401K Matching About to Start

Just learned that my employer is about to start a matching program on my company's 401k. First thing I did: suspend my contributions to the program.

Why continue to invest in the 401k when I can hold off for a few months and then get free money on my contribution?

Don't worry, I still have every intention of maxing out my contributions to my 401k, just as I do every year.

401k matching is awesome.

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No "Means Testing" for Social Security

The social security system is broken. Pretty much everyone agrees on that much. In fact, even the Social Security Administration is upfront about its current fiscal prospects. From my own social security statement from earlier this year:

"Social Security is a compact between generations. Since 1935, America has kept the promise of security for its workers and their families. Now, however, the Social Security system is facing serious financial problems, and action is needed soon to make sure the system will be sound when today's younger workers are ready for retirement.

In 2016 we will begin paying more in benefits than we collect in taxes. Without changes, by 2037 the Social Security Trust Fund will be exhausted and there will be enough money to pay only about 76 cents for each dollar of scheduled benefits...."

Well there you have it. There's simply not enough money in the bank to pay for all the obligations. A solution must be found, and whatever proposal goes on the table is likely to raise serious objections from those whose financial interests will be harmed by the proposed solution.

Clearly, sacrifices need to be made, and a number of sound options have been put on the table, including raising the retirement age, indexing benefits to inflation rather than to salary increases and so forth. However, there has been one proposed solution that is really upsetting to me - the idea that Social Security benefits should be means tested.

My wife and I consistently pay the maximum annual amount in Social Security taxes - currently 6.2% of our salary, each. We make a decent living, and I am not going to apologize for it. It is already pretty clear that we can expect to receive far less in benefits than we pay out in taxes, and you know what, I am OK with that. I make more money, I will pay my fair share. This is part of the social contract - we should take care of those less fortunate in our society. However, I think that it is completely unfair to charge us hundreds of thousands of dollars over our working lives, claiming that this money will be used to guarantee us regular income in retirement, only to later take the money and run.

Alpaca and I work hard. We take take sizable chunks of our paychecks and save them - setting money aside for a rainy day and ultimately to give us the lifestyle that we want in retirement. And, yes, we also want to leave something to our kids when we are gone. The money which we save will become income generating assets. Under the means testing proposal, our hard work and propensity to save could be used to revoke or reduce our right for Social Security income. Income which we rightfully earned and paid for with our hard-earned, maxed-out taxes. We don't have to save. We could take the money and just spend it, but that would be irresponsible, wouldn't it?

Means testing is a pernicious approach that penalizes the saver compared to the spender. If instead of saving our money today we spent it all, leaving nothing for retirement, we would have no "means" that could be used as justification to reduce or eliminate our Social Security income. This policy would perversely encourage people to spend rather than save their extra income. Great for the economy today, horrible for our economic prospects as a nation.

I am willing to work a few more years before I am entitled to receive Social Security payments. I also think it's justifiable to index Social Security to inflation rather than to salary increases. I think that taking away our hard earned Social Security benefits for which we are paying over a lifetime of hard work is nothing short of robbery.

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Many companies that have stopped matching employees' 401(k) contributions when the economy tanked, are now thinking about renewing these matching contributions. My wife's company is one such employer, and there is talk that the company will begin matching contributions again in the coming months. In such a situation, should you stop your contributions until the company renews its matching or should you stick to your guns?

The benefit of delaying contributions is obvious: wait a few months and the same money that you would contribute now with no employer matching will yield a guaranteed return in the form of employer moola... However, there are a few arguments I can think of against this strategy. For one, unless you know for sure that your company will be renewing the match, you are delaying contributions that could be invested in the market and yielding a return (assuming the market goes up, that is). For another, if you delay your contributions, will you have the discipline to max out your retirement savings for the year when the matching actually begins, or will you leave money on the table? There is also the question of how matching is to be calculated. Many companies limit matching to a percentage of employee pay in a given pay period, meaning that stacking all your contributions may not give you the desired bump in employer matching funds.

My wife and I discussed the option of delaying her contributions, but have not yet made a decision. Any opinions or suggestions?

My company has never matched employee contributions, nor is it likely to do so in the foreseeable future. Let's just say that for now I am happy to have a steady paycheck... :-)

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Questions for Your 401K Plan Administrators

Not all 401K plans are created equal - some can be pretty good while others lack important features or impose ridiculous costs on participants. In my previous company I was involved in running my employer's 401K plan (read this post for that interesting story). In my current company I haven't done anything about our plan, primarily because I thought it was reasonable from the get-go, but also because I found my work as a new executive to be extremely interesting and challenging - quite frankly, I just didn't have the time. It has been almost two years since I started my current position (it's amazing how quickly time passes), and I am now thinking about pushing for some changes in our 401K plan. This week a plan representative will be coming to visit us for a "lunch and learn" session and I was planning on bringing up a few issues that I think we need to address. Here they are:

Roth 401K - my company offers only a traditional 401K plan. No Roth 401K. Given prevailing expectations that tax rates will only go up in the coming decades, being able to squirrel away retirement savings without having any future tax liability is a pretty attractive proposition. Alpaca and I "make too much money" to invest in a ROTH-IRA, but participation in a ROTH-401K has no income caps. The mission: get my company to adopt a ROTH-401K option.

Expenses - as far as I can tell, Fidelity has been pretty above board with their disclosure of plan expenses. Checking my 401K account the other day, I was able to find a line that stated very clearly a charge of $30 for plan expenses in 2009. Obviously, this charge is on top of any expenses charged by the mutual funds themselves. Nevertheless, 401K plans are renowned for having all kinds of hidden fees and charges. In my former company even the 401K committee (of which I was a member) did not have clear information about what our employees were paying in fees. We were simply unable to get that data from our plan provider. Fees are a major scourge of the long term investor. They can quietly leech away returns without a lot of evidence that this is happening. The mission: get full disclosure of plan fees.

Index Funds - most of my 401K money (70% of my allocation) is directed towards Fidelity's excellent total market index fund, with an expense ratio of only 0.1%. However, this is the only index fund available in the plan. International index? Nope. Bond index? Niet. REIT index? Better luck next time. Once again, it goes back to the issue of expenses. I don't believe that fund managers can beat their benchmark indexes in the long run, and if that is the case, why should I pay them for the disservice they are doing to me? The mission: Let's have more index funds and fewer fees.

Automatic Re-balancing - Fidelity offers automatic re-balancing of plan funds, but it only allows this on an annual basis. I re-balance my funds quarterly (I think it's particularly important after such dramatic asset price increases as we've had in recent months), but I need to do this manually. The mission: can we have quarterly automatic re-balancing options?

Opt-Out Enrollment - I am a big believer in the concept that employers need to nudge employees to make the best long term decisions. Automatically enrolling people in the 401K plan unless they opt out is a great way to send a signal to people that they should be thinking about saving for their retirement.

My company's 401K plan is run by Fidelity and overall, I am very happy with the plan. Documentation is plentiful and simple to understand, the website is easily accessible and manageable, and fund choices (for the most part) are reasonable. Still, there is always room for improvement.

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Insanely High Public Pensions

Last week I came across this article in the WSJ which talks about the insanely high public sector pensions that some individuals are receiving. Here is a brief excerpt from the article:

"Those named are former public employees and their dependents who receive an annual pension of more than $100,000. Atop one list is a former city administrator from the small Southern California town of Vernon, whose annual pension is $499,674.84."

How insane is that? By comparison, the President receives an annual salary of $400K. Look, I am all in favor of people saving for retirement and having a decent pension after many years of loyal service. I think this is entirely justifiable. However, How is it possible or even legal for government agencies and public sector entities to pay such ridiculously high pensions? More interestingly, how is it even fiscally possible for a tiny town like Vernon, CA to support (never mind justify) such an obscenely high pension? According to Wikipedia that town had a population of 91 in the 2000 census. What is going on here?

Leaving aside the town of Vernon for a second, I did some research online to find the database of high pensions mentioned in the WSJ article and here it is. This list contains over 5,000 names of individuals who receive public pensions of over $100K annually, but it only includes individuals from California. How widespread is this phenomenon? Can it be justified that former public "servants" receive such huge pensions, backed by tax payer dollars, while the rest of us are expected to do our best and come up with whatever retirement savings we can scrape together, with or without a company match? Incidentally, do you think that these folks' pensions were reduced when the markets tumbled and the rest of us lost much of our retirement savings?

In California, $100K may not be excessive given the very high cost of living, and especially when such pensions are paid to high ranking former public servants, but some of the examples on that website are dramatically higher. How about some oversight? How about some sanity? Next time you are worried about your retirement savings, maybe you should consider working for the government... The rest of us will pick up the tab.

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Rebalancing My 401K

Planning for our retirement is very important to me and my wife and I have been religiously maxing out our 401K contributions every year. Since I joined my employer last April I have done nothing to re-balance my 401K investments, and as you can imagine, with all the market turmoil the asset allocation of my plan has gotten a bit out of whack. Yesterday I went on the Fidelity website to do some re-balancing.  

Re-balancing is a pretty simple process in which you bring your investments back into your desired asset allocation. Say you would like to have your assets invested 50% in stocks and 50% in bonds, but with stocks taking a major hit over the past couple of years your stock values fell by a half, while your bonds remain unchanged. While your overall portfolio has lost 25% of its value, stocks now account for only 25% of the remaining funds. When re-balancing you would sell some bonds and buy some stocks such that the new asset allocation matched your original investment targets of 50% in each asset class.

The idea behind re-balancing is the notion of "regression to the mean" - certain asset classes tend to yield certain returns over the long haul. If in a given year an asset class dramatically over performs or under performs, it is reasonable to expect that in the following years it will reverse the trend such that over the long term returns will roughly meet the historical average. When re-balancing you sell the assets that have done well and now account for a larger share of your portfolio than you intended, while buying some of the lagging asset classes that have done worse than they usually do. This serves two purposes: first, it ensures that your portfolio has the risk characteristics which you desire and second, it forces you to sell high and buy low. I have previously written a post on the subject of re-balancing if you are interested in more information (although my views on the subject have evolved somewhat since I wrote the post 2 years ago).

Anyway, Fidelity does a fairly good job of hiding its re-balancing services. However, it turns out that I did not need to manually re-balance the account. Fidelity offers an annual re-balancing option - although I would have preferred quarterly re-balancing. It also gives you the option of being alerted about imbalances in your asset allocation on a quarterly basis - however it will only alert you to substantial deviations in your relative asset balances, i.e. 10% or more. These re-balancing services are good enough for me. I signed up for annual re-balancing and it's nice to know that I no longer need to think about asset allocation in my 401K.

With that in mind, and following my post on the topic from yesterday, I am now going to start lobbying for a ROTH 401K plan to be adopted by my company and will also try to convince the powers that be to adopt childcare and medical flex accounts.

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Tax Injustices and Strange Rules

Why should your tax liability be dependant on something that your employer does or does not do? Basic fairness demands that your tax burden be dependent on your own specific circumstances, such as your income, your number of dependents etc. However, the tax code is riddled with examples where Uncle Sam reaches into your pocket to a different extent depending on the benefits that your employer provides. Here are some prime examples, but I am sure that there are many, many others:

Childcare Flex Accounts - childcare flex accounts allow you to reduce your tax liability, by paying with pre-tax money for childcare expenses, up to a limit specified in law (I believe it's $5,000). My previous employer offered childcare flex accounts, which I maxed out annually to great benefit. My current employer is not offering a childcare flex and consequently, even though we can get a deduction for childcare expenses, my accountant tells me that our tax liability was hundreds of dollars higher than it would have been had a flex account been in place.

Medical Flex Accounts - In my previous company I was able to deposit $1,500 annually in a medical flex account, leading to hundreds of dollars in tax savings on our medical expenses. Since my current employer does not offer this benefit, the only way we would have been able to deduct our medical expenses is if they had exceeded 7.5% of our adjusted gross income. Since - thankfully - our medical expenses do not reach that minimum, we end up paying considerably more in taxes.

401K vs. IRA - why is it that if your employer offers a 401K plan you can contribute $16,500 towards your retirement but can only contribute $5,000 to an IRA if your employer does not offer such a plan? What is the rationale for tax discrimination against people whose employer does not care about their retirement? Similarly, why is it that unemployed individuals are not permitted to contribute the full 401K allowable amount?

ROTH 401K vs. Regular 401K - does it make sense that if your employer offers a ROTH 401K option you are able to make a full $16,500 in after tax contributions to a ROTH account, regardless of your income, but you cannot contribute a single cent to a ROTH IRA account if your adjusted gross income is over $169,000 (for joint filers).

The tax code is riddled with asinine and capricious tax rules. It is time for Congress to take up serious tax reform and to do away with this injustice. The amounts you save for retirement or are able to deduct from your tax liability should have nothing to do with the benefits that your employer chooses to offer. The tax treatment of individuals should be equal and based on their own unique circumstances rather than on the decisions of their company's benefits administrators.

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Dismal 401K Results. A Great Opportunity!

A colleague came to me earlier this week and commiserated that when he got his 401K statement for 2008, he found out that his 401K lost 9% in the last quarter of the year. He asked how my 401K was doing, and I admitted that I didn't know but that I could check on the spot and tell him. I logged onto the Fidelity website and checked the numbers: down 22% between October and December. My friend was shocked. How could I have lost 22% in the last quarter alone? I explained that since I have about 30 years left to retirement, I am aggressively invested and don't mind taking some risk for a chance at a higher return. My friend, who is much closer to retirement than I, was aghast.

I believe that my 401K asset allocation is appropriate for my age and risk tolerance, and besides, I manage our investment portfolio as a whole, not considering my 401K independently. My asset allocation in the plan is as follows: 70% S&P 500 index fund (this is a good fund with a 0.1% expense ratio - pretty impressive); 10% in a real estate fund; 10% in a bond fund; and 10% in an international fund. Normally my international allocation is closer to 30%, but the international fund offered by my plan is actively managed (I typically invest only in index funds) and charges a hefty expense ratio to boot.

As you would expect, all of my 401K funds have taken major hits over the past year, with the international and real-estate funds showing the biggest declines, as similar investments did in the rest of our portfolio. Nevertheless, I am unfazed. Retirement savings are the very definition of long term savings and with retirement approximately 30 years away, now is the time to take some investment risk in an attempt to grow a sizable asset cushion. It's not that I enjoy looking at these losses, but as I have previously written these declines represent an investment gold mine for those of us who will be net savers over the next couple of decades.

Hey, don't listen to me. Listen to Warren Buffet - supposedly he thinks now is a good time to be in equities.

What does your 401K look like these days?

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The Retirement Gold Mine

If you are early on in your career, say your 20's or early 30's and you are starting to develop your retirement savings strategy, the opportunity of a lifetime may just have materialized for you! A bear market...

The thing about retirement savings, 401(k)'s, IRAs and their ilk is that you only draw down on your savings in... retirement. And in your case, retirement is decades away, while all the stocks you will be buying just went on a very big sale (and may even go on clearance in the near future).

Yes, the market is down, but if your investment horizon is truly far in the future, that is completely irrelevant for you. When thinking how to allocate your savings, don't worry about what your stocks may do tomorrow, next year or even five years from now. All you need to care about is the very long term.

The bottom line is that if I were now starting to plan my retirement savings strategy, I would go pretty aggressive and put 100% of my money in stocks - at least for the first few years. Even now, although I am 37, my investment horizon is still far in the future. I don't plan to retire until I am about 60 and so my investment stance is still very aggressive. My 401(k) asset allocation is 80% stocks (of which approximately 50% are international stocks), 10% real estate and 10% bonds.

What I am trying to say is: rejoice young folk! The stock market is on sale! Come in droves and bring your friends! You'll thank yourselves later.

CD IRAs - a Really Bad Idea

Last week I visited my local branch of Bank of America where I saw a large poster advertising "high rates" on CD IRAs - a high rate being an APY of 3.3%. On their website, BoA says that this product is for "People who want to take the guess work out of investing while enjoying the peace of mind of a steady high yield return." My take on the issue is that unless you are in your 60s and are approaching your retirement years, investing in a CD IRA strike me as a really bad idea. Even in such cases, investing your long term savings in a CD is a dangerous game.


When investing for retirement, many folks worry about taking excessive risk. They are concerned that their investments will tank and that they will lose their retirement savings at a time when they are unable to work. However, reality is that with a long investment horizon, the biggest investment risk one can take is to invest in a way that will not allow your investments to outpace inflation.

While in recent years inflation has been relatively benign, there have been a number of periods historically where the U.S. has seen considerably faster price increases. Check out this chart on Wikipedia. But forget historical inflationary break-outs, at 3.3% APY the yield BoA is offering does not even keep pace with the current pace of expected inflation. This means that while you are thinking you are saving for retirement by contributing to this so-called high-yield CD IRA, the money you are putting aside purchases less and less every year.

Although it may be counter-intuitive for some, if you are planning to save for retirement (or for another long term goal, for that matter), investing in a well balanced portfolio of index funds, which includes both stocks and bonds, is a much safer way to go. Inflation is the quiet killer of low yield "safe" portfolios. Don't be fooled.

I have written in the past about how to build a portfolio, if you are interested take a look at this topic in more detail (or simply select the "investing" category in the left column on this page).

401K Roll-Over: Complete

It's done. My old 401K has been rolled over into my Vanguard Traditional IRA acount. The trades were correctly executed, and the whole thing took about 20 minutes of work, a single phone call and one mailed check. Presto. As simple as that.

What are you waiting for? Got an old 401K? Roll it over. There are many good reasons.

Now, all I need to do is get my wife to Roll over her old 401K from Charles Schwab to her E*Trade IRA. We'll see if the process is as smooth. I think that the fact that my roll-over was so easy will inspire her to make the move. I'll keep you posted.

I think this qualifies as my shortest post ever.

Rolling Over My 401K to Vanguard

I recently left my old job for a brand new and exciting one, and as I have previously written, I am a big believer in rolling-over my 401K as soon as feasible after I leave a job. There are many reasons to roll-over a 401K into an IRA, but some of the biggest are the high-costs and limited transparency of typical 401K plans and the relatively limited investment options.

Being the devoted index investor that I am, I rolled my 401K money into my traditional Vanguard IRA. The process itself was smooth and painless. First, I logged into my 401K account online. There I chose to terminate my account and to take my money in the form of a direct roll-over. Note that if you choose to withdraw your cash instead of rolling it over, you may be subject to a 10% tax penalty, and to an immediate 20% withholding. ADP - my now former 401K plan provider - asked me to enter the name of the institution into which I will be rolling over my account, and presto - a week later a check arrived in the mail made out to Vanguard, for the benefit of your humble blogger.

This morning I called Vanguard - whose service center closes at 5 PM Pacific for some strange reason. The representative was very friendly and informative and simply asked me to identify myself, which account the money will be rolled into and how I would like my money invested. I chose to invest my hard earned $46,000 as follows: 15% Total REIT Index (VGSIX) - I have been beefing up my investments in that fund recently to offset declines over the past year; 40% in Total International Stock Index Fund (VGTSX); 35% in Total Market Index Fund (VTSMX) and the remaining 10% in Vanguard's Extended Market Index Fund (VEXMX). The whole process took me about 10 minutes. I mailed the check to Vanguard today, so with any luck my money will be back in the market within a few short days.

On a (little) sad note, when I left my employer after almost three years, I left behind 50% of my employer matching funds, which were not yet vested. This amounted to a few thousands of dollars, but if you get a good career opportunity, you don't give it up for some short term gains. Still, I am never happy when I need to leave money on the table.

Get a Retirement "Quota"

This evening I asked one of my colleagues a simple question: "when do you want to retire?". Once again I am on a business trip, this time in good ol' Florida. I am traveling with one of my colleagues, a Director of Sales in his late 40's. When I asked the retirement question, I got a very thoughtful and encouraging answer. Here is what my colleague said (loosely paraphrased):

"Retirement is like sales. You have to meet a certain quota, and that quota is the amount of money you will need to fund your retirement. Just like in sales, to meet your quota you have to shoot for a higher number than you really need and build some safety margins into your plan. I am shooting for retirement at 58, but I know that I want to retire by 63. As far as I am concerned, if you don't plan for a specific retirement date, you will have to continue working for the rest of your life. I have plan, but I have built some flexibility into it. At the end of the day, being able to retire doesn't mean that I will actually retire. As long as I enjoy my work, I will continue do it."

Amen to that. A well thought-out and well explained retirement plan AND from a sales guy no less (sorry, I couldn't resist the dig at sales folks, being a marketing guy myself). I don't yet have a target retirement date myself, but I do have a target "quota" of $4 million. This is a stretch goal but I think that my wife and I can achieve it by developing our careers and living modest and balanced lives.

What about you? Do you have a target retirement age and "quota"? If so, are you on track to achieving those goals?

Personal Finance: Intentions & Reality

A couple of days ago I ran across this interesting article. The article outlines the often huge distance between intentions and actions as far as personal finance is concerned. Here is a summary of one section that I thought was especially informative:

Attendees at a retirement planning seminar all claimed that they would be joining their company's 401K plan. In reality, only 14% of un-enrolled seminar participants actually joined the plan. For comparison it should be noted that only 7% of those that did not attend the seminar joined the same plan. This information could lead you to the conclusion that the seminar helped motivate people to take action, however, it could also be argued that there is selection bias at work: i.e. people that chose to attend the seminar did so because they were more serious about taking action regarding their retirement planning. This means that the seminar itself may not have influenced people's actions at all, rather it simply provided a gathering venue for those more serious about retirement planning.

The article also shows that a large majority of people who were already enrolled in their 401K but needed to take certain actions, such as increasing their contribution rate also failed to follow up on their intentions after the seminar.

Here is what I take from this article: people procrastinate. It is in our very nature. We mean well, but our intentions do not always translate into action. Take me for example. I have been meaning to take my car in for an oil change for the past three weeks, but somehow I just can't seem to get it done. I have many good excuses: work has been crazy; my brother is in town for a visit; I have to pick up the kids and so forth. All excellent reasons. Still, no oil change.

What does that mean for people who care about personal finance? A couple of things: first, recognize your tendency to procrastinate, and combat it by building a plan and attaching schedules and goals to it. You want to do something? When are you going to do it? Second, don't develop personal finance plans that require too much activity or that rely on perfect timing. Those would be the most susceptible to procrastination damage.

What does this mean for public policy planners? If you think people are going to plan for their own retirement or make provisions for their long term economic well-being, there is a very strong chance that a majority of the population, while very well intentioned, will never actually get around to doing so. In fact, Congress and regulators are trying to use people's procrastination and laziness as tools to promote healthy retirement savings. One of the ways to achieve this is automatic enrollment of people in their 401K plans. Congress ok'd auto-enrollment in the Pension Protection Act of 2006. Hopefully procrastination now becomes a tool for good, as people who otherwise would never have saved now don't actually get around to opting-out of their retirement plans.

I hope you enjoyed this post. I was actually planning to write it last week, but never got around to it...

The Future of Retirement

The retirement system in the U.S. is broken. This weekend I was reading my copy of Business Week, when I came across an ad on the back cover of the magazine. The full page ad by Allstate was so well-written and to the point that I decided to do an entire post about it. Here are some quotes from the ad and my take on them:

"1. Examine Social Security - Americans will not be able to rely solely on Social Security for a comfortable retirement. In the future, it's projected to cover an increasingly small percentage of the average retirement. There's debate as to whether it should be repaired or replaced. But What's clear is we need to reform Social Security now."

I could not agree more. Where is Congress? Why are we paying those guys to spend all that time in Washington if they cannot be bothered to fix a system that is obviously broken and that many Americans will have to rely upon in their old age? There are about 20 presidential candidates running around the country, both Democrats and Republicans. How many times have you heard them talk about plans for fixing Social Security? Far fewer times than you heard them talk about gay marriage, that's for sure. Why is it that we cannot make our politicians focus on what's important to the vast majority of their constituents?

Here is a sobering statistic. Take a look at the following quote from Wikipedia:

"According to most projections, the Social Security trust fund will begin drawing on its Treasury Notes toward the end of the next decade (around 2018 or 2019), at which time the repayment of these notes will have to be financed from the general fund. At some time thereafter, variously estimated as 2041 (by the Social Security Administration[30]) or 2052 (by the Congressional Budget Office[31]), the Social Security Trust Fund will have exhausted the claim on general revenues that had been built up during the years of surplus. At that point, current Social Security tax receipts would be sufficient to fund 74 or 78% of the promised benefits, according to the two respective projections."

If this information is true, politicians are choosing to ignore this problem knowing that the bad stuff will happen long after most of them leave office. Rule number one of politics: let the next guy deal with the bad stuff.

More from the ad:

"2. Boost Retirement Plan Enrollment. Companies should continue looking for ways to encourage employee participation in 401(k) plans. One proven way to increase retirement savings is through company matches. Another is automatic enrollment - employees are signed up for savings plans when they join the company, unless they specifically opt out."

I completely agree. Especially since Social Security is in such a sorry state, 401(k)'s are extremely important to the financial well-being of Americans. For once, Congress did the right thing in encouraging companies to automatically enroll employees into 401(k) plans, as part of the Pension Protection Act of 2006.

My company is about to move to automatic enrollment, and it is my hope that this encourages the 20% or so of employees who are not yet enrolled, to do so.

Finally, the last quote from the ad:

"3. Increase Personal Savings. Ultimately, everyone is responsible for their own retirement. It's why we support laws that reward people for saving. Tax-advantaged savings vehicles like annuities and IRAs are two examples of products that can help allay Baby Boomers' biggest fear: living to see the well run dry. When planning for retirement, it's time to realize that no one is going to take care of us unless we start taking care of ourselves."

Once again, spot on. Personally, when making our financial plans for retirement I am assuming that the only resources we will have are the ones we save ourselves. We are not counting on a dime from social security, not a nickel from any inheritances, and we are certainly not taking into account any manna from heaven. It's all about our personal savings. That may be too conservative, but my philosophy is that it is better to have too much money saved up than too little. After all, you can always take an extra trip to the South Pacific if you have too much money, but if you have too little you may be planning on dinner for two at Chez Dumpster.

While we should fight to make sure that Congress addresses the Social Security situation, and push companies to become more generous and more diligent in their 401(k) offerings, the ultimate responsibility for your retirement rests with one and only person: you.

So there you go. I never thought I would write a favorable article about a financial ad, but I guess there is a first time for everything.

By the way, to read about how I think the retirement situation can be at least partially fixed, check out this post.

How to Invest Your 401K Funds

In my role as a member of my company's 401K committee, I have recently had conversations about the topic of 401K asset allocation with a number of people in my company. I discovered that people don't really know how to invest their retirement money. Below are some of the poor investment strategies that I have heard about:

Pretend Diversification - one employee told me that his investment strategy is to split his contributions between all available fund options. Since we offer our employees a total of 15 funds, he essentially puts 6.7% of his funds in each of them. What a horrible strategy. Essentially this employee believes that whatever it is we put in front of him is worth spending money on, regardless of cost or performance. That's not diversification, it's laziness. Such laziness makes me want to roll up a newspaper, smack that guy on the nose and yell, "No! Bad investor!" This is probably the second worst 401K investment strategy that I have heard about. Here is the worst:

Putting Your Money in the Safest Investment - one employee puts most of his money in the stable value fund offered in our plan. He thinks he is doing himself a favor by playing it ultra conservative. This is a poor strategy. A 401K is a very long term investment. Arguably it is the longest term investment most people make. That being the case, the daily, monthly and even annual ups and downs of the market are not relevant. All the matters are the long term trends, and in the long run stable value funds barely keep up with inflation. Try to be too conservative with your money and you are bound to end up with a cash stash too small to support you comfortably in retirement.

Over Confidence - more than one employee told me that they are investing their money in only one or two funds. Unless you are talking about a lifestyle fund, or a couple of very broad based index funds, you are probably not going to get the diversification you need from such a small number of funds. You may feel confident about the hotshot international equity fund you picked, but without sufficient diversification you'll be sorry when the next international melt down hits.

Not Paying Enough Attention to Cost - few employees demonstrated to me an understanding of the costs associated with the investments that they picked. That's too bad for them. Costs can have a critical impact on your portfolio. Let me give you an example: let's say that your equity fund generates an average return of 8% a year. If your fund charges an expense ratio of 2%, you are essentially paying a commission of 25% on your profit! And don't think I am exaggerating either. Our 401K plan has more than one fund that carries that expense ratio. That's partly the reason that we are switching 401K plan providers.

So how should you invest your retirement money? Here are a few tips:

1. If You Don't Know Ask - ask your plan's sponsor or call a financial advisor directly. Better yet, go online and read some personal finance blogs for some hints. Go to the library, get a few books and read. Whatever you do, educate yourslef before you commit to any investment strategy.

2. Consider the Costs - very few investment options are worth 2% per year in fees. I am a big proponent of index investing. If your 401K plan offer a broad index fund, check it's expense ratio and consider investing some of your money in that option. Generally speaking, if you are given the choice between two funds that cover the same asset class, you probably want to pick the one with the lower cost. Studies have shown a negative correlation between investment fees and investment returns: the more you pay, the less you get for your payment. What a scheme.

3. Diversify for Real - Don't just select multiple funds. Select funds that cover different asset classes. Get a broad exposure to the domestic stock market, the international stock market and to the bond market. If you can add a small exposure to the real estate market, that might not be a bad option either.

4. Consider Lifestyle Funds - lifestyle funds are an excellent option for investors who feel that they don't know enough to invest for themselves or that don't want to deal with the hassle. All it takes is for you to pick your retirement date, put in your money and the fund invests your assets in a mixture of stocks and bonds that gets progressively more conservative as you age.

5. Stay Out of the Money Market Fund or Stable Value Funds - such funds are great if you are building an emergency cash reserve or saving for your summer vacation, but if your investment time horizon is long, putting your money in such vehicles is a poor decision.

Of Retirement & Dwarves

A few weeks ago I came across this interesting website on Get Rich Slowly. The website offers a tool for calculating your cross-over point: the point at which the income from from your investments exceeds the amount of money you spend on a monthly basis. Theoretically, from that point forward you are financially independent and would no longer be required to work to maintain your living standard.

I found the notion intriguing and played around with the numbers a little bit. Here is what I came up with: assuming we spend 80% of what we make (which is pretty close to the mark), achieve a return on our invested capital of 8% per year, inflation averages at a rate of 3% per year and we gain a pay increase of 4% per year, my wife and I will be achieving our cross over point in... wait for it... 12 years. Financial freedom, here we come! Or, maybe not so fast.

Here's the rub. While the crossover theory is sound in principle, it fails to take into account a number of parameters:

1. Inflation - say we were to get to our cross-over point and then stop working. At that point our income from investment would equal our expenses and we would no longer be adding to our savings, nor would we, in theory, be diminishing them. However, inflation is a nasty beast. Just because we stop saving and investing, doesn't mean that prices will remain fixed. In fact to the two eternal truths (death and taxes) we should probably add a third: inflation. With time inflation would erode the purchasing power of our investment income, and back to work we go (with very few hi-hoes).

2. Market Fluctuations - while our portfolio can reasonably be expected to return 8% annually over the long term, there are no guarantees that we will not be hitting any short term bear markets. Assume we stop working at our crossover point, and the very next year the market tanks and goes does 20%. If at that point we continue to draw down our investment income at the previous rate, the value of our portfolio will erode very quickly. Once again if you listen carefully, you can hear seven dwarves singing a much too cheerful song in the background.

3. Additional Expenses - if indeed we reach our crossover point in 12 years and choose to retire, we will be many years away from qualifying for medicare. Right now our medical insurance costs are largely covered by our employers, but if we need to pay for medical insurance ourselves, that crossover point is probably a little bit farther into the future. Will someone shut-up those darn dwarves already?

4. Asset Allocation - while we are young, both working and have no immediate need of our retirement assets, we can reasonably expect our investments to yield something like 8% a year on average. However, as the time comes for drawing down on those assets to support our living expenses, a more conservative investment strategy will probably be required, and the more conservative your investment the lower the average return you can expect. Once again, our crossover point just got a bit farther away.

So, is there no hope? On the contrary, there's big hope. As we close in on the cross-over point, we will have amassed a substantial asset base, and this asset base will be compounding at a pretty impressive rate. We may not be able to wave our bosses good-bye quite yet, but we will be well on our way and with just a few more years of hard work we will be able to kiss the corporate life good-bye.

Interestingly, I actually enjoy my work and as of today I am not in a rush to leave it behind me. Still, it would be nice to know that the option is there, if I choose to use it.

For a detailed discussion of the cross-over concept, be sure to visit The Simple Dollar.

How Is My 401K Doing?

As I perviously mentioned, EBRI just released their 401K survey for 2006. A couple of days ago I wrote a post about how lifestyle funds are becoming more popular in 401K plans. Today, I want to take stock of my own 401K situation and compare my performance with the data provided in the report.

I joined my company a little over 2 years ago and my current 401K balance is approximately $41,000. According to the EBRI report, my 401K balance is higher than about 65% of plan balances out there. This is where I pause, and pat myself on the back. Now it's time to get a bit more detailed, and compare my balance with that of my peer group.

I am in my mid thirties. Of people in my age group, 29% have less than $10,000 in their 401K accounts; 27% have between $40,000 and $50,000 and 11% have over $100,000. Interestingly, about 0.5% of employees in their 20s have 401K balances in excess of $100,000. Good for them. On the flip side, about 6% of employees in their 60s have account balances under $10,000. I guess some people are simply aching to become Wal-Mart greeters in their golden years.

Of people that have a tenure of 2 to 5 years with their employers, the group into which I fall, about 26% have account balances below $10,000; 15% have balances between $40,000 and $50,000; and about 4% have account balances above $100,000. Folks with 2 to 5 years of tenure who have over $100,000 must have either rolled over an old 401K plan into their current employer's plan; have been contributing aggressively for 4 or 5 years; or have been investing in something on steroids. In any case, good for them. Once again, it is interesting to note that about 8% of employees who have been with their employer for over 20 years still have less than $10,000 in their 401K plans. Repeat after me: "Welcome Wal-Mart Shoppers!".

Finally, according to the report, people in their 30s, who have been with their employers 2 to 5 years have on average $22,368 in their 401K plans. This is my specific peer group, and compared to this group, my 401K is doing spectacularly well. Steady as she goes, then.

To compare your own performance to that of the correct peer group, go to the EBRI report and take a look at figure 13 (page 18).

The Best 401K Plans

A few years ago I was interviewing for a position with VISA. The position I was interviewing for was so-so, and in the end I didn't get it. I was told I was over qualified, which I was, but that's a story for another day. I got pretty far along in the interview process, and at one point the HR person discussed compensation and benefits with me. The compensation was nothing to write home about, but the benefits were pretty amazing. At the time, VISA's 401K plan included a 4:1 match up to 6% of salary. To date, these are the best 401K benefits that I have heard of. Recently I interviewed someone who was working for VISA and was thinking of leaving. The person told me that the golden age of the VISA 401K was over and that benefits have been sharply reduced. He did not share the details.

A relative of mine joined Boston Consulting Group after finishing his MBA. When I asked him what the company match to his 401K was, he said that there was none. The company simply contributed the maximum amount permissible to each employee's 401K account. No contribution from the employee was needed. That is the second best 401K plan I have heard of. Of course, the downside to this contribution structure is that the employee doesn't get a chance to contribute even more towards his own retirement plan. Actually, I am not sure whether employees were prevented from adding to the amount contributed by the company. Regardless, we are still talking about a lot of free money.

This is where I open up the floor for discussion and comments. I am asking my readers to tell me about the best 401K plans out there. Let's see if we can create a list of the best retirement plans offered by ordinary employers. Call it the "Best Companies for Future Retirees" list. All viable suggestions will be added to this post with a link to the appropriate blog.

Planning for Retirement in Your 20's

This is the fifth and final post in my Personal Finance in Your 20's series. It's all about making sure that when you are finally ready to quit your day job you are able to do so.

Most people in their 20's are not yet thinking about planning for retirement. That's a shame because the earlier you start saving, the less you need to invest in order to assure yourself a comfortable retirement. It's all about that famous magic of compound interest.

From my conversations with young employees in my company, and from what I remember about myself from just a few years ago, many people in their 20's don't save for retirement not because they can't or don't want to do so, but because they are either overwhelmed by the topic, are afraid of making a mistake or simply don't know where to start. In my opinion, not saving is the biggest mistake of all.

Below are five strategies that I would follow if I were in my 20's and starting to save for retirement today:

1. Figuring Our What You Will Need - if you research the topic of retirement planning online, you are bound to come across advice telling you to figure out what your financial needs will be in retirement and to build your plan accordingly. Trouble is, in your 20's there really is no way for you to know how much you will need forty years down the line. So I say, forget about figuring out your needs. Save as much as you can afford, and at least 10% of your gross pay. If at some point in the future you decide that you are saving too much, saving less is always possible. Going back in time to save more is a bit more tricky.

2. Invest in a ROTH IRA - the great thing about making a pittance is that your taxes are low... OK, there is nothing great about making a pittance, but the point I am trying to make is that it is likely that you are paying less tax now than you ever will in the future. That means, that if you invest your retirement money in a ROTH IRA, you will be paying very little tax now (because your tax bracket is lower) and you will be paying NO taxes when you withdraw the money. Not paying taxes rocks.

3. Invest Aggressively - if you are starting to save for retirement in your 20's your time horizon for your investment can be as long as forty years or more. With that vast amount of time, I would be quite aggressive in my investment strategy, investing close to 100% of my assets in the stock market. If you have enough time for your investments to recover from eventual bear markets, stocks tend to outperform other investment options.

4. Sign Up for Your Company's 401(k) & Get Matching Funds - Who said there is no such thing as a free lunch? If your company matches your 401(k) contributions, or even a part of them, you are getting free money. Take it. I am always amazed that about 20% of the employees in my company are not signed up for the 401(k) plan. These people are essentially refusing a gift of cold, hard cash.

5. Keep it Simple - If you are overwhelmed by all the investment options that you have, the best strategy for you is to keep things simple. If your company offers a target retirement fund in its 401(K), put all your money in the one fund that matches your planned retirement date. The asset mix in such funds shifts as you age, to reduce your level of risk. If you are investing in an IRA or other account that you manage yourself, put your money in a highly diversified stock equity fund, such as Vanguard's VTSMX. Over time you can improve your investment strategy and become more sophisticated. If you wait until you feel more confident in your investments, you may never get started, and that is the biggest investment mistake you can make.