By Mark Folgmann In order to create a solution we must first admit we have a problem. If you are a regular reader of my column you will already know that I believe we have a major disappointment coming when our current workforce gets ready to retire over the next 25 years. Most 401(k) plans we review are dramatically under funded and will not be large enough at retirement to assure a desired lifestyle. The average employee has less than one year of income accumulated within their plan. Unfortunately most fiduciaries entrusted with the oversight of these plans are not actively engaged and are somewhat in denial. Operating in this environment reminds me of the quote by the Pulitzer Prize-winning historian Daniel Boortin when he said “The greatest obstacle to discovery is not ignorance, it is the illusion of knowledge.” Both employees and employers are way overconfident about their ability to deliver successful outcomes.
Albert Einstein said “You can’t fix the problems with the same minds that created them.” Therefore the solution to the 401(k) problem is for the employers and professional asset gathers (Financial Advisors) to get out of the retirement plan business. We must admit we have a problem and enlist the minds of people that truly understand the problems and know what they must do to solve them. Someone who can discharge their duties of loyalty to both the participants and their beneficiaries so they can increase retirement incomes. It’s my personal opinion that virtually all plans with less than 10 million of assets join a multiple employer plan. This is a plan that allows small business owners to ban together like the Governments Thrift Savings Plan to gain economies of scale and create successful outcomes for employees. In his August column this year Scott Simon from Morningstar Advisor calls the multiple employer plan the “Platinum Standard.”
In the marketplace there are very innovative solutions that allow the small business owner to get out of the retirement plan business while still providing a fantastic retirement plan for their employees. The business owner ends up making only one decision, to join the plan or not while everything else is automatic. Just imagine, no enrollment meetings, no boring employee education sessions eating away at company time but yet a plan structured for success while providing the company protection from liability. The best also utilize professional portfolio managers to create model portfolios to obtain market returns for their employees. Since the average employee is not trained or capable of managing their investment portfolio these professionally managed model portfolios will increase their account balances. A multiple employer plan can typically be joined for about half the cost of a typical 401(k) offered by the financial service industry. To learn more about multiple employer plans visit www.gfiduciary.com. With a combination of technology and innovation we are likely to see more and more solutions for the retirement dilemma but we must be willing to get outside the box and look for 21st century solutions.
By Mark FolgmannLast time we talked about the Federal Thrift Plan and how the economies of scale have created a plan with not only extremely low cost but also very efficient investment options with great oversight. Most small business owners are at a great disadvantage because they try to set up a stand alone retirement plan and due to their size they end up paying far too much in expenses and set-up cost. They also are at the mercy of the financial service industry which markets bundled 401(k) s that are filled with excess fees, mediocre investment and often end up locked into an expensive insurance or annuity product. When I talk to small business owners I usually find two very different scenarios, the first is the busy owner who ignores his companies retirement plan due to his time spent running his company and second is the person that fills the fiduciary role but overestimates their ability to create successful outcomes for their employees.
When I review a plan with employers I already have a real good idea whether they have a good plan or not because all information about their plan is public information and can be obtained with two clicks of the mouse. Therefore I can evaluate a plan based on the mechanics of the plan which are things like contribution rates, loan amounts, investment choices and employer generosity. I can also estimate average employee balances and project number of year till the plan will be fully funded. There are somewhere between eight and twelve levers that will either create success or assure failure within a 401(k). Unfortunately most of the people responsible for the oversight of the plan don’t recognize what they are. Most of their time is spent discussing investment choices, don’t get me wrong these are important but investment choice will not make or break a plan if the more important factors are not addressed. This becomes very frustrating because they usually don’t understand their own plan well enough to ask the critical questions to assure successful retirement outcomes for their employees. They are being asked to act as fiduciary’s for their companies retirement plans and have not been trained for this role. A sound fiduciary process demands that a plan sponsor utilize Prudent Experts. Once again I stress creating successful retirement outcomes is very hard work not something you can take lightly and hope it works out. In my twenty plus years of reviewing hundreds of 401(k)s and thousands of employees that contribute to them I have only found one company plan that meets my criteria as an excellent well thought out plan that was truly created to increase their employees retirement income. Don’t get me wrong there are many plans today that are getting much better but most if not all benefit the companies offering the plan more than the employees funding the plan. Next time in part two of the 401(k) solution I will show you how to beat the odds and guarantee your company has a great retirement plan.
By Mark FolgmannWe are constantly bombarded by all the things our government does not do well. What kind of grade would we give them on the management and oversight of Medicare or Social Security? Probably not an “A.” Let me share a little know area where our government does an excellent job. It’s in an area that benefits them directly and the rest of us indirectly. The Government Thrift Savings Plan is bar none the most attractive voluntary retirement plan system in the nation. This plan is so well thought out and implemented that the overall cost is almost zero. They have linked all the Federal agencies and into the same plan to obtain economies of scale and drive down overall cost to the Federal employees to 1.9 basis points. They have limited asset class choice to only five and have dramatically simplified the plan. This means that an employee saving for their own retirement will pay only 19 cents in cost for every one thousand dollars invested in their account. When I review 401(k)s in our region I typically find the overall plan cost are in excess of 300 basis points, that’s right 150 times more expensive than the government’s thrift plan. Let’s assume we have a 35 year old earning $45,000 with $15,000 accumulated in his 401(k) and adds $300/month until he’s 65. Let’s also assume that both portfolios earn an identical 7.5% gross return before cost. The government employee in this case would end up with approximately $515,000 account balance that would generate $1,716 per month in retirement income. The non government employee would have an ending balance of $285,000 which would generate $950 per month in retirement income. Since the government takes its fiduciary responsibility serious and have implemented the best low cost solutions they are demonstrating that it is possible to produce successful outcomes.
Just think about this for one minute, a difference of $766 per month in retirement income for the rest of your life and the only thing we changed was the cost of the plan. We have not even addressed the problem of contribution rates or investment behavior. We have not even talked about implementing a prudent fiduciary process to increase outcomes. We haven’t yet thought about matching cash flows of the plan with future expected liabilities nor have we discussed proper investment diversification. We have only focused on one thing, fees! I stated earlier that the Government Thrift Savings Plan benefits us indirectly and what I was referring to is the fact that most if not all government employees will retire with more money than they would in the private sector and therefore they will have the economic ability to live with dignity independence and therefore support and drive our economy. This probably will not be the case with the private sector unless we really start to pay attention. I talk to employers each and every week and there are too many employers placing their employee’s retirement income in the hands of unqualified people and therefore trusting them to deliver successful outcomes. The typical worker needs between ten and fifteen times their ending salary in their plan to maintain their lifestyle and dignity in retirement. Imagine what Northern Michigan or Michigan for that matter would be like if each and every retiree had an additional $766/month, each and every month for the rest of their life. Next time we will discuss how we can copy the Government Thrift Plan to produce better retirement outcomes for private sector employees.
By Mark Folgmann I recently attended a 401(k) Fiduciary Symposium at Boise State University hosted by Matthew Hutcheson the nation’s best know Independent Fiduciary currently working with both Congress and the Department of Labor on improving America’s retirement income. I had the pleasure of sitting next to Sheryl Garrett founder of “The Garrett Planning Network.” This is a group of fee-only financial advisors that have a very unique business model and have over three hundred advisors around the country that help individual clients on an hourly basis. This advice can be purchased in blocks of time depending your level of complexity and the amount of time you need. You could purchase two hours to review you 401(k) and asset allocation while also updating your insurance needs. Once this is completed you may not need additional help till 2011 at which time you come back in for two or three hours of review. Since the advisors are paid by the client on an individual basis they have eliminated most conflicts of interest and are able to deliver quality advice because their only agenda is to help the client and provide more value than what they charge. They spend time educating clients so they can make smarter financial decisions with regard to their overall financial situation and are always available if you get stuck or need additional help.
With so many jobs leaving Michigan, this is an area where many jobs could and should be created. Traverse City is an excellent example of a place where an hourly planner is desperately needed. It’s my belief that the majority of the country should hire and do business with an hourly planner. Unfortunately there is not one available in our area and I believe we could support at least four in Traverse City alone. Most people’s situations are not so complicated that they need ongoing comprehensive analysis and care. Normally you must acquire significant assets before this level of care is needed and usually would be in excess of $750,000 if not $1,000,000. In my practice I have noticed that there is a certain level of assets where many people become uncomfortable managing their own investments. I believe most of our workforce (at least 95%) could benefit from financial advice delivered on an hourly basis ordered up when life and situations change. There are too many salespeople whom are marketing products under the title of “Financial Advisor or Financial Planner” and not nearly enough true advisors whom do not sell products. The question is “Are we ready to write a check for advice or will we continue believing we are getting trustworthy advice for free by people selling products?” Most still believe they are not paying fees if they don’t write a check but in reality you always pay the bill. I hope Sheryl will find an advisor for our community and I will do my part to support that effort.
By Mark FolgmannOnce again I’m watching human behavior take over and it’s causing people to do the wrong things at the wrong time. The individual investors that sold their holdings after the major market decline in 2008 and have been sitting on the sidelines throughout 2009 are now ready to re-enter the market. Be very cautious since we have already witnessed a 25-75% increase since the March 9th low depending on which asset class we are discussing. This is the problem with investors that try to time the market and are controlled by fear and greed. You have to always make multiple right decisions. When do I get out and when do I get back in? Make one wrong decision and you loose money and run the risk of never recovering. In my humble opinion a properly diversified portfolio will always win over the long term. Instead of jumping back in after this major increase it might be smart to dollar cost average back into the market to reduce your risk of buying after a major run up in the markets.
For those of you that did not have a diversified portfolio last year and suffered significant losses but stuck it out, this might be a perfect time to reorganize your portfolio. If you’re in this group it would be a great time to diversify since we have had a significant increase in your portfolio during the current year. Hopefully you have realized that a prudent investor does not expose himself to a portfolio that consists of 100% stocks regardless of his age. The time tested estimate of holding your fixed assets within your portfolio equal to your age is a real good rule of thumb, even when the media wants you to believe these common sense strategies somehow have become obsolete.
Dalbar recently completed their annual survey on investor results and once again confirmed that we are not very good investors. The most recent 20 year results for the S/P500 ending in 2008 was 8.5% per year yet the average investors return was
a paltry 1.9% after fees, taxes and bad behavior. Remember your retirement accounts are like a bar of soap. The more you touch them the smaller they get. Remember Wall Street operates on volume. Transactions generate fees and fees generate profits for Wall Street. Pick a prudent allocation and diversify your portfolio with low cost investment options. Add regularly and rebalance on your birthday. It’s really that simple!
By Mark FolgmannThe financial service industry loves to use the word independent. Almost every advisor uses the word in all their advertising. Let’s take a closer look at what this means and why it’s so important. Webster dictionary’s definition of Independence is “Not contingent on something else for existence, operation, etc or not influence by others in opinion.” Virtually every advisor that will use the term Independent will have small print at the bottom of the advertisement that states whom they really represent and normally this is a broker-dealer or insurance company. This broker-dealer decides what products they can offer, process all their business and writes their paychecks. Without a broker-dealer the advisor can not operate. Typically these advisors want you to believe they sit on your side of the table and always act in your best interest but in reality they owe no Fiduciary Standard to you their loyalty and responsibility is to their mother-ship and their only duty to you the client is known as the Suitability Standard. In the simplest terms this means that they have done you no harm but have not necessarily done the best job possible because they are constrained by what they can do through their broker-dealer. Therefore it is my argument that they are not Independent at all because their existence relies on someone else for existence and operation.
Why is a word so important? This lack of Independence also creates many conflicts of interest driven once again by the mother-ship. They set compensation based on the negotiation completed by the broker-dealer and the product companies. Normally they have different compensation for like products which are structure to increase sales. There are also trips and conferences that are structured to drive sales and these also can create multiple conflicts of interest that may change client recommendations. Now don’t get me wrong, you will end up with many more choices from these advisors claiming to be independent but in my mind this still does not meet Webster’s definition of “Independent.” Hopefully this will give you a little more insight so that you can ask the right questions in the search for a true independent advisor
By MARK FOLGMANNThe last 16 articles I’ve written were to educate the marketplace about some of the problems you face when you deal with the financial service industry. Today I would like to share what we do at Ark Advisors LLC and why we act as Independent Pension Fiduciary's for 401(k)s.
Our main objective is to protect and safeguard the retirement incomes of employees while improving overall retirement outcomes. We find that most employers do not have a very good way to evaluate and monitor the success of their plan. We are hired directly by the 401(k) therefore our loyalty is to the plan participants and this eliminates conflicts of interest. We accept fiduciary responsibility in writing therefore releasing the small business owner of many risks involved within the plan.
We also find that we must set reasonable expectations with the business owners that oversee the plans because we do not believe most people can increase their retirement income by thousands of dollars per month - but we do believe the average employee can increase their retirement income by $500-$700 per month by utilizing an Independent Fiduciary.
This may not sound like a tremendous amount of money but to a 78 year old trying to pay his heat bill or a retiree attempting to buy medicine for his ailing wife of 40 years; it’s a significant amount of money. This is why employers can’t become complacent by implementing a 401(k) and forgetting about it. It is not a financial product to be bought and sold but a delicate income producing system that has the ability to under girth the American economy for the next 25-40 years.
It’s critical that employers meet your employees halfway to assure success. Once you understand how important this issue is, you will start to ask yourselves some critical questions.
Is our retirement plan good enough so that when our employees retire they will have enough money to come back and purchase goods and services from us? Once we begin to understand the depth of this question we will start to understand the intended role of the Independent Fiduciary.
In most cases it’s my job to get the small business owner out of the retirement plan business so they can focus on running their business. At that point I can then implement a proven fiduciary process that will increase the overall probability for success within the plan.
This process is based on expectations, insurance is based on guarantees but everything in finance is based on expectations. Therefore, part of our process is to match plan cash flows with expected portfolio returns so that we can set expectations regarding retirement income. By combining these expectations with the lowest cost solutions, we can consistently improve retirement outcomes for the employees.
With proper fiduciary oversight, the 401(k)s in America will live up to their expectations and without oversight they are doomed to failure.Mark Folgmann is president of Ark Advisors LLC in Traverse City. He has more than 25 years of experience within the financial service industry. To learn more about the plan review process discussed here, contact Folgmann at (231) 668-4118 or mark@arkadvisor.com.
By Mark Folgmann
“A Crack in the Wall”
Is this the start of Small 401(k) Lawsuits? We have been talking with small business owners for the last two years about the potential lawsuits that may be lingering over the horizon. A small business 401(k) is not an investment product but rather a delicate income generating machine that will fund our eventual retirement years. Since this is classified as a “real” retirement plan there is a fiduciary requirement that must be met by the people in charge of the plan. Here is where the problem begins, the plan fiduciaries are not taking their responsibilities serious and therefore run the risk of lawsuits by their employees. Until last month the only companies involved in litigation over fees, conflicts of interest or lack of disclosure were large Fortune 500 companies and most thought the small employer ran very little risk. We have now learned that the first small 401(k) with less than 30 employees in Kansas has filed a lawsuit on a plan with under $2 million in assets. This Wichita-based Orthopedic and Sports Medicine office has filed litigation against their advisor, the record keeper and the custodian of the plan claiming that the trio of plan providers caused participants to pay “secret” and “excessive” fees.
Unfortunately this appears to be the one and only way to get employers to pay attention to their plans. We still have the opportunity to save the existing 401(k) but it will take our undivided attention. The excess fees and lack of disclosure are costing Americans between 30% and 50% of their cash flow in retirement. Matt Hutcheson who is the nations best know Independent Fiduciary estimates that the average retiree would increase their eventual income by over $500 per month in retirement if they had a competent Investment Fiduciary overseeing their 401(k). This means the typical employee will have to work an extra 6yrs to make up the high cost of fees within the plan If some of these changes would have happened 25 years ago we would not have anywhere near the amount of senior going back to work and taking service jobs from our young people. This means the typical employee will have to work an extra 6yrs to make up the high cost of fees within the plan If some of these changes would have happened 25 years ago we would not have anywhere near the amount of senior going back to work and taking service jobs from our young people.
By Mark Folgmann
The New Retirement – Solutions Last time we started the discussion about how the old retirement paradigm is dead and why we need to think and prepare for our last stage of life in a new way. We can no longer depend on company pensions and social security to provide our economic base so that we can sit back and relax. The new retirement will depend on the greatest generation in American history making multiple adjustments in order to create ongoing streams of income to supplement their 401(k) s. There are numerous small adjustments that can enhance and create a very proactive and productive lifestyle in our later years.
These are my top six. 1. Save 10% of total household gross income till the day you die, notice I did not say till you retire but till the day you die. The main reason I suggest this strategy is because it will automatically cause you to live within your means and accumulate more money each year of your life. I’ve known people that retired broke but lived long enough to become millionaires. 2. Plan to eliminate your mortgage around the time you start collecting social security. Anyone can get their hands on a mortgage calculator and determine how much extra you need to pay each and every month in order to accomplish this. This will provide tremendous relief and peace of mind throughout your later years. 3. Maintain a well balanced portfolio with maximum diversification. You should start shifting to a higher Allocation of fixed assets 5-10 years prior to retirement and can use your age as a general guide to determine the percent invested in fixed assets. Most people take far too many risks and don’t really understand what it feels like to lose half your portfolio in a rough year. Don’t let this happen to you; maintain your fixed positions in your portfolio. 4. Pay attention to cost. Almost all financial decisions carry heavy cost and you must know what and to whom you are paying this cost. Everything from your checking account, car loan, investment portfolio and insurance program generates fees and commissions for someone other than you. Do your homework and work diligently to reduce your cost over your lifetime. We usually find that when we take on a new client we reduce fees over their lifetime by hundreds of thousand of dollars. Jack Bogle the founder of the Vanguard group refers to this as the tyranny of compounding fees. 5. Manage taxes throughout your retirement because we find that today many retirees pay taxes than when they worked. There are two main reasons for this which are distributions from 401(k) s or IRAs and the loss of deductions because children are grown and hopefully no mortgage expense. Many are also taxed on their social security up to 85% and before you know it your quarterly tax bill is quite daunting. We find with proper tax planning we can keep most retirees in an effective tax rate of 5% or less. 6. This one is my favorite because it allows you to stay productive and active till the day you die. Streams of income using your unique skills and abilities you have developed over your lifetime of learning. Don’t wait till you want to leave your employer to add additional income streams, these should be learned and established by the time you want to slow down and live life on your own terms.
My personal goal is to create and establish between 6 and 12 ongoing income streams that will last forever and allow me to spend time on things I love like helping the people around me achieve the impossible. Colonel Sanders didn’t get started cooking chicken till he was 65 years old and look how long that lasted. Most of these things are common sense and certainly something our grandparents would teach us. I believe if you will take these lessons to heart and follow through you will create a lifetime of financial peace and well being. Many will want you to believe that this stuff is rocket science but I’ll bet you would agree most if not all these strategies can be accomplished on your own with very little outside help. Good luck and enjoy your “New Retirement”
By Mark Folgmann
“Preparing for the future” Americans have historically depended on the “Three Legged Stool Theory” for their retirement security driven by a monthly pension, social security and their retirement savings. I believe this strategy is dead and gone and for most will never return. If I’m right we must change our paradigm and step outside the traditional retirement box. The past will not repeat itself and most of us will grow old without the benefit of a pension and some may not even see any benefit from social security. A mobile workforce with the average employee changing employers 7-10 times in a career will force us to think differently about our retirement years. Somewhere along the line we decided that we had the right to sit back and enjoy life somewhere around the age of 62. This was a great strategy when we had three sources of income, a paid off home and typically only lived another 10-12 years. Now with pensions all but obsolete, social security at great risk and a national savings rate at -2% we are kidding ourselves if we think we can retire under this obsolete system. On top of all that most are still carrying debt at retirement and may live another 30 plus years. Even with all that against us we can still thoroughly enjoy our later years with a few slight adjustments.
First of all the Financial Service Industry will not save you with all their fear tactics, hot investment tips and their efforts to make you believe their on your side. Their Not. I believe that most people are far worse off with a financial planner or advisor than they would be on their own. After 25 years of observing the tactics of this industry I firmly believe that almost all advisors destroy more value than they create. Remember the financial service industry is a zero-sum game. Every dollar in fees or cost has to come out of your accounts. Don’t get me wrong, there are some people that reach a point where they are uncomfortable handling their affairs and it makes sense for these people to get some advice but for the most part it’s a loosing game. The advisor will win, his mother ship will win but in the long run you will suffer. An extra 1-2% in fees over a lifetime could eat 30-50% of your profits and all that loss goes to the industry.
The future solutions revolve around multiple streams of income and common sense. Part of the preparation for the “New Retirement” involves thinking about what you love to do and what specific skills you have. We were downtown last weekend with my grandson Mark and ran into a retired clown making balloon animals for kids for $1 each. I thought wow, if he did this 6 days per month at different locations and passed out 100 per day he is generating about $600/month. Do you realize he would have to save about $150,000 to generate the same income? What if he also repaired small engines one day per week in his garage and generated another $800/month and owned a rental house that paid him another $750/month. Of course I’m only giving you a hypothetical illustration but you probably get the picture. It would take over $750,000 in his 401(k) to generate that kind of income. Every single person has different interest and skills so the hard part is to determine what you really love to do and figure how to create lifetime incomes from it. Over our working career we must continue to refine and develop new skills so that we can create multiple streams of income while enjoying the work. The butterfly effect tells us that minor changes create major results and it’s my feeling that we need Americans to be productive and not sitting on the sidelines for the next 30 years. Next time we’ll discuss other things you can do to prepare for the “New Retirement”.
Tess Vigeland: The average 401k plan costs its participants 3 to 3.5 percent in fees and other hidden charges. For a closer look we're joined by pension consultant Matthew Hutcheson:
Tess Vigeland: Thanks for coming on the show today.
Matthew Hutcheson: Thank you. It's wonderful to be here.
Vigeland: Is it possible to estimate just how much we're all losing because of these hidden fees?
Hutcheson: Over a 20-25 year period, if you are being charged a total of 1 percent in your retirement account, the ultimate benefits that you will receive when you retire -- let's say age 65 -- will be reduced by approximately 20 percent.
Vigeland: So we're talking thousands of dollars?
Hutcheson: Over a regular working lifetime, we're talking about $80,000, and to make that shortfall up, a person would have to work three or four additional years just to break even, based on an excess 1 percent fee.
Vigeland: How high do some of these costs go? Are we talking 3 percent? 5 percent?
Hutcheson: The average plan, which is really 90 percent or more of all of the 401k plans in the United States, is paying approximately 3-3.5 percent. However, there are some plans, especially those that are associated with insurance companies, that have additional layers of fees added on; I've seen as high as 5 percent.
Vigeland: Is it possible to figure out how much money you are losing in fees?
Hutcheson: It is possible. There is a rigorous way, a scientific way that's based on some rigorous mathematical application, where you can determine what you're paying over a long period of time, but a normal participant wouldn't know where to look.
Vigeland: There are some mutual fund companies that have publicly argued "look, if we give people who are investing -- employees -- more information about fees, they're going to get so confused that they stop investing." What do you say to that?
Hutcheson: It seems odd to me that they would require a participant to take on the most difficult aspect of investing, which is selecting the investments themselves and constructing a proper portfolio. That is far more complicated then just having fees presented to them. When the FDA required food companies to disclose nutritional information on the back of food packages, soup cans, bags of potato chips, whatever, did you stop eating? Did you become overwhelmed and stop eating? Look, participants are going to invest; it's just that we need to give them the right information so that they can construct a portfolio that is not fast food, but is a healthy well-balanced meal.
Vigeland: What is necessary and what's not in terms of mutual funds charging for their services. They do have to make money somehow -- obviously it's a business. How do you know what's a good, justified fee and what's a ridiculous one?
Hutcheson: That is a very good question and there's some relativity to that. The relativity comes in the presumption that a mutual fund company can, over time, outperform ordinary market returns.
Vigeland: In other words, the whole reason we hire these companies is because we assume these professionals will get us a better than market return?
Hutcheson: That is correct, and, what we know is that a simple portfolio of 60 percent equities -- that would be stocks -- and 40 percent bonds outperforms 90 percent of the best and brightest portfolio managers in the country over the long term. So any dollars spent trying to chase returns when you do not have a guarantee that they will actually yield the results you are seeking are excessive. Now, some people may say, "well, those fees are reasonable because the fund manager is actually doing the work to try to get the better returns." I understand that. Are those expenses justified when we know that they're probably not going to be able to outperform the market over the long haul?
Vigeland: If I'm contributing to a 401k, a 403b plan, is it possible to say potentially how many people have their fingers in my money?
Hutcheson: Yeah, I estimate it's 14 or 15 potential individuals or companies who could be payed from your account for a variety of services. You've got the fund company, you have, potentially, an independent investment adviser who is directing that company, you have salespeople who could be selling for a commission, record keepers, fund custodians, you have accountants, actuaries, lawyers, outside consultants and the list goes on, and most of those things I mentioned are not stated in the prospectus.
Vigeland: Is it possible that any one 401k participant -- an employee -- could be paying an expense ratio, revenue sharing commissions, 12b-1, Sub-transfer agent, contract fees, early redemption fees, brokerage commissions, custodial fees, wrap fees, investment advisor fees and soft dollar revenue?
Hutcheson: Absolutely, I have seen that and I have seen accounts that pay well over 4 percent when you add all those up.
Vigeland: Why aren't more people angry about this and what's the most important thing that can be done to fix this?
Hutcheson: Good question. Most people aren't angry because they don't really understand what's happening. They presume that in our society today, everything's disclosed -- why wouldn't it be? What to do about it is, regulators and legislators need to understand that we can't have our society paying for services they don't use and we need to make sure that where the risk is, full disclosure exists also. So, if we have a system that is placing the investment decisions on the shoulders of novices(i.e.: participants: regular workers), then we need to honor them by providing them all of the relevant information, even if they don't understand it at first -- they're smart, they'll have the capability to learn and understand over time -- but we can't withhold it from them under the guise that it will overwhelm them. Don't dishonor us by withholding important elements that are going to reduce our ability to have a dignified retirement in the future. That's not OK and that's what's got to stop right now.
By Mark Folgmann Everybody is trying to predict when this economy will turn. Has real estate hit bottom? When will the bear market turn back into the roaring bull and what about jobs? Sure the real estate agents tell you it’s over and the brokers want you to believe we have hit bottom but the reality is “nobody knows”. I’m not a pessimist but even I can see this thing could go on for some time. When you really study world history not American history you will find that an economy can hit the skids for a very long time. Just because it hasn’t happen recently (last 100 years) doesn’t mean it can’t.
With my clients I have to prepare for the worst case scenario even if it never happens. What if we have another 9/11 before we see recovery? Many of my clients are already retired and can’t afford to loose another 10-20 years due to the economy. Have you ever thought about what it might be like if it took the country 8 more years to recover and Michigan 15 years? What would you do different? Would you save a little more while your family was still employed? What about reducing your debt by 50% over the next 2-3 years or maybe build up additional cash reserves? Should your 401k be allocated different and what about finally paying attention to investment cost? Can we really afford to pay 2-3% on our investments when we are only earning 2-5%? With over 90% of our country still working we still have plenty of time to shore up the ship and these minor changes can have a huge impact on our financial lives.
Hopefully we don’t see another decade of trouble ahead but if we do, you will be much better prepared. Today is the end of this years Cherry Festival and my wife and I have spent most of the week downtown either serving beer or enjoying the festival and can’t help but notice that many of the downtown stores close early during the festival or don’t open at all. This I don’t get, can’t we keep our town open till 9 or 10 pm for one week each year while hundreds of thousands of people come to spend money. We heard countless comments about stores being closed and would encourage everyone to stay open because the overall shopping experience is a big part of the festival. Even with Michigan tough economy it appears we have had another successful Cherry Festival, great job Traverse City.
By Mark Folgmann
“The Free Lunch Seminar” I work with an elderly widow downstate and meet with both her and her grown children at least three times per year. A little over a year ago her husband of 50 years passed and she lives pretty much on her own since her daughter is about two hours away. While completing her taxes for 2008 we noticed multiple transactions that we were not familiar with that generated excess taxes for my client. I immediately called a family meeting with the intent of taking an updated inventory and bring everyone up to speed. We got the children involved about 3 years ago because we were becoming more and more aware of my clients aging process and her memory loss and believed they needed their family to help in the decision making process. We set up trust and put the daughter in charge of most of her assets but like any independent individual she was not willing to give full control of her assets to her family.
Anyway, as we completed an inventory of assets and changes made for the year my client mentioned the name of the individual that she had been working with for about 3 months whom she met when she attended a “Free Lunch Seminar”. As we worked our way through the transactions we learned that IRAs were cashed with no regard for taxes and CDs were surrendered with multiple surrender charges. Annuities were liquidated and transferred again without attention to taxes or surrender charges. All told this individual sold my client 4 annuities, LTC policy, life insurance and a prepaid funeral policy. Now remember this was all going on while her daughter and I was meeting with her on a regular basis and when we asked if she wrote any checks to this individual or his company she said “I don’t remember”. After reviewing her check register we discovered checks written for hundreds of thousands of dollars and many checks were written within days of our meetings. All told we estimated the insurance agent made over $30,000 in commissions and tied her money up to age 95 with surrender charges. Have you ever wondered how they can afford to buy lunch for a room full of senior citizens? After this episode my client’s daughter took a full day off work and they visited all the banks where money was left and moved everything into the trust for safekeeping. The lesson I learned from this episode is we must have open communication with professional oversight. Your family’s professionals should communicate with each other as a form of checks and balance for the safety and security of your family.
By Mark Folgmann This is the 12th and last in a series of articles on 401ks. We have spent the past 6 months attempting to educate both the employers and employees about their retirement plans. These plans have the potential of becoming great and funding our retirements but we must spend time educating ourselves and understanding how to keep our 401(k) current. I have found that there are many outstanding resources that can help us do that and most of us can be highly informed with as little as 8 - 10 hours of concentrated study. Just imagine, we spend somewhere around 80,000 hrs working so that we can retire and most don’t have the time for 10 hours of preparation on how to assure retirement becomes a reality. I see more and more people who will never be able to retire and that is a real sad situation.
For employees that are two excellent books available at your local bookstore. The first is “The Smartest 401(k) Book You’ll Ever Read” by Daniel Solin. This is a really easy read broken down into 4-5 page chapters on key points that affect your plan. Dan also does an excellent job of covering how your behavior can destroy your retirement plan. The second book I would recommend is “Stop the Retirement Rip-Off, How to Avoid Hidden Fees and Keep More of Your Money” by David Loeper. David will teach you how to uncover all you plan fees and what to do if your fees are too high. These 2 books will put you in a position to make great decisions about your 401(k) and I would add “The Successful Investor Today” by Larry Swedroe who will show you how to experience a successful outcome with regard to your investment choices within your plan. For employers I would recommend “Fixing the 401(k) by Josh Itzoe. This book focuses on the problems of the plan sponsor and will lead you to a great plan.
We will be continuing this article next time with information that you need to make informed financial decisions and empower you to deal with the financial service industry. Remember Wall Street is not your friend and it’s main objective is to make profits off your money.
By Mark Folgmann Most of us get only one shot at retirement so therefore we really need to pay attention. I am continuously amazed at how much trust and faith employers place with their financial salesperson. I talk to companies each and every week that are blindly following recommendations by someone who gets compensated to sell them products. Wake up employers; these “advisors” whom want you to believe they are on your side are really in the business of marketing products – not creating wealth for you and your employees. As stated in previous articles; it is not ok to be down 50 -60% in your retirement accounts and if you are, look for a second opinion from someone who is not paid to sell products. The criteria for selecting a retirement plan provider should not be the place where we have our checking account or where we buy our life insurance. It should be someone who specializes and understands the unique problems that surround the issue of assuring my employees will be able to retire and their families will be financially secure. This is the definition of a financial fiduciary.
Employees it’s your money and retirement; you can’t bury your head in the sand and hope the problem will go away, it won’t. At some point your 401k will turn into your monthly check for the rest of your life and if that monthly check is reduced by 40% because you did not pay attention to fees it will be a very sad period for your family. Your life is not too busy to take a couple hours educating yourself about your own retirement. Dalbar conducted a survey over a 20 years timeframe where they determined the S/P 500 return was in excess of 11% but the average investors return was only 4.28%. How could this happen? I’ll tell you how, the financial service industry took 30- 50% of the return in fees and the investor made investment mistakes managing his portfolio which cost him the rest. This is why it’s important that we build low cost 401ks (less than 1% in annual fees) and make available model portfolios for employees to choose instead of individual mutual funds.
Employees managing their own 401k are equal to asking you to land a 747 in mid flight, it really does take training. My firm is in the process of helping a local company rebuild their 401k and so far 100% of the employees have selected model portfolios over individual funds. This gives them great relief because they don’t feel comfortable managing their own investments and realize they have not been trained to do so. Our next article will be our 12th and last article on 401ks. Next time we will provide you resources to educate yourself so you can take charge of your family’s retirement.
By MARK R. FOLGMANNI’ve spent the last nine articles discussing a lot of problems with 401(k)s, which may lead you to believe I don’t like them. The truth of the matter is I love them and spend the majority of my working hours helping companies fix their plans.
I was on vacation last week in Asheville, North Carolina watching the Kentucky Derby and was amazed when “Mine that Bird” came from last place and blew by the field like they were standing still to win by six lengths.
I thought to myself wow that is what a great 401(k) should look like. It would leave all other 401(k)s in its dust especially as we recover from this horrible downturn in the economy.
Most 401(k)s look like those horses that we thought were standing still. They have a 300 lb. jockey, no regular training program and suffer from malnutrition. We know real quickly when a racehorse is out of shape because they race periodically, not so with your retirement plan. We tend to close our eyes and hope we will be all right at the finish line (age 65). Our race tends to last 30 or 40 years.
I believe the 401(k) is the absolute best vehicle to assure America’s retirement, but we must race now and then. We must review fees, conflicts of interest and make sure our fiduciaries are truly acting in our best interest. If we keep our 401(k) in top shape, we will be in position to win the race.
I am extremely proud to announce on April 28 my firm, Ark Advisors LLC, was endorsed by Matthew Hutcheson as one of only 17 firms in the United States that truly embraces a “Participant First” approach to delivering retirement plan services.
Matt in my opinion is the foremost expert with regard to 401(k) plans and fiduciary responsibility in the nation. He is currently working hand in hand with both the Department of Labor and Congress to identify fiduciary firms and solve the country’s retirement dilemma.
Matt was the key figure within the Bloomberg Report on hidden fees and recently participated in both the “60 Minutes” and “CBS Evening News” segments covering the same subject. We were required to go through a rigorous screening process before being selected as one of the nation’s select few who strive to create the best possible retirement outcomes for employees.
Mark Folgmann is president of Ark Advisors LLC in Traverse City. He has more than 25 years of experience within the financial service industry. This is the 10th in a series of columns discussing topics related to 401(k) planning. To contact Folgmann, call (231) 668-4118 or mark@arkadvisor.com.
By Mark FolgmannHopefully you caught 60 Minutes on CBS last week, they had a great segment on all the hidden fees within our 401ks. Katie Couric also picked up the story and did a follow-up on Tuesday. It’s great to see the problem is getting more press on a national basis. We approached a random local company and asked if we could review their plan for our article. We wanted to pick a local company to illustrate that almost all plans are filled with problems and fees that are not disclosed. The company employees over 100 employees and has in excess of 7.5 million dollars in their plan invested with a bank.
This plan was review by the bank recently and the disclosed fees were approximately $39,000 for investment expenses and $6,000 in administrative cost for a total of approximately $45,000. These were the obvious fees and once we started reading all the fine print we discovered revenue sharing fees, additional fund access fees, transaction/brokerage fees and custodial fees. Do you ever wonder why all the questionable fees are in the fine print? By the time we added it all up we were over $120,000 per year in total cost. Our analysis showed that even though the majority of the plan assets were invested in low cost Vanguard funds the bank was charging outrageous fees on top of the Vanguard management fees to allow access within the plan. Virtually all investment choices other than Vanguard were paying kick-backs to the bank to be included in the investment line-up. This pay to play philosophy creates huge conflicts of interest for the plan sponsor. Great funds do not have to pay to play and they stand on their ability to generate excellent returns with low cost. Imagine the bank charging employees 300-600% more that the Vanguard managers charge, just to include them in the fund line-up. This plan prices out at about 1.75% of plan assets with virtually all the cost being asset based, meaning the percentage remains constant on future plan growth. I believe there is another .5 -1% that even I can’t find; most experts agree that overall plan cost are usually in excess of 2.5% per year. If you recall from previous articles I stated that most plans should cost less than 1% of total assets and large plans like this one should be closer to .75% of assets. Overall this would save the employees between $60,000 and $120,000 per year in unnecessary fees. This cost should be able to be obtained while using an advisor that accepts written fiduciary responsibility; which the bank will not. Lastly there was not an Investment Policy Statement in place which acts as the plans guiding principles. It allows for a fiduciary process so the plan sponsors can make smart ongoing decisions regarding the investments within the plan. This statement would have driven different decisions to eliminated most of the conflicts of interest within this plan.
Just wanted to remind you employers out there that we are conducting another “Understanding you 401k” class at NMU on Thurs 5/14 @ 2:00pm. Call the college for details.
By Mark Folgmann I was planning on a case study this week but due to a long tax season and timely questions from my daughter-in-law I decided to put off the case study till next time. We have an excellent local plan to use in our 1st case study and would like to review another 3-4 over the next month. Please call my office if you would like your companies plan reviewed and you have the authority to provide us with all the specific details.
Over the weekend she came to me and asked about an article from a few weeks ago when I stated that many employees are better off not participating in their 401ks especially if they don’t receive matching on their savings. I thought it would be a good idea to explain further so we ran the numbers on her plan (which is one of the worst I’ve reviewed) and compared her end results with a Roth IRA funded through Vanguard. She is 24 years old and we funded her Roth IRA for 41 years at $3,000/year without any increases. We also grew her account by 9%/year compounded with .20% annual fees through Vanguard and 3.00% annual fees through her 401k. The advisor on her plan is using “C” class shares which are about the most expensive share classes in the entire industry.
I’m sure you can guess what account outperformed. The Vanguard Roth IRA value at age 65 was $1,207,140 and the 401k account value at age 65 was $531,664. Just imagine, a 55% increase in retirement value and retirement income all because of one choice. My calculation ends at 65 and we all know that her money will work for another 25 or 30 years after her retirement date. I won’t even show you how much would be lost to fees on account balances that large because you would not believe it possible. End result could be loss of 70-80% of retirement income because of one ill informed decision when she was 24 years old, all caused by the lack of fee disclosure. It’s a shame that most can’t even get the information to make an informed decision about how and where to save for retirement.
There are two distinct advantages to her 401k at this point. #1 is payroll deducted savings and this is a big one. Money is deposited before it gets in her hands and this assures it gets into the retirement account (very important but not worth $675,476) and #2 higher contribution limits within the 401k. It’s very complicated and hard to make good choices about your retirement accounts without knowing all the fees and rules of the different accounts. With all the choices available both pretax 401k and Roth 401ks (not all 401ks have updated for Roth contributions) regular IRAs, Roth IRAs and Spousal IRAs if you are married it can be a quite daunting task without professional help. You also have income restrictions on your individual IRA accounts which could eliminate your deduction if your household income is too high. These decisions should be based on savings amounts, household income, fees attached to accounts and timeframes. These factors should be evaluated by an unbiased 3rd party and second opinions are very important so you don’t make costly mistakes.
By MARK FOLGMANN
We’ve spent the last six articles unpacking the problems and concerns with the small business 401(k). Today we will take a closer look at what an ideal plan would look like so that you may compare your plan with an ideal plan. For my money an ideal plan would revolve around three issues - which would be plan design, cost and overall investment experience. The overall goal should be to create a plan that would allow for the greatest chance of a successful retirement for each and every employee.
We start with plan design because this puts all the triggers and measurements in place to assure success. This starts with a fiduciary process in which an Investment Policy Statement is created with the rules of the plan. This document would specify what our investment strategy is, and why we include certain investments and how and why investments are replaced. It would also point out what we measure success against with regard to indexes such as S/P500 or Russell 2000.
Next we would create an Investment Committee, whom along with a Fiduciary Advisor (RIA) will implement and monitor the process. We would also suggest automatic sign-up and annual increases in salary deferral till an employee reaches a benchmark of 10, 12 or 15 percent. Add in a Roth option because tax-free is the name of the game when possible.
Cost is the next areas of focus within a plan. Start with transparency, if you don’t know who is getting paid and how much – you have a problem.
The only control you have over your plan is the cost and most don’t know what they are paying. I would expect your overall cost within your plan to be south of one percent, and this should include everyone including the advisor. A well-crafted plan should have about .30 percent (or less) for investment cost, .30 percent (or less) for recordkeeping and custodial care and .40 percent (or less) for a fiduciary advisor.
In order to get your investment cost less than .30 percent you will have to utilize low cost institutional class index/passive mutual funds. Since there is no academic proof that high cost actively managed funds outperform the market over long periods of time, we believe the best strategy is to match the market with the lowest cost.
The typical plan I review has all in cost of 2.5 percent or more with many of these fees buried in hidden cost. Once you know who is getting paid and how much, you can monitor and make annual decisions on who needs to stay and who needs to go - this is the plan sponsors fiduciary responsibility. Normally these funds or investments are institutional classes such as Vanguard or Dimensional Funds who do not pay advisors to market them. An annual check-up on all plan cost keeps everyone on their toes.
Lastly we must deal with investment experience of the participants. As stated in an earlier article, the average investor during the boom 1990s only experienced 3.9 percent annual growth from their funds while the market return was over 10 percent a year. Therefore, we should allow professional money managers to create model portfolios and let the employees pick their portfolios based on their individual situations.
The current market has shaken the most sophisticated investors and most are now in agreement that we are not trained to manage our own money.
Last but not least is the use of Institutional Funds vs. retail funds. You want your retirement money commingled with professional money managers, not the typical retail investor who does the wrong thing at the wrong time (all the time). Professional managers are not driven by fear and greed; they are driven by asset allocation and rebalancing. Over time this has a significant impact on the overall investment experience.
A friend of mine Josh Itzoe, author of “Fixing the 401(k)” recently wrote a white paper available on my Web site, which estimates the cost of not having a “Fiduciary Advisor” at $450,000 per participant. You can read the full article at www.arkadvisor.com under the 401(k) section. If you oversee a 401(k) and would like a review of your plan, you can reach me at (231) 668-4118 or mark@arkadvisor.com. Next time we will look at a case study to demonstrate what an inferior plan can cost you over time.
Mark Folgmann is president of Ark Advisors LLC in Traverse City. He has more than 25 years of experience within the financial service industry. This is the seventh in a series of columns discussing topics related to 401(k) planning.
By Mark FolgmannThe profitability of the 401k industry depends on the magnitude of fees it can extract from plan assets, not on how well it protects and enhances the retirement income security of plan participants. Conflicts of interest run rampant in the Financial Service Industry and it begins with the advisors or brokers pay. Rarely is it disclosed that different investments pay different commissions or fees to the broker and even different mutual fund share classes provide different income to the selling agent. This is what creates the conflict when we have the broker picking or advising what funds or investments to include within our 401ks and receiving different compensation as a result. People tend to do what they get paid to do and the greater the pay the more they make the recommendation.. I see this in the insurance industry quite often when the agent suggest whole life insurance which cost and pays much more over term insurance which is less expensive and probably better for most people. Advisors will want you to believe they have a special skill for identifying and choosing outstanding mutual funds to be included in your 401k when in reality these mutual funds have bought their spot with “pay to play” money and may even throw in a free trip for the salesman (advisor) if he sells enough of their product.
Many people think their 401ks are free because most of the fees are never disclosed and sharing the fees generated by a common practice called Revenue Sharing. The 401k may only offer the most expensive mutual fund share classes which generate enormous fees which in turn are used to pay for record keeping and advisor servicing fees. Since the employees participating in the 401k never see the fees deducted, it appears the services are free when in reality they are being charged so much they would be better off not participating in the 401k and instead funding a private IRA with a low cost Vanguard Fund. This is not the case if you are receiving matching by your employer. I have recently reviewed 401ks that are charging employees 35 times more in fees than they would pay at Vanguard for equal if not superior investments.
By Mark FolgmannA Fiduciary is someone who occupies a position of special trust and confidence. The sponsor of your 401k holds this position and their sole purpose is to protect and secure your families retirement income. This responsibility involves many parts such as selecting advisors, cost analysis, evaluating conflicts of interest, implementing a fiduciary process and ensuring a successful retirement outcome. Unfortunately many fiduciaries are not fulfilling their duty and are incorrectly assuming their advisors are sitting on the same side of the table and sharing the risk.
You must start by asking your advisors if they accept fiduciary responsibility, in my opinion this is the most important question you will ever ask your advisor. Most firms and advisors operate under the suitability standard and that does a great job protecting the advisor and his firm but does not protect you the client. Fiduciary advisors must act in their client’s best interest so make sure you get confirmation in writing. You can learn more by visiting www.focusonfiduciary.com. Employees depend on their plan fiduciaries to be knowledgeable and implement a process that will protect their family’s retirement income. Based on the current status of our 401k plans we need a wake-up call to plan sponsors. Remember the interest of the financial service industry is diametrically opposed to the American worker whose retirement funds they have been entrusted to invest. Every dollar of cost reduces your retirement account by an equal dollar. Plan sponsors can learn more by registering for our February 25th NMC class from 1-4pm “Understanding your 401k” at 995-1700.
Next time: What the financial service industry does not want you to know (conflict of interest)
By Mark FolgmannProbably not the best time to bring up fees in your 401k since many account values are already down 40 or 50%. In order to get maximum recovery when the economy improves it’s imperative that you pay attention to cost within your plan. As I ask people what their cost are within their 401ks I usually hear that there is no cost or my employer pays the fee. This simply is not true; you always pay virtually all the cost. The industry is masterful at hiding and concealing these fees a lot like the line in the Wizard of Oz when they say “Pay no attention to that man behind the curtain.” At last count there are 14 ways to hide fees and those fees can eat as much as 50% of your retirement balance over a 40 year career.
This seems to be impossible but remember two things, first fees come out each year whether you make money or not and second the compounding effect is one of the most powerful forces in the universe. A 25 year old saving $400/month with $200/month employer matching would accumulate $2.8 million by age 65. This illustration assumes a 9% portfolio growth rate and zero investment/plan cost, neither very likely, the typical small business plan (plans with assets less than $20million) I review has total carrying cost of 2.5- 3.5%. If I run the same illustration assuming a 2.5% total cost/yr in fees the accumulated balance at 65 becomes $1.37 million, which is a reduction of 52%. Now it is unrealistic that we have a plan with zero cost but we would make a lot of progress if we first understand that there is a cost and we as participants are paying the bill. Once we realize we have a problem we can determine exactly what it is costing. I say that with tongue in check since it’s extremely difficult to find all the fees since currently there is not a requirement of full disclosure. My personal belief is your complete plan cost should not exceed 1% and you should have a goal of .75% or less and this should include all fund expenses, record keeping and advisor fees. Your employer has fiduciary responsibility to review plan cost and make sure they are reasonable and competitive.
The Department of Labor is currently working on increased requirements demanding full fee disclosure that should take effect later this year. Many 401k plans with high fees are scrambling to replace current plans with lower cost plans prior to the new disclosure rules taking effect. You can visit my website at www.arkadvisor.com for a 30 minute free video on Hidden Fees under the 401k Pension Consulting Page and as always to can e-mail question to me at mark@arkadvisor.com. Our next article will be addressing Fiduciary Responsibility for employers.
