Your employer may be stealing from you!

Intrigue over at 7m7y.com! Who’s the Millionaire … In Training leaving? And why? Click here to find out

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“Oh, little 401k, how I hate thee … let me count the ways” (2008, Anon.)

I don’t know who first uttered these words ūüėČ but, they strike a chord with me; here are some (admittedly, slightly cynical) reasons NOT to like the humble 401k:

1. Little or no choice of investments

2. Have to wait to traditional retirement age to receive the benefits

3. Stuck with low-returning investment choices

4. Little or no opportunity to ‘gear’ (I guess the employer match and tax benefits counts as a kind of gearing)

5. Fees

6. Your employer may be ‘stealing’ from you

Stealing?!

Yeah, in a way … but, first let’s take another quick look at fees [AJC: Inspired by a comment left on a post by Dustbusterz … thanks ‘Dusty’!]; in 1998 (!) the Department of Labor received and published an independent Study of 401(k) Plan Fees and Expenses.

It found the following average fees being charged by the larger 401k funds:

Total Annual Plan Fees

Lowest       0.57%
Mean         1.32%
Median      1.28%
Highest     2.14%

(Source: Butler, Pension Dynamics Corporation, in Wang, Money, April 1997)

Now, this goes back to 1997, but I just covered some very recent work by Scott Burns, noted financial columnist, and published in his new book, Spend ’til the End, which points to the fees continuing to trend up, citing average (mean? median?) fees of 1.88% now.

Remember that, according to Scott, even a “1% increase in a fund’s annual expenses can reduce an investor’s ending account balance in that fund by 18% after twenty years”!

I calculate that a 1.88% fee reduces your returns after 20 years by a whopping 38%

But, do you know how your employer actually chooses your funds / 401k provider? On the basis of better returns to you? Given the possible 38% ‘hit’, you would assume at least on the basis of lowest fees for you?

Right?!

Nope … not a chance. In fact, the study quoted an earlier report that found that “78% of plan sponsors [employers] did not know their plan costs” (Benjamin) …

… Great! You are putting your financial future into the hands of your employer, 3/4’s of whom don’t even know what the plans that they are choosing will cost you!

So how do they choose the plan that’s right for you [AJC: ironic snicker]?

The study found, one of two ways:

1. In my opinion, an unethical way: The Study of 401(k) Fees and Expenses quoted a prior report that found employers most often choose “the institutions that furnish the firm other financial services – banking, insurance, defined benefit plan management – to provide their 401(k) plan services and may not make an independent search for the lowest cost provider.”

Your employer feathers the bed of their own business relationships with your retirement money. Nice!

2. In my opinion, a criminal way: That would have been enough for me, if I hadn’t accidentally come across what is regarded as the Retirement Industry’s ‘Big Secret’ … it’s a doozy: it’s where the 401k provider shares some of the fees that you pay them with your boss!

Think about it; your employer provides you with a match to encourage you to remain employed then gets back some of that in fees, rebates, ‘free’ services, or just good old ‘relationship building’ at your expense, literally!

How do the funds and your bosses get away with this? Simple, nobody’s looking: “Revenue sharing is a poorly disclosed and relatively unregulated practice, which falls into the gap between Department of Labor and SEC oversight.”

OK, so does this mean that you shouldn’t participate in your employer’s 401K?

Not at all … it just means that you should do the following:

1. Decide if the 401k is going to do the job for you … will it get you to your Number? At a maximum ‘investment’ of $15,500 per year and a compound annual growth rate of 8% – 12% less fees, this is highly unlikely … you run the numbers then make your choice!

2. If not, is it still wise to continue your 401k (consider it a backup plan) as well as more aggressively investing elsewhere?

3. If you can’t do both, you have no choice but to decide which investing strategy is going to have to give way to the other?

4. If you do decide to continue with the 401k, choose any ultra-low-cost Index Fund option that may be on offer over any other selection; if not available, choose a ‘no load’ fund (be careful … some ‘no loads’ are actually just ‘lower load’). And, do your own homework on fees, because you just know your employer ain’t doing it!

5. Lobby your employer to pass back any revenue-sharing back to the employees

6. Insist that your employer choose funds that work best for you over the funds that work best for them.

What you do with this information is entirely up to you; I don’t need a damn 401k … never have and never will ūüėČ

Making Money 301? Hold on to your horses ….

Part 3 of a 3 part series on weathering the current financial storm …

By now you know that when we have made our Number, our #1 objective is to hold on to our money!

We do that by a combination of wise spending and savings habits (learned way back in Making Money 101, and practiced almost to the point of stupidity in Making Money 201) and very sound investing strategies.

Firstly, though, what do you do if you have just had the wind kicked out of your 401k’s sails by the sudden crash?

Well, it really shouldn’t be an issue, because the chances are that you planned for an annual stock market return of something like 11% – 12% over 20 years and you overachieved dramatically for most of it … but, rather than increasing your spending based upon your unexpected ‘good fortune’ you realized that all good things must come to an end and you gritted your teeth expecting a reversal to bring you back to earth.

In fact, if you were really smart, you set yourself 10 or 20 year ‘targets’ and when you achieved those, you started preparing for Making Money 301 early and sold down your excess stocks and/or real-estate (i.e. the equity in excess of your ‘target’) and moved it into cash, bonds, or far more boring commercial real-estate investments (using minimal, if any, borrowings).

Now you are retired (well, you at least aren’t counting on any outside income), but you have been battered and bruised a little by the current ‘meltdown’ so your buffer isn’t as large as it was a few months ago, but you are still OK.

[AJC: I’m speaking from personal experience, now]

Remember, your Rule of 20 strategy was designed to deliver 5% of your ‘nest egg’ to live off each year, leaving another 5% to be reinvested to keep pace with an expected 5% average inflation … in other words, produce an indefinite stream of annual income that grows with inflation.

The problem is 5% + 5% = 10% AFTER TAX, so we NEED a 12% to 15% compounded annual growth rate to make all of this work …

… and, the current crash has probably temporarily wiped out most of any buffer that we had managed to retire with i.e. any money that you managed to salt away in excess of expectations … who said that EXACTLY Your Number was going to fall into your lap EXACTLY on Your date?!

What to do, given that there are signs of a prolonged flattening of the market?

Here are a some advanced strategies, sensible in ANY market for Making Money 301, but particularly now:

1. Do NOT keep your money in CASH (other than a 2 year Emergency Fund) – if you have no buffer, then every year you earn ONLY 5% on your CD’s is a year that you are really LOSING 5% of the remaining value of your ‘nest egg’ to inflation!

Equally, do not keep it in a cash-equivalent (e.g. bonds – with the exception noted below) OR in stocks or Index Funds: you need a min. 5% return – indexed for inflation) UNLESS there are stocks that you understand/love that pay a 5% dividend and you are 100% certain that dividends won’t be cut in the coming recession.

2. Purchase commercial property for 100% cash or very low LVR (Loan-to-Valuation ratios), such that the net rents each year provide EXACTLY the annual income $$$ amount that you are looking for + 25% ‘buffer’ (for vacancies, repairs/maintenance/etc.). If you are worried by commercial, residential (or a mixture) is OK.

You can spend the entire rent (except for the buffer) as it will:

a. Keep up with inflation, because you will have a CPI ‘ratchet clause’ in your lease, if you rent well, and

b. Your capital (represented by the property itself) will also at least increase with inflation, if you buy well.

3. Buy a select group of ‘blue chip’ stocks that you love/understand (etc., etc.) on low historic P/E’s and write Covered Calls against them; this works well in a flat-to-slightly-growing market, so the current volatility may need to settle into a more extended period of gloom-with-some-slight-hope before you can execute properly … but, now’s a great time to start (very!) small and experiment!

4. Be boring: buy TIPS (Inflation protected Treasury Bonds), but only if you applied the Rule of 40 instead of the Rule of 20 … these currently only produce about 2.5% TAXABLE annual income (except if your Number is so small that ROTH IRA’s – or similar – will do the job for you).

Only buy the TIPS using 95% of your ‘nest egg’; retain 5% of your cash (over-and-above that emergency fund – although, holding TIPS means that you can probably cut this back, as well) … use it to start buying Calls against the market (pick an ETF that tracks the S&P 500) or, against 4 or 5 individual stocks if you are more daring.

While you’re waiting for the market to stabilize a little, now’s a good time to start slow and practice: after each major pull back, buy a Call and see if you can make a gain on the upswing (set a profit target and sell when your reach it … wait for the next ‘pull back’ and try again).

5. Buy a Fixed Annuity – costs suck, but if you can’t do 2. or 3., what’s really left for you besides TIPS or this?

And, if it (in fact, any of these strategies) produces your required Annual Income Number (the annuity MUST be indexed for inflation) who cares? But, remember to spread your risks over a few insurers (remember AIG?) … you don’t want them to go down holding your cash (keep in mind that even if the insurer crashes, your underlying investments should still be safe and be handed back to you … at least, that’s how the story goes)!

So, for any rich readers out there sweating my posts (you know, like the doctors who watch ER just to point out all the faults: “Oh, what a bunch of BS … he’d never spline the clavicle with a Humphreys 458!”):

What’s worked for you in past ‘bear markets’? What do you think will work for you in this one?

Retirement Planning Made Easy!

Meg, a reader, asks:

My goal has long been to reach $1MM (net worth, not assets) by age 30 Рwhich is under 6 years away for me. I’ve been working actively towards the goal for over a year now, so if I reach it it will have been $1MM in 7yrs. Not nearly as impressive as 7MM in 7 yrs, but that’s if I do it the most conservative way possible with minimal risk and leverage. If all goes according to that plan (which primarily involves utilizing real estate leverage) I will reach $2MM by 35 and then more than double it again by 40…of course that’s almost 2 decades away. Maybe I should look into ramping up my plan with some risk!

[AJC: My response …]

Meg,

Sounds great!

Now, I suggest that you work backwards:

How much income do you need (forget inflation for now, just use today’s dollars) and by when (figure costs of family, college, travel, etc.) … no more work for you OR hubby from then on!

OK, then double that amount for every 20 years until The Date (that accounts for 4% inflation) … and, multiply by 20 (if you want to be really conservtive, multiply by anything up to 40) to get The Number Рthat’s your Net Worth target (assuming that you also obey the 20% Rule).

Now, do you need to ramp up your plan with some risk, or not?!

Retirement Planning Made Easy! )

Good Luck!

AJC.

Who wants to retire in their 20's, anyway?

Join AJC’s Live Video Chat on Thursday @ 8pm CST …¬†7 Millionaires … In Training LIVE Results Show: Final 30¬†announced live tomorrow (!)

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Yesterday we talked about starting young, not just as it applies to saving, but as it applies to accelerating your retirement plan.

Maybe you couldn’t find your WHY?

After all, who wants to think about retirement when they are still in their 20’s or even 30’s? Most are still thinking about their job!

Yet, as yesterday’s post showed, there are some good reasons for starting early. And, who wouldn’t want to retire early if their goals matched these from a recent survey of GenXfinance‘s readers:

How Do You Envision Your Ideal Retirement? 

Being a ‘Gen X’ PF site, we can probably assume that most of the respondents were younger than, say, me. But, it’s even more interesting to notice how each of the first three categories (where the majority of the votes fell) require MONEY and/or TIME:

1. Extensive Travel

Think about it, you can escape money to a greater of lesser degree if you are willing to travel frugally, work at least during some of your stopovers (haven’t you noticed how all the ‘servers’ in restaurants in¬†vacations areas¬†are young foreigners?) …

… but, you can’t escape the time element: this means that you have to be ‘retired’ from your day job.

2. Not going to work; just taking things one day at a time

Obviously, this means that you are retired from your day job … but, two things happen when this occurs:

i) Your income goes DOWN

ii) Your spending goes UP

For those who subscribe to the “75% of current income in retirement” theory, I ask this: have you ever tried spending time doing anything BESIDES WORKING that doesn’t COST money?

Think about it … it stopped me from cashing out when I was offered $4 mill. a few years before I eventually did cash out (for a helluva lot more!).

3. Doing volunteer or charity work

All [charity] work and no play makes Jack a dull boy … this is really 2. plus you are spending some of your time (perhaps a lot) giving back. This is a good thing … as well as the great work you are doing, you are spending less time … well … spending!

4. Other

If you scroll down the comments attached to GenXfinance’s post, you will see that¬†most of the ‘other’-folk either mean not retiring at all (like the ‘pursuing a second career’ option) or involve a similar outflow of money¬†and/or a similar savings-account-draining, non-income-earning amount of time.

But, they are all things that you will probably want to start whilst still young enough to enjoy them …

… which means starting to build a pretty damn large nest-egg pretty damn soon!

Let me know what (and how much by when)¬†‘retirement’ means to you?

How do I figure social security and pension plans into my 'Number'?

In a couple of posts, I have talked about The Number – the amount that you need to have saved (preferably, invested in passive income-producing investments) by the time you retire.

Before we move on, it’s probably time for a quick review of what I mean by ‘retirement date’ because it’s not the same age-related¬†date as most Personal Finance books and blogs assume:

‘Retirement Date’ = The Date YOU Choose to Stop Work!

… This is not 65 or any other¬†age your boss, the government, or society tells you! If you are 35 years old and actually want to retire @ 65 on $1,000,000 a year this is NOT the blog for you!

Now, having¬†got that one off my chest¬†(!), one of my readers, who IS close to the traditional retirement age,¬†asks a great question about how to figure his retirement benefits (which, he will receive as an annuity rather than a¬†lump sum) into The Number for him …

… you can read his original comments¬†here, but¬†this is the essence of his problem:

I am just having trouble trying to quantify my pension so I can include it in my net worth … the trouble is I don‚Äôt receive a lump sum, but rather 65% of my base upon retirement, every year, which includes increases for cost of living every year.

The problem is that this reader was trying to find a way to calculate the ‘implied passive asset value’ of this pension into his Net Worth … while you could do that, there’s no real reason to.

If you are in a similar situation, what you really need to know is:

Can I live my ideal retirement on this pension … if not how much extra do I need to count on having in investments by the time I do want to retire?

To do that, we only need to make a slight modification to the formula we have used before.

1. STATE how much you need to live your ‘ideal retirement‘ assuming that you stopped work today (it’s not how much you would have, but how much you would need). What is that number?

2. DOUBLE that amount for every twenty years that you have left until retirement (add 50% if only 10 years, etc.). What is that number?

3. SUBTRACTthe annual value of any social security, annuities, pensions, or other regular amounts that you are reasonably (actually, very) certain to get. What is that number?

4. MULTIPLY your answer¬†by 20 (slightly conservative) to 40 (very conservative). That is The Number … for you!

A couple of points:

I usually ignore Social Security and other government benefits, mainly because governments and regulations change … the longer until your chosen ‘retirement’ the more chance that these things will vaporize before you get there.

Similarly, I work on pre-tax numbers, because I have no idea what the tax regulations will be like …. the longer you have to wait until your chosen ‘retirement date’ the more chance that taxes will change (read: increase) before you get there.

But, these are only rough calcs to get you aiming towards a (probably) larger target than you previously figured on … as you get closer to your planned retirement, you will no doubt have had a number of sessions with a suitably qualified financial adviser who will figure out the exact effects of things like: inflation, taxes, social security.

Now, if you are still a fair way away from retirement (say 10+ years) you may want to figure in the impact of the pension on your Investment Net Worth.

You could multiply your expected yearly retirement benefit, again assuming that you were retiring today, by 20 (this time using the lower number means that you are being extra-conservative) and add this figure to your assumed Investment Net Worth.

You could also add it to your ordinary, garden-variety Net Worth to make 20% Rule decisions¬†regarding how much¬†‘house’ you can afford.

You could do these things … but, I wouldn’t.

Why?

How certain can you be that you will qualify for any of these things in 10+ years?

What happens if you can’t work, get laid off,¬†your company goes broke or it can’t meet it’s obligations, or … ?

The reason for these ‘rules’ is to ensure that you put your foot on the investment gasnowand, hard!

Don’t use¬†possible future company or government benefits as an excuse to over-spend and under-invest!

By the time you do retire, you’ll be glad that you didn’t …

Be your own President by turning your retirement savings into your very own monthly 'social security' check

I read an interesting post on Free Money Finance – one of my¬†favourite blogs in the ‘Making Money 101’ space –¬†the other day;¬†FMF¬†said:

Here’s an interesting report on the value of Social Security :

The average monthly benefit for retirees is $1,045 in 2007. A 65-year old who wanted to buy a guaranteed income of that size ‚Äď with payments that go up with the cost of living and continue for a widowed spouse — would need to pay an insurance company about $225,000.

Firstly, if you are rubbing your hands and thinking “I need to save $225k LESS” for my retirement now, you have rocks in your head!

Why?

Relying on a government hand out is¬†always bad advice … as the population ages there will HAVE to be changes in Social Security¬†– none of them good … for you!

My advice is simple: PLAN to go without, GRATEFULLY ACCEPT what you are given.

But, there is an even more interesting lesson to be learned here:

The government is prepared to pay you 2% of that ‘invisible’ $225,000 that they have effectively put aside for you, each year … and INCREASE it each year to keep up with the cost of living … nice.

 How would you like to be able to set up your own plan that works exactly the same way?

 There is a way!

It’s safe … it’s legal … and, it’s easy … and it’s all covered in this book by a highly respected professor.

Here’s what you do …

 You invest your lump sum at (or before) retirement in special inflation-proof government bonds called TIPS.

TIPS¬†are as safe as Social Security because they are US Federal Government Treasury Bonds … the difference is that you put up your own money so, unlike Social Security, the government can NEVER get out of it’s obligation to:

a) Pay you back your Principal (the amount you put in) plus the value of inflation! And,

b) Pay you a 6-monthly dividend (call it your ‘social security check’) also adjusted for inflation each year.

This is not financial advice, as you will need to see your own financial adviser to determine:

1. If this strategy can work for you;

2. How much to expect in bond interest each year; and,

3. Whether you should substitute inflation-protected MUNI’s for the TIP’s that the author recommends … useful if you are investing outside of a tax-shelter (e.g. ROTH IRA).

Let me know what you think?

Do you know how much you will retire on?

If you are like most Americans, the chances are that you have virtually no idea how much you will be able to retire on …

In fact, only 1 in 3 do. And, everybody else in the world is pretty clueless, too … at least according to this AXA survey:

Do you know how much you will retire on?

It gets worse, of those who do know (or think they know) how much they will retire on almost half don’t think it will be enough:

Retirement Shortfall

… and, I bet that 90% of the other half are simply settling for a LOT LESS than their dream retirement.

Don’t let that be you … start by working out your Number, and let’s go from there …

Why does real-estate investing crush your 401k mutual funds?

You know that you can’t just save your way to a fortune¬†… right?!

So, what to do with that ‘extra’ cash that you manage to scrounge from time to time?

In a previous post , I pointed out that we are at a UNIQUE point in history.

For the FIRST TIME that I can recall BOTH money AND real-estate are cheap!!

If you save up a deposit (AFTER paying of¬†any pesky credit card debt) and plonk it down on a rental property (or even your own house,¬†if you ain’t got one yet) and LOCK IT IN for 30 years, how can you EVER go wrong?

If you do buy to live in it, eventually you will move on – just keep it as a rental FOR EVER.

I don’t know what will happen over the next year or so, but over 30 years it’s a no-brainer …

… your mortgage payments¬†remain flat (you fixed them, remember?) …

… the value of the house doubles every 7 years or so (and, you will take advantage of this ‘spare’ equity, won’t you?) …

…¬†and – here’s the kicker – your rents rise roughly in line with inflation … see how that compounds over 10, 20 or even 30 years to spin off income that will help you stop working!

And when you eventually do retire, the real-estate strategy STILL kicks your 401k’s butt …

This built-in inflation-protection makes real-estate a great adjunct or alternative to so-called safe retirement strategies such as the Grangaard Strategy and Worry-Free Investing (two of the best that I have come across).

Try doing any of that with your 401K or mutual fund!

Who needs more than $1,000,000?

Almost everybody will need more than $1,000,000 to retire on … most a lot more!

Look at this excerpt from an excellent report (that I would highly recommend you spend the $5 bucks on) from Retire Early:

Perhaps the most troubling aspect of safe withdrawal rates is that very few folks will have the financial assets required to [even bother] …¬†While we‚Äôre blessed to live in a rich and prosperous country, only a tiny sliver of the US population can comfortably retire on their savings alone. “

In 1998 the median family income in the US was $38,885 so using a fairly safe inflation-adjusted withdrawal rate of 4% would require nearly $1 million in assets.

Since most folks acquire a bit more wealth as they age, about 5% of the 47-year-olds could boast $1 million nest eggs in 1998.

That’s why the Retire Early report goes on to say:

More worrisome, is the fact that few people with million dollar portfolios would be comfortable living on $40,000 per year. Most feel that level of wealth should support a more expansive lifestyle…

…¬†it doesn‚Äôt, at least not safely.

There‚Äôs an old adage in wealth building, ‚ÄúThe first million is the hardest. The second million usually comes a lot easier and quicker.‚ÄĚ

Why?

To fund even a modest retirement, you’ll need a significant wad of cash. Prudent folks will begin saving aggressively today!

Good advice indeed!

Are you really on track?

I¬†read an interesting question on one of my favorite blogs the other day.It was from a couple thinking about retirement asking the usual saving-for-retirement questions, peppered with the usual ho-hum terms: ROTH IRA’s, 401K, HSA, CD’s …

What caught my attention was the opening sentence to their post:

“I feel very knowledgeble about long term investments.¬† I feel I manage my retriement savings very well and this has been a top priority.”

If you think your ‘retirement is on track’ just because you are saving your 10% or so into all the ‘right investment vehicles,¬†or retirement for you is still a hell of a long way off, I would just ask that you do the following quick ‘reality check’:

1. What is your current Net Worth (try the CNNMoney calculator)?

2. What is your annual income goal to fund the retirement that you always hoped for?

Multiply that by 20 to 40; depending on how certain you want to be that your money will last as long as you do …

3. The difference between 1. and 2. is what you have to make up (ADD a little more for inflation) between now and retirement.

If it’s only a little, keep doing what you’re doing; your retirment is probably ‘on track’ …

BUT,¬†if it’s a lot, maybe you need to think about INVESTING actively (business, real-estate, trading) rather just SAVING (CD’s, 401K’s, etc.).”