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.
