Smart401k Blog

Last week, we conducted some focus group sessions to see how people who didn’t know anything about Smart401k reacted when presented with our website and our service.  What was unique about this group from our perspective was that they didn’t ask to find out about our service – we were coming to them to gauge their reactions and understand their needs and values regarding retirement savings and investing. 

We learned a lot, and not only about the strengths and weaknesses of our website and how we describe our service.  We also learned that people have different perspectives about what the most important things are you can do when saving and investing for retirement. 

Instead of just telling you what our focus group thought, or what we at Smart401k believe the best practices are, we’d like to ask you what you think – In your words.   Just tell us what you think are the three most important actions you can take to positively impact your retirement savings investments and why.   At the conclusion of the survey we’ll send a  $50 Starbucks Gift Card to the person who gives us the best response (in our opinion).

In addition, we’ll put a selection of the responses as comments to this blog entry.  Let us know if you don’t want us to publish your name and we’ll be sure to exclude it before posting your response.  If you are more comfortable just emailing us your response rather than commenting on this blog entry, please send it to info@smart401k.com. 

We’ll close this contest/survey on Monday, September 22nd and send out the Gift Card shortly afterwards.  Thanks, and good luck! 

As part of a well diversified portfolio, we feel most investors should have some exposure to international funds.  There are several different types of international funds to select from.  From my experience talking to investors, it appears many are unsure of the differences between the different types of international funds. For example, if I asked my family or friends, whom I would consider similar to the average investor, to tell me what the differences between a world stock fund, foreign fund and emerging market funds are, they would be hard pressed to do so.  Yes, they are all international funds, but each has an entirely different investment strategy.  Today I hope to help you (and hopefully my friends and family) understand the differences between these types of international funds.

Foreign Funds: These funds have the ability to invest in companies from across the globe and will have little to no U.S. exposure.  The fund manager is basically given free reign to select any company from across the globe (minus the U.S.) that fits his or her fund’s investment strategy.  This gives the fund manager a great deal of flexibility, which typically results in greater diversification than the other international funds.  Just as domestic funds, foreign funds are categorized by the size and type of companies they invest in.  For example, you will often see foreign funds labeled as large value, large growth, small/mid cap value, etc.  As expected, investing in foreign funds that invest in smaller companies will have a higher risk level than one that invests in larger companies.  Since foreign funds offer greater diversification and don’t typically include U.S. companies in their portfolio, we like to recommend them for our clients. 

World Stock Funds: What sets world stock funds, also known as global funds, apart from other international funds is the fact that they will invest in stocks or bonds throughout the world, including the U.S.  The confusion comes from the fact that when we think of an international fund, we think of one investing solely in foreign based companies.  Since a world stock fund can invest in any company from any part of the world, it’s very important to understand where their investments lie.  For example, Third Avenue Value Fund (TAVFX) and Janus Worldwide (JAWWX), two funds with world or global focuses, have dramatically different levels of exposure to international equity.  The Third Avenue Fund has 58% of its portfolio in foreign stocks while Janus Worldwide (JAWWX) has 58% in domestic stocks and reinforces the importance of knowing what’s in the fund.  Based off these figures, I would not consider either of these a true international fund.

Emerging Markets Funds: By definition, an emerging market fund is a mutual fund that invests primarily in a single developing country or a group of developing countries. For the most part, these countries are in Eastern Europe, Africa, the Middle East, Latin America, the Far East and Asia.   Typically the developing country is characterized as being vulnerable to political and economic instability, having low average per-capita incomes, and of being in the process of building its industrial and commercial base.  Emerging market funds are very volatile because of all this instability, and if you are considering one for your plan, it should only make up a tiny fraction of your account (possibly as a compliment to another international fund.)  It is very important that you understand the risk associated with an emerging market fund and are willing and able to handle potentially large swings in the value of your account.  An emerging market fund is not for everyone. 

Regional or Country specific funds:  As the names imply, these funds will concentrate their holdings to one area of the world.  Since these types have a concentrated holding, the risk associated with them is greater.  Region and country specific funds allow you to control your international exposure and where you want to invest; however, it will also require substantially more work to diversify your investments across all international regions.  If you see yourself as a savvy investor with time to put in the research, these types of international funds might be for you since you can control what regions you’re invested in.  However, if you don’t have the time to put in for the research or have any doubt what so ever in your selections, we would not recommend going this route. 

With any type of fund, there is always risk associated with it.  Typically, international funds have a greater level of risk associated with them.  However, for most investors a well diversified portfolio will include a small amount of exposure to international funds.  It is very important to understand the different types of international funds for your selection process and I hope I have shed some light on the topic.  Now my Dad better not have an excuse when I ask what the differences are next week.  As always, if you have any questions, please feel free to call us at, 1-877-627-8401.

Jeff Studebaker, Investment Advisor

For this week’s article, I want to start out by thanking everyone for their questions and comments regarding our investment articles. Based on your feedback, I thought it would be helpful if I did another investment definition; and this week I will cover sector funds.

As their name implies, sector funds are mutual funds that invest in a particular sector of the market. For example, Fidelity Select Health Care invests only in health care companies. The idea behind these funds is to allow investors to bet on specific sectors of the market. Sectors funds can give you access to a manager that only focuses on that particular industry or country which can work to an investor’s advantage.

They are more volatile and carry more inherent risk since they are focused investments. This focus can magnify your gains and losses. For example real estate stocks averaged 25.9% from 2003 through the end of 2006 compared with S&P 500, a common benchmark for the overall market, which averaged 12.5%. This changed last year as real estate stocks underperformed the S&P 500 by 20.1%.

Sector funds can serve a unique purpose in a diversified portfolio. They can provide diversification within a specific industry or country with a limited amount of investment. Sector funds can serve as a hedge as some industries do well during different parts of the business cycle. For example, stocks of companies that produce products such as toothpaste and paper towels do well during bear markets because these are products that consumers buy regardless of how the economy is doing.

Typically we do not include sector funds in our recommendations due to the focus of their investments. However, if you do decide to invest in a sector fund, we recommend limiting your investment to no more than 5% of your overall portfolio to ensure you maintain your proper risk level.

If you have any questions, please feel free to contact us by email at info@smart401k.com or by phone at 877.627.8401.  Or, if you have any investment topics you would like us to help explain or define, please let us know.

Buck Wendel, Investment Advisor

It’s almost that time of year again – the time where you begin to trade your Sundays on the lake for some time in front of your TV, eagerly hoping that your favorite football team finally has a successful season.  Being a Chiefs fan for as long as I can remember, I’m not expecting good things anytime soon.  Luckily though, I am also involved in our work-sponsored fantasy football league, ensuring that my Sundays will almost certainly be unproductive for the next few months.   

For those who have not played before, the basic setup is you first draft your team and then each week you compete against one person in your league.  Scores are calculated based on the real performance of those players you select, and the person with the highest score earns a win for that week. 

In preparation for our draft last night, I realized that the process I took to decide which players I would pick was very similar to that of the investment selection process:

·       Do your research.  In fantasy football, you look at each player’s track record of success, whether they are working with the same coach, health status and their outlook for the season based on any other factors you know.  You should also research your investment options as extensively as you can, by looking at the fund type, past return history, manager tenure, performance outlook, etc.

·       The future is uncertain.  Because you do not actually know whether your picks will be good or not, you manage your risk as much as possible by making informed decisions.  Remember that past performance does not guarantee future results in either situation; you shouldn’t pick a player based completely on last year’s performance and you shouldn’t just select a fund based only on recent returns.

·       Monitoring your selections is important.  Just as you need to make sure your players are healthy and performing in fantasy football, you need to also periodically evaluate how your investments are doing.  We recommend doing this once every quarter.

·       You will inevitably make mistakes and there will be some surprises.  What seemed like a fool-proof pick early in the season may turn disastrous later (e.g. your star player gets hurt); or maybe a relatively unknown player has a career year and unexpectedly gives one owner a huge boost.  Maybe you mistakingly drafted your quarterback too soon, which left you with lower quality picks later.  The same is true with picking investments; some things could have been prevented, and others are completely beyond your control. 

What looked like a solid investment when you picked it may suddenly take a big downturn, or an unproven investment takes off and becomes your portfolio’s biggest star.  Perhaps you became overly aggressive when the markets were doing well, and have now experienced huge losses during the downturn.  The important thing is that you learn from previous experiences and make changes that are appropriate for your situation.

And I could go on… but remember that this is an ongoing process.  Proper investing requires some attention periodically to make sure you stay on course with your current goals and objectives. 

The last connection I want to make is one major diffence between the two.  From past experiences, and all the message boards I’ve read leading up to our draft, my conclusion is that people make more informed decisions and are more prepared for fantasy football than they are about investing.  Of course, I don’t know this for sure, but people are certainly more enthusiastic about it anyway.   There are also more accessible resources for draft-day strategies; you can print off a cheat sheet five minutes before your draft and still be pretty well-prepared to make some decent decisions (cheat sheets are prepared by fantasy football ‘experts’).  The same is not true for investment strategies. 

Even though you may know that investment selection is probably more important than something like fantasy football (or any hobby for that matter), it’s easy to understand that it’s not terribly exciting.  For those that are interested in making better investment choices, many do not know where to turn or how to even begin getting the guidance they need. 

A couple of basic sites that I suggest to get started are:

http://morningstar.com/

http://finance.yahoo.com/

These sites will allow you to research any publicly-traded funds that you have available in your retirement plan.  Look for funds with good track records, and be sure that the managers have been with the fund long enough to take credit for the past performance.  Also, pay attention to the types of funds you are looking at; you shouldn’t have too much exposure in any one single asset category.  There is no set amount of time you should spend researching your options, but the goal is to at least have a gameplan set in place before you start picking your investment options.

For those that are getting stuck at this point, or just don’t have the time necessary for this process, do not give up – the quality of your retirement may depend on it. 

If you find yourself looking at the list of funds in your work-sponsored retirement plan, and wondering how to begin building your team of investments, please consider allowing us to assist you.  We will put together a strategy that makes sense for you so your investment ‘draft’ goes as successful as possible.

 Kevin Jaegers, Senior Investment Advisor

Soon, 401(k) investors will begin receiving quarterly statements to summarize the performance of their retirement account. The first thing many investors look for is the rate of return, and rightly so, it directly impacts the amount of money available for retirement. Investors also understand that the amount of risk they take will impact the returns they experience. For this reason, more focus should be paid to managing risk, rather than managing returns.

The fundamental method of risk management is in the asset allocation decision, which involves the process of deciding how money should be allocated between asset classes – stocks and bonds, foreign and domestic holdings, and large caps versus small caps. This decision becomes increasingly more important in volatile market environments.

The appropriate investment strategy is influenced by many factors, such as: investing time horizon (how long the money is invested), and the investor’s objectives, goals and risk tolerance. It is important that these factors are decided upon before making any long-term investment decisions. If you find yourself struggling with this step, it is important that you get some help.

The purpose of this article, however, is to evaluate what to do after this step. Before we proceed, please understand that from this point forward, the assumption is that you have already completed this thorough process.

Once you have decided on the right mix of asset classes for you at this particular moment, it’s always a good idea to revisit your account on a periodic basis. We suggest four times a year, once per quarter, to make sure that your allocation doesn’t move too far from the intended target.

Overtime, if left unchecked, your balances in each of the asset classes will stray away from the initial target allocation as the various sectors of the market perform differently. For example, let’s say you start with an allocation of international funds at 15 percent two years ago. This asset type has performed well over this time period, so now it makes up 20 percent or more of your total portfolio. The result: you now are more aggressive than you intended to be, and the risk builds that the well-performing sector may revert back to its historical mean return. A great resource for how asset classes have performed over time is shown in The Callan Periodic Table of Investment Returns:
http://callan.com/research/institute/download/?file=periodic/free/256.pdf

This chart shows the annual rank and return of each asset class from 1988 to 2007. Notice that the top performing asset class for the past three years, the “MSCI EAFE” (international) index, was also the worst performing asset class in seven of the 13 years from 1989 to 2001.

The idea here is that no one asset class is always the best performer, or even a good performer. I know it’s hard to sell an investment that’s doing well, but essentially you are selling high and buying low when you take this approach. According to findings from DALBAR’s study of Quantitative Analysis of Investor Behavior (QAIB), the average investor’s return is far less than the S&P 500 index return, which is in large part due to unsuccessful market timing. This shortfall is often caused by the tendency to gravitate towards areas of the market that have the best recent (short-term) performance.

Lesson learned: Be diversified across major asset classes, continue to invest in all market cycles (dollar-cost averaging) and periodically rebalance the account to make sure that your investments stay aligned with your long-term investment strategy. Some plans are now offering an automatic rebalance feature that lets you select the frequency your account is reset back to the original allocation. One word of caution with this feature is that you don’t completely forget to look at your account again, and remember, that you must take prudent action to decide how the investments should be allocated in the first place.

Managing your own investments can be hard sometimes, especially in periods of high market volatility. We think you will have a lot more success, and will rest much easier, if you follow this systematic approach to investing. A sound investment strategy and rebalancing schedule will be your guide, rather than letting fear and emotion lead you to an inevitable journey of irrational decisions.

If you feel you need help with this area of your investment strategy, or at least want a second opinion, please give us a call at (877) 627-8401.

Kevin Jaegers, Senior Investment Advisor

A customer wrote us yesterday and told us that they didn’t need our advice right now because they had pulled all their money out of the market and put it into the money market fund in their account. While this is not the first time this has happened, it still bothers me a great deal whenever I hear about it.

There are certainly very legitimate reasons to move your retirement money into a cash-equivalent investment like a money market or stable value fund.  When you don’t have the time to ride out shorter-term ups and downs of the market, you may need to get more conservative with your money.  But the more frequent reason people pull out of the market is flat out nervousness.  Many people that get nervous about the markets are tempted to pull their money out before (they think) things could get worse.  When the market starts to go back up, the plan is to jump back into their original investments, reaping the rewards of future market gains. 

Well, I’m here to tell you two things: 

1.  Pulling out of the market whenever you fear further declines is a form of market timing

2.  Market timing is extremely risky and can easily cost you tens of thousands of dollars if your timing is off the slightest bit.  Read on to get the facts. 

Goldman Sachs Asset Management did a study that looked at market returns as represented by the S&P 500 Index from 1986 to 2006.  Here is what the data shows:

Stay invested in all 5,297 days of this study period, and the annual return is 12.12%

Miss the 10 best days and the annual return is 8.56% – a difference of 3.56% per year.

Miss the best 40 days and the annual return drops to 1.87%.

Miss the best 70 days and the annual return drops to -3.02%. 

As the data above indicates, if you are out of the market only a handfull of key times, your returns can be severely impacted.  What does this return difference mean in terms of dollars in your account at retirement?  Let’s say you just missed the 10 best days over the above 20 year period, saved $400 per month for all of those 20 years, and had a return on your investments of 8.6% (rounded for our calculator) per year.  You would have $254,500 after the 20 years.  Under the same assumptions, except if your return were instead 12% per year (rounded for our calculator), you would have $ 399,700 – a difference of over $145,000 (these are before tax numbers).  And that’s only 10 days! Imagine if you had missed the top 70 days, just over 1% of the days covered in the time period, and lost money! 

Given these numbers, is it really worth the risk of going in and out of the market?  We think not.

-Scott Revare

The returns listed are based on the S&P 500 Index, which is the Standard & Poors’ 500 composite stock price index of 500 stocks, an unmanaged index of common stock prices. The index figures do not reflect any deduction for fees, expenses or taxes.  Past performance is not indicative of future results.

I read a report today from the Employee Benefit Research Institute (“EBRI”) that stated Americans have become more worried about the state of their retirement savings than they have been in the past. In fact, the number of people who are very confident that they will have a comfortable retirement dropped by about a quarter since last year to 27% (the largest drop in the surveys 18 year history). A lot of this is probably related to the current state of the economy and people’s uneasiness with the market. However, a number of things jumped out at me in the article that reinforced the need to build a nest egg now rather than in the future.

According to EBRI, 49% of surveyed individuals have less than $50,000 saved for retirement, and 28% have no retirement savings at all (if you exclude the value of their primary residence and defined benefit plans). This in and of itself is alarming, but what I found more alarming is what people believe to be an adequate amount of savings. According to the survey, 25% of individuals think they need less than $250,000, and an additional 16% of individuals believe they need $250,000-$499,000 in retirement savings. Now, I can’t say for sure whether they are right or not, but it seems awfully low when you consider things like increased life expectancy and rapidly rising healthcare costs. In addition, less than half of those surveyed had actually gone through the steps of estimating how much they’ll need in retirement (with a calculator or a financial advisor). Of those that did take the time to calculate their need, almost 50% made changes to their retirement planning (the most frequently cited change was to either start saving or to invest more).

It probably doesn’t surprise you that retirement savings is at the top of my mind, but what might surprise you more is that for most people it isn’t even in the top six of most pressing financial issues. It ranks behind things such as cost of living, insurance costs and paying down debt which are all important things. So you might be wondering what you can do to start building your nest egg without impairing your ability to live and pay the bills.

First, I would suggest calculating how much you might need to live how you want in retirement. This will show you how close or far you are from your retirement goal. If you want to experiment with the calculation you can try one of our calculators at http://www.smart401k.com/Calculate.aspx (I’d suggest using the calculator titled – Are My Current Retirement Savings Sufficient?). Its generally believed that you need to replace 70-80% of your pre-retirement annual income to maintain your current lifestyle. If you’re like me and want to travel the world, you might need as much or more than your current level of income. I also found it interesting to play around with rates of return on your pre and post retirement savings and number of years you’ll spend in retirement.

Next, I’d look at what you can do to make your retirement more secure. The easiest and probably most painless way to increase your savings is to increase your contributions to your 401(k). I wrote a previous post about what increasing your contribution by 1% can mean to you at retirement (“How much is a Latte Worth?“) … so give up that latte already! Then I would check to see if your plan has an auto-escalation feature, and if so, I would set it up so that your contribution increases by 1% a year. This will enable you to increase the amount you are saving without impacting your lifestyle (as long as you get a raise of more than 1% a year you won’t even notice the change). If you can do more than 1%, then do it, it’ll pay off in the future when you’re enjoying your retirement.

Scott H

Source: Employee Benefit Research Institute: The 2008 Retirement Confidence Survey

As I was waiting for my latte this morning, I began to wonder what it was worth to my retirement…..

• If you‘re 30 years old or younger it could be worth more than $60,000….
• For someone with at least 25 years until they will need the funds, it could be worth more than $25,000….
• And for someone with at least 15 years until they will need the funds, it could be worth almost $10,000….

You might be saying, “Wow, that’s a lot of money, but I just can’t alter my current budget?”

Well, you could start by drinking one less latte a week.  Increasing the amount you save in your 401(k) by $25 per month or less than $4.50 per week in take home pay (using a 30% combined tax rate) could help you build an additional nestegg for your retirement.

• For example, if you make $30,000 a year it would mean investing just 1% of you salary into your 401(k) plan. At $50,000 a year you would only need to defer slightly more than 0.5% of your annual salary.

What’s our point?  One of the most common statements people make is that they can’t save any more money or that increasing their deferral amount won’t be worthwhile.  Well, if you can skip one latte a week, you will be in a better place for your retirement.

Scott H

Methodology:  This example is for illustrative purposes only.  We used an investment schedule of $25/month, a tax-deferred account and an 8.5% annual return (this return does not represent the return of a particular investment option) to project the account balance

Questions about company stock are some of the most frequently asked by our clients, and in light of the recent events involving Bear Stearns (NYSE: BSC) and JP Morgan (NYSE: JPM) we thought we would remind you about the importance of diversification and the risk of holding a large percentage of your retirement assets in your employer’s stock.  I, like many of you, have been reading about the troubles at Bear Stearns and its recent acquisition by JP Morgan. What caught my eye was that almost one-third of the company’s stock was held by employees of the firm. After digging a bit more, I found the following statistics that surprised me (Source: Hewitt Associates & Employee Benefits Research Institute and the Investment Company Institute): Â

• 40% of employees have at least 20% of their 401(k) in their employer’s stock.
• 16% of employees have more than 50% of their account in their employer’s stock.
• 9% of employees have 80% or more of the 401(k) assets in their employer’s stock.

There are several reasons often cited for holding significant amounts of company stock, including the following:

• Many employees feel their company’s stock is safer than a mutual fund.
• Employer matching contributions often come in the form of company stock.
• Employees want to invest in what they know.

However, our belief, and the message we communicate to our clients, is that if you do decide to invest in your employer’s stock, you should limit your holding to no more than 10% of your overall account balance. This will provide you with exposure to your company’s stock, but also give you the opportunity to properly diversify your account.  If you hold more than 10%, you may want to consider rebalancing your account to increase your account’s diversification.

As a reminder to our clients, we advise you to revisit our risk tolerance questionnaire at least once a year to determine whether your recommended allocation properly reflects your current situation and risk tolerance.  If you have any questions or comments, please feel free to contact us at 877-627-8401.

Buck Wendel, Investment Advisor

As the economy has slowed recently, more and more people are taking loans from their 401(k)s.  While we generally believe that you should avoid taking a loan from your 401(k) we understand that there are times when it makes financial sense.  The main points of the article are summarized below and we have also included a link to the article on MSNBC.

Key Points

• You pay the loan back with Post-Tax dollars while the original contributions were Pre-Tax dollars.
• The maximum amount you can withdraw is $50,000 or 50% of your account value, whichever is less.
• If you leave your employer the loan immediately becomes due.
• If you fail to make the required payments or do not repay the loan in full when you leave your employer your loan will be considered to be in default.  If this occurs you will have to pay a 10% early withdrawal penalty and income taxes on the defaulted amount.

http://www.msnbc.msn.com/id/23241606/

Please let us know if there are issues that you would like more information on or if you have a question about your account that you would like us to answer on the blog.