Your 401(k) And Why You Should Rethink How You Use It

There are more and more articles being written that stress how you're fundamentally making a major mistake by not maximizing or at least, dramatically increasing your contributions to your 401k plan. 

Unfortunately, there's little actual thinking behind the articles touting the options of throwing more money at a less than optimal mode of investing. 

First off, prior to the tax changes in 1987 (TEFRA: The Tax Equities and Fiscal Responsibility Act) simply the notion of retirement plans was a lot more palatable. Before the changes, there were 14 tax brackets and it wasn't hard to conceive that you'd most likely be in a lower one when you retired than you were in while you were working. Even a "less than dramatic" reduction in post-retirement income yielded considerable tax savings. 

 

TEFRA left us with not 14 tax brackets but three.  And the width of those brackets leave many American's in a position where their post-retirement tax bracket will be the same one they'll retire into. 

Deferring money at the 38% bracket pre-TEFRA and getting it back in the 20% tax bracket looked like a good deal back then, but I'm not so sure it looks as good when you're in the 28% bracket before and after retirement. And let's not forget, that 100% of what you take out of your 401k after retirement is taxable as ordinary income, every single penny of it!

Now, were you to have limited your 401k contribution to the maximum you could put in and get your full employer's match and then figured out something different to do with the rest, that might at the end of the day, be the optimal strategy. 

If your employer matches 50% of the first 6% you put away, the clearly 6% is the optimal number to may way of thinking. So, based on a $200,000 salary, that'd make your 401k contribution about $12,000.  But wait the plan says that you can put as much as 10% of your salary away, or roughly $20,000 but you'd be capped at the max contribution under the tax law of $18,000 but that's still another $6k that you could stuff into the plan, so why not?

I'm not saying that you shouldn't save that $6k, but frankly, I think a personal investment account outside of the retirement realm might be a better option;

  • First, if you build a portfolio correctly and avoid actively managed mutual funds or sticking the money into an annuity of some sort, you'll have a small if any, annual income tax bill
  • When you withdraw money from your personal account, you'll pay capital gains taxes at about half the rate of income tax you'll pay on 401k withdrawals. It takes a long time for the tax deferral advantage of a 401k deposit to offset what could be a 100% increase in post retirement tax rates
  • If you retire earlier or choose to work in a different job and need some additional dollars each year to float the household cash flow; you'll have access to funds a personal account that don't require premature tax payments to the IRS. Remember, the IRS forces you to take retirement plan distributions but only when you're 70 and 1/2, anything before that means your coughing up tax dollars that the government isn't really asking for
  • You'll have more, infinitely more investment options outside of your 401k and they'll be infinitely cheaper than the ones your company retirement plan offers in almost circumstance

Retirement plans are like annuities, or municipal bonds or another other financial instrument, when they're over used or solely used, there's likely to be problems that follow.

We're enticed by the write off that putting money into a retirement plan affords us and sometimes, if not many times, to a fault. 

What Motivates Us Can Be Telling

Why Advisors Will Likely Clamor Soon for Cheaper Annuities

A recent article in Financial Planning Online, makes a prescient statement...

"If the Department of Labor's Fiduciary proposal goes into effect, advisors may find themselves taking a close look at low-cost annuities."

So let me get this straight, up until now, what exactly have they been looking at? Up until now I suppose it was the more expensive variety with higher commissions and higher internal charges and investment related expense ratios and trading costs and mortality and expense charges. 

It's odd isn't it that people won't put their Client's best interest first until the law forces them to. 

If you already own an annuity you may want to opt for dealing with someone who'll put your best interest first because it's the right thing to do.

I'd love to hear the explanation from the rep who will move your annuity to where you should have been all along a year from now if the law passes. 

And if that conversation even remotely touches on "boy, that last one we sold you was super expensive...." it's gonna come down to the fact that that's all that their employer would let them sell.

Because that's how it works.....you get played and then played again. 

Stop it as soon as you can. 

The "Hunger Games....."

Evidently, the mutual funds are chomping up your money at a rate about akin to an old Pac Man game. 

Whether it's expense ratios near 2%, coupled with undisclosed trading costs and necessary tax costs, the "active/retail" mutual fund industry continues to pocket literally thousands of your hard earned dollars for their use instead of letting your keep it for yours. All on the failed premise that with their help, you're going to outperform a rather naive "buy and hold" strategy such as buying an S&P 500 Index Fund or ETF. 

photo-1441716844725-09cedc13a4e7.jpg

History as does this article, seems to demonstrate that you're highly unlikely to beat the market using people/funds that [a] are in and of themselves actually the market and [b] who have to cover their costs which are huge given other investment alternatives. 

Remember, cutting expenses doesn't depend on the market, or Fed Policy or the general direction of interest rates. Reducing the cost of operating a given investment portfolio by 2% means that you get to keep that 2% and it flows right to your bottom line. 

Who needs that 2% more than you do?

Likely, no one. So why not stop doing it.

Let us know, we're here to help. 

Five "Get Ready" Rules for Retirement

There continues to be no lack of pressure on American's to get to work on building a prosperous retirement. 

Study after study, article after article, report after report continues to show what most advisors already know, American's are woefully unprepared for retirement. 

There are a lot of reasons that this is the case, lack of savings and investment, poor estimates of what post retirement spending will actually be like and the paralysis of just not being able to get started on "planning" for your golden years in any meaningful way. 

"Numbers scare me. I'm not alone in this. Scientists who study math anxiety say that the anticipation of crunching numbers can lead to the kind of agitation that, on a brain scan, looks a lot like the perception of physical pain." So said John Schwartz in his March 2015 blog post titled "Retirement Reality is Catching Up With Me" which ran on the 11th of that month in the New York Times. 

And, there are a lot of numbers to be crunched to get it right. If that weren't bad enough, the numbers need to be crunched on pretty much a regular basis, year-over-year.  We have family and life issues that change the pattern of spending and it's timing, we have market issues that impact the value of assets as well as their ability to provide either an income source to supplement us or a pool of funds we can draw on when needed to adjust to changing circumstances. 

Many an investor has been duped by the notion that "making 8%" on their portfolio means that they'll make 8% every year. Little do most pre and post retirees know that "averaging" 8% can be woefully different than earning 8%.  I mean, if the top half of your body is put in a freezer and the bottom half in an oven, we can surely figure out what the temperature of each could be to get you to your ideal 98.6 average temperature. But I'll bet you're going to be pretty uncomfortable no matter how that plays out. Averages and how we actually arrive at them can be at mathematically daunting to say the least. 

Investing for income, another notion that on it's face seems to work, inadvertently becomes an "income straight jacket" as investors allocate assets towards dividend paying stocks and long-term bonds. That's good for generating income, right?  Well, it might be, for at least a period of time. Once the Fed starts raising rates and inflationary pressures kick in we have a problem. Our dividend and interest payments from our investments are more or less locked in so now our "income" isn't keeping pace with inflation and the gap between "what we get" and "what we need" is ever increasing. In addition, both dividend paying stocks and longer term bonds are susceptible to interest rate swings, driving down the value of most investors holdings. Hamstrung, they won't sell because of depressed prices to improve their overall "income" return and they can't live any longer only on what's coming in. 

Is it any wonder that nationally the Pension Rights Center motes that the nation, as a whole, is almost $8 Trillion short in funding retirement. An increase of $2 Trillion from just five years earlier.

So what to do? Here's five things that should hold you in good stead as you move toward and through your retirement time;

  • Your magic number isn't about what you accumulate. It's about what you plan on spending during retirement. Five million dollars in banks, brokerage and retirement accounts isn't enough money if you plan on spending six million 
  • Build a long-term investment strategy and stick with it. As a sage market observer once said, "If they ain't ringing a bell to tell you when to get out of the market, I can assure you that they ain't ringing one to tell you when to get back in."  Market timing is akin to pipe dreams and tooth fairies, it'd be wonderful if it worked, but it doesn't, it won't and it never has
  • Don't forget randomness. The likelihood that a series of investment returns won't deviate from it's expected return is ZERO.  Any plan, no matter how well thought out, no matter who the provider of it is that portends that the way you average 8% is by earning 8% every year has a probability of success equal to ZERO
  • Follow the money. In 2015 everyone's asking, where to put their money when things are most uncertain. If you can't make money on cash (which you can't) and you can't make money on intermediate term bonds (bonds with maturity/duration periods of 3-7 years) then the only result is....it goes back into the market. In 1986 you may have been able to get 9% on government bonds or; ride the market tumult out.  Government bonds at 9% were a good alternative in 1986. The paucity of a 0.15% return on cash isn't an option for you, nor is it for any investment banker, mutual fund manager, endowment or any other living creature who might derive their compensation in whole or in part on making market type returns
  • Get your head out of the sand.  Unless immediate death is your post retirement plan, get comfortable with the fact that as medical technology improves so does your chance of living longer. I know you think that you can pull this one out of the fire at the last minute, but you can't. Taking more investment risk, working longer, downsizing etc. all seem like real options but there's two little problems there, which are [1] sometimes you can't and [2] they all begin from the premise that retirement will then be "based on a lifestyle less bountiful than you had envisioned and less hopeful than you'd planned for."  Those aren't good things. Plan ahead, well ahead for this goal. 

Best that you start actually thinking this one through. I know that finding out that there's a problem isn't a comfortable reality for anyone, but finding out early leaves time to adjust, plan, and rethink things a bit. Finding out too late, leads to chaos, bad decisions, and the severe likelihood that all you'll do at that point is compound your problem. 

Confront the issue, understand the pitfalls and gaps, develop or buy the expertise to deal with them and remember, retirement is suppose to be at least as good a time as your working years were, if not better. 

But that isn't going to happen by chance. You have to make it so. 



Three Reasons To Stop Benchmarking Your Investments

Arbitrary, unrelated and irrelevant.....there they are three reasons. Now let's take a closer look at the rest of the story. 

Benchmarking

Comparing your investment portfolio performance to something has been around a long time. 

Many people use an index as a benchmark, comparing their portfolio to let's say the S&P 500 Index or the Dow Jones Industrial Average.  Those are ok choices, but they're more or less meaningless in the real world. You might as well be comparing your portfolio to the performance of your colleague in accounting. 

  • Arbitrary- any benchmark you pick is of your own choosing, there's no real way to tell which benchmark is better for you than any other. What about the EAFE Index, or the Russell 2000 Value or Russell 1000 Growth Index, why not them? (Other than the fact that those are a bit harder to get data on, but that doesn't mean that they might not be better does it? Gold is harder to find than wood and that's worth more right?)
  • Unrelated- depending on your holdings, the benchmark you pick might be totally unrelated, especially if you don't have any real idea of what it is that you own, beyond a Morningstar or Lipper style designator. What about style attribution, doesn't that matter? If you own a derivative laden large company growth fund, guess what, it's not a large company growth fund is it, if the fund's leveraged to the moon, it's more like a micro-cap fund than a large company growth fund, albeit that the fund company would prefer you continue to think about them as "large company growth" especially when they out-perform their peers by 8%! (Oh, did I mention that that 8% out-performance comes at 200% of the risk?)
  • Irrelevant- ahhhh, saving the best for last. The benchmark that matters most to you is the one that is "all" about you. How much do you need to earn on average so that the net present value of your [a] future income streams such as your pension, social security, annuity payments, etc., plus the net present value of your investment assets and cash, exceeds by some meaningful amount to you, the net present value of all your future spending?  That's the number that matters most, because that's the number that gets you to the finish line.  

If your goal is your future then your benchmark should be your benchmark. Not mine, not The Wall Street Journal's and certainly not Harry's in accounting.

benchmark

If, in the future, you're forced to stop going on vacations, or trading down out of your house or not being able to throw the kids a couple thousand a year for the extras that they need but can't afford, it won't matter much that you outperformed the S&P 500 will it?

No, it won't because it wasn't your performance that let you down, it'll be the fact that you didn't invest enough....something that comparing your portfolio to a benchmark other than your own can't possibly tell you can it?

If they're your goals, and it's your life, make that your benchmark. 

 

How Does Your Door Fit?

Is by "design" or by "default?"

As I was reading Simon Sinek's recent offering, "Start With Why," a story he told early on in the book resonated with me, not only from the standpoint of entrepreneur/business owner but also from the perspective of wealth manager/advisor. 

It seems that a ways back,  some U.S. car manufacturers had visited a Japanese auto manufacturer and were watching the various tasks that were performed along the Japanese assembly line.  While much of the work was the same as "back home,"  the one thing the U.S.  delegation noticed that was missing,  was that in the U.S. there was a last person at the very end of the line who was tasked with whacking each car door with a rubber mallet to get the door to sit properly and line up with the overall body contour. 

When questioned about why step didn't exist in Japan,  the American's Japanese counterpart noted that "we design the doors to fit from the beginning, that's the difference." 

Many people treat their efforts at achieving financial success and as a result the life that they truly desire, in the same way as the American auto assembly line; they treat each and every financial transaction, be it, picking a money market account or deciding on an investment allocation for their 401k plan, about like a U.S. car door; whack it till it ultimately fits, even if it doesn't.

The "piecemeal"  approach is seldom ever going to be efficient and like the U.S. auto builders who had to pay a union worker to swing the mallet and purchase lots of rubber mallets for them to swing, generally, in the long run to be sure, it's going to be more much more expensive. 

Because we fail to choose a path to take, cobbling together financial assets and financial decisions seems the norm.  Without a well thought out plan, we have little context to balance our decisions against. Absent a well defined standard, almost everything is going to fit more-or-less, even if we have to hit it with a mallet to make it so. But the reality remains that it didn't really fit at all did it?

To be sure, it's one more thing checked off the list. But that doesn't make it either effective or right, does it?

The fact is, that on its surface, you'd have a hard time telling the folks with a well thought out plan and path from the ones without one. But, over time, as calamity and change have their influence, it wouldn't be hard to tell at all.  If you never had a plan, it'd be awful hard to stick to it. 

Set a course for your financial future and stick to it. Decide what you'll need to live the life you truly believe that you're entitled to based on a lifetime of work, then figure out how to get there.  There are steps, pragmatic and calculable ones, that put you on the right course. 

Find them.