Trovena Weblog

A Big Step in the Right Direction

This isn't law yet, but it has overwhelmingly passed a vote in an influential House committee.  If this bill passes, and is signed into law, it will restrict 401(k) advice to independent advisers, taking away the ability of commissioned brokers from charging high fees in these plans.  The high fees has long been one of our criticisms of many 401(k) plans.  Unfortunately, they are pitched to employers as plans that will not cost the employer any administrative fees.  Of course, the revenue is then collected from the high cost investment options given to the employees.

To quote the last line of the article, "it's about time that Wall Street stop viewing workers' 401(k) accounts like a gold deposit to mine."

This brings the working/investing public one step closer to having freedom and independence in how their 401(k) assets are invested.  Currently, most plans have a limited set of mutual funds for plan participants to choose from.  In most cases, the investment selection is limited to inadequate due to a number of reasons:

1. The funds offered have high expenses.  Whether this is due to broker related commissions or the high cost of active management varies.  In many cases, it may be both.
2. The breadth of funds is not complete to construct a well diversified portfolio, especially in the small cap, international, international small and emerging markets.
3. The fund choices usually consist of actively managed funds.  There is considerable academic evidence that active management does not add value over a passively managed portfolio, especially over the long term.

We applaude companies such as Northrop Grumman, which offers employees the option to invest their 401(k) assets independently through the Schwab Personal Choice Retirement Account (PCRA).  This option effectively turns the employee's 401(k) assets into a self-directed brokerage account.  Employees may invest in stocks, bonds, no-load mutual funds or hire an independent Investment Adviser to assist them with the investment of these assets.

Here's the complete story in the Investment News:  "House committee approves bill that restricts 401(k) advice to indie advisers"

Journalist Request: Essentially a question of tax diversification

Here was the reader question that was asked by Raj Sharan, a financial writer for the Christian Science Monitor:

"I currently contribute about $20,000 a year tax deferred into a 401(k). My employer does not contribute. Since in the future (I'm 2 years from retirement) I'll roll this over into an IRA, would it be better to pay taxes now on the $20,000 and just invest in a regular account? Otherwise, when the money is withdrawn from an IRA, I'll be paying taxes on the entire investment as regular income, not just on the capital gains. I'm assuming that my tax bracket will be the same at retirement. A Roth 401(k) seems like a better deal, but my employer doesn't offer one."

Most investors, after relatively little study of investing, realize that diversification is an important principle.  "Don't put all your eggs in one basket!"  Pretty simple, right?  Of course, loading up on tech stocks in the late 90s aside, most investors get this on some basic level.  True diversification of non-correlating asset classes, without biases towards large U.S. stocks, is rare however.

Even if investors truly understand the principles of investing, another type of diversification has to be considered, especially as investors approach retirement:  Tax Diversification.

So, here is my response to the question:

The origin and rise of the 401(k)

Let's say you are 65 years old.  Which sounds like more money?

• $455,140 now, or
• $3,000 per month for life.

It wasn't too long ago (if one generation counts as "not too long ago") when pensions were considered the default retirement plan for most Americans.  Work for a good company, get your gold pen at retirement (if you're retired, what do you need a fancy pen for?), and sit back while the pension money rolls in.  This is where the phrase "seniors on a fixed income" originated.  Between Social Security and pension income, their income was not expected to increase much over time.  Conversely, inflation during the 70s and early 80s far outpaced any increase that they could expect in retirement income.  Sadly, standards of living were ravaged.

In the 1980s, an obscure piece of tax code, section 401(k), ushered in the largest and most popular retirement plan for an entire generation of Americans, and perhaps more to come.

How does the recent decline in the market impact retirees or near retirees?

The following question was recently posed by a reporter:

What kind of advice are advisors offering clients who are either retired (especially those who have recently retired) or who are preparing to retire shortly, who may have just experienced a big drop in the value of their financial portfolios, as well as possibly a drop in their home values. Beyond telling people to pare spending or continue to work, is there any good advice you can offer to people in this situation?

It's a valid question, and one of great importance to many. This topic is something that I have been addressing in a course I teach at UCLA and in presentations around the country.  If I may, let me take a moment to frame the issue.

I'm gonna help some folks jump start their RETIREMENT!

The National Association of Personal Financial Advisors (NAPFA) has teamed up with Kiplinger's Personal Finance Magazine to offer "Jump Start Your Retirement" days.  I will be a volunteer NAPFA advisor this Friday, January 25, taking questions from Kiplinger readers and the general public about their retirement planning or any other financial planning matter.  I am taking questions "virtually" through the chat room that they are setting up for the day.  My time slot is 10:00am-11:00am pacific time.  So, get online and shoot me a question!

Here's the press release from NAPFA: