Your 401(k) should have been your retirement savior

Despite the metaphors surrounding what retirement planning is supposed to be: a three legged stool, a three pronged approach, whatever visual cue you need to make sense of the process, your retirement is or at least should be, a lopsided financial affair. It should be something that works as a part of whole but not in any sort of equal sense. Social Security and the state of your financial affairs at the time you decide to quit working is really only supposed to be a small part of the retirement plan. In truth, the most prudent people who plan their retirement do so without any consideration of income from any outside source.

Not so in the years following the Great Recession. The vulnerabilities are now something we have seen first hand and many of us have recoiled in horror. Instead of relearning where we went wrong, we looked for the safest rock to hide under. Perhaps that is why, when the latest report from the Investment Company Institute was released this past November, your defined contribution plan or for most of you, your 401(k) was given equal stature amongst the other two "legs" of the retirement stool.

Social Security was designed to help keep those without from becoming destitute in retirement. Not surprisingly, the report points out this use of the program by those who are the least fortunate, the lower paid worker, as more reliant on those benefits than the higher paid worker. As they look at a post-ERISA world (the 401(k) actually came nto being in 1981), they conclude that this has always been the case and if it has, then so be it.

But the study wasn't designed to be much more than a good-old-boy pat-on-the-back. The ICI sees the distance between the demise of the pension as the sole means for retirement among workers in 1974 as a trip worth traveling. Coming out on the other end of that journey finds the lobby arm of the mutual fund industry rather satisfied. they point out that the median income from a defined contribution plan per person in 2009 was $6,000; in those same 2009 dollars, the same median was $4,500 in 1974.

It is not surprise that many of the remaining firms in the private sector still maintain them. But these plans are not considered a reason to work at these companies when it comes to the younger workforce. Pension breed company loyalty while 401(k)s allow workers to shift jobs when a better offer is available. On the other hand, pensions often leave this same group of workers with no retirement benefits, essentially, at least according to the ICI report, when vesting rules and the timing of benefit accural are used as a rodbloack to getting those benefits for time worked.

But during the time frame they used to conduct the comparisons (1975 to 2009), Social Security now makes up a larger share of retirement income even among those who had assets and other income sources. Based on per capita income at either end of the spectrum, with the lowest income group using just 2% of what the study calls asset income with an 85% reliance on Social Security compared with what the higher income group employs (20% assets and 33% of income from Social Security).

While the ICI celebrates the success of the defined contribution plan that replaced the private sector pension and they point out that those with DC plans are doing better than DB plan recipients in the past, one simple fact remains: we aren't doing enough.

While the answers seem clear: you need to invest more - probably much more than you would be comfortable in making, live smaller now while you are working, and hope that your health, inflation or taxes doesn't take a toll on those accumulated finances. In the face of such daunting news, you could expect a pull back. Instead of increased focus, we would get more ennui. Instead of an emphasis on better educated investment and financial decisions, we should expect more use of what we assume of are set-it-and-forget-it investments such as target date funds.

To answer the question in the title: was your 401(k) intended to be complimentary for retirement? I believe the answer was no. It should have been the investment savior, a Wall Street miracle. Trouble is, now many people. financial professionals included are looking for a way to provide the same guaranteed income that those long-shunned pensions provided. And when they do, we will wish it was 1975 all over again because it will come at a much higher cost than we imagined.

The Old Mutual Fund vs ETF Argument or An Investment Stranger than Truth

Mark Twain once submitted an essay to a contest about the art of falsehood.  In it, he suggested that only children and fools tell the truth, citing what he thought of as an old proverb.  What really dismayed him wasn't the actual lie, he described that as: "as a Virtue, A Principle, is eternal; the Lie, as a recreation, a solace, a refuge in time of need, the fourth Grace, the tenth Muse, man's best and surest friend, is immortal, and cannot perish from the earth while this club remains" , it was instead the ability to deliver in a successful way. A noble art he called it. Which makes theETF lie all the more true.


What do we know about ETFs? We know they are low cost. But perhaps not as low cost as they might seem.  For the investor moving millions of shares, or even thousands, the costs are just as low for them as it is for the investor owning a single share.  They are basically index funds.  But they are also stocks.  And the lie that owning a single share is just as costly as owning a million or so is told so often, individual investors often become dismayed, even disillusioned by the security when they purchase or sell it.


ETFs are not meant to be a buy-and-hold investment. This is actually a truth designed to look like a lie. Folks who buy ETFs intend on selling them, sometimes at the close of the trading day only to buy them again at the beginning. You can do this when the quantities are huge.  But when they are small, you are left with some tough decisions.  Wait it out and hope that the big investors jump back in or sell on the movement?  Either way, you have bought and are left holding.


ETFs have made the market more democratic and safer. On the other hand, ETFs are responsible for the flash crash where the Dow dropped a 1000 points and regained 650 points. Perhaps not directly, but indirect selling in those ETFs and of those ETFs created more volatility than was needed. According to Chuck Jaffe at Marketwatch: "Many ETF investors set stop-loss orders — pre-scheduling a sale to protect profits if the share price drops to some pre-determined level — but that didn’t minimize their pain in the flash crash, as the market busted many of those orders, flying past the limits because there were no buyers at those prices." The truth was that just because you have something to sell, there will be buyers.  The lie: someone always wants what you have unless everyone is selling the same thing.


ETFs are not mutual funds. Except when they are. If it looks like a basket of stocks or bonds or whatever is popular and you can't afford to buy each and every company in the sector, you look to make a purchase as a group. That is a fund with a mutual benefit.  The fund goes down and everyone loses except when the smart ones get out first. And that is the peril with a fund acting like a stock and trading openly throughout the day.
Some folks just know more than you do and benefit from that. No, they are necessarily seers or prognosticators or even forecasters.  They are just intuitive and quick and you are at work and busy and about to lose more than you thought you could.


Markets are not scary, therefore ETFs aren't scary - its investors who are scary.  Investors often don't have time to be scared before they are scarred by their own inaction. ETFs create volatility because that is how they are designed. Suppose you knew that something big was about to happen in technology or pharmaceuticals. You being a smart investor wouldn't look for an individual stock; you would buy a basket. And soon as the news panned out, or didn't, out you would go.


ETFs in your 401(k) are a good idea. Perhaps one of the single biggest lies being told by retirement planners.  They tout the low-cost, the employee demand and anything else they think the poor guy or gal in HR or in the CFO's chair wants to hear.  But ETFs in a 401(k) drips commissions and fees to the plan sponsor and gives the employee the illusion of doing something they really aren't doing.


The ETF lie is true. Odysseus told numerous fictions to a wide variety of people, each crafted to the circumstance of the one receiving the falsehood. The Greeks may have given the liar his due, even their admiration of a lie well-told. But when it comes to your portfolio, when it comes to your circumstance and your willingness to hear what you need to hear, the ETF is crafty fiction indeed. Good for some who understand it. But for those who think they do, it is simply a deception.

This article originally appeared at Target2025.com and was written by Paul Petillo

Mutual Funds and Performance Based Fees

Investors talk a good story when it comes to fees. While much of the conversation is begun by those who advocate index funds or exchange traded funds (ETFs are index funds that trade like stocks), the question of fees, how they should be paid and even more importantly, how much is usually based on why they (actively managed mutual funds) charge the rate they do. If mutual fund fees are so important to the investor, why haven’t they pushed harder for performance based fees?

Often referred to as the fulcrum fee, this method of charging the investor based on how well the fund manager actually did has been attempted in the past (and is currently being adopted by the Janus fund family) but has not received much more than a luke warm embrace. Is it because we simply don’t invest the way the wealthy do?

Mutual Fund Fees, Performance and the Fulcrum

by Paul Petillo, Managing Editor of Target2025.com

Mutual Fund Fees

There was a time in the not-so-distant past when mutual funds were not highly regarded. They did provide the average investor with the opportunity to purchase their segment of the stock market with the guidance of a fund manager and comfort of knowing that others felt the same way you did. After all, they were giving this fund their money as well.

But not all investors were thrilled with the arrangement and in the day before the internet, the only way you could find out if your fund was charging too much for their services, was to dig. Not all of us were inclined to do so. We were average investors.

More...

Resolution Time: Fixing a Few Bad Investment Habits

Most of us look at the turn of a calendar year with the hope that the investment mistakes we made in the previous year will not be made in the new one. This is noble and in many cases futile. These attempts are usually too difficult to handle, which is why, in many cases you haven't done anything before this point.

But with little effort, you can change how you invest. For the vast majority of us, investing requires far too much time. It requires continued education (which I fully recommend), frequent monitoring (which can involve little more than opening your statement just to make sure your investments are going where you intended) and a clear-cut understanding of where you are on the timeline (beginning to invest or at it for awhile).

Altering bad investment habits is not that difficult. Five Tips for 2010...

Paul Petillo is the Managing Editor of Target2025.com

A Performance Discussion on Mutual Funds

The last lines of Matthew P. Fink's book, "The Rise of the Mutual Fund" suggest that although he is a "worrier; nonetheless, I am optimistic". This speaks volumes to the "extraordinary success of mutual funds". Mr. Fink believes that despite the speculation about the maturity of the industry, it is far from falling from its exalted position. This elevated status is due, he writes "to adherence to high standards of fiduciary behavior".

Yet the mutual fund industry continues to be attacked for any number of reasons. The largest component of your 401(k) plan, your IRAs and the driving force behind numerous college savings plans, these investments are often questioned on their transparency, why they charge what they charge and even more commonly, why, if you win one quarter, can you not win the game.

Comparing Mutual Funds
There are numerous ways to compare mutual funds and none of them good. The rule of thumb for a fund is relatively straightforward: look for long-term performance (I have suggested that you also look to how well the fund manager did in poor markets rather than how they did during the good times), the cost of the fund (fees and expenses do not often tell the whole story but offer a telling sign of how much the fund manager trades and why), and the tenure of the manager in charge (an ever shifting picture as fund managers come and go and new managers look to put their investment stamp on the portfolio).

The subject of performance is often more confusing when actively managed funds are compared to indexes. These passive measures are poor indicators of what an active manager holds. This is why, so often, index investors make the claim that not only do passively managed funds offer a cost advantage but because the strategy of buy-and-hold limits volatility, they increase returns by limiting exposure to unnecessary risk. Your cost for less risk however can be higher than the low cost of these funds. Also consider that index funds do not hold all of the stocks in the indexes they mimic. And actively managed funds hold even less.

Looking at Past Performance
Performance also comes to the forefront when we look backwards. For quite sometime now, the mutual fund industry has warned investors that the past is no indication of the future. While this has been disclaimed as a method of disclosure, it is still one of the default guides for new and even seasoned investors when making the choice for which fund to buy.

Over the last decade we have had two bubbles and two market reactions to those events. Had you purchased a mutual fund, any fund as a bubble reached its peak, the previous five years would not have reflected the previous bull market's demise. I clearly remember the sigh of relief as the year 2001 was dropped from the 5 year returns in 2007. No longer would the bad bets made during the internet bubble show up as a stain on the investor information sheets. Ironically, even as some funds dove into the depths, they took the whole market down with them. (As did happen recently in 2008.)

Just by removing the bad year from the five-year returns made many funds appear much better to investors and they flocked to own them again. Averages suggest some odd things. A line-up of one hundred persons, ninety-eight of whom are six feet tall would not change the average if the person on one end was ten feet tall and the one on the other end was three feet in height.

But stock markets rarely have a peak that moves quickly from the bottom to the top whereas the bottom is often reached in less than six months. The top of a bull market takes five years, at least as witnessed over the last decade, to attain. This is not the case for any period prior to this. Bottoms were reached quickly while the top of the market was often a slow slog.

So we have the performance of actively managed mutual funds as compared by using index funds possessing some flaws. And past performance leaving us with no real picture of the future based on the past, how does one judge performance? Without considering fees, the worst day of a fund. Based on the simple idea that, if mutual funds are the primary holding in a retirement account and at one point in time, you will be begin to drawdown that account, picking the worst day to do so gives you a valuable peek at a worst case scenario. That is probably a truer indication of performance that averaging it our over a period in time. You can read more about low-mark performance here.

Next, a discussion about fees.

Paul Petillo is the Managing Editor of Target2025.com

Understanding Money Market Funds

Paul Volker doesn't like them much. Institutional investors use them frequently. And individual investors, particularly those of the smaller variety don't really understand what they do and in many instances, use them for the wrong reasons. They are like banks but are not regulated as such. The Securities and Exchange Commission oversees their activity as per the Investment Company Act of 1940.

The question is: Do we need money market mutual funds?

Money market funds, first created in 1971 offer an investor, institutional or otherwise the opportunity to maintain the asset value of their investment - these funds offer a stable $1 net asset value or NAV - and make a little money in the process. For someone saving for their retirement, it is very little money and should not be part of the plan. But for the investor sitting on a pile of cash and not seeing any other good place to put, the money market fund is as good as any place - in the short term.

Are Money Market Mutual Funds a Shadow Bank?
Yes and no. By design, they are short-term debt instruments. Cash comes in and is lent to commercial borrowers in need of a short-term loan - usually less than thirteen months. This activity, according to former Federal Reserve chairman Paul Volker, who now works as an economic adviser to President Obama is done without the regulation needed to protect the consumer should a large lender default on that loan.

The overall worth of money market funds is around $3.5 trillion. Because the loans these funds offer thousands of borrowers are at a lower rate than those offered by banks and often for a shorter term, Mr. Volker believes that the industry needs to be insured much the same way banks are.

Volker has His Reasons
Back in September of 2008, just as Lehman Brothers and Bear Stearns shook the financial world, one with a bailout the other with a failure. a money market fund made headlines when it "broke the buck".

Money market funds seek to maintain that net asset value of one dollar, offering investors an assurance that whatever they place in the fund will still be there when they withdraw it. Some short-term (often minuscule) return is offered but the safety of that dollar is why investors park cash in these types of instruments.

When the Reserve Primary Fund wrote off the debt that was issued by Lehman Brothers on September 16, 2008, the oldest money fund broke the buck when its shares fell to 97 cents. This incident threatened to collapse the commercial paper market, essentially freezing the ability of many businesses to obtain short-term loans. Some of those loans were made so these businesses could make their payroll.

A Year Later
The President's Working Group on Financial Markets is expected to issue a statement on this part of the industry on September 15th. Although the SEC has not moved to change any of the liquidity requirements (the ability to tap reserves or insurance, such as the FDIC), Volker's suggestion would practically dissolve the money market as it is now known and add regulations that banks currently have in place. I say "practically" because if these regulations were in place, the popularity of these funds would be greatly diminished.

The real question is: can the FDIC handle the increased participation when (and if) money market funds were added to the list of lenders it insures? Even as the FDIC has been forced to bailout numerous banks over the last year, reducing its reserves to $13 billion - its lowest point - it still has access to over $100 billion from the Treasury, and if needed $500 billion.

The FDIC is suggesting that foreign banks be allowed to takeover troubled banks. This would be an interesting maneuver. With a 101 banks having failed since the crisis in financial markets began and the possibility that another 150 to 200 banks may still be at risk of failure, allowing foreign banks to enter into the marketplace might be the only alternative.

There is a decision expected today (08.26.09)to allow private equity to step in a purchase some of these troubles banks. Richard Bove of Rochdale Securities believes "The difficulty at the moment is finding enough healthy banks to buy the failing banks."

If any of these suggestions take hold, Volker's wish to regulate the money market funds, the FDIC opening the door to private equity or the allowing foreign banks (those with a presence here in the US), we might well see the recovery take a firm footing. Until then, we are simply playing the waiting game, hoping the proverbial "other shoe" doesn't drop.

Mutual Funds: Rookie Mistakes

Beginning investors are often confronted by numerous descriptions of what mutual funds actually are. Some have even gone so far as to suggest that "A mutual fund is simply a firm that collects money from investors and invests them on stocks, bonds, and other money market instruments. If you invest in one, you will be considered a share holder and your portfolio will consist of a diverse investment."

This is a very simplified description of what mutual funds are. Consider this: a mutual fund is an investment whereby like-minded individuals (those who are looking for the same exposure to risk) hire a mutual fund manager who focuses on those investment goals and seeks to grow their money. Yes, they are shareholders. But unlike folks who buy individual stocks or bonds, they only own a portion of the investment with the group rather than owning a voting share.

You will also find that numerous financial planners and professionals also oversimplify the process by touting Fidelity or Vanguard, both of which are too big for their own good as the simplest way to enter this type of investment. This overlooks numerous other funds that do just as good a job, often at a lower entry fee and with better strategies.

Index funds, such as Vanguard's 500 can be less expensive fee-wise than most of its rivals but the $3,000 to get started will keep most beginners away.

Beginning investors (who are buying funds for their retirement, a tax-deferred situation that is best suited for actively managed funds and not for passively managed ones like indexes) should look to actively managed funds for low fees and expenses compared to their peer group, managers with tenure and low entrance fees. Index funds should be kept outside of tax-deferred plans due in part because they create no real taxable situation that would be worth putting off until the future - considering the capital gains tax for long-term investors is still low and worth paying as you go.