Smart401k Blog

As many of you probably do, I read the Wall Street Journal as often as possible.  Last week, I read an article detailing how West Virginia had recently switched back to a pension plan from a 401(k).  I initially focused on the article because “401(k)” was in the title, but became more interested as I read about the issues that brought about the change of heart.  Upon finishing the article I was both concerned for those adversely affected and reinforced in my belief of the importance of impartial, unbiased advice for participants.

Let’s start with a quick recap.  The state of West Virginia switched to a 401(k) because like many employers they were facing continually increasing costs from their defined benefit (”db”) plan.  When they decided to switch to a 401(k) they instituted a generous employer contribution of 7.5% vs. the most common private sector match of 50% on the dollar up to 6% of an individual’s salary.  The plan offered stock and bond mutual funds, a money market fund, and an annuity.  Seems like a pretty good set-up… right? Well, besides the fixed annuity part, but that’s a personal opinion.

So what went wrong and forced the state to switch back to a defined benefit plan?

First, the state actually lowered the amount employees were required to contribute to the plan (6% in the db plan and only 4.5% in the dc, or defined contribution, plan).  A large employer match is great and certainly helps individuals prepare for retirement, but lowering the required contribution each individual had to make seems a bit odd to me.

Second, the plan had a fixed annuity option.  I imagine there are situations where a fixed annuity makes sense for an individual. However, I struggle to think of a reason why almost 2/3 of plan assets should be invested in one, which according to the article was reached at one point during the plans existence. (If you want to learn more about annuities, check out our Primer on Annuities) 

Now while I don’t understand why you would invest in a fixed annuity in a dc plan, I do understand how it happened.  The story mentions that Valic (the company that offered the fixed annuity) sent in salespeople to talk about the annuity.  In fact many of these salespeople were former educators and school employees.  While I’m all for knowledgeable advisors working with participants to build appropriate investment plans, I have a problem with individuals who are “not authorized or directed to give investment advice” but who are “… only authorized to sell a fixed-annuity contract.”  Inherently, this relationship is going to be rife with potential conflicts.  First, a salesperson is incented to sell a product.  Second, if you are a knowledge resource shouldn’t you be able to talk about other investments or the pension plan as a whole… especially in something as important as retirement investing?

So what does this mean?

I urge everyone who reads this post, no matter if you are a participant or employer, to do the research necessary to select appropriate investments.  Or if you aren’t interested (or don’t think you have the knowledge) please consider using an advice provider.  I’d love for it to be Smart401k, but would find it gratifying simply to know that you are taking control of your investments.

If you are an individual and want more information on Smart401k click here or contact one of our advisors who are authorized to provide advice.  If you’re an employer and want to know more about how we can strengthen your plan and educate your employees click here to request more information.

If you have any questions or comments, feel free to post of comment to this article or call us at 1-877-627-8401.

Till next time…

Scott H

Full Disclosure: My knowledge about the situation is entirely contained with the WSJ article “When 401(k) Investing Goes Bad” that was published on Monday, August 4, 2008.

In the headlines

A look at some of the market movers over the past week:

• Oil continued to fall this week as concerns over US demand grew and the dollar strengthened
• New factory orders were up more than economists expected
• Results from Freddie Mac (NYSE: FRE) were much worse than expected
• Fannie Mae (NYSE: FNM) wasn’t looking any better
• Bond insurer Ambac (NYSE: ABK) reported a loss and drew the ire of analysts
• The Federal Reserve decided to keep rates steady at 2%
• Cisco (Nasdaq: CSCO) expects tough times ahead, but investors were happy nonetheless
• The non-manufacturing business index from the Institute for Supply Management showed contraction in July, but is moving in the right direction
• Comp store sales from Costco (Nasdaq: COST) beat estimates, while Wal-Mart’s (NYSE: WMT) were decidedly less positive
• Citigroup (NYSE: C), Merrill Lynch (NYSE: MER), and UBS (NYSE: UBS) are all buying back auction rate securities
• July retail sales disappointed investors
• Jobless claims hit a high, while pending home sales surprised to the upside
• Lower insurance premiums and an unrealized derivative loss at Berkshire Hathaway (NYSE: BRK-A) brought down quarterly results

Commentary

The bulls won a tough tug of war this week and the S&P 500 tacked on nearly three percentage points despite significant down days on Monday and Thursday.

If you’ve been following the market in recent weeks, the playbook hasn’t changed. Investors are still focused intently on the earnings results from financial and retail companies, changes in commodity prices, and everything that says anything about the direction of the economy.

We fared well this week for a number of reasons. Though results from the likes of Fannie Mae, Freddie Mac, and Wal-Mart weren’t particularly good, it’s arguable that they also weren’t as bad as they could have been. Meanwhile, oil and other commodity prices continue to decline. Though it’s unclear whether this is a short correction or the popping of a bubble, investors have been taking it as a good sign all the same.

And while the good news isn’t exactly pouring in on the economy, the economic reports coming out at least appear to be mixed. That doesn’t say that the threat of further economic contraction is behind us, but it at least confirms that we’re not hurtling downward into the abyss.

Looking ahead

I talked a little bit last week about why it’s not worth your time to lose sleep over short term market fluctuations. Building on that a bit, I thought I’d spend a moment talking about why it often makes sense to turn down the volume on the media.

In the end, the media does make information convenient. They (hopefully!) find primary sources that provide useful information and then they put it in front of us in a very readable format. Unfortunately though, the facts are often gelled together with writing that’s intended to not only make the article more interesting, but also to draw readers away from other news sources.

And how do media companies try to draw readers away from competitors? By trying to make the news as exciting as possible. The headlines are all too familiar — every down day on the market is a “plunge” and on every up day the market is “soaring.” A headline from FOXBusiness on Friday read “Olympic-Sized Rally: Dow Soars 225 Points.” Sounds good, but it was only a day earlier that Briefing.com thought things looked bad enough to run a headline “Barrage of Negative News Sinks Stocks.” Of course if you tuned in to Forbes on Tuesday, you might’ve seen “Street Heats Up After Fed Stands Pat.”

I’m all for excitement, but I prefer to get it from TV, movies, and outdoor sports — not my investments. So what’s the solution? You don’t have to throw out your newspapers and erase the news bookmarks on your browser. However, you’ll find it much easier on the stomach to read financial news if you remember that news sources are trying to excite you and get your emotions going while they are also conveying information.

On that note, there will be plenty of ammo for news outlets in the coming week. Earnings will continue pouring out, with many of the all-important retail companies reporting during the week. On the economic side, retail sales, consumer price index, and the consumer sentiment index will likely have the biggest impact on the markets. CPI in particular will be notable as it will have implications for how quickly the Federal Reserve will start raising interest rates from the current 2% level. Moderating energy prices should help stem the growth in total CPI.

As always, a steady, consistent investment plan is the best way to go. You won’t find many in the media espousing such an approach because without constant excitement around the stock market many of these outlets would be out of business. So feel free to continue following financial news, but leave the excitement to Jack Bauer and Chuck Norris.

I’m now about three months out from the marathon which means that I’m in the heart of my training schedule. 

So far, my longest run has been 14.1 miles.  I’m currently dealing with the humidity of a Midwest summer (I moved from the San Francisco area about a year ago which has a far milder climate) and as a result have made a number of adjustments to my training regimen. I’ve been told that the best way to train is to get up in the morning before the humidity and heat hit their peak.  Unfortunately, I have a bit of an issue with waking up in the morning. Despite the best of intentions, I always seem to start my run as the heat and humidity are peaking.  After this Sunday, I think I may have finally have the motivation to change my ways.  I ended up running outside for a little less than an hour and then finishing inside on the treadmill.  I realized that it was probably counterproductive for me to run outside if I was going to subject myself to the worst part of the day.  While I usually run indoors once a week (a quick thank you to whoever mounted a TV on workout equipment), I really don’t see myself having the patience to run for more than an hour on a treadmill.

The other changes that I’ve made so far are to buy another pair of shoes (unfortunately, I bought the wrong size the first time and only found out on my long runs), increased my caloric intake and have added a fourth day to my running schedule.   I switched back to my now trusted Mizuno’s after realizing that my other pair was a bit small when my feet swelled on the longer runs.  Other than the cost of buying another pair of shoes this was the easiest thing to fix so far.  I have learned that a proper pair of shoes is equivalent to having an investment allocation that fits your personal situation (i.e. one of the most important pieces of any training or investment plan).  I wish I wouldn’t have had to deal with the blisters to realize the mistake, but you live and learn (plus, now I know all about New-Skin).

After bonking on a couple long runs, I realized that I needed to increase my calorie intake to more properly fuel my body.  In addition, I added a fourth day of running to increase the mileage that I am putting in each week in an effort to strengthen my legs and get used to the pounding your body takes from distance running.

So how does all of this relate to investing? 

First, as I mentioned in my first blog article, without a plan and the tools to pursue that plan you the likelihood that you won’t reach your retirement goals on time. 

Second, although I don’t advocate making significant changes to your retirement investment plan on a regular basis, I do believe in monitoring your plan in relation to your goal and making small adjustments when you discover they are necessary.  Changes could be as simple as reviewing your account on a quarterly basis and updating your contribution elections to match our recommendations or they could be bigger like increasing your savings rate if you decide that you want to travel more than you initially thought.

And last but not least…. Educate yourself!  I feel like I could have avoided most of these mistakes if I invested more time upfront to learn about the common pitfalls of marathon training.  I’ve been working out for a long time, researched a number of different training schedules and examined several training related diets, but I could have easily taken it a bit further.  This is all to say that there is always more to learn no matter how knowledgeable you are on a subject.  You’ve taken the first step by reading this blog.  The next step could be checking out our Insight articles.  After that, you might want to check out some of the sites that we have recommended here.  And as always, our advisors are here to answer any questions you might have regarding our advice or investing in general. 

Thanks again for tuning in… I’ll make sure that the next post doesn’t take so long.

Scott H

P.S.  Ed, thanks for the tips.  I’m working on 3, 4, 5 and can’t wait for 6,7

In the headlines

A look at some of the market movers over the past week:

• KKR announced plans to go public via the acquisition of its publicly held European fund
• Unilever (NYSE: UL) announced the sale of its North American laundry business — which includes the Surf, Snuggle, Wisk, and Sunlight brands — to private equity firm Vestar Capital
• Investors were highly disappointed in the outlook from European airline Ryanair
• The FDIC found itself taking over two additional banks
• Merrill Lynch (NYSE: MER) announced two moves to continue trying to bail water from its balance sheet
• The White House lowered its economic growth forecast
• The SEC decided to extend its ban on naked short selling
• Wyeth (NYSE: WYE) and Elan (NYSE: ELN) took a hit as trial data from their Alzheimer’s drug candidate was not as conclusive as hoped for
• Though consumer confidence was up slightly in July, it remains at notably low levels
• Like many fellow large bank/brokerages Deutsche Bank (NYSE: DB) posted a steep drop in profits, but still managed to beat analysts’ estimates
• The US isn’t the only place where inflation is rearing its ugly head
• Jobless claims rose even more than economists had expected
• Increased joblessness led to the unemployment rate climbing to 5.7%

Commentary

The S&P 500 managed to stay just above flat for the week despite three down days out of the five. Monday started the week on a sour note as investors — particularly those that were starting to get bullish on financials again — digested the failure of two more banks. Tuesday came to the rescue with a gain of more than 2% as consumer posted a modest increase against the expectation of a decline.

Wednesday tacked on a bit more as oil prices and the ADP employment report weighed in positively. However, the balance of the week was spent declining. Employment, as measured by both the weekly initial jobless claims report and the monthly unemployment reading, highlighted the cracks in the economy.

Meanwhile, initial GDP readings for the second quarter came in well below what was expected. Though the 1.9% growth may still seem like a good sign, this quarter was expected to be higher due to the government’s tax rebate program. In addition to releasing second quarter GDP, readings on first quarter and fourth quarter 2007 readings were also revised down. Economists now believe that the economy grew at a 0.9% pace in the first quarter — down from 1.0% — and that it shrank by 0.2% in the final quarter of last year.

Though earnings were coming fast and furious during the week, they seemed to have far less impact on the market than the economic releases.

Looking ahead

Volatility continues, and that’s not what we want to see. A market that’s unsure of itself is a market that will continue to have us tossing and turning at night — if we let it.

However, if we break down the week’s market movements, we can emphasize why fretting about the day-to-day movements isn’t worth your time. On Monday, the S&P dipped nearly 2% on worries over financial companies, inspiring the talking heads to take off on a bearish charge. Tuesday and Wednesday, though, the market charged back largely on the stronger than expected consumer confidence reading, and by Wednesday evening the market was up over 2% for the week.

Thursday and Friday came along with renewed pessimism, this time largely over the state of the job market and peeled off 1.9% from Wednesday’s close. So at market close today, after the violent swings during the week, we stand at just about where we started. Considering that when we talk about the S&P index we’re talking about a collection of companies worth over $11 trillion, do the movements of the week sound like sober analysis by investors or gut reactions to whatever is in front of them at the moment?

There’s no reason to expect that the volatility will simmer down next week either. Earning will continue to pour out next and though we will have some major releases such as Procter & Gamble (NYSE: PG) and Cisco (Nasdaq: CSCO), I expect that the market will be less concerned with earnings until the major retailers start coming to the podium. That will start the week of the 11th and continue through the following week and will include everyone from Wal-Mart (NYSE: WMT) and Target (NYSE: TGT) to Nordstrom (NYSE: JWN) and Gap (NYSE: GPS).

What the market will be watching with eagle eyes next week is the Federal Reserve’s policy statement. The Fed meeting took on less significance the last time around because it was generally accepted that the Fed was done lowering rates and that it wasn’t ready to begin raising them yet. And when the market has a clear expectation of what will happen it tends to be much calmer.

This time around, though, there is somewhat less certainty. According to data from the Federal Reserve Bank of Cleveland, an overwhelming percentage of market participants believe that rates will be kept steady again. The probability of a 25 basis point rate hike is growing though and is looked at as an even greater probability in the September meeting, so the commentary, as well as the rate decision, will be watched closely.

It should be noted that rates are not the simple “down is good, up is bad” binary that they often seem to be interpreted as. Though lower rates are typically better for businesses and equity markets, the ability of higher rates to contain inflation is very desirable to keep the economy running smoothly. In addition, higher rates would almost certainly have a positive affect on the dollar and put downward pressure on the prices of oil and other commodities.

Since I’m not a clairvoyant and we aren’t a group that likes to make predictions — especially about short term events — we’ll have to wait and see what the Fed does. Regardless of the rate meeting outcome though, we still believe that retirement investors are best served by regarding the day-to-day market fluctuations as entertainment at most, and sticking to a steady, long-term oriented plan when it comes to investing their hard earned money.

I recently received an email inquiry from a client and wanted to share a little bit about our discussion with you.  The client had recently heard, from a friend, that it was better to use an advisor who worked on a commission basis rather than on a fee basis and wanted to know if we could refer him to someone.  I have to admit that I was surprised to hear the request, but then I realized there are probably a lot of people who don’t understand the differences between commission and fee based advisors.  I immediately called him to talk about the differences between a commission based advisor and fee based advisor.   

This biggest difference is that an advisor paid solely on commission is receiving a portion of the proceeds from selling you a product. This means they only make money if they make trades/investments on your behalf (unfortunately this means the more trades they make the more revenue they generate for themselves).  A fee based advisor on the other hand, is someone who gets paid on a flat hourly rate or other fixed rate schedule.  They don’t make money off what they sell you but rather by keeping you as a long term client (by keeping you happy). 

Another potential conflict of interest that exists for commission based advisors deals with the specific investments they recommend.  For example, if there are two funds with similar investment strategies and returns, but Fund A pays out at a higher rate than Fund B, the advisor faces the moral hazard of making money or recommending the fund that is likely better suited for their client. In the case of the fee based advisor this conflict doesn’t exist because they aren’t paid based on specific investments, but rather on whether they retain their clientele.

No matter what type of advisor you work with there are several things that, in my opinion, distinguish one advisor from another.  I have provided a few examples below to help you get started, but by no means is it an all encompassing list.

1) An advisor should take the time to learn about your personal situation, goals for the future and significant life changes as they occur.

2) They should have a way to evaluate whether you are a conservative or aggressive investor.

3) They should set expectations for how they will be paid, how oftenthey will communicate with you and how they will evaluate their performance.

Being a commission based or fee based advisor doesn’t automatically make you a good or bad advisor.  However, we do believe that the characteristics of a commission based relationship call for increased diligence on the part of the client.  In our opinion, fewer opportunities exist for a conflict of interest in a fee based arrangement.  After all, wouldn’t you prefer to be able to decide whether to continue to pay for a service based on your level of satisfaction rather than pay up-front and have no recourse if you aren’t satisfied?

At the end of the day, one of the most important aspects in an advisor/client relationship is trust (i.e. do you trust that they are looking out for your best interests).  Please enter any financial arrangement with caution and an informed perspective. Hope you guys find this helpful and as always, if you ever have any questions, please feel free to email us at, info@smart401k.com or call us at, 1-877-627-8401.

Jeff Studebaker, Investment Advisor