agent offers you what is called a residual disability rider, they are suggesting that even though you are hurt, you might be able to return to work in a limited fashion and because of that, this policy makes up some, not all of the difference in your pay.  It typically provides a partial benefit when your earnings are reduced by at least 15-25% as a result of an injury or illness. But it will cost about 20-25% more if your policy doesn’t have it already built-in.

Think you might need more insurance at some point down the road? While most of us either fall into one of two categories: over insured or under insured, this rider called a future increase offers a sort of Goldilocks add-on. It suggests that if at some point in the future, you might like to increase your monthly benefit, because the benefit you have “just isn’t quite right”, you can do so without re-applying and submitting to additional medical examinations. 

All you need do is pay for the rider (sometimes 10% more in premiums) and should you decide to exercise it, simply prove that you make more now by providing the right financial documentation. To do so without the rider means you will need to get another medical exam.

The catastrophic disability rider sometimes called the 2 of 6 rider (meaning you are unable because of your disability to perform 2 of the 6 basic morning duties: getting out of bed, going to the bathroom, showering, getting breakfast, brushing teeth, getting dressed) allows you to purchase an additional benefit amount that will be paid if you are catastrophically disabled. Catastrophically disabled means you have a complete and irrecoverable loss of sight in both eyes, hearing in both ears, speech; or the use of both feet, both hands, or one foot and one hand. Alzheimer's Disease or other irrecoverable forms of dementia or senility are also considered. Keep in mind that this is not a Long Term Care policy. Some policies include this; others don’t. That’s the best way to compare the true cost of this benefit against a separate LTC policy.

The automatic increase benefit is available with most carriers at no additional cost. The AIB rider will increase your monthly benefit amount by 5% of the original benefit at each policy anniversary, for the first 5 anniversaries. Your premium will be increased based on attained age at each anniversary. If you have this rider and chose not to accept the annual increase, you can do so by submitting a written request to the insurer.

The own-occupation rider allows certain occupation classes to upgrade the definition of disability to a “true own-occupation” definition. If this rider is added to your contract it will replace the standard definition of disability offered, to one that states “You will be considered totally disabled if due to injury or sickness you are unable to perform the material and substantial duties of your regular occupation”. Good luck finding this but if you do, it can be worth the cost, which is about 10% more in premiums. If you are in a relatively hazardous job, this sort of rider can also retrain you after a period to do another job.

By having a refund of premium or as it is sometimes referred to as the good health benefit rider on your policy, the insurance company will refund a percentage of the premium paid over a defined period of time that you remain healthy and not on disability claim, until age 65. This costs a lot and if you do have a claim, it will be all for naught.

This one is quite possibly the best rider available in part because it actually lowers your premium in many cases as opposed to increasing it. Called the Social Security rider It is actually a bet with the insurer that suggest that, if you should be come disabled, and Social Security coverage kicks in, the insurer is off the hook for a percentage of the benefit owed. I actually have this and should I become so disabled that Social Security kicks in, the insurer is only obligated to pay 20% or what they may have owed me. But as Social Security suggested, the next step in life if you qualify for Social Security is death.

Like all insurance policies, shop around, be sure that your employer doesn’t already cover you in some way and be careful you don’t buy coverage that might be better suited as a stand alone policy.

And one last note: the more you have saved in an emergency account, the less you have to worry about some of these riders. While all insurance is designed to never be used, an emergency account can make it easier to forego exercising the policy or adding on expensive riders you may never need.

Your Retirement Investments Might Have Risk but are they a Risk?

Are mutual funds a systemically important financial risk? It seems that so far, the answer is no. To explain what this dreaded SIFI label actually means, the NYU Stern School of Business has developed a risk indicator and alist of the top banks and CEOs capable of bringing the whole system down should their activities run into problems.

Senator Chris Dodd and Rep. Barney Frank, authors of the Dodd-Frank comprehensive financial reform law began identifying which institutions could be the most troublesome for the economy as a whole should they fail. It was one thing suggesting that all banks with $50 billion plus in assets be labeled as SIFI. But other institutions could also create risk and in the time since the creation of the reform law, other large entities have scrambled to get out of the way. Ideally, the right balance, not too many and not too few, something the Brookings Institute suggests as a Goldilocks problem, is what the law is aiming to create.

At a recent conference held in February, Doug Elliot asked the question: "So, if you’re going to define systemically important financial institutions you have to have some concept of what systemic risk is.  And you have to have some way of measuring it, at least in some subjective manner.  And are then setting a threshold to say where does something go from having too little systemic risk to worry about to enough that it should be treated separately here?" Mr. Elliot is well known as a former investment banker, former head and founder of COFFI, his own think tank, and a very prolific and insightful writer on financial reform issues with a book soon to be published titled "Uncle Sam in Pinstripes".

The biggest fear is what is known as a domino effect. Essentially, if a number of SIFI act in unison or a number of institutions engage in the same financial activities with an SIFI labeled entity, failure would knock one, then the next over, creating a systematic breakdown. But identifying who is at the greatest risk is a lot tougher than it sounds. Mr. Elliot points out that both irrational panic, such as a run on a bank creates, and rational panic, such as identifying the problem but making a wrongheaded assumption that whatever the problem is, it isn't really that bad, can both add to the systematic tumbling of one institution, and then another.

The recent crisis had a component about it that it turns out isn't all that unusual. In fact, most of the problems in the recent history all possess the same problems: assets that were overvalued and folks knew it and leverage that was chasing it, even if it knew it was overvalued. This embracing of risk is what causes systems to break and in some cases, have the potential for bringing the whole of the economy down with it.

Given their size, mutual funds were considered as well in the discussion (which can be found here). They are not directly leveraged nor are they intermediaries (such as insurers and re-insurers) or affiliates of larger financial institutions. In fact, mutual funds are generally referred to as pass-through entities. But some funds have worried regulators based on their size. But that size is not threatening if it isn't used as leverage.

The one exception Mr. Elliot pointed out was the money market mutual fund, an entity that many believe is, or should I say, was, as a safe as a bank - at least in the mind of the average investor. A buck, they thought was always a buck, until one moment during the financial crisis, when a MMF declared ti wasn't. Investors were told that there was risk. But with this sort of situation having never occurred, the risk was set aside for most investors.

While mutual funds may have escaped the scrutiny of those studying these financial risks, hedge funds, institutional investors (pensions) and some investment firms have not. Just because some funds fit some of the criteria, of which six are listed, doesn't mean that the Frank-Dodd regulations would necessarily miss this group altogether. They do have size but because of the number of funds available, they provide numerous substitutes for the services and products they provide investors.

There is an adequate degree of separation from other financial firms, an borrowing that they may do (leverage) is clearly stated by most funds in their charter. While many of the largest funds do face some liquidity risk if investors lose faith in the ability of the fund to perform, it usually occurs as a dribble of discontent rather than a one day sell-off. Mutual funds tend to keep a limited amount of cash on hand so a sell-off would be something that whole of the marketplace would be experiencing rather than just a handful of large funds (which all tend to be indexed to the market and not actively managed entities. In truth, funds that become too large, tend to lumber when attempting to move in either direction.

Those large index funds are passive. But some large bond funds may not be but their size keeps any sort of maturity mismatch from occurring. And the existing level of regulatory oversight provided by the SEC is seen as adequate to protect the overall system from any imminent problems.

Although MMF aren't necessarily problematic, as the Investment Company Institute, the lobby arm of the industry points out: "a liquidity backstop could provide reassurance to investors and thereby limit the risk that liquidity concerns in a single fund might spur in-creased redemptions".  There is a possibility that hedge funds might see this as an opportunity to roll what they do into into mutual funds. But the regulations provided by the SEC make this not as attractive.

It may be too soon for the mutual fund industry to breath a sigh of relief. While one or more of the 243 rules and 59 studies commissioned by Dodd-Frank may still find mutual funds in the crosshairs of the reform law, the industry believes that this will not happen.

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

Insuring Our Retirements

A great many of you already know what the Pension Benefit Guaranty Corporation is and what it does. The PBGC basically insures pensions and uses the premiums paid to it by employers to guarantee that no matter what happens to the pension an employer might have, the benefit (referred to as a defined benefit plan) will be there, perhaps in total, when the worker retires. This organization was born out the need to protect workers from company defaults, mergers and acquisitions and other business practices that essentially took a lifetime of retirement income away.

The PBGC is a government agency that does not rely on tax revenues to conduct its business. According to their site, the explain how they pay for what they do as: "financed by insurance premiums set by Congress and paid by sponsors of defined benefit plans, investment income, assets from pension plans trusteed by PBGC, and recoveries from the companies formerly responsible for the plans." There a limits to how much you can collect if the PBGC steps in and takes over your pension (such as a limit of $4500 a month) but the benefit far outweighs the total loss of your plan.

Now there is a movement in Washington, spurred on by the Government Accounting Office (GAO) to create a similar type program for those who have 401(k)s. If we have learned anything since these defined contribution plans made their debut 30 years ago is that they are still under-used and those who do use them, are still unsure what they are doing. Even as the predictions of these plans growing in the coming years by a third by 2015, this doesn't necessarily mean that the plans have improved or the still-as-yet-to-embrace the plan participants will do a better job funding and/or planning for their future on their own.

The hearings center around the introduction of some sort of insurance, much like the insurance the PBGC offers to pensions, for 401(k)s or what banks offer as deposit insurance (FDIC). The GAO is pushing for such protections and the plan sponsors are pushing back, suggesting that the efforts they have made in education and plan improvements are enough of a guarantee.

The current set-up of these 401(k) plans is still, as one participant in the hearings suggested, too murky with too much leeway given to the plan sponsor, too little transparency into how those underlying investments are chosen and whether they are the right fit for all plan participants. Robert Reynolds, president and chief executive officer of Putnam Investments stepped into the fray with his suggestion of something similar to the FDIC involvement with bank deposits.

Mr. Reynolds called on Congress to create a new Lifetime Income Security Agency. In a speech given at the 2011 Retirement Income Industry Association, Reynolds outlined the need for this sort of protection. He suggested: "As the oldest Baby Boomers reach the traditional retirement age of 65, we need to go beyond helping Americans accumulate assets for retirement to helping them draw those assets down to provide reliable income throughout retirements that could last 20 to 30 years or more. It’s even more challenging to draw assets down sustainably as it was to accumulate them in the first place,”

Subjecting these plans to rigorous standards would allow for the denial or approval of products such as annuities in these plans designed to guarantee income for these retirement investors, market downturns or not. He believes that this sort of insured confidence would spur more people to embrace the plans and give those who currently use them additional incentive to increase their participation. The restrictions put in place by the 1986 reform measures passed by Congress did more harm than good.

Reynolds believes: "With Baby Boomers now in or approaching retirement, the stakes are much higher now than they were 25 years ago." That change is needed and needed now. By creating some sort of protection, he suggests a domino effect that would begin with "encouraging savings that fuels investment, business formation and job creation."  Any focus on the deficits without a focus on increasing personal and workplace savings would be misdirected and he suggested that "Congress should dismiss such ideas out of hand."

Auto-enrollment, savings escalation and guidance to wise asset allocation improved the current state of 401(k) participation but did not go far enough. These provisions in the Pension Protection Act of 2006 did not include workers without access to traditional employer sponsored plans. Reynolds suggested that some sort of auto-enrollment into IRAs woud be a good first step. But guarantees would be far better and instill a sense of future promise and retirement income safety where, for many Americans, there is little or none.

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

The Possible Appeal of Long Term Mutual Fund Managers

One of the single toughest problems facing any investor is research. The information we seek is mostly conflicting, mostly difficult to understand and worse, readily available for the taking. The trouble is, access doesn't make the choices we need to make about where to put our money any easier.

You might consider the grocery store analogy. You may want to cook a whole chicken for dinner tonight but when standing at the meat counter you find three perhaps four different types of whole birds to chose from ranging from the very pricey organic variety to the very cheap store brand. They look alike, perhaps even clucked alike at one time. But what they are, besides all being chickens, different somehow.

Now mutual fund managers can hardly be compared to chickens. But in some ways, we have the same sort of conundrum facing us when it comes to a mutual fund selection. How much is the fund the manager and does it matter?

Mutual fund managers do have some appeal to certain investors. The longer the term some managers have, the more likely they will remain with the same investment style. Consider the long-term managers at these funds: Parnassus Fund (PARNX) which has had  Jerome Dodson as the fund's lead for 26 years,  Richard Aster Jr. of Meridian Growth (MERDX) has also put in just as many years and the grandfathers of the industry are people like Albert Nicholas who created his namesake Nicholas Fund (NICSX) and has managed it since its 1969 inception and perhaps the oldest fund manager Bernard Klawans who at 89 years old still runs the small Valley Forge Fund (VAFGX).

But is the same investment style still in style? Yes and no. Markets have remained essentially the same since they were conceived. And although we often consider them as impersonal entities, much like a Watson, they are not. Instead they are made up of people who, for want of a better term, want you to lose. There are two sides to every transaction and good will doesn't enter into the equation. Hiring a professional such as a mutual fund manager - and this is what you are doing - offers you box seats in the battle of who will win and who will lose in the marketplace.

Understanding the nuances of the markets is a timeless venture that involves understanding the players involved. Sure, computers have made the world smaller and faster and more efficient. Companies have broaden their customer bases and in the process made the oceans that separate the world seem like nothing more than a small pond. The world is at our doorstep.  But the people at the heart of every investment haven't evolved one iota since the markets were conceived.

It is still not about chasing the next new thing; it is about finding the things that no one really sees as bright and shiny, old investment ideas that have never changed. This is what older managers bring to the conversation. So that would be yes.

On the other hand, the reason these fund managers have remained at the helm for so long has more than a lot to do with who owns the fund family., The four above mentioned fund managers can't be fired from the positions they created. They can only step aside. So too long is perhaps too long.

Each fund manager must do three things. One they must create a portfolio that is sustainable and worth holding. Fund managers generally have ideas about how this is done and new fund managers will come on board and switch things around, selling one security in favor of another. So they initial year is generally a wash in terms of comparisons. By the five year mark, they should have settled in with their strategies in place. So five years is a good judge of turnover - a term that references how much of the portfolio has changed in the previous year. Less is better.
The second thing they must do is create returns that are better than an index and enough to pay the bills. If the expenses are low, this shouldn't be too much of problem provided the markets cooperate a little bit during those initial years in the lead position. Returns are tricky though. Weighed against fees, risk and a host of other obstacles, the number the fund posts can mean the difference in whether investors stay invested or turn a look for something more suitable.

Each exiting investor, aside from a no-confidence vote is a sale which forces a sale which in turn, creates some disruption to the investment plan. Get a lot of investors headed toward the door and no matter how good you think you are, you will not be able to sell enough to make ends meet for the remaining investors. This cascade effect was seen best in late 2008 when numerous investors ran rather than staying put and allowing the fund managers to keep the level head they were hired to have. So they must contend with investors and the markets.

The last thing a fund manager needs to contend with is the shareholders in the fund company. Many mutual fund companies are publicly traded entities which puts the manager in the middle of two sets of shareholders. One demands returns and the other demands returns and both consider themselves the most important part of the equation.

There are more than a handful of mutual funds that circumvent this one manager stewardship by using teams or even people and computers, the former to take the blame should things go awry. But some rules do apply across all mutual funds. New anything is not worth buying. A new fund, a new fund manager and new investment strategy are all worth giving a little time and latitude to before you invest. Let the folks who don't know any better buy first.

Three years is barely enough time to make a performance call on a mutual fund manager; five is better but ten tends to be best. Remember, the three parts to a fund manager's skill: the markets, the investors and the shareholders. Mastery of those masters is never done in a short period of time.

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

The High Net Worth Boomer and the Lies They Tell

You would like to think that we are all truthful. But that may not be the case. Are Baby Boomers, more specifically those considered high net worth, telling a story about their retirement that isn't quite truthful?

Oscar Wilde probably said it best: "What we have to do, what at any rate it is our duty to do, is to revive the old art of Lying.” Nowhere is this resurgence in the falsehood more prevalent than when we tell a surveyor about our finances. When they look extremely bleak, we tell them they look even worse. When they look okay, we tell them they are really good. It is in our natures to tell lies considering we do it when we smile.

Evidently, a group of wealthy Baby Boomers told a survey group from Bank of America/Merrill Lynch that their retirement not only looked promising but was much better than their parent's retirement was. This is pretty lofty talk from a group that just a couple of years ago was not one bit happy with where their portfolios had gone in the wake of the financial meltdown. Now, $250,000 in investable asets is enough to warrant such retirement superlatives as "freedom" and "relaxation".

What changed? True the markets recovered over the ensuing couple of years. But I doubt that this had anything to do with it. many of these folks, like all age and wealth groups did, panicked at the sudden rebalancing of their portfolios by market forces. Unaccustomed to an all-inclusive debacle, many moved into much more conservative type investments and in the process, created their own mini-bubble in the bond market.

The rest of us moved into target date funds, a sketchy hybrid of funds designed to rebalance our aggressive natures for us. If you are older, the fund you plopped the remaining balance of your 401(k) is close to your age - so you too may have benefited from the updraft of conservatively invested enthusiasm. I wrote about this relationship with the bond market a couple of days ago suggesting that if their isn't a bubble in the bond market, it is because it won't pop when it reaches the end of its run; it'll hiss itself into normalcy.

It may be that this group has a better restructuring plan in place or they are simply lying to themselves - and the surveyors. Consider this: $250,000 in investable assets was consider the borderline between the rest of us schmucks and the high-net worth individual. I'm sure that this number is not even close to the actual investable assets these people had. It is our carrot.

One thing that stands out with the group surveyed is the change in attitude about what retirement is. They mostly believe working in retirement is a way to stay physically and mentally engaged. And for many, it is. For those with less than $250,000 in investable assets, it often isn't the case.

But these high-net worth folks worry about the same things you do: the cost of health care, the cost of children still living at home and that there portfolios, no matter how well managed, might not be enough. So they smile when they say they have it better than their parents and do so while lying about how much better.

And these high-net worth folks are not short on advice, even if they didn't take their own. Get a financial adviser as early as possible, they suggest and of course start early. Good pieces of hindsight advice that they were told as they began their working careers - and didn't follow.

About this advice to use financial advisers earlier. Then there was a survey conducted in 2006, when things were going great: housing values were appreciating, the markets were humming along, and early retirement was well within reach or it was assumed to be. And the results show a complete turnaround in thinking from then to now.

Back then - keep in mind these were the good times - another survey was published: In it, the following: "According to a new MyWay Investment Advisors (MWIA - an independent financial planning and investment advisory firm) survey, 98% of respondents would change the way they work with their advisor with 43% saying they wanted to change the amount they paid for the financial advice and services. This compares to only 13% of advisors who would look to improve how they currently operate, including pricing for clients.. The survey focused on how individuals would like to be treated by their financial advisor or investment professional and how they would like to pay for those services.

"The survey targeted the individuals with annual incomes greater than $75,000 and $150,000 to $600,000 in invested assets, including 401Ks. A duplicate survey was sent to financial planners, investment managers, insurance sales people and other financial industry professionals to compare responses." Why has this advice changed? Pricing and the way pricing is structured has evolved. Yet the higher the net worth, no matter what you pay, you pay more than you should.

So which is the truth? Are they happy now or were they happy then? The most telling piece of info coming from that survey: "When it comes to financial advice, however, financial advisors isn't where most of those surveyed go for information. Only 27% utilize financial advisors while over half (56%) get advice from a friend, publications or on their own.

"Of those that have a financial advisor, only 18% are happy with him or her. a whopping 56% say they are dissatisfied and 23% still have not made a decision."

This means one thing. We can no longer look to those we consider net-worth wealthy for guidance in how to become net-worth wealthy ourselves. Retirement has become a reality and an illusion. It is something we want and fear, something we strive for and are repelled by, something that is both possible and impossible. Yes it is a conundrum.

But it is your puzzle to figure out. And the simplest way to do that is figure out if you are willing to live on less than you have now. You don't need a financial adviser to tell you that you probably haven't invested enough. You know that you are probably wrangling more debt that you would like. You know that your contribution to your 401(k) is les than it should be. And you know that your goals concerning retirement are lofty than they are on paper.

Your balance sheet needs to be revisited and often. You need to double your 401(k) contribution now, no matter what age you are. There are numerous, almost painless ways of doing this including channeling the tax relief on your Social Security payroll tax (2% for the next two years) or simply increasing your contribution by 1% for every month of the upcoming year. You have the pieces to solve this puzzle. It all depends on how much you want to lie. The rich can. So can you.

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

Beautifully Broken: Boomer Resolutions

Even as the news told us with the turn of the calendar that the first Baby Boomer was eligible to retire, all of us wondered if they did. Were their retirement accounts so much better than ours? Did they make promises that they kept? Were they able to dance between the raindrops rather than simply weather the storm? We may never know more than we know about ourselves. But what do we know about ourselves and our retirement plans? Does the answer lie in how we approach our New Years resolutions?

By the time you read this, your New Year's resolutions may already be broken. If not, in the next couple of days they will be seriously tested. This doesn't make you a bad person - in part because you have broken them so often in the past. But there is a pattern in your lapses and if you promised yourself to build a better financial plan, focus more of your income on your retirement accounts, and/or simply spend less, breaking those commitments can have longer range effects that simply gaining a few pounds.

Why do we break the resolutions in the first place? In large part, our resolutions are well intended. But they tend to be an all-or nothing type of promise to not do better so much as to change course. This might relatively easy to do if you are 20 years old. But the older you get, the longer it will take for that ship you call life to readjust its headings.

Which brings us to the second reason we fail to follow through: lack of patience. As much as I hate to bring up the dieting analogy, it does apply to the way you treat your finances. Nothing is instant. You can't will away years of bad habits and as soon as one of those bad habits creeps into your diet, its over. In the world of finance, it might be a purchase done outside of your budget that has the ripple effect of bringing the resolution down.

Statistics have shown that resolutions morph from something that is a need-to-keep promise to one's self to a nice-to-keep promise. This is another reason why, by the end of the first week in January, you have back-burnered the promise to increase your 401(k) contribution, put your credit cards away, talk to your children about money, talk to your husband about the course of your retirement plan. Even if the idea was to build a plan, something anything more than what you have haphazardly pieced together, you have already lost some of the goals you set forth.

Men have no problem breaking resolutions if they make them at all. Women often see it breaking a resolution as a sign of some weakness. Both are wrong. Here are five easy steps to make your financial promises stick in the new year - and if you haven't made any, this will help you make some commitment without the pressure of a change in the calendar.

1. Be patient. No retirement plan was hatched in a day or a week or a year. Most 401(k) plans have internet access available to their plan participants. Log on and find out where you are in terms of contribution. If it is less than 5%, change it to 5%. This is usually the threshold where your pre-tax contribution has no effect on your take-home pay.

2. If you are a couple, do this together. One resolution to keep is that retirement plans are best used if they are combined. Not physically, but on a decision level. One plan might be better, the other might be more generous in the match. One of you might earn more where a 5% contribution is actually a larger dollar amount. One plan might have better investment opportunities. If don't approach this together, you will not get the benefit of two plans as one.

3. Add 1% a month every month thereafter until you reach the 12% mark. This will be not-as-painful but will require you readjust your spending habits.

4. Educate yourself about risk and how much you can embrace. Women have been studied and most of those surveys have drawn similar conclusions: women are more pragmatic when it comes to investments. If men and women looked at what they want and how their plan could help to achieve it, they might find themselves much better situated 15 years down the road than if they chased the next-hot investment cycle.

5. Take a look at your beneficiaries. Your investments and insurances need to be specific. Your will needs to be clear. And if you do this, you will find that this forces you to look deep into the future at a time when one of you - most likely, the woman, will still be around.

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

Is your retirement account suffering from Investment Paralysis

Boomers should take note of the seemingly robust economy around us as we head into the holiday season. The stock markets seem to be poised for what has been termed often as the "Santa Claus rally". Consumers, at least according to business surveys, are beginning to spend. And this is all occurring, while in the shadows, the economy or its numbers remain little changed. That and most of us are still suffering from investment paralysis.

Here we are, years after the fall of 2008, and the average middle class worker still has an account balance that is far from where it should be - if they plan on retiring. When most of us think is retirement age, we think in terms of what has been the generally accepted retirement age. This unfortunately is a failure on two fronts: yours and the plan sponsor.


Your responsibility is in the contribution.According to a Wells Fargo survey (pdf) conducted among 357 plans, middle class is defined as: "those aged 30 to 69 with $40,000 to $100,000 in household income or $25,000 to $100,000 in investable assets and those aged 25 to 29 with income or investable assets of $25,000 to $100,000." This group knows that they will need more than $300,000 to fund a basic retirement yet, on average those balances fall far short of that goal with $20,000. Is it any wonder that this group is increasingly buying into the notion that working longer is a fact of life in the post-downturn world?

Most of the middle class group contributes only about 7% of their pre-tax income to these plans. And if the survey is any indication, much of the fault lies in the employer's approach to these plans. The study suggests that employers are concerned about their legal liabilities in helping their employees even as they acknowledge the shared role in helping those workers.

These fiduciary concerns are widespread among plan sponsors who worry that should they provide advice, and that advice doesn't meet employee expectations, they will see the plan sued.

This has led these employers to look for plans that offer third party advice, shifting the liability to another player. What they fail to embrace is that using a TPA (third party administrator) doesn't lessen the liability. While 89% of the plan sponsors understand that there is a need for retirement help, only 71% (as of 2009) think that they should help those employees understand what the plan can do for them.

In order of importance, and in reality, employers do something else entirely and your defined contribution plan's ability to get you there is reflective of this lackluster effort. Only 35% of the DC sponsors surveyed think that education is important, 22% encourage greater participation and increased contributions, 9% think investment diversification is important while only 2% facilitate the planning process by pointing out what is need in retirement and helping their employees use the plan to achieve this.


Are more funds in the plan the answer? Some DC sponsors believe they are and are looking to increase their offerings. But often, plans with more than fifteen funds aren't necessarily giving the employee more choices that suit their needs. The new choices are often in the form of target date funds and other more conservative investment offerings. This is often done at the exclusion of more suitable offerings (such as aggressive mutual funds for younger workers). Once again, they fear retribution for suggesting anything akin to risk.

DC sponsors are worried about what the industry calls investment paralysis. Too many funds, studies have suggested, often have lower overall participation rates that those with 15 fund or fewer in their plans. Because there is a growing movement to offer auto-enrollment, choosing a fund for that new employee often requires the plan to carry a wide variety of target date funds to pinpoint a "potential" retirement year.


But understanding the need and acting on it, from both a participants point-of-view and that of the DC sponsor are often far from what they are actually doing. Plan sponsors need to understand more than just the investment array, plan design, distribution options, education and communication, and fees charged by the plan. It is their fiduciary responsibility, one that carries legal risks if mishandled, to measure their plan's impact. Only 15%, according to the survey do so.

The employer still offers matching contributions in many defined contribution plans. But how and what are a matter of debate. Many still offer matches that are tied to company stock, put restrictions on access to those matching funds, and use the auto-increase contribution system as a way to offset raises. Often, maintaining the 401(k) plans they might have, as many of the companies surveyed suggested, is done for the sole purpose of getting and retaining new employees. This, in light of less-than-robust private hiring, might come at a reduction of other benefit programs.


If you are still in a DC plan and your employer's match is not as adequate as it should be, this doesn't let you off the hook. You still need to save more, much more than you are presently doing. While it is true that 5% is the cut-off point where pre-tax contribution investments don't impact take-home pay, some sacrifice on the employee's end is needed. And this should be done,match or no match.

If your employer's 401(k) plan is not as robust as it should be or doesn't fit your age needs, open an IRA or Roth IRA on your own. Contributing to both plans (10% to your 401(k) and the maximum allowed to an IRA or Roth IRA) is your responsibility. While we still look to the company we work for for guidance, and even to the point where we believe they care about us and our retirement future, the facts are not bearing this fuzzy feeling out in the surveys I have read.

As Laurie Nordquist, director of Wells Fargo Institutional Retirement Trust said: "If people aren't willing to pay for advice they are going to get a more vanilla approach to planning," adding, "But a simple plan is better than no plan."

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