By Mark FolgmannJust about everyone can enjoy a successful retirement with three upgrades. Upgrade number one; increase your savings rate by 3% within your 401(k) or retirement plan. Make sure this is 3% of your total household income. You can accomplish this without pain by bumping your savings rate 1% each and every birthday till you reach 10%. The average person is saving about 7% into their retirement plan and this will get you to 10% plus any company matching. Upgrade number two; increase your expected returns on your portfolio by 3% per year. You can accomplish this by paying attention to cost and creating portfolios that have an expected rate of return 8-9% per year. About half of the 3% increase could be driven by cost reduction in most plans we see in the marketplace. The other half comes from the elimination of bad investment behavior. If you have done your homework and feel comfortable managing your own portfolios make sure you also rebalance on your birthday each year when you increase your savings rate. Most employees we talk to aren’t confident managing their portfolios so this is a service we provide on the 401(k) s we provide oversight. Statistics show that the average employee averages less than 5% per year after fees and expenses on their account. These first two upgrades will fix over sixty percent of the retirement scenarios. Remember these changes should be made on all household income; if you have two people employed you must figure out how to implement these suggestions on both incomes even if you only have one retirement plan available through your employers. If this is the case you may need to fund an IRA or Roth IRA on the side or fund the available 401(k) at twice the rate. If you are still coming up short in retirement income after you make the above changes you must consider upgrade number three which is work 3-5 years longer than planned. This really should not be a tough call since retirement was never intended to last 25 plus years. The clients I have worked with over the years that have stayed productive well into their late 60s or even 70s have been the ones I’ve enjoyed being around the most. Since they are productive and active both mentally and physically they energize the people around them with stimulating conversations about the new and exciting things they are accomplishing. If your profession does not allow for an extra 3-5 years of employment you must start preparing for this transition at least 5 years prior to leaving your current employment. You might turn a hobby into an income or become a consultant in an area where you have specialized knowledge. Either way the extra years working will enhance your retirement years by saving more and spending less while you continue to work. These three upgrades will not solve the problem for everyone but will get over eighty percent of American workers into a position where they can retire with dignity and independence.
By Mark FolgmannA new client recently asked me what he should focus on during this uncertain economy and what I thought to be the keys to success over the next five years. It seems that on a daily basis I hear people say that recovery is right around the corner, from my office landlord claiming that the commercial market will recover within three years to the financial news media insisting that we are coming out of this recession. In my personal viewpoint, I’m not even sure if we have started the commercial market downturn nor do I know if the economy is rebounding. What if everyone is wrong? I believe the only things that matter are the things within your control. I have laid out a list of things that one can control over the next 5 years that I believe will leave you better off in the year 2015 than you are in the year 2010 simply by implementing these into your life.
Buy the right size home and use standard financing. The maximum home value should be no more than 2.5 times your household income with a minimum of 20% down payment on a fixed 15 or 30 year mortgage. If you can’t satisfy these three requirements; rent until you can.
Live within your means. Simply; spend less than you make. Save 10% of your total household income into your retirement program (IRA, Roth or 401k). This should be implemented until the day you die.
Develop a plan to eliminate all other debt by the end of 2015. Operate off of cash going forward. Build cash reserves with eliminated debt payments.
Implement a diversified investment strategy with your existing investments. Hopefully you learned last time that a balance approach works much better. I have many simple reads to help you accomplish this. One of my favorites is “The Coffeehouse Investor” by Bill Schultheis. This is a book that you can read in a couple of hours and be better qualified to handle your portfolio than most financial advisors.
Cost matter. Make sure you understand every dollar you pay in fees and cost. Remember each and every dollar you pay in fees is one less dollar you will have to support your retirement. Vanguard is always a great place to start here. Not only will they help with your cost but will also help structure your portfolios. Jack Bogel is one of my favorite authors and I would suggest reading anything he has written. His most recent book “Enough” is a great read.
Of course most of these suggestions are common sense to many but all will put you in a much stronger position. Just imagine if our leaders in Washington implemented the same list.
By Mark FolgmannThe underlying difference between fee-based advising and fee-only advising is often disguised through many shades of grey. Advisors today use all kinds of smoke and mirrors to confuse investors and blur the lines between services offered in each form. Fee-based advisors would like clients to believe they are the same as fee-only advisors when in reality these are two completely different practices of investing which may result in substantially different financial futures for the client. It is the commissioned salespeople that find it to be a much better business model if they can produce predictable ongoing revenue from their clients when they can. When I see fee-based accounts created by broker-dealers and distributed by their sales force, they typically contain expensive, actively managed retail mutual funds that would have been offered in the past with sales loads. The fee-based account typically waives the loads (front end or back end) and allows the advisor to tack on a 1-2% fee each year to generate ongoing revenue. The average actively managed mutual fund charges about 1.25% in expense ratio and has about the same in trading cost (brokerage commissions, bid/ask spreads, market impact and cancelled trades) for a total cost of approximately 2.50% per year. Of course trading cost will vary depending on the percent of portfolio turnover and the asset class of the fund. After the advisor adds on their fee-based amount of 1-2%, the total cost amounts to 3.5-4.5% of the account balance each and every year. If you do the math and use the rule of 72 which states money doubles every ten years at 7.2%; it doesn’t take long to figure out why they would rather take their commissions each and every year on a growing pot of money. Keep in mind that a well diversified portfolio may return 8-9% each year before cost and if you lose 3.5 - 4.5% in fees, your ending value will be 40-60% less due to fees alone.
The National Association of Personal Financial Advisors (www.napfa.org) is a great place to find a fee-only advisor. To comply with full disclosure I should mention that I am a full member of NAPFA and we have a great group of NAPFA members in Traverse City. There are many advantages to using a fee-only advisor but in context of this article the difference is substantial. When a fee-only advisor creates your portfolio they will not use high priced retail funds with high annual turnover when they create your portfolio. They will either use low cost institutional funds, index/passive funds or individual securities. All of these options will significantly reduce fees and friction on your portfolio which in turn should increase your net return. Most of the fee-only advisors I know will create portfolios that have an all in cost of 1.25% or less which includes the advisor fees. Obviously it's impossible to completely eliminate all fees but it is important to understand the difference in pricing models. A long term annual fee of only 1.25% compared to 3.5% or 4.5% with the same expected returns on your portfolio will increase your monthly retirement income by a substantial amount over the long haul making this a notable difference.
By Mark FolgmannI was recently reminded how troublesome it is to get financial advice. Over the last several months we have had numerous calls from individuals looking for second opinions regarding their financial future. People are looking for someone to advise them on a fiduciary basis with full disclosure and without any conflicts of interest. Most of these potential clients decided to look for a new advisor because they did not feel they were well represented over the last two years as we watched the market collapse and recover. After deciding to work with us, one of our new clients arrived for his appointment and shared with me a dream he had a few nights earlier. He said that he woke up in a cold sweat because he had arrived for his scheduled appointment and the office was empty; no furniture, no phones, no people; just an empty space. For a moment we laughed and joked about it but then I started to think about this concern; it was in fact a legitimate concern.
Every day I read in trade publications about advisors all over the country going to jail for stealing client’s money and spending it on their own lifestyles. How does the average person ensure their money is safeguarded and not in a position to be used by their advisors? There are distinct advantages to working with a truly independent advisor who does not sell products and acts in the client's best interest but regardless you also must know how to safeguard your money. The top 5 tips for safeguarding your money when selecting and using an independent advisor are:
#1. Use an advisor that will accept fiduciary responsibility in writing. This alone will not protect you but will be a good first step... remember criminals still carry guns even though it may be illegal. At the very least this will eliminate the salespeople who will not agree to act in your best interest before their own.
#2. Review their ADV Part II which will introduce you to their firm and the services they provide. Get a service contract that explains the scope of services provided. All fees should be fully disclosed in writing.
#3. Always make sure you know where your money is deposited. Typically this would be at a custodian or brokerage that is responsible for safeguarding your money. These are names like Charles Schwab, TD Ameritrade, Fidelity or Vanguard. Never make a check out to your advisor or your advisor's firm unless you are paying them directly for advice on a retainer or hourly basis. Your investment checks should be made out to the place they are being invested or deposited with. Don’t abbreviate names on your checks and follow the money. Check and double check the deposit through a third party source. Call Ameritrade direct or log into your account over the internet to confirm the money has arrived and has been properly allocated.
#4. Many times an advisor will create personalized statements when they are misusing client’s assets. This allows advisors to hide transactions; you must receive your statements directly from the place your money is being held. Once again this would be from places like Schwab, Ameritrade or Fidelity. If you receive customized statements from your advisor they must be accompanied by custodian statements.
#5 Typically someone that will separate you from your money illegally will use their likeability and their personality to make you trust them. You must not be afraid to ask the tough questions and do not accept their answers without checking. The more you like your advisor the easier it is to take advantage of you. When things don’t feel right; many times they are not.
By Mark Folgmann This year there has been an awful lot of hype over converting all or part of your pre-tax IRA to a tax- free Roth. Due to the unique tax rules in place this year, if you convert all or part of your regular IRA to a Roth IRA you will have the option of paying your tax based on this year’s income or spreading the tax over two years based on your 2011 and 2012 income. Clearly this provides for specialized tax planning based on your individual circumstances and may present you an opportunity to benefit from the tax code. The typical $100,000 income ceiling for conversions is also lifted this year which allows for an individual or family to convert part or all of their IRA. In all honesty, we have selectively been converting regular IRAs to Roth IRAs for clients over the last five years. We typically capitalize on low income years to convert assets so we end up paying very little tax on the conversion. We also proactively plan income streams to control our tax bracket by distributing income from various asset locations to reduce our overall tax obligations. Usually within the first ten years of retirement we have numerous opportunities to control our tax burden. However, this becomes a little more difficult after a client reaches the age of required minimum distributions from their retirement plans. Overall I’m a believer of strategic planning which would allow for the reduction of taxes for both you and your family. It is my personal belief that you have far more control over how much you will pay in taxes and when you will pay these than you think. We have multiple clients that have very high six and even seven figure portfolios that have a 10% or less effective tax rate.
This massive marketing campaign by the financial service industry makes me wonder who really benefits from this great opportunity. First of all, we know the financial service industry will benefit tremendously. They make money when transactions are completed and as long as we believe this is in our best interest, they will continue promoting change. Second is the government who appears to be the biggest winner. It continues to pile up large deficits and is now promoting the collection of taxes in advance. Doesn’t it seem a little strange to you that the whole benefit of funding an IRA was a tax deduction while we were still working and compounded deferral of all the money that would have been paid in taxes? Why did that change? Not only does the government receive large amounts of prepaid taxes but they promote it as if they are doing us a favor. Remember, I am in support of tax planning but most people will not know in advance if they will be better off by converting and paying taxes now or deferring and paying taxes later in life. Far too many things change and the calculations require so many assumptions that the end result becomes an unknown. My personal belief is that most investors will not end up better off converting their IRA to a Roth. Make sure you check with your tax advisor prior to completing any conversions. Ultimately you get to be the judge on who benefits from this once in a lifetime opportunity. My money says the investor will finish third.
By Mark FolgmannI was listening to a local radio show about money last week when a small business owner called in to discuss a financial concern. The caller asked the host if he thought it would be advisable for her to listen to her financial advisor who was suggesting that she move her SEP (Retirement Savings Account) into an Annuity. She went onto say that she has been funding her SEP for 20 years and the account balance was currently less than she had deposited over the years. At this point the host went into a five minute review of annuities. Both seemed pleased that the current advisor had disclosed the fact that the cost could be as high as 3 or 4 percent per year in the new investment. At this point, I believe they decided that it could be a viable option to move her SEP into an Annuity but were not entirely certain on this transition.
What are you thinking and what will it take for you to get rid of your advisor? Must you lose all your money? At some point we must ask the right question and it is not, "Should I allow my advisor who has not figured out how to make any profit in 20 years invest my money for another 20 years in a product that cost 3-4 percent each and every year?"
Dr. Phil says it best when he asks “How’s that working for you”? In this case, the right question is, "When do I re-evaluate my advisor?" I would think it must be before you spend half of your investing life and show zero growth on your capital. Current surveys show that as high as 75 percent of investors are questioning their advisors and are seriously considering a second opinion. I believe this is an excellent time for a second opinion due to the strong rebound we experienced last year. Even if you had lost half of your portfolio in 2008, you should have had a strong recovery in 2009. This puts most people in an excellent position to re-evaluate the advice they have been receiving. A partial list of questions I might ask myself in this re-evaluation may include: Did my advisor provide me with an asset allocation that was appropriate for my age and risk tolerance? Was my advisor meeting with me throughout these troubled times? If we had losses in our holdings, did we harvest losses in order to reduce current and future taxes? How often did we rebalance our portfolio in order to take advantage of the market fluctuations? Or maybe the best question is, "Did my advisor have a prudent and reasonable game plan prior to the turmoil that allowed me to sleep at night with the feeling that he was as concerned with my financial well-being as I was?" If all of these things happened over the last 2 years you should have recovered all your losses and be ahead of the game at this point. If that is the case, you have a prudent advisor and have no need to look around. Make sure you thank them in some special way. If not, start your research and educate yourself before the next storm arrives. Make no mistake, it will rain again.
By Mark Folgmann In his most recent book “Outliers” Malcolm Gladwell states that his research shows you can be an expert in just about anything if you put in 10,000 hours. This applies to playing hockey, writing software, music and yes even brain surgery. If we do the math we find out that this would take up 5 years of full time effort or 10 years at 20 hours per week each and every year. Last year my wife and I were invited to Hilton Head to spend 4 days with my favorite Uncle and Aunt. Once we arrived we were notified that my cousin Brian was driving up from Florida to grill steaks. I was happy that I would get to see Brian but thought to myself, heck I can grill steaks, why was everyone so excited to have Brian grill steaks. Brian showed up at noon after a three hour drive and spent about 15 minutes preparing the steaks. I’m not sure what he did but since it only took 15 minutes it couldn’t be all that important, right? Anyway after he was done Brian and I shot off to play golf for the rest of the afternoon with no further thought about those steaks. Brian had them marinating back at the condo after he trimmed the fat and prepared for cooking. About 5 hours later we returned from golf and Brian started on the rest of the meal. Preparing the salad and cutting and washing vegetables. After taking everyone’s order on how they wanted their steaks prepared he left and returned with the best steaks I have ever tasted. I have to say the meal Brian prepared was the highlight of my trip. Sure it was great seeing everyone but to watch someone that is truly great at what they do was a pure pleasure. Most would not realize what went into that meal but I truly did. I knew Brian had spent his 10,000 hours becoming an expert and I appreciated someone who is great at what they do. Not only was it interesting to watch but I benefited from his effort. Even though the end process looked effortless I was fully aware that Brian had paid the price and pulled off an experience that was unforgettable. After all I am still thinking about that meal a year later.
The question is what does this have to do with your retirement? Everything. We can’t be expected to create a successful outcome with only one opportunity to practice. Sure retirement is far more important than grilling steaks so don’t you think the prudent thing to do would be find someone that has 10,000 hours of experience. Someone that understands how to prepare, monitor and evaluate the process. Wouldn’t you want someone that has burned a few steaks and has learned from that experience? When I grill my wife knows to have a glass of water handy at all times. Anyone that has ever grilled knows what the water is for. There are clearly two problems to this retirement dilemma, first is the accumulation stage which is by far the easier issue. The more difficult problem is once you retire and attempt to make your money last as long as you do. Brian knows exactly what temperature to grill steaks so they don’t burn and in my world I have to know what distribution rate and expense ratio’s are acceptable over a 30 year retirement so your money doesn’t disappear before you do. There is always a very fine line between a great meal and burning steaks. Oh, did I forget to tell you what Brian's profession is? He's a Chef.
By Mark Folgmann In today’s uncertain environment where few trust Wall Street; it’s fair to wonder if your 401(k) is structured and monitored in a prudent way. Most companies slap a 401(k) into place, let the advisor pick a basket of funds and hope it all works out. Sure they review the funds once per year but really never get to the bottom line; is my retirement account going to be fully funded the day I retire? If not, what changes need to be made to assure that happens. I mentioned countless times in previous articles that the 401(k) is not a product; it’s a delicate income producing system that needs constant care by trained fiduciaries who understand the critical questions to ask in order to improve employee’s retirement income.
For the first time there is an independent rating service for your 401(k), a start-up out of San Diego run by brothers Mike and Ryan Alfred. You can access the rating system as a plan sponsor or employee by visiting www.brightscope.com. Since Brightscope is a start-up it does not have all plans in its system yet but just passed a milestone of rating its thirty thousandth plan and also just released their top 30 list of 401(k)s for 2009. They have developed a rating algorithm that calculates a single numbered score for each and every 401(k) evaluated which falls between 1 and 100. Currently the highest rated company score is 96 and the lowest is 26 and this score is derived from over 200 data points such as plan cost, investment quality, contribution rates and company generosity. A score of 100 would indicate a typical employee would be able to retire and walk away with a million dollars on a working salary of fifty or sixty thousand dollars. They also translate this number score into how many additional years the average employee will have to work because his company has an inferior plan. The companies that were rated best in class for 2009 have average employee balances over $350,000 and scored in the 90s with over 15,000 employees. The weakest plans might have average employee balances of $15,000 or less than one year’s current income. Remember this is not the only factor since there are 200 data points but average account balance is a very good starting point. They also do an excellent job of uncovering most of the plan cost including trading cost for investments which many times can double the overall cost of the plan.
I had the pleasure of spending time with both Mike and Ryan Alfred at a recent Independent Fiduciary Symposium hosted by Matthew Hutcheson in Boise Idaho and can attest to the passion these young men have about the future of 401(k) improvement that will be driven by an independent rating system much like Morningstar rates individual mutual fund. Any employee or employer can go to Brightscope to check if your companies plan has been rated. If your plan has not yet been rated you can follow instructions on the website to input data and have your plan evaluated. Since Brightscope does not receive any funding from the financial service industry you can be sure you will get an unbiased review of your plan and there is no fee to have your plan evaluated. Once again this is an example of an innovative approach to improving our futures by a private company that was started because they saw the need for third party independent evaluation of our retirement plans. Remember this is information that Wall Street does not want you to know and they spend million and millions each year fighting full disclosure with their lobbing efforts.
