April, 2008
by Dr. Thomas E. Bell, CMG Member, Michelson Awardee (Retired)
In the first installment of this series, we made the strong suggestion that you begin EARLY with collecting financial assets for your retirement. We're happy that many of you have been collecting such assets for years and years - mainly because nearly every one of your employers has had a pension or 401(k) program. Now you need to make sure that those assets earn income (and don't disappear) so you can eventually retire.
If you're like most CMGers, you've worked at a number of different organizations, and you've probably participated in (at least) the same number of retirement plans. Even though you've worked hard to organize the computer performance data for each of those organizations, you may have sort of, more-or-less, kind of, forgotten to get all the assets consolidated and organized so you can track what's happening with them.
But they're probably all in nice safe accounts paying you a good return and available whenever you have time to do anything with them, right? Maybe, but how much are you willing to bet on that? Your retirement? My experience is that unwatched assets may just sort of drift away and go into someone else's pockets.
Doing incremental consolidation is generally a good idea, but by age 55 you really need to get them together. By that age they will, hopefully, have grown to the point that they really need some active management, and that probably won't happen if they're sliced up into different, random accounts.
The core of the problem is that it's really hard to look at each of those account statements and make sense of them each month (or each three months). They're very likely to have different formats and to have different, obscure language that drives off your scrutiny. Until you get them together into a minimum number of accounts, you'll find the difficulty of understanding them simply too great to deal with.
At one time I assumed that the difficulty was just a function of my lack of focus on looking at different account statements. Today, I'm far less willing to accept myself as the cause of the problem. My change of attitude arose from the following experiences:
1. The monthly statements from my broker (Joe Delano) have improved year-by-year as his firm has worked to provide me with better reports. This really doesn't seem to be an insurmountable problem.
2. I can check my progress hour-by-hour, day-by-day, and month-by-month using commonly-available products on the web. No, making it easy isn't beyond the technology. (I like to use moneycentral.msn.com, but lots of alternatives are available.)
3. I became Chairman of our church's charitable Board three years ago. As you might assume, we had some assets in investment accounts in order to support activities over a number of years. So I tried to determine what returns we were achieving on each of them. To find out, I took the latest account statements and anything else I could get my hands on. After many, many hours, I determined that a nice "helpful" organization contracted with a brokerage to invest assets. It turned out that the organization took 1.5% of each account each year for ... nothing. In addition, the brokerage charged 1.5% of total assets each year for its skill in investments. (That's a total of 3% of our assets each year.) However, the "skill" of that brokerage led to only 2.75% return each year before fees - with a LOSS each year (negative return) to us. So we closed out those accounts and bought Certificates of Deposit yielding over 5% per year. The reports I had to analyze to figure out how we were losing 0.25% were extremely confusing.
Thinking back on the situation, I have to suspect that the design of the reports and ancillary information were not intended to make analysis easy. Would you put clarity of financial results as a priority if you were giving clients an annual return of -0.25%?
Don't assume that confusing statements are the result of your ignorance. Until proven otherwise, assume that some brokerage firm isn't interested in your making sense of the statements. But you probably don't have the time to figure out a bunch of different formats and terms; instead, you probably ignore the whole thing. That's a very bad idea.
In order to manage your assets, you need a minimum of reports and therefore a minimum number of accounts. In general, you can roll over retirement accounts into other ones in order to consolidate them. The chart below is taken from the IRS sitei and shows a number of "from/to" possibilities, including "Qualified Plans" like Pension Plans and 401(k)s. The article contributed by Joe Delano in this issue of MeasureIT deals specifically with making choices about 401(k) accounts.
For more information regarding retirement plans and rollovers, please visit www.irs.gov/ep.
If you take my advice and consolidate accounts, please first check on the format and the content of reports that you will be receiving for the consolidated account; unless they can be made clear to you, find another firm. Then check out the potential broker's history. Indeed, past performance is no guarantee of future results, but a broker who has been willing to compromise honesty in the past is not a good bet for your consolidated retirement assets. Fortunately, the Financial Industry Regulatory Authority (FINRA, the result of a merger including the old NASD) provides information on the characteristics of both brokers and firmsii.
You need to combine accounts to reduce the confusion about account statements and to improve your ability to understand how your assets are doing. If you don't, you'll worry about the situation before you retire, and regret it after you retire. This is not a life-style you should accept.
If you didn't start saving early enough (like me), you may be tempted by the claim from some random caller that you "should just put all your assets into this great financial mechanism that will return you 30% to 40% per year". The caller will assure you that this is a proven approach used by the very most powerful investors all the time, and they don't even need to pay taxes on it! You just need to consolidate all your assets into his very special account and your retirement will be wonderful. Given that even the skeptical Dr. Bell has suggested that consolidation is good (see the above section), who could possibly disagree with putting all your assets into this one investment?
Well, me (as one among many).
A general rule applies here: If it sounds too good to be true, it probably isiii.
Sorry, but stock returns much higher than the growth rate of the Dow-Jones or the S&P 500 are extremely risky (also unlikely). Probably you should plan on no more than about 7% to 9% (prior to fees of 1% to 2.5%) per year for stock funds and 4% to 5% in bonds over the next 5 to 10 yearsiv unless you personally invest very brilliantly. If someone tells you he/she will get you 30% or 35% in stocks or bonds, please seek out alternatives; I don't want to hear about the unfortunate results of investing in the "high-return" alternatives when we're next both at PARS.
There are dangers in each class of financial products, and you need to have a strategy that limits the down-side risks to you (as well as giving you a good up-side). If you invest everything in stocks, a down-turn in the stock market could leave you with little to retire on. If you invest everything in bonds, an increase in interest rates or in inflation will reduce the value of your investments and you'll suffer. (And if we have stagflation, both will be crimped. That's where the value of your real estate - your home - may be helpful - unless there's a housing bust like the way we're having now.)
In a later issue we'll discuss details about allocating retirement funds across asset classes as well as investing in ways to accomplish risk-reduction. Right now, however, plan to have your assets in several different types of investments; don't get locked into just a single type of investment.
I really don't know what the level of stocks or interest rates will be over the next few years, so for the last 10 years I've been using a diversified approach with some bonds/CDs, some cash, some stocks, and some real estate. (At the moment, I have about an equal amount in bonds/cash, stocks, and real estate.) Everything except my home is in a single account so I can manage the investments. (I don't seem willing to give up on that topic do I?) I encourage you to minimize the number of your accounts, but also to keep your assets diversified enough to live through most of the anomalies that are certain to occur. If your broker suggests that you can't do both, choose a different broker.
Many years ago I had my brokerage account with the local office manager of a major brokerage firm with offices in New Jersey (where I lived at the time). He made reasonable investments at my direction. Then he retired and the turkey who took over the account called me to say that HE had decided that investing in commodities futures options was the right direction to go. I explained that I was reasonably expert in commodities futures options and that my son and I had written programs used in that area (based on the research by Black & Scholes); that area did not meet my investment objectives due to my limited time, limited money, and aversion to risk. Two months later he called me to say that all my assets were now invested in commodities futures options, and he wanted to know whether I had more money to send him for investment. Fortunately, my brother was an attorney and wrote a very stern letter to the firm demanding that my assets be returned to their previous status and that they be transferred to California (where I had moved). They caved in immediately.
Watch out for those salesmen who firmly "know" the one type of investment you should make (the one where they'll get the biggest commissions). Otherwise you may need a brother who just happens to be a lawyer.
So keep your investments diversified. Chose an honest broker who suggests reasonable rates of return instead of unreasonable ones.
A very urgent issue to a number of CMGers is medical cost during retirement, and I've received questions about how to handle the issue. Many CMGers aren't knowledgeable about the various parts of Medicare or when they need to take action about it. We'll devote a future installment to Medicare, but you may need to take some actions before that.
The Centers for Medicare and Medicaid Services annually produces a bookletv describing Medicare's characteristics, and especially dealing with "Medigap" alternatives. You need to act by the time you are 64 years and 9 months old; everyone 60 or older really should be knowledgeable about how that program works so they can plan their futures. I'm a bit ashamed to reveal that I didn't know about its details until I was almost 64 years old; however, I couldn't have done very much about it anyhow, and I'm a fast study. (How's that for self-justification? Actually, I know I should have started several years earlier to make better choices and plan my finances more accurately.)
You aren't required to apply for Medicare; some companies promise benefits equal to or greater than Medicare. However, a pretty brutal penalty will apply if you need Medicare later and have not received the required level of medical insurance earlier. You need a certificate each year that says you have received at least Medicare's level of service.
The real problem with Medicare is that it promises so much that the US would require a massive change in the economy to provide the promised services to all the Baby Boomersvi. We'll deal with that issue in a later issue of this series, but you should probably assume that you'll need to pay more than the current costs of Medicare.
If you'd like to reach Joe Delano or me, please put [CMG] at the beginning of your Subject Line. Our e-mail addresses are:
i. Its contents come from www.irs.gov/pub/irs-tege/rollover_chart.pdf dated Sept. 2006; lots of different kinds of rollovers are allowed. As noted there, look at www.irs.gov/ep or IRS Publication 590 to find details. Before taking actions, you should check with a retirement accountant or a Certified Financial Planner for details of what actions would be best for your specific situation. For instance 20% of your existing IRA must be withheld if you have the money transferred to you personally prior to putting it into another qualified account (within 60 days). You can get the 20% back, but that is a real pain.
ii. Just put http://www.FINRA.Org into your browser and then click on the FINRA BrokerCheck button on the left of the screen (the first entry under "Top Links"). You can follow the links quickly, and within a few seconds you’ll be able to find out about possible complaints against the broker and/or firm. In addition, you can get a feel for the brokers’ education.
iii. For better understanding about why claims of very high returns are made, watch "American Greed" on CNBC. That series describes many of the financial scams that have hooked investors.
iv. An interesting assessment of stock market returns was presented in The Wall Street Journal in a front-page article on March 26, 2008. It was titled "Stocks Tarnished By ‘Lost Decade’" and noted that, through time, average after-inflation returns have been on the order of 7%. Many (most?) mutual funds do not consistently beat the industry averages, so higher returns from your stock mutual fund are unlikely.
v. You can get it at http://www.medicare.gov/publications/pubs/pdf/02110.pdf. .
vi. The financial situation of both Social Security and Medicare is summarized each year by the Social Security and Medicare Boards of Trustees. If you’re planning to live for more than the next five years, you should find out about it at http://www.ssa.gov/OACT/TRSUM/trsummary.html