Purchasing Power vs. Capital Preservation..What’s Your Balance?

Many of us make trade-offs everyday . We attempt to balance one aspect of our life with another. This happens every day, all day. If we work more hours we will be able to provide more things for our family. On the other hand we have less time to spend with our family. To be happy we must balance the two. There is no right answer for everyone, just your answer.

Risk (Photo credit: The Fayj)

While talking with investors we discuss their risk tolerance, how much risk are you willing to take? When I bring up the subject of risk, some look at me blankly, some instantly have the look of fear on their face and will begin to panic. I decided there must be a better way to determine the proper mix of assets for each investor.

Since the 2008-9 crisis and the subsequent volatility many investors have understandably moved capital preservation to the top of the list. The danger of this approach is that these same investors believe that capital preservation means no risk.

With capital preservation the risk these investors realize is the risk of inflation or loss of purchasing power.

This loss cannot be seen on their statements because their principal does not go down. However each year that passes this same principal  will buy less goods and services. For example if you believe that $30,000 is enough annual income to meet your current needs. With just 4% inflation, which includes food and energy, in ten years you would need more than $44,000 to maintain your standard of living. In 15 years $54,000 and 20 years over $65,000.

Planning for retirement is very difficult because we have no idea how long we will live. What advances will there be in medicine? These questions go on and on.

Therefore I believe the question must become

  • What balance of capital preservation vs. purchasing power are you comfortable with? In other words what mix of fixed income vs. equities will you be comfortable with while reaching your long term goals?

A younger investor might be comfortable with a higher proportion of equities, while someone nearing or in retirement might prefer one with a lower proportion of equities.

The former is interested in higher growth which exceeds inflation and the latter in more interested in less volatility while keeping up with inflation or maintaining their purchasing power.

Whenever you are deciding which balance is right for you ask these questions:

  • What is the expected return?
  • What is the expected volatility?

Whatever you decide there will be risks, some will be apparent some will be invisible. The invisible risk, inflation or loss of purchasing power, is the most dangerous to your financial future because it is unrelenting.

A globally diversified portfolio with the right balance for you will provide the best opportunity to reach your long term financial goals.

Remember equities are the greatest creators of wealth if properly used. This would involve that you

  • Own equities
  • Globally diversify
  • Rebalance

By following these rules you will reach your long term financial goals.

  • Going Broke Safely.
  • Inflation Sucks!!
  • Market Timing….Luck or Skill?
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Inflation Sucks!!

Remember when a stamp was a nickel or you could buy a candy bar for a dime? We do. At a relatively low inflation rate of 4%, it only takes 18 years for your wealth and its buying power to be cut in half. One of the primary goals of your portfolio should be to stay well ahead of inflation.

Risk (Photo credit: The Fayj)

Inflation can suck the lifeblood out of your portfolio.

Many investors are looking to avoid the volatility of stocks. They see this equity risk as too much to bear. The uncertainty of the economy brought on by the child-like antics going on in Washington DC. The struggles of the Eurozone to pay off their ever mounting debt has investors concerned about the future. There is nothing but bad news in the financial media. Nothing leads investors to a place of optimism.

All these concerns lead investors to seek out ‘safe’ investments. Investments such as CDs, annuities, cash, treasury bills or even bonds are sought because there is no apparent volatility.  What investors don’t realize is that these ‘safe’ investments have risks of their own.

This risk is even more dangerous than equity risk to your long term wealth.

Regardless of your investments there is risk involved. In the case of equity risk we see the effects every time we look at our statement or watch the daily news. We know that when the markets are down our account balances are down. This risk is visible and unwavering.

With regard to inflation risk we cannot see it daily, weekly or monthly. Unless we are paying attention to our rising food bill or utility bill or when we fiil our vehicle with fuel. These risks are losses in our purchasing power.

Remember with a small 4% inflation rate, in 18 years our cost of living will double.

Although we are in ‘safe’ investments and our account balances only show positive gains we are losing value every day, month, year.

The trade-off between equity risk and inflation risk will always be there.  If we view our portfolio including stocks on a long term basis we will stay well ahead of inflation. The end result is building our wealth for a secure future and retirement.

To succeed in reaching these goals we must:

  • Own equities
  • Globally Diversify
  • Rebalance

With the help of an investor coach we can stay focused on our long term goals. We will avoid the emotional panic selling during down markets. We will also avoid emotional euphoric buying of a hot asset class in up markets. We will follow the investment policy statement developed jointly. Do this and we will succeed, long term.

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Annuities: Don’t Believe The Hype

The Wall Street bullies want you to believe that they have your best interest in mind. Remember if what the insurance companies are protecting you from actually happens, they will be unable to honor their promises. You cannot avoid all risks with your investments you just take different kinds of risk. These risks are all real. Some worse than others.

English: 60 Wall Street
English: 60 Wall Street (Photo credit: Wikipedia)

Have you bought a variable annuity yet? If you’re a baby boomer and your answer is no, get ready for the hard sell. The promoters of these savings vehicles will prey on your insecurity about not having enough money for retirement to get you to sign up for what could be a costly investment. Even if you already have a variable annuity, someone may try to convince you to trade in your existing contract for one with new bells and whistles — in which are buried higher fees. The problem with variable annuities is they are often a high-cost answer to a problem that may have simpler, cheaper solutions, such as fully funding your tax-deferred retirement accounts or assembling a portfolio of reliable dividend-paying stocks. Still, through Sept. 30, 2004, variable annuity sales were $98.4 billion, about 4% higher than during the same period in 2003. And it’s insurance salespeople, not Wall Street brokers, who are making most of the sales. Financial planners in particular have been cool to the product. Variable annuities “are tax-inefficient, difficult if not impossible to understand, and have high costs,” says Warren McIntyre, a financial planner in Troy, Mich. 

The sales pitch of both fixed and variable annuities rely on the consumers fears. These agents point to the volatility of the stock market and offer a product which deals with this fear. The cost for this insurance is excessive and unnecessary. It jeopardizes your financial future.

Please comment or call to discuss.

Posted via email from Curated 401k Plan Content

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A Rational Response to Irrational Market Anxiety

The Wall Street bullies have a vested interest in keeping you guessing. What is the best investment for right now? Who has the answer ? What fund managerswill out perform?The answer is, no one knows what the future will bring. Your best strategy is a prudent one. Once designed and implemented your goal is to rebalance regularly and remain disciplined.

Dangerous Risk Adrenaline Suicide by Fear of F...
Dangerous Risk Adrenaline Suicide by Fear of Falling (Photo credit: epSos.de)

There is always risk in the stock and bond markets. Risk is the source of returns. The greater the risk, the higher the expected return. Here’s an example:

We all know there is a risk that Greece, Italy and Spain may default on their sovereign debt. As that risk level increases, buyers of that debt demand a higher rate of return to compensate them for that risk.

The current price of publicly traded stocks and bonds represents the collective judgment of tens of millions of buyers and sellers, trading about ten billion shares a day. Their judgment is what places a value (the “price”) on these shares. It takes into account all levels of economic uncertainty.

When you hear financial pundits discuss economic uncertainty and recommend buying or selling certain assets, you should reject their advice. Whatever facts they are relying on have already been priced into the asset they are recommending you buy or sell. That asset is fairly priced. Trying to find a misplaced asset flies in the face of this basic reality.

There will continue to be financial ‘experts’ who claim they will earn you greater return for little or no risk. They supply evidence which is unsupported and of no value. There is no substitute for a prudent strategy and discipline.

Please comment or call to discuss how this affects you and your long term financial goals.

Posted via email from Curated 401k Plan Content

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Meaningful Multiple Employer Plan Minutiae

Multiple Employer Plans have been given a bad rap by the financial institutions. The implementation of a MEP would allow more Americans to an affordable retireement plan. This would result in the end of the cash cow for the financial industry.

WASHINGTON - OCTOBER 26:  Internal Revenue Ser...
WASHINGTON - OCTOBER 26: Internal Revenue Service Commissioner Douglas Shulman addresses the American Institute of Certified Public Accountants' 35th Annual National Tax Conference October 26, 2010 in Washington, DC. Shulman addressed a new IRS program requiring that anyone making money from completing tax returns must register with the IRS, pay a fee and pass competency tests and eventually attend continuing education programs. (Image credit: Getty Images via @daylife)

One bad apple.  One of the risks in adopting a MEP is that, under IRS rules, a single bad plan can disqualify the entire MEP. What minutiae is critical here, though, is Section 10.12 of EPCRS (the IRS’s correction programs): a MEP which has a violating plan sponsor is fixed by fixing only the broken portion of the MEP (of course), but the Plan Administrator may elect to have the compliance fee or sanction based only upon the offending plan, not based on the entire arrangement; while 14.03 permits similar treatment for “tainted” assets transferred into the plan from an offending plan (if the offense does not continue). As a practical matter, this means the risk of an economic catastrophe from a single employerdisqualifying an entire MEP can be cost effectively managed. 

This clears up one of the concerns when becoming an adopting employer in a multiple employer plan.

Please comment or call to discuss how this could affect you and your company’s decision to join a MEP.

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Eight suggestions for improving your 401(k) plan

President George W. Bush signs into law H.R. 4...
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Providing your employees with a pension fund like plan will be the single most effective way to improve the quality of plan you offer while reducing your fiduciary risks. The Pension Protection Act of 2006 allows many incentives to improve the retirement outcomes for all Americans. Good companies will use these provisions to improve their plan and improve their competitiveness for talented employees.

6. Reduce the number of investmentoptions.Consider offering only five risk and five age-based options as the only investment option(s). Also, consider an employer-directed 401(k) plan (yes, there are employer-directed 401(k) plans), or at least one that initially defaults the employee to an age- or risk-based fund based on certain demographics. Too much choice confuses and alienates participants. Exotic investments may be dangerous in the hands of an unsophisticated employee.

This change to your retirement plan will improve your employees ability to retire with dignity. It essentially changes your plan to a pension fund like plan. Most plan participants are confused about all the choices presented them in the typical plan. They lack the knowledge and discipline to buila a successful retirement plan.

Please comment or call to discuss how this can help you and your company.

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Siedle’s Rules for Handling Financial Adviser Conflicts of Interest

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The new fiduciary standard for all advising clients on investments will help avoid these conflicts. The question remains, why is the financial services industryso adamant about not following the fiduciary standard?

First, conflicts of interest are generally to be avoided. Why? It’s a simple matter of loyalty. You want to know that the agent you’ve hired to handle your hard-earned savings is exclusively motivated by what’s best for you and not what’s best for him or his firm. Again, conflicts result in real harm. We’re not concerned here with theoretical moral dilemmas. The concerns are improper economic incentives and divisions of loyalty that will cost you. Every financial adviser that admits to a conflict will, in the same breath, tell you that you should not be worried. Already the guy is lying to you. Don’t believe it for a minute. Conflicts are red flagsthat demand your attention. Don’t dismiss your concerns before you’ve even begun to address them.Second, conflicts of interest are to be tolerated only when they are either (1) unavoidable; or (2) the potential rewards outweigh the risks. In my professional experience, when it comes to investment products and services, rarely, if ever, are conflicts unavoidable. You can almost always find another firm with comparable pedigree and performance results that is not subject to the conflict at issue. There are tens of thousands of advisers out there and unless you’re living on a deserted island, seriously consider whether you can get the same product or service without the attendant baggage, i.e. conflict-related risk.

More likely, you may believe that the potential reward (future outperformance) outweighs the potential risk (known conflicts). That may be a valid conclusion but the question is: how did you arrive at it?

Great article. The financial services industry will need to more thoroughly train their representatives on what they sell rather than how to sell more.

Please comment or call to dicuss how this affects you and your financial future.

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Stable-Value Strategies Becoming Riskier

WASHINGTON - NOVEMBER 23:  Members of the news...
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After all fees are deducted your ‘stable value fund’ might show negative returns if circumstances change. Care must be taken when employment structure changes.

While stable value investment strategies have performed relatively well during the past few years compared to money market strategies, we believe the changed environment means investors should revisit these with a view to understanding all the risks now associated with this investment strategy,” said Peter Schmit, research manager in Towers Watson’s investment business and coauthor of the paper. “Regardless of upcoming regulatory decisions, we believe there has been a structural shift in competitive advantage away from plan sponsors and stable-value managers over to insurance providers and the investment strategy now faces distinct market risks and regulatory headwinds.”According to the research, stable value has long been a popular investment option in defined contribution (DC) plans, as plan participants have appreciated the principal preservation, benefit responsiveness, liquidity and consistently higher returns compared with money market options, with a similar risk profile.

However, Towers Watson notes that plan sponsors should be aware of the type of events that may trigger a violation of the wrap agreements and cause a potential market-value adjustment, such as a workforce reduction or the addition of a competing fund option (money market or self-directed brokerage option) within the DC plan.

Such risks include counterparty, term, credit and liquidity (at the plan level) and are exacerbated by:

  • Complexity
  • Lack of standardization
  • Less-than-ideal transparency
  • Changing markets prompted by uncertainty over Dodd-Frank, swap legislation, diminishing capacity and evolution of the wrap market
  • The reality of higher wrap fees and lower yields

There is no such thing as risk free.

Please comment or call to discuss how this could affect your company retirement plan.

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Reducing Fiduciary Risk

Investment Process Focused on Risk Measurement...
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A prudent process is essential when designing your qualified plan. If you do not have the expertise to properly design a prudent process formally hire an expert.

Fiduciaries and business owners already take on enough risk elsewhere. In an environment that allows government protection by following a series of procedures and practicing due diligence, it makes no sense to place fiduciariesat added risk.Plan sponsors should review their investment-policy statement for a quantitative approach to investment monitoring. A good rule of thumb is: If you can explain to a novice the criteria of “how and when” a fund is placed on a watch list, removed or replaced, your work is done.

The formula should be simple: for example, a scorecard of each investment based on distinct and unique criteria, including peer group comparisons of:

* Fees;

* Risk-adjusted performance;

* Performance consistency; and

* Fund manager value-add.

Every quarter, the figures are formulated and the outcome is clear: A fund passes or fails. The removal of qualitative factors to skew the decision makes the process more meaningful and effective.

The worst investments decisions are based on emotions. Removing emotion from the equation provides added protection from risk for plan fiduciaries, whatever external factors might make the markets swoon.

When you are sponsoring a qualified retirement plan for your employees a prudent process is essential. Following this prudent process will reduce your fiduciary risk as well as provide your employees with the best plan possible for your firm.

Please comment or call to discuss how this affects your company.

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Why Fees Matter for 401(k) Plan Fiduciaries, But Not Defined Benefit Pension Plans

401(k) Fee HELP Hearing Mitchem
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Defined Benefit: Plan Sponsor Bears Risks

Plan sponsors more or less guarantee a predetermined benefit to participants in traditional pension plans. This is why they’re called defined benefit (DB) plans. Whether plan sponsors spend wisely or foolishly on their plans, the sponsors are still on the hook for paying the agreed-upon pensions to their retirees.

For example, let’s say a plan sponsor invests in a global index fund with an expense ratio of 2% instead of 1%. The additional 1% in expenses has no direct impact on plan participants’ retirement income because participants’ benefits are set independently of investment returns. Also, the extra 1% in expenses comes out of the plan sponsor’s pockets, not the plan participants’. Pensions’ investment portfolio assets belong to corporations, not employees. This contrasts with the situation for defined contribution plans.

Defined Contribution: Plan Sponsors “Off the Hook” for Benefit Level

Plan sponsors make no promises about the level of benefits that participants in defined contribution plans will receive. In fact, the only thing participants know for sure is what is contributed into their defined contribution (DC) plan. The plan sponsor isn’t even required to contribute to participants’ retirement. Moreover, in contrast to the DB situation, the assets in the DC plans don’t belong to the corporation. They are held in trust for the benefit of the participants and their beneficiaries.

Here’s why plan expenses matter in 401(k) plans: The level of portfolio returns will affect the participants’ retirement income. Expenses—along with contributions and investment performance—are an important factor in long-term returns. Plan participants bear all of the risk if their portfolios don’t return enough to provide the retirement income they anticipated.

Higher expenses mean lower returns. This is why DOL sets high standards for DC plan sponsors’ expenses, yet pays little attention to expenses of their DB peers.

Plan sponsors maintain the responsibility to monitor plan expenses. The new fee disclosure regulations will show employees that they the employees are paying all or most of the fees associated with their plan. Questions will begin soon after the regulations take affect January 1, 2012.

Please comment or call to discuss how you will be affected.

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