“Pick a Great Game and Keep Your Butt in the Seat”

Behavior Matters

At Ark Advisors LLC we have been educating clients about the downfalls of hanging out with Retail Investors” for many years. Sometimes we forget how much protection we provide clients without ever thinking twice about it. Earlier this week I was reading an Investment News article about the number one family of retail funds by volume; American Funds. The article talks about the massive exit by retail investors of over 24 Billion dollars; that’s right Billion with a “B”. These mammoth actively managed funds that try to maintain high returns while investors bail is like an aircraft carrier attempting a U turn. We have been telling our clients for years that the mass population will normally do the wrong thing at the wrong time and sure enough here we go again. With over fifteen percent of the fund cashing out the managers are forced to hold extra cash and liquidate holdings they would like to hold. It always reflects in returns; as stated in the article Growth Fund of America has underperformed its group by over 5% for one year and underperformed its group by over 2% per year over three years. This is happening with several American Funds and other retail funds throughout the country. If you combine this with DFA funds out performing its groups by 1-3% you end up with a 3-8% spread on overall returns.
I compare this behavior with DFA investors and we find that the opposite is true. DFA investors are disciplined, diversified and behave as professional investors would. I can remember when I went to DFA training in Chicago and they used the hockey analogy to explain investment discipline. If you show up for the game fifteen minutes late (miss the first goal) and during a bathroom break (miss the second goal) and actually find yourself in your seat for the final goal; you are going to have a much different experience (outcome) than the person in front of you that happened to enjoy all three goals. We never want to be caught out of the market when a goal is scored and we never know when the next goal will be. If we pick disciplined low cost funds and diversify the risk, we should end up with a successful investment experience. Just think how many times you have witnessed fans leaving the stadium just in time to miss the greatest comeback in franchise history. These fans get stuck listening to the end of the game while stuck in their parking space.
This is the reason we use DFA funds within “The Cambridge Plan”. I can remember during 2007 and 2008 when the financial worlds were crumbling; inflows into DFA funds were positive. It’s like your parents always said “It’s who you hang out with that matters”. Remember; hang out with institutional investors and keep your butt in your seat.

Upgrade to “First Class”

The SIMPLE has been compared to having the middle seat on an airplane. Flying is a much faster way to travel long distances than driving, but it’s just not as good as having the window and definitely not as nice as flying first class. The SIMPLE IRA’s name is a bit misleading (it actually stands for Savings Incentive Match Plan for Employees). While both employer and employee can contribute to the plan, the employer must match and matching is vested immediately. Also, the employee contribution limit is set at $11,500 for 2011 and catch-up for those over age 50 is only $2,500. Also there is not a Roth option, loans or annual contribution increases. Almost all current SIMPLE contributions end up in expensive Retail Funds with individual accounts in actively managed funds many times with up front loads. SIMPLE’s also carry a 25% penalty if withdrawn within the first two years and you are not allowed to contribute to both a SIMPLE and 401(k) within the same year.

Since the SIMPLE already demands matching; it has already overcome the major stumbling block for the employer joining “The Cambridge Plan”. With that taken care of we can upgrade the client to first class (The Cambridge Plan) in most cases for less expense and pick up all the benefits of flying first class. Roth (many employees will be better off funding their portion of savings on a post tax basis including high income earners) and Loan options. Automatic annual increase using institutional portfolios tied to age based glide paths with potential of extended vesting schedules. On top of all these benefits each employee has the option of increasing their total contribution to as high as $22,000 for employee’s over age 50 from just $14,000 within the SIMPLE. Employees under age 50 can contribute $16,500 vs. $11,500. Ask each and every small business if they would like to upgrade to “First Class”.

SEPs; The Good, the Bad and the Ugly

Last month we talked about how a SIMPLE was like flying from coast to coast sitting in a middle seat instead of first class. After thinking about it I realized I was completely wrong. Both first class and coach arrive at the final destination with the same success rate and this is absolutely not true of The Cambridge Plan and the SIMPLE and certainly not true of this month’s topic the SEP. There are too many problems with a SEP for most of the employees to arrive successfully at their final destination (Retirement with Dignity). Let’s start with only an employer contribution; that’s right no employee contributions. No Roth option or profit sharing option, and no catch-up if you’re behind. Forget about automatic salary deferrals and escalating contribution levels over time. Probably not using Institutional funds or any type of model portfolios. Most of the time invested in “Retail” loaded funds. With all these deficiencies’ there’s no wonder why we can’t safely get to our destination. As you can see it would be a much better analogy to compare a first class flight “The Cambridge Plan” with attempting to fly across the United States in a glider. Statistics I’ve read indicate that less than 7% will successfully navigate the retirement dilemma with a standard 401(k) where they can contribute; I would love to see the statistics on SEPs.

As many of you are aware; we have discontinued the monthly training sessions on “The Cambridge Plan” but we are still available to help and support on any individual cases you may run into throughout your year. We have found that both CPAs and accountants are very receptive to the idea of discussing and upgrading their clients SIMPLE, SEPs and Profit Sharing Plans. This is a big win for the CPAs in front of their clients but in most cases need to be educated on what a MEP is and how it can help their clients. Take a CPA to lunch and have the talk. It works.

“American Workers Short on Retirement”

The Wall Street Journal published an excellent article last Saturday focusing on the shortage in retirement savings for the age group between ages 60 and 62. These are the pre-retirees that hope to retire within the next 5 years. Their findings are that this group is about 75% short of their needed amount within their 401(k) s. The typical household was earning $87,700 and the assumption was they could retire on 85% of this amount for a total retirement need of $74,545. I find this to be a false assumption since most households can’t or won’t accept a 25% drop in income and expenses unless it is forced on them through job loss or disability. The article goes on to explain the average employee in this situation has under $150,000 in their 401(k) when in fact they would need $636,000 to bridge this gap. Remember the gap already assumes a 25% drop in income and expenses and confirms that the average employee has accumulated approximately 3 years of income when they typically need a minimum of 8-10 years of income.

We have a crisis on our hands that we are not yet addressing with the level of urgency that’s needed to create viable solutions. Our current retired population is much different than our next retired generation. My parent’s generation retired with monthly pensions, paid off homes and very little consumer debt; if any. The baby boomers are a whole new dilemma. Most don’t have a pension and many carry large mortgages well into retirement. Many have most of their money in their 401(k) s and all of this money will be taxed when withdrawn.


There is plenty of blame to go around about who is responsible for this future financial crisis. Just imagine 100 million retiree’s running out of money and dignity; well this isn’t totally true because 8% are estimated to be on track. An 8% success rate tells me that it can be accomplished even within the current less than perfect system, after all, what one man can do another can do. We must learn about the behaviors and attitudes of the most successful savers and incorporate these characteristics into our retirement system while drastically improving the quality of the investment experience by creating low cost and efficient plans. Many of these traits and behaviors can be automatically built into the plan to nudge us in the right direction using technology. In my travels I view this as a joint effort between the companies and the employees. In almost all cases I see inferior, high cost and inefficient plans that are run by employers and HR Departments that are not trained in result based retirement plans. They tend to be complacent and thrilled to have a plan no matter how bad it might be and once they own it they tend to defend it for years. On the other hand, we have employees that must figure out how to mirror the 8% that have successfully funded their retirement plans. These behaviors are things like; signing up early and regularly increasing their savings amount. They choose low cost, diversified portfolios within their plan; they don’t spend their accounts when they change employers and rarely use loans. The best state of the art plans have automatic sign-up at certain percent of income with annual increases of 1 -2 % per year until you reach a maximum savings rate. They also provide professionally managed accounts so the employees can choose risk adjusted portfolios instead of trying to assemble and manage a portfolio using expensive and normally high turnover funds. I hope we begin to take these warnings to heart and start to ask; “What can I or my company do to improve our Retirement Outcomes?” Just Ask!

A Retirement Fix for Almost Everyone

By Mark Folgmann

Just 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.

“Going Forward” What Should I Do Now

By Mark Folgmann

A 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.

“Fee-Based or Fee-Only” They Are Not the Same

By Mark Folgmann

The 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.