Why You Should Roll Your 401(k) to Your New Employer

September 19, 2016

When changing jobs, what should you do with your employer-sponsored retirement account balance? Our blog editor,  Erik Carter, JD, CFP®, recently wrote a post titled What Should You Do With That Old Retirement Plan, in which he stated that if he left an employer, he would be very likely to roll over his retirement account balance to an IRA in order to have access to more investment choices. Erik outlined a job-changing employee’s four options: 1) leave the money in the former employer’s plan, 2) cash out your account, 3) roll over your balance to a new employer or to an individual IRA or 4) purchase an immediate income annuity (if it’s a feature of your former plan.)

Option 3, rolling over your balance, is by far the preferable choice for the large majority of retirement savers. For most people, it may make more sense to roll their retirement plan balance to their new employer’s plan rather than an IRA. Here’s why:

Lower Fees

Many 401(k) plans offer participants access to institutional share class mutual funds and very low cost index funds, especially those sponsored by large employers. Conversely, investing in your IRA can get expensive if you aren’t careful to monitor the mutual fund fees, trading costs and account fees. Before you make your distribution decision, compare and contrast the fees for all your options, including leaving your account with your previous employer, rolling your balance to an IRA and rolling it to your new employer. Not sure which option offers you the lowest cost of investing, given the type of investments your want to choose? Use FINRA’s free mutual fund fee analyzer tool.

Keep it Simple

While it’s true that there is a broader universe of investment options in a self-directed IRA account at a brokerage firm or mutual fund company than in your workplace retirement plan, many investors don’t need or want that kind of customization in their investment strategy. Keeping your retirement plan balances in one place allows you to see at a glance the investment mix of your retirement savings and how much you’ve saved simply by logging on to one site. If you’re a more “hands-off” investor, a target date fund in your plan with a date near your target retirement can offer you an easy, diversified, one-stop-shopping investment strategy.

Protection Against Lawsuits

Balances in retirement plans, such as 401(ks), are protected against civil judgments and bankruptcy. (But if you owe taxes, your 401(k) assets can be seized to settle the tax debt – and you’ll have to pay more taxes and a 10% penalty if you take an early withdrawal to settle the bill.) The higher your income and/or net worth, the more important it is to consider this factor. However, depending on where you live, your state may not extend that protection to IRAs.

Borrowing Power

Many 401(k) plans permit participants to borrow from their plan assets at a very low rate of interest. If you roll your old plan into your new plan, you’ll have a bigger base of assets against which to borrow. (A common borrowing limit is 50% of your vested balance up to $50,000, but check with your plan administrator for the specifics of your plan.)

While the disadvantages usually outweigh the advantages in borrowing against your retirement plan, there are times when it may make sense, such as preventing eviction, foreclosure or auto repossession, paying off very high interest debt or putting 20% down on a home purchase to avoid PMI. Keep in mind that you’ll repay the loan with after-tax dollars so you’ll end up being double-taxed on the interest when you eventually withdraw it, and those funds won’t have access to market performance during the loan repayment period. Also, if you leave your company for any reason before the loan is repaid, your unpaid balance becomes a taxable retirement plan distribution, subject to a 10% penalty.

Workplace Financial Guidance

More and more companies are offering workplace financial wellness programs, where financial education and guidance are offered to employees as an employer-paid benefit. Can you attend a workshop or webcast, use an online learning resource or work one-on-one with a financial coach? More 401(k) plan sponsors also offer access to robo advice, where an online investment adviser service sets your investment mix based on your risk tolerance and time horizon and regularly re-balances your portfolio.

How about you? What do you think is a better idea: rolling an old retirement plan into an IRA or into your next employer’s plan? Email me at [email protected] or let me know on Twitter @cynthiameyer_FF.

 

 

How to Build Your Own “Hedge Fund”

June 02, 2016

Hedge funds have long been considered the sexiest investments. Part of it is that they’re exclusive, legally limited to “accredited investors” and financially limited to those who can afford their high fees (typically a management fee of 1-2% plus about 20% of the fund’s performance). They’re also the largely unregulated bad boy of the financially world, which allows them to use complex investments and strategies to try to outperform or hedge against the market for higher returns and/or lower risk.

I’ve always been skeptical of hedge funds though, so I was interested to read an article titled “Hedging on the Case Against Hedge Funds.” It defends hedge funds from a lot of criticism they’ve been getting lately for charging those high fees while producing disappointing performance numbers. (For example, Warren Buffett is on track to win a $1 million bet that a simple S&P 500 index fund would beat a group of top hedge funds over 10 years.)

The article makes the case that hedge funds can’t be expected to always outperform the stock market when stocks are doing particularly well. After all, many hedge funds are designed to “hedge” against the market so while they may not do as well when stocks are up, they should do better when stocks are down. But the article still ends up arguing that hedge fund fees are too high and that they perform too similarly to the stock market rather than acting as a true hedge. Fortunately, there are ways to get that type of hedging without paying such high fees.

For example, one strategy is the “permanent portfolio,” described by the late investment author Harry Browne in his book Fail Safe Investing. The concept is to divide your money with 25% each to stocks, long term government bonds, gold, and cash. The idea is that since stocks tend to do best during prosperity, long term government bonds during deflationary recessions, gold during periods of rising inflation (which can be bad for both stocks and bonds), and cash during “tight money” recessions when all the others may lose value, part of the portfolio should always be doing okay no matter what the economy is doing. By periodically re-balancing, you would sell some of the best performing investments while they’re priced relatively high and buy more of the worst performing ones while they’re priced relatively low. This can reduce your risk and increase your returns.

The numbers speak for themselves. From the year the book was published in 1999 to 2015, the permanent portfolio earned a 6.13% compound annualized return compared to 5.76% for a traditional 60/40 stock/bond allocation and 4.89% for the S&P 500. More impressively, the permanent portfolio’s worst year was a loss of only -3% vs. -20% for the traditional portfolio and -37% for the S&P 500.

Unlike the high fees charged by hedge funds and other active managers, the portfolio can also be created with a mix of low cost index funds. The value of this shouldn’t be overlooked. A study comparing the model portfolio allocations of various financial institutions found that the difference in returns between the best performing portfolio (9.72%) and the worst (9.19%) from 1973-2015 was about half a percentage point. Since the average active stock fund charges .86% in expenses and the average stock index fund charges .11%, going from index to active funds could have turned the best performing portfolio allocation into the worst! (And no, active funds don’t generally make up for their higher fees with higher performance.)

So does this mean you should invest in the permanent portfolio? Not necessarily. You just need to make sure your portfolio is broadly diversified beyond the stock market (including more conservative investments like government bonds and cash and real assets like gold or real estate) and has low costs. If you do that, there’s a good chance you’ll actually outperform most hedge funds. Your portfolio may not be as sexy but you can take it home to mom and dad.

 

 

 

The F Word In Financial Services – And Why You Need To Know It

April 04, 2016

Should financial advisors have to act in the best interest of their clients? Absolutely yes, according to the U.S. Department of Labor. The Office of Management and Budget will soon release the final version of the DOL’s fiduciary rule, which will require more of those who provide retirement investment advice to put their clients’ best interests first by expanding the type of retirement investment advice covered by fiduciary protections. What does this mean, and how will it impact employees saving for retirement?

The term “fiduciary” comes from the Latin word, “fiducia,” meaning trust. A fiduciary must act for the benefit of another person in a financial relationship and not for their own personal gain. Fiduciaries must disclose all conflicts of interest, and have a legal obligation to take into account the beneficiary’s circumstances, goals, risk tolerance, time horizon and investment experience. In other words, when you hire a fiduciary, he or she is legally and ethically required to act in your best interests.

The practical implication of this is that when choosing between two otherwise very similar investments, a fiduciary would choose the one with the lower costs. This is very helpful as the structure of much of the financial services industry is full of inherent conflicts of interest that don’t always favor consumers. A fiduciary can’t charge you ridiculously high commissions on an investment just because they have a mortgage to pay on their second home or their broker-dealer has a current sales promotion with a favored mutual fund company.

But wait…Aren’t all financial advisors supposed to do that anyway? Not to the same extent.

Many financial advisors operate under something called the “suitability standard,” which states that the advisor must have a “reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through reasonable diligence.”  This is why a financial advisor can sell you a mutual fund with a 4% up front sales charge, recommend investment strategies with lagging performance or encourage you to roll over your 401(k) into a higher fee account when you leave a job. Fellow Financial Finesse planner Erik Carter wrote about this conundrum for financial advisors recently in his Forbes column.

Thankfully, there are some financial advisors already follow the fiduciary standard, such as registered investment advisors (RIAs) and certain retirement plan advisors under ERISA, the law that governs employer-sponsored retirement plans. Fee-only financial advisors who are members of the National Association of Personal Financial Advisors sign a Fiduciary Oath as part of their membership. According to the CFP Board, “CERTIFIED FINANCIAL PLANNER™ professionals providing financial planning services also must abide by the fiduciary standard,” acting “solely in the client’s best interest when offering personal financial planning advice,” and the Board has been very active in promoting adoption of the DOL rule and a uniform standard. However, some CFP® professionals work for big financial services firms who have not yet adopted the standard. So what is the new DOL rule likely to mean for retirement savers?

Lower fees

More types of retirement investment advice are covered, including for IRAs and individual work-sponsored retirement plan accounts. This could mean that certain types of investments are less easy to justify selling to retirement investors, such as high fee mutual funds, and may put downward pressure on fees overall. The DOL estimates that expanding who must provide fiduciary advice will save investors up to $40 billion in fees over the next ten years.

Less pressure to rollover your retirement plan to an IRA

According to a recent Wall Street Journal article, the new DOL rule will make it harder for advisers to recommend a rollover of your work-sponsored retirement plan if you leave your job, “as they will have to clearly document why it is in a client’s best interest. Additionally, once the money is in an IRA, advisers would generally have to avoid payments, including commissions, that create incentives for them to select one product over another.”

Rebuilds trust and confidence

The most consumer-friendly aspect of the expanded fiduciary rule is that it aligns the interests of retirement financial advisors and their clients. This eliminates conflicts of interest and gets financial advisors and clients on the same side of the table when it comes to retirement investing. If you know that your advisor is legally looking out for your best interest and not just looking to make a sale, this makes it more likely that you’ll consider his/her advice carefully.

More transparency should rebuild trust and confidence in financial advice. That is good for investors and good for financial services. The DOL rule has prompted the SEC to begin looking at adopting a Uniform Fiduciary Standard for all investment advice, not just retirement advice.

 

 

What Makes A Good Mutual Fund?

June 25, 2015

That’s a common question I get in our investing workshops. Most people instinctively look at performance. After all, that’s how we typically measure ability and try to predict future performance in most areas but investing is different. Continue reading “What Makes A Good Mutual Fund?”

How New Online Tools Will Save One Woman Tens of Thousands of Dollars Per Year

April 30, 2015

Last week, I wrote about my three favorite online investment services. This week, I’ll show you an example of how a couple of those tools saved a friend’s mother tens of thousands of dollars. When I spoke to my friend, his mother had just retired with a $1 million portfolio and he wanted to know how she should invest it for retirement. Since we can’t provide specific investment advice at Financial Finesse, this was a rare opportunity for me to be more hands-on. Here’s what we did: Continue reading “How New Online Tools Will Save One Woman Tens of Thousands of Dollars Per Year”

Should You Invest in a “Motif?”

September 12, 2013

A friend of mine recently asked me what I thought of a site called Motif Investing. The idea of the site is that it allows you to buy a basket of up to 30 stocks or ETFs based on an idea or “motif.” Some popular examples are stocks benefiting from things like the rise of 3D printing or biotechnology, stocks  that have recently suffered a sharp decline, or stocks with good dividend payouts. The weighting of each motif can be customized and individual stocks or ETFs can even be removed. It costs $9.95 to purchase, sell, or re-balance each motif. So is this a good way to invest in stocks? Let’s take a look at the pros and cons: Continue reading “Should You Invest in a “Motif?””

Which of Your Actions Fail the “Piggy Bank Test?”

January 25, 2013
The other day I was looking through some boxes that I hadn’t opened in a few years and I found an old piggy bank that I had from very long ago.  I opened it and there was about $30, all in dimes, inside the piggy bank.  I vaguely recall being a fan of dimes a long time ago.  They are our smallest coins and “pound for pound” give the highest value /size ratio in the world of U.S. coins.  I started to think about the logic behind piggy banks and a few things hit me. Continue reading “Which of Your Actions Fail the “Piggy Bank Test?””

Do You Know What’s Really in Your Water Bottle…or Your Portfolio?

June 22, 2012

My kids absolutely LOVE bottled water.  I remember that when bottled water first came into the public eye, my friends & I laughed and said that if we came up with catchy packaging, a cool name, and maybe even a slogan that sounds like we care about something, we could make millions of dollars selling regular tap water to people who are far too easily separated from their hard earned dollars. Little did we know that we underestimated how much money we could make big time!!!! It’s not MILLIONS, it’s BILLIONS…per month!!! Continue reading “Do You Know What’s Really in Your Water Bottle…or Your Portfolio?”