The Pit and the Pendulum

They say that desperate times call for desperate measures. Well, of late, the markets have surely seemed desperate—and goodness knows, the response by regulators and lawmakers, certainly to this point, reeks of desperation, IMHO. We do seem, for the moment anyway, to be in something of a “pit” (and one, I must say, that the politicians seem to be trying to fill with money).

As if things weren’t complicated enough, we’re also in the waning weeks of what is perhaps the longest election cycle in history—one that, according to the pundits, will sweep the Democrats into a fuller, if not veto-proof, majority in Congress, if not the White House itself. If those trends hold, the pendulum would have continued its swing back—from the 2000 elections where the Republicans controlled all three, the 2004 elections where they solidified that hold, and the 2006 interim elections where Democrats regained their control of Congress. Such is the way of American politics.

Still, having spent some part of the last several years worrying about the establishment of a “you’re on your own-ership” society (see IMHO: Legs to Stand On , IMHO: Dead "Beat" ), I have been distressed to see a growing voice given to those who would treat the ills of the employer-based leg of the three-legged stool - by amputation.

Unwanted Attention

Those voices garnered some unwanted attention this month when the House Education and Labor Committee conducted a round of hearings on “The Impact of the Financial Crisis on Workers’ Retirement Security.” Unwanted attention in the form of headlines that read “House Democrats Contemplate Abolishing 401(k) Tax Breaks,” “Would Obama, Dems Kill 401(k) Plans?”, “Eyeing Your Pension: Are 401(k)s safe from congressional Democrats?”, and blog headlines that were even more provocative (“A 'Spread the Wealth' Plan for your 401k?”). Why, the word got out so fast that Congressman George Miller (D-California), who chaired the hearings in question, felt the need to reassure the media of his good intentions regarding the programs by issuing a background memo ahead of another hearing on Friday with the subject line “Background Memo on Preserving and Strengthening 401(k)s.”

What stirred things up was the testimony of Dr. Teresa Ghilarducci, who reiterated her previous advocacy for a “Guaranteed Retirement Account” (funded by a 5% of pay tax on workers and employers and a $600/worker contribution from the federal government) in place of the current tax preferences accorded 401(k)-type plans. And, apparently in keeping with lawmakers’ current inclination to bailout various troubled constituencies, she also suggested allowing workers to “trade their 401(k) and 401(k)-type plan assets” for one of those Guaranteed Accounts—at mid-August prices, no less.

Of course, it’s one thing to make a proposal (Ghilarducci has gone so far as to write a book around hers; see IMHO: Conspiracy Theories ), or even to entertain the notion as part of a broader inquiry into considering ways to shore up the existing system. What got things stirred up were the intimations that Miller and Congressman Jim McDermott (D-Washington), chairman of the House Ways and Means Committee’s Subcommittee on Income Security and Family Support, were actively considering the approach (1).

It doesn’t take much imagination to see where this kind of approach would take us. IMHO, it’s, at best, just a sneaky way to raise the Social Security tax from 12.7% of wages to 17.7% (and that’s not even counting the cost of the $600/worker the federal government would toss in). And that for an account that you couldn’t tap in a financial emergency, or leave to a spouse or children—because, despite the nomenclature, it wouldn’t be an “account” at all. On the other hand, you’d no longer have to worry about that saving for retirement plan—you’d just have to worry what new plans politicians might develop for your retirement “savings” (in her book, Gilharducci says that the financial risks are “borne by the government, not by the worker”—as though the government has a funding system independent of those workers).

Now, as I said before, these are difficult, extraordinary, even unprecedented times—and we find ourselves dealing with them smack dab in the middle of an election year. It is a time that cries out for bold action—and yet it is a time when even those with the best of intentions can do great harm.

The pendulum does, after all, swing back and forth. But if, god forbid, those pendulum swings wipe out the 401(k)—well, IMHO, that would really be the pits.

— Nevin E. Adams, JD

(1)Fueling concerns was the announcement that Argentina's leftist President Cristina Kirchner had signed a proposal nationalizing the country's private pension funds. The move, which is being challenged in the courts there, would transfer all the assets in individual accounts to the nation’s "pay as you go" system, even as it made future contributions to the state system mandatory. See “Argentina President Moves to Nationalize Pensions”

see also:

IMHO: Wonder Land

IMHO: Picture Perfect?

IMHO: “Diss” Ingenuous

IMHO: Vanishing Points?

No Time Like the Present

My September 30 statement arrived on Friday. No, I didn’t look at it.

My wife opened hers (she’s braver than I). I heard her rip the envelope open, and I’m pretty sure I held my breath (doubtless listening for the thud of a body in the next room). But then, much to my surprise, she commented that it wasn’t as bad as she thought it might be. For a brief second optimism flittered—I started to get up to check it out.

Then, I remembered the date of the statement. That’s right, September 30, 2008. Or as I think of them now, the “good old days.”

We’ve all been dreading the arrival of those statements for what seems an eternity now. Yes, the headlines have been screaming about the stock market losses, and the 24-hour news cycle has been feasting on one interminable voice after another offering their perspectives on what it means, and when—or if—it will end. Participants—even those who have been trying not to think about it—surely have to be prepared for the worst.

And therein lies a possible ray of hope, IMHO. As disappointing as many of those September 30 balances will be, they are almost certainly better than many will be expecting (not all, of course—and some are surely monitoring the daily impact on their accounts via the Internet). And, while I would never advocate misleading participants about the painful realities of market cycles, it seems to me that, between now and the next statement cycle, there is a window of opportunity to recapture the attention of participants who might otherwise be inattentive to the current state of their retirement readiness.

There’s no time like the present to remind participants of:

• the importance of keeping a regular eye on their asset allocation—and/or the tools that can help them do so; automatic rebalancing is now a common feature in many recordkeeping platforms, not to mention managed accounts or asset allocation solutions, such as target-date funds;

• the need to refine those allocations as they approach retirement, to move money toward less volatile options that can provide the steady source of income we’re all looking for in retirement;

• the importance of their retirement savings account as a part of broader approach to retirement planning;

• the value and role of things like defined benefit pensions and retiree health care, for those who have access to those resources (dare one hope for a resurgence in participant interest?);

• the importance of remembering longer-term trends in the markets; for instance, what happened between October 19, 1987, and the end of that year. Or, for those too young to appreciate that reference, the recovery after the tech bubble “burst”;

• the fact that regular investment through payroll deduction means that they invest at different times and different prices—neither the peak, nor the trough;

• the “return” on their account that comes from their employer’s match;

• the importance of saving the right amount versus picking the “right” investments.


Now, these are extraordinary times, by any measure. But there’s no time like the present, IMHO, to remember—and remind participants—of their future – and the importance not only of saving, but of saving the right way.

- Nevin E. Adams, JD

Due Process

The recent market tumult has hit Main Street in its retirement pocketbook—and some are once again fretting about their “201(k)s.” You can say all you want that this is a good buying opportunity, but the reality is that our retirement savings accounts have taken a hit, and most people are going to be in mourning, at least for a time.

Regardless of the markets (which we can’t control), we all know that the most important determinant of retirement security is how much we save—something we can, within bounds, control. However, when it comes to saving, there are two big questions looming over us, IMHO: Are we saving enough?—and, more importantly, Can we save enough?

Those of the opinion that Americans are saving enough are few and far between. With a median retirement savings plan balance of less than $125,000 (and that was before the impact of the last several weeks), it’s hard to see how we could be saving “enough” based on historical spending patterns, much less taking into account the projected increases in longevity and health-care costs.

The answer to the second question exposes the Achilles’ heel of the voluntary savings system. For most of us, saving for retirement remains one of those things we do after we pay for food, mortgage, gasoline, and even the kid’s braces. That’s not necessarily an irresponsible approach, IMHO, though it can be. The problem, of course, is that most household budgets get divided into things that have to be paid, those that have to be paid eventually, and what’s left over after you have dealt with the former two. Frequently, retirement savings still slips into the last group—for while we often give lip service to the need to “pay yourself,” most people still see it as saving toward something you’d like to have one day, not a bill that has to be paid.

How Much Is Enough?

But, to the point: If retirement savings was a bill, how big would it be? That’s the $64,000 question—and, unfortunately, there tends to be some disparity depending on who you ask and the assumptions you employ. However, if you assume a need to replace roughly 70% of pre-retirement income (and that number is too low, by some accounts), and if you assume that you are looking at a 30-year-old employee who makes $50,000, a recent Vanguard study puts that annual savings rate at 17% of pay—per year. Even if the worker makes no more than $25,000, the deferral rate would need to be 14%. There is disagreement on the amount that needs to be replaced, though 70% is about as low as any credible source still goes. The bottom line—what’s likely to be required is likely more, perhaps much more, than anybody you work with is currently saving.

Can—or will—workers save at that rate? Well, some are already close to that, certainly once you factor in an employer match. But again, those rates of saving “work” only if you start early—and, of course, if you are “only” trying to replace about 70%. If you think you’ll need more—or if you start later—or if you are trying to replace a higher income—you’d need to save more, or hope for other sources of income.

What does that mean for the future of retirement? Well, for those still in the workforce—and certainly for those on the “wee” side of 55—I suspect retirement will start later, and perhaps start differently, than it has for today’s retirees. Some will try to stay in the workplace longer (let’s face it, you won’t even get full Social Security benefits today if you retire at 65), though they may look for ways to cut back or “phase down” ahead of full retirement.

This actually works out to be a powerful savings strategy. I have seen any number of studies that suggest that working till 70—continuing to add to your nest egg—while at the same time forestalling tapping into it for another five years can transform many (most?) of those projections of inadequate savings accumulations into sufficiency (you can see this on just about any retirement projection calculator as well).

Want “Adds?”

On the other hand, it’s one thing to want to work longer (“want” perhaps not being the best word to describe that decision), and perhaps another altogether to have that option. Indeed, statistics suggest that workers routinely depart the workforce prior to their 65th birthday, and frequently not of their own volition (and not because they have achieved the requisite level of retirement income security). Consequently, while working longer may be part of the plan, you can’t afford (no pun intended) to simply expect that will be an option.

These past several weeks, much has been said about the economic crisis foisted on the “rest of us” by those who promised a free lunch to others who were willing to be duped, or were at least willing to be led to believe (of course, some drew that conclusion on their own) that what couldn’t be afforded now would be available at more favorable terms in the future. $700 billion later (before add-ons), we’re not even sure who we’re “helping.”

It’s not too much of a stretch to see a similar pattern emerge in retirement savings. There are plenty of folks who, rather than make a tough choice today, have chosen to put off the day of reckoning. They’re hoping for a time when it will be easier to save for retirement, a time when it will be more affordable—and some, no doubt, are simply hoping that someone else will solve the problem for them. And yes, some got rich while fostering those illusions.

Like it or not, retirement savings is a bill. It may look like “no money down” today, but there’s one heck of a balloon payment coming.

- Nevin E. Adams, JD

Reference Points

For most 401(k) plan participants, this has been a good quarter—to lose your statement.

Sure, we all know that the lower prices make this a good chance to invest new contributions at a bargain price (once we get past the concern that those prices won’t continue to fall), but there is a very real possibility that some (many?) participants will see a 09/30 balance that is lower than it was a quarter ago, wiping out three months’ worth of contributions (and then some).

It is interesting—and perhaps fortuitous—that, even as the markets struggle, asset allocation choices are available on a growing number of retirement plan menus. That they are increasingly a favorite as a plan default option—even as a growing number of automatically enrolled participants are defaulted into them—represents, IMHO, one of those rare occurrences where a much-needed solution is actually available and in place before the crisis it is designed for hits.

Having said that, it is also a year when even diversified portfolios are taking it on the chin. And participants defaulted into those choices—even participants who actively embraced the convenience of the “just pick one” solution—may not fully appreciate the benefits of that alternative.

On the other hand, these are the kinds of markets where the benefits of diversification should stand out, but only if you are able to provide them a point of reference. In a quarter when the S&P 500 shed 9% of its value, those target-date funds may look very good indeed.

The Bigger Picture

There is another aspect to this, of course—because all target-date funds are not created equal. Despite the commonality in naming structures, there are marked differences in fees, in their choice of fund structures and, most critically, in their glide paths—the underlying asset allocation, and the philosophy that underpins it. Of course, plan fiduciaries have an obligation to prudently select and monitor all investment options, a standard in no way diminished or excused when it comes to these target-date funds (or, more broadly, the qualified default investment alternative (QDIA) enclave to which they now belong).

Still, their relative newness has made it difficult to objectively evaluate their appropriateness, at least according to traditional standards, while their limited availability on specific recordkeeping platforms has perhaps made it seem less necessary (after all, if you only have one target-date family to choose from, what choice do you really have?).

But with the passage of time, we now not only have more choices, we have begun to accumulate track records, and just as significantly, a more refined sense of purpose for these offerings—some have, in fact, refined their purposes. True, as things stand today, for many, the gap between their stated goals and the reality of their asset allocations looms large—and, IMHO, the stated goals of many are still obtuse to the point of obfuscation. Nonetheless, we are rapidly reaching the point where such ambiguities can be appreciated.

The passage of time has also brought a new generation of indexes for these funds. Perhaps not surprisingly, in view of the breadth of philosophies underlying the various glide paths, this new generation of indexes—most of which are only just being brought to market, and some of which are still in incubation—bring to the table different philosophies about how these offerings should be evaluated. In other words, while this new generation of indexes purports to provide a standard against which target-date fund choices can—and should—be evaluated, there is not yet a consensus on what standards should be applied.

That’s not necessarily a bad thing, of course. People, even experts, have different notions of what constitutes an appropriate asset allocation, and people—perhaps especially experts—are certainly entitled to their varied opinions.

What that means for fiduciaries—and for those who counsel them—is that the selection of that benchmark could be as important as the funds we measure against it.

— Nevin E. Adams, JD