Brighton Perspective

Where's your 401k?

If you’re leaving your company because of a downsizing or a switch in jobs don’t forget about the assets in your 401(k) plan. All too often, departing employees leave behind their retirement plans without giving much thought to the consequences.

According to a recent survey by Charles Schwab, almost half of the money held in 401(k) plans by employees who left their jobs during the first quarter of 2008 had not been moved a year later. While there is no penalty for leaving your 401k with your prior employer, there are benefits to moving the account. In fact, you have three other principal options: take a cash distribution, move the funds to a new employer’s plan, or roll over the assets to an IRA.

The cash distribution option should be considered the last resort, hardship option only. Under this scenario, you elect to take a lump-sum distribution from a 401(k) plan when leaving. Unfortunately, that election could result in a hefty tax bill. The amount representing pre-tax contributions and earnings in the 401(k) is taxed at ordinary income rates reaching as high as 35% on the federal level. If you’re under age 59½, the IRS will generally tack on a 10% “early withdrawal” penalty. And you still have to worry about state and local taxes and state penalties.

Besides incurring tax liability now, this approach means forfeiting the future benefit of tax-deferred savings and leaving a gap in your retirement plan. After 60 days have passed, you’ll have lost the opportunity to transfer the funds to another tax-advantaged plan. The final kicker? The employer’s 401(k) administrator will automatically withhold 20% of the payout, regardless of your personal circumstances. Again, this is the last resort, hardship option only.

If and when you find another job, you often can move your 401(k) balance to another 401(k) or other tax-qualified retirement plan available through your new company. That way, your assets will continue to grow tax-deferred without interruption. This direct transfer is also exempt from the early withdrawal penalty, and there’s no tax withholding as long as you arrange a trustee-to-trustee transfer from one plan to another. Avoid taking the funds yourself, because if you do, 20% will be withheld, and you won’t be able to recover that money until you file your tax return for the year of the transfer.

Finally, you can role the 401k account into an Individual Retirement Account (IRA). This may be the most advantageous approach. An IRA generally offers greater investment flexibility, letting you invest in a wide variety of stocks, bonds, and mutual funds, compared with 401(k) choices that tend to be more limited. And the IRA may give you greater control over distributions during retirement.
Beginning in 2010, all employees now also have a fourth option—rolling over employer plan funds to a Roth IRA that provides tax-free distributions during retirement. (Previously, Roth conversions were allowed only in a year in which your adjusted gross income didn’t exceed $100,000.) But moving money to a Roth means paying income tax on the untaxed portion of your account, unless you have large tax deductions that you can claim to offset this extra income.

The High Cost of No Price — The American, A Magazine of Ideas

The High Cost of No Price — The American, A Magazine of Ideas.

I'm venturing slightly outside the financial markets but this is something that impacts financial planning decisions. Or at least it should.

We, as consumers, have the right to shop for property insurance, vehicle and life insurance to find the best combination of coverage terms and price for each of us. Yet, we can't shop for health insurance. How many really know the full cost of their health insurance policy?

I think this is one of the keys to resolving the health care issue - enable consumers to shop for their own health insurance. My thought is enable companies to cross state lines, allow consumers to choose any company, coverage, etc they prefer and have companies providing health benefit dollars, then pay the insurance company directly. In this scenario, the company dollars are fixed, the consumer knows what they get and what it cost and recognizes clearly the full cost/benefit ratio. Competition managed by the consumer, to me, is vastly superior to the current model or to anything currently being proposed in Washington. While I'm sure it is not without fault, it can work.

Is it time for your annual checkup?

Most everyone has, formally or informally, a financial strategy that should be regularly reviewed. For example, you probably follow a budget, save for special goals, or look over your retirement savings from time to time. Whether paying bills or preparing your income tax return, you frequently look at various parts of your finances. However, at least once each year, you should pull all your records together and take a close look at your entire financial picture. Here’s a brief description of what a typical annual review might entail:

1) Cash flow analysis. Does your income equal or exceed your fixed and variable expenses? The amount of income that exceeds what you spend is called positive cash flow. If your expenses exceed your income, you have negative cash flow. If your cash flow is negative, it may be time to reorganize your budget and minimize any unnecessary expenses so that you can focus on saving for your future.

2) Provide money for special goals. For every financial goal you establish, you need to address the projected cost, the amount of time until your goal is to be realized (time horizon), and your funding method (a scheduled savings plan, liquidating some assets, or taking a loan). You should plan your goals according to priority. Most importantly, you should have an emergency fund of at least three months of income to handle life’s unexpected turns. Secondly, you may establish a savings plan for larger, long-term goals, such as your child’s wedding or educational expenses. Finally, consider the priority of more flexible goals (e.g., purchasing an automobile, enacting home renovations, and planning a vacation).

3) Enrich your retirement. Are you going to have enough money when you retire? Pensions and Social Security may provide insufficient income to maintain existing lifestyles during your retirement years. Consequently, review your retirement needs and plan a disciplined savings program for your retirement.

4) Minimize income taxes. Many taxpayers reduce their liability by taking advantage of tax breaks, such as contributing pre-tax dollars to an employer-sponsored retirement plan. Most also claim deductions for mortgage interest, traditional IRA contributions, or charitable donations. In addition, there may be other ways of reducing your tax liability. For example, under appropriate circumstances, losses or expenses from previous years may be carried over to the next tax year.

5) Beat inflation. Suppose the current inflation rate is 4%. In order to maintain your buying power, you would need a 4% annual wage increase so that your income keeps pace with rising prices. A decline in your buying power would certainly lower your standard of living and affect your lifestyle. Consequently, consider putting your money to work for you to beat inflation.

6) Manage unexpected risks. You are probably well aware that life involves risk, which could lead to financial loss. For example, you could become disabled without income, or an untimely death could cause financial hardship for your family. As a result, many have made insurance the cornerstone of their overall finances because it offers protection that can help cover potential liabilities and risks.

These six steps will help you focus on the important issues that affect your finances. As you review your financial situation on at least an annual basis, you will probably need to make alterations due to changing goals and circumstances.

Leaving Your Job? Don't Forget Your 401(k)

Leaving Your Job? Don't Forget Your 401(k). Nice Article - I would generally suggest that you rollover your 401k when leaving a firm but this article does highlight some of the considerations. Generally, you're better off having control over your money, asset selections, etc than you are if you leave the 401k account with the prior firm.

What Should a Financial Advisor Do for You?

I've seen a number of articles lately on the role of the financial advisor. I've also been asked lately where do I think the markets are headed. Both thoughts dovetail nicely I think.

The financial advisor's role is to help protect and build your asset base. You have worked hard over the years to build up a 401k balance, own a nice home and build, hopefully, a taxable investment portfolio as well. You have also tried to save money for college, for retirement and for future generations. You want to retire earlier than your parents did and enjoy the "fruits of your labor". This is where the advisor comes in.

Most of us do not have the ability to forecast the future with precision. Thus, our objective is to forecast as best as possible and hedge the potential risks we expect to encounter along the way. We will attempt to protect your assets via financial and estate planning techniques so that you keep as much as possible of what you have earned and have the best opportunities to pass on a legacy to future generations of your family. A number of risks are encountered in this process - legal and regulatory changes, economic cycles, etc. Not all can be forecast with certainty and the advisor should account for that uncertainty.

With regard to investments, I believe advisors should be focused on constructing portfolios that attempt to meet basic goals - generate an absolute return that exceeds inflation plus a spending percentage and hedge against potential downside risks. These are competing goals and thus require constant examination. Asset allocation is not dead but does need to be revisited conceptually. I believe that rather than regarding asset allocation as an equity/fixed/other combination, advisors should be viewing asset allocation as core-satellite or on a risk basis. The allocation decision is driven by risk targets first, then by return. So the objective is to properly allocate risk among various assets. In this assessment, lower risk strategies are considered core strategies and can be fixed income, equity or other assets. Same goes for riskier assets (satellite). This does involve a degree of tactical asset allocation which involves trading more the riskier assets more frequently. I'm not trying to time the perfect entry and exit, rather, I'm trying to take advantage of volatility to provide excess return when assets are moving up and hedge downside risk when assets are declining. It's not perfect but I think better addresses my primary objectives than the traditional asset allocation approach.

So the financial advisor is attempting to preserve and grow what you've acquired. We should be more conservative than you most of the time and should be the "voice inside your head" attempting to reason you out of more aggressive decisions. We're not perfect, but if we successful one more time than we're not, we should do well for you.

As to where the markets are going, I don't know. I'm always skeptical (never truly a bull or a bear) and always more comfortable with a portfolio that has some "insurance" against a market decline. I think the "premium" paid to hedge some of the downside volatility is worthwhile.

Have you rebalanced your 401k yet?

How many investors entered September of 2008 with a heavy overweight in domestic equities? How many ignored their 401k's during the six month decline that followed? How many benefited as a result, over the last 5 months as equities have recovered (still 25% below the early September level and roughly 33% below the October 07 S&P peak)? How many moved to cash at some point during the decline and are still sitting in cash now?

Whether you "cashed-out" or stayed in equities, the asset allocation you had established 12 months ago is most certainly out of sorts now. Take time to review your allocation now and consider what it should be in light of the current market and economic environment. Also consider your risk tolerance - to what extent did the 9/08 to 3/09 decline clarify for you what your true risk tolerance is? If you went to all cash quickly, you probably have a much lower threshold than you thought.

Strive for true diversification - look for exposure globally rather than just domestic and ensure you have exposure to asset classes other than equities. Use the asset allocation tools on your plan provider's website and research the options available in your plan. Take advantage of the improvement in financial markets to reduce your risk (if you're still overweight equities) or to improve your return potential (if you're 100% cash). Going forward, try to revisit your 401k asset allocation quarterly and make changes as necessary.

Housekeeping

I have added a link on the left hand side below my picture for my monthly newsletter- Brighton Bulletin. I write on 3 to 4 topics each month, trying to stay brief, which I believe are of interest to readers. I welcome new subscribers as well as suggestions on relevant topics. Feel free to subscribe!

2009's Best and Worst 529 Plans - Morningstar Advisor

2009's Best and Worst 529 Plans - Morningstar Advisor.

I am a proponent of 529 plans. They offer several advantages over competing options such as taxable investment accounts, UTMAs and UGMAs and alternative financing options. First, tax deferral of investment gains can help the account balance increase more quickly than taxable accounts. Second, ownership of the 529 remains with the account holder (most often the parent) and that provides greater flexibility of use relative to UTMAs and UGMAs. Third, as the assets in the 529 are considered those of the parents for FAFSA purposes, they have less impact on financial aid calculations than UTMAs and UGMAs.

It is important to remind yourself of the purpose of the 529, that is, to pay for educational expenses for the beneficiary. Don't be aggressive when choosing the age based portfolio - ie choosing a 7 to 9 year old portfolio which will be heavily in equities for a 15 year old child, in an effort to play catch-up or to get ahead. Choose the portfolio that fits the beneficiary age best. You still have risk because of the long-only nature of the portfolios, don't take on more than necessary (one of the commandments of investing).

planadviser - Americans See Favorable Tax Treatment As Best Road To Retirement Funding

planadviser - Americans See Favorable Tax Treatment As Best Road To Retirement Funding.

I've discussed similar findings in the past. In this post - 86% of respondents don't know what their retirement income will look like yet 58% believe they're at least "fairly well-prepared" for retirement. If you don't have an idea what you'll need how can you possibly believe you're prepared!

Don't neglect retirement planning. Contact an advisor and get started now regardless of how close you may be to retirement. The younger, the better.

A Tax Break for Sending the Kids to Camp - Kiplinger.com

A Tax Break for Sending the Kids to Camp - Kiplinger.com.

Summer is almost here and school is almost out. If you haven't signed your children up for camps, here's an article to keep in mind when looking for good camp options.

When It Pays to Hire a Financial Professional - Morningstar - Specialists

When It Pays to Hire a Financial Professional - Morningstar - Specialists.

There are many individuals more than capable of managing their own money. In fact, most people are more than capable. The challenge is finding the time to manage your own money while also managing a full-time job, or multiple jobs, managing the kids academic, athletic and social schedules and managing your own non-work related schedules. For many, this is impossible and the financial plan fails. For others, managing their finances is complicated because of wealth and/or life events (such as divorce). Finally, as noted in the article, if you're a business owner, establishing and managing your own retirement plan can be challenging.

Thus, there are a number of situations in which retaining an advisor can and does make sense. If you are discovering you don't have the time or the inclination to properly manage your investments and your financial plan, you should consider hiring an advisor. If you run a business and have or want to establish a retirement plan, you should hire an advisor. In both situations, the advisor will serve as your chief investment officer. His/her responsbility will be to ensure your investment portfolio, financial plan and/or retirement plan are designed with your (or your plan participants) best interests at hand and to ensure the effort is on target.

I've written before about the tendency of many to believe they have it all worked out yet don't have any idea how much they need to live in retirement. This is a behavorial finance concept known as over-confidence. Yes, most of these individuals (if not all) are very smart and very capable of handling their own finances. Yet, most don't do so well because they don't make it a priority. Don't fall into this trap. If you want to manage your own financial plan and investments, do so, but make it a priority not a spare time thing. If you can't or won't out-source to someone who will.

Investment Policy Statements

According to a recent article in Kiplinger's Personal Finance Magazine only 36% of wealthy investors believe their advisor managed last year's crisis well. One possible explanation for this lack of confidence in their advisors is a lack of a written investment policy statement (IPS). The IPS is only mandatory for ERISA governed retirement plans but it should be mandatory for all investors. The document is your blueprint which you and your advisor will follow to construct and maintain your portfolio.

Writing the IPS requires meeting with your advisor and discussing several critical issues:

1) Return objectives - what do you expect your portfolio to earn annually? This target should be constructed carefully. Assess your current income needs and expectations about future uses of the portfolio. Your advisor can then calculate a rate of return target consistent with these needs.

2) Risk tolerance - how much risk can you bear? This is frequently the most difficult step in the process. Investors generally perceive themselves to be more tolerant of risk than they really are and the advisor must work closely with you to determine your true risk tolerance as accurately as possible. This is often done as the first step in the process because the portfolio rate of return is usually constrained by risk tolerance.

3) Time Horizon - what do you intend to do with this portfolio? Is it to be used to meet current income needs, college expenses in 5 or 10 years, retirement income needs in 15 or 20 years? Time horizon helps refine how much risk should be borne by the portfolio. You may be more tolerant of risk than your portfolio can bear because your time horizon is short.

4) Liquidity needs - this goes hand in hand with time horizon. If you need immediate liquidity, you are unlikely to invest in real estate, private equity, hedge funds, etc which don't or can't provide immediate liquidity. Instead, you'll invest in low risk, highly liquid securities such as Treasury bills.

5) Unique circumstances - this can incorporate anything. For example, you're time horizon is long, liquidity needs low, risk tolerance high, but you're planning to travel around the world next year. If you leave this out, you're advisor will likely have to make significant portfolio changes to provide you the cash you need to pay for the trip. This is the step where the advisor asks "What else do we need to consider?"

The answers to these questions define the mission statement of the IPS. The advisor will then incorporate an asset allocation, permissable investments, frequency of rebalancing, tax considerations and reporting requirements. The blueprint now clearly defines the intentions of both parties. This document should be reviewed at least annually and revised as necessary. If you don't have one, sit down with your advisor and get started on creating one. If you don't use an advisor, answer the questions above for yourself and devise your own IPS. It will serve as a useful guide and reminder as to why you made the decisions you've made for your portfolio.  I can't stress enough the value of an investment policy statement.

The-Trouble-With-Public-Colleges: Personal Finance News from Yahoo! Finance

The-Trouble-With-Public-Colleges: Personal Finance News from Yahoo! Finance.

An interesting article for several reasons:

1) If you have children you should already be saving for college, ideally using a Section 529 plan

2) Our government is pushing the idea of college for everyone, yet this article notes several times "Quantity has been maintained at the expense of college". If we're already educating more students than we should, does adding even more debase the value of a degree as well as the learning experience: 'At Florida, president Bernard Machen worries about a high student-to-faculty ratio and whether his students are challenged in class and learning to think critically. "We have some evidence that our kids are not," says Machen.'

3) Why is most of the 14% tuition increase in the state of NY going to reduce the state deficit? Sneaky, little tax increase, huh!

4) Why, exactly, are college costs increasing at twice the rate of inflation (4 times 2009 inflation)?

Points 2-4 aside, a college education does make a financial difference for graduates. Do what you can to help ensure your children get their chance to graduate.

Lots of Tax Hikes Coming in 2011 - Kiplinger.com

Lots of Tax Hikes Coming in 2011 - Kiplinger.com.

Clients with taxable portfolios should pay particular attention to this article and start planning now to manage your taxes (if you're not already doing so). It's interesting to see that the average rate is the same as in 1982 and that "high income" earners are paying more than in 1982. Many studies have shown that raising marginal rates does not raise revenue as taxpayers make necessary adjustments. The net result is that taxpayers will pay what they believe to be a "fair" rate.

This is contributory to the economic pressures we face now and will likely face in the future. New monetary and fiscal stimulus, particularly fiscal, will have a meaningful impact if consumers spend. But consumers will instead save if they believe the fiscal stimulus will be funded by higher future taxes. They save because they know they'll have a higher future tax bill that must be paid. Lower spending/higher savings by consumers increases the probability the government will need additional stimulus. Higher savings and tax deferral strategies combine to keep revenue growing at a lower rate than expenses. In fact, U.S government revenue (mostly taxes) grew roughly 7% annually from 1947 through year-end 2008. Government expenses grew roughly 8%. Thus we have a growing budget deficit. Surprised?

The Best and Worst 529 College-Savings Plans - Morningstar - Fund Spy

The Best and Worst 529 College-Savings Plans - Morningstar - Fund Spy.

529 plans shared the pain last year. Despite that, they still should be a cornerstone of your college planning efforts. There are many, many flavors from which to choose, so conducting through due diligence is a must. This article covers the best and worst according to Morningstar. There are several other excellent sites worth reviewing as well, including:

www.savingforcollege.com

Security and Exchange Commission

www.529s.com

I have recommended Utah and Michigan in the past for many of the reasons Morningstar lists for Utah in the linked article. Do your homwork, or have an advisor do the homework for you. Use common sense when selecting the appropriate portfolio - realize the additional risk you're assuming if you decide to be more aggressive than your child's age based portfolio suggests (this is accomplished by choosing a portfolio for a younger age), be patient with the results and continue to add each year (dollar cost averaging).

A Crisis of Ethic Proportions - WSJ.com

A Crisis of Ethic Proportions - WSJ.com

A well written article on the need for a renewed emphasis on ethics and fiduciary duty. I had a conversation with the proctor while taking the CFP exam last month. He asked me if I thought that current events would lead to a change in exam topics as well as in B-school courses. I stated that I thought ethics needed to be elevated again. When I took the CFA exams in the mid to late 90s ethics were front and center and were a determining factor in pass/fail determination. I don't think that's the case today in most arenas. We've move to what Bogle refers to as moral relativism with regard to ethics - essentially if its ok for him its ok for me. Clients need to challenge their advisors to live up to their responsibility to do what is in your best interests. I've noted before that advisors should be willing to acknowledge their fiduciary duty to clients and if your advisor won't do so, reconsider your reasons for working with that advisor.

Paying for College: 529 Plans Won't Cover It Anymore - Personal Finance * US * News * Story - CNBC.com

Paying for College: 529 Plans Won't Cover It Anymore - Personal Finance * US * News * Story - CNBC.com.

529s are an excellent vehicle for college planning. However, as the article indicates they shouldn't be viewed as the only options. Rather, they are a key component in the college savings plan. The tax deferral benefits of a 529 should make it the core of your plan. Be sure to select a plan and an investment strategy that fits the age of the child you're covering. Be patient with the process and refrain from being overly aggressive. If you started early you have time. As your child approaches college age, other methods of financing college can be incorporated:

1) File for financial aid even if you don't believe you'll qualify. File the FAFSA on or as close to January 1st of the year in which your child will enter college.

2) Have your child visit the guidance office at his/her high school and pick up any applications available for scholarships and grants. You'll be surprised how many are available and how many don't receive applications. Many students receive scholarships and/or grants simply because the applied.

3) Taxable investment accounts can be used to cover whatever the 529 assets don't.

4) Consider home equity - the tax deduction will help offset the cost of college.

5) Other options include loans and borrowing from your 401k but these should be considered after other options are tapped.

Finally, in the current economy many families are opting to have their college age children start at a community college and transfer after 2 years to a 4 year college. They still get that 4 year degree from a great school but at 2/3rds the 4 year cost.

Five Financial Moves to Make During the Recession -- and Five You Shouldn't - WSJ.com

Five Financial Moves to Make During the Recession -- and Five You Shouldn't - WSJ.com.

Take this article to heart. It's very well reasoned and offers an excellent strategy for moving forward. I've written before regarding the 5 stages of grief. Stage 5 involves letting go and moving on. This article highlights how to do that. With regard to investments, if you've done it on your own in the past, consider using an advisor. Consider using one on an hourly basis (they exist) if you're uncomfortable turning over authority. In this capacity, the advisor can be a sounding board for your plans or serve as devil's advocate. Either way, value can be added. If you have used an advisor, sit down and review your current plan. Challenge the underlying assumptions in light of the current environment and your expectations for the future - inflation/deflation, job prospects, retirement, college, etc. I expect at least some of these assumptions have changed in the last 6 months. Develop a constructive plan to move forward and incorporate much of what you read in the linked article. It will be a productive exercise.

Fiduciary Values

Fiduciary – A fiduciary is an individual or an organization legally responsible for managing assets on behalf of someone else, often defined as the beneficiary. The assets must be managed in the best interests of that beneficiary. Why is that important? Your advisor should adhere to a standard of care which best serves your interests. Specifically, your advisor should place your best interests first, act with due care and in good faith at all times, provide full transparency of material facts and work to manage and avoid conflicts of interest. These actions sound reasonable, and I’m sure are fully expected by you. Yet, many advisors choose not to acknowledge their fiduciary duty. Over the years, this unwillingness to acknowledge responsibility has lead investors to avoid using investment advisors. 

Consider, a survey conducted in 2006 by the Retirement Corporation of America found that more Americans handled their investments themselves or with input from friends and family than by using the services of an investment advisor. The primary reason was distrust regarding the motives of these advisors. Another survey was conducted by the Financial Planning Association and Ameriprise Value of Financial Planning last night. The survey placed respondents in 3 categories - Gen X (30 to 43 years old), Baby Boomer (44 to 62 years old) and Mature Boomer (63 and above). The focus was mostly on Gen X, but I found the Mature Boomers results most fascinating. For example, 41% believed they were on track toward their retirement planning goal and 51% were on track toward their goal of wealth accumulation. 86% stated they understood the financial risks related to retirement and 75% believed they understood financial issues yet only 23% actually knew how much they needed to save for retirement.

Not surprisingly, when asked why they didn't work with an advisor, 35% of Mature Boomers believed they didn't need the services of a financial advisor (almost double that of Gen X) and 28% believed they could do a better job themselves. Further, 62% believed they were very or completely in control of their financial future and 60% were very or extremely confident in their financial future. Sadly, this second survey was conducted between June and July 2008!

Many people need and, can benefit from, the advice of an investment advisor, particularly now. A number of factors contribute to the success of a portfolio and of a relationship. The knowledge that your advisors are acting as fiduciaries on your behalf, and have stated so explicitly, should help build the foundation of trust necessary for a healthy, productive relationship. Require your advisor to acknowledge his/her fiduciary responsibility to you. If he or she is unwilling to do so, consider finding an advisor that will. The bottom line is anyone involved in managing your financial well-being should be willing to acknowledge that you come first.

Custodial 529s

Section 529 college savings plans gained prominence in 2001 with the passing of the Economic Growth and Tax Relief Reconciliation Act of 2001. Prior to 2001, many parents with the foresight to think about funding college expenses had used established Uniform Transfer to Minors Accounts (UTMA) or Uniform Gifts to Minors Accounts (UGMA). These accounts were established with good intents but, today, have become problematic for many families. Two significant reasons for this are:

1) the assets in the UTMA or UGMA belong to the child. Thus when the child reaches the designated age, the assets can be claimed by said child and used for any purpose they wish. So that college fund just became the travel around the world fund and the parents can't do anything about it.

2) the assets in these accounts are included as student income and assets when completing the FAFSA and PROFILE forms for financial aid. The student is expected to contribute a larger portion of his/her assets and income to fund college expenses. Thus, these accounts, in effect, penalize families for saving for college.

One partial solution is to establish custodial 529 accounts. It's a partial solution because it doesn't remove the child as the owner of the account. However, it does enable the account to grow on a tax-deferred basis (as long as assets are used to fund college expenses). It also changes the FAFSA calculation as the custodial 529 is treated as an asset of the parents rather than the student. Since parents are expected to contribute a smaller percentage of their assets and income it can improve the chance for an aid package.

There are tax issues to consider (aren't there always tax issues to consider?). 529s can only be funded with cash. Thus, if the UTMA or UGMA account has other types of holdings, these will need to be sold and taxes paid on the disposition. The timing might be good, though, in 2009 since market conditions over the past 12 months have been very poor. There may be losses generated which can be used to offset potential gains generated.

So, if you have UTMA or UGMA accounts, it is worth examining the potential advantages and disadvantages of established custodial 529s for these accounts. As always, talk with your financial advisor and your accountant before making a final decision. Final thought - establish a traditional 529 at the same time you establish the custodial 529 and fund that one going forward. The traditional 529 enables you to change the beneficiary so you can continue to save for college and still maintain control of the assets.

Madoff Lessons Learned

Most people are, by now, well aware of Bernard Madoff. He is the “hedge fund” manager who, in reality, was running a large Ponzi scheme. Charles Ponzi didn’t invent the scheme but was the first to raise substantial amounts of money using it. Essentially, in a Ponzi scheme, investors are promised specific returns over time. Frequently, the investment process is not disclosed by the investment advisor but returns are shown to justify performance. These returns are often very stable over time, high returns/low risk, leading people and institutions to commit large sums of money. Purportedly, Madoff had over $50 billion. However, the reality is that the returns are fraudulent. Early investors are paid with funds provided the operator, Madoff in this case, by later investors. This circular effect continues as long as the operator can bring in new funds. When new investors can no longer be found, the scheme begins to collapse. In most cases, this happens quickly and spectacularly. Unfortunately, it is more common than it should be. However, there are steps you can take to ensure you are not a victim of such a scheme.

First, conduct your own due diligence. Ask your advisor about his/her philosophy, process, people, and performance. The Advisor’s answers should be transparent and understandable. Avoid advisors who claim their process is “proprietary” or a “trade secret”. As for performance, risk and return coexist. You cannot increase return without increasing risk. Understanding this relationship should make a skeptic of anyone who hears a pitch similar to Madoff. Long-term consistent positive returns with low volatility, even in bear markets, are unachievable. Further, each investment advisor will provide you with information on his/her firm and their Form ADV part II. This is a document firms file with the U.S. Securities and Exchange Commission to register as Registered Investment Advisors. It provides information on  process, people, fees, and history. Form ADV part I covers the advisor’s education, business and disciplinary history over the past 10 year and is available online via the SEC website – www.sec.gov.

Second, do not accept statements only from the advisor. Your assets are held by a third party custodian, such as Charles Schwab, Pershing or State Street. The custodian provides statements on a regular basis, usually monthly. Require your advisor to ensure the custodian provides you at least quarterly statements. Review these statements to ensure they make sense. Question anything that appears unusual to you, such as an increase in trading or unusual cash flows. This is your best audit statement of an advisor’s performance. Do not accept statements only from the advisor. It can, however, be a good audit step, to receive and reconcile statements from the advisor and from the custodian.

Third, continue to stay diversified. Diversification not only helps to mitigate the volatility of investment markets but it helps to minimize the damage done by one poor investment decision. Most mutual funds, and indeed most hedge funds, will hold numerous positions for this reason. While the managers are confident in their abilities, they know they will not be right all the time, thus they hedge their own bets via diversification. Just as location, location, location is the mantra of the real estate industry, diversify, diversify, diversify should be the mantra for investors.

Finally, don’t lose faith in financial advisors. The vast majority are honest, hard-working professionals with their client’s best interests at heart. The financial system operates on trust backed up by regulation. Ronald Reagan had a slogan which is applicable here – “Trust but verify”. Further, many advisors operate under a standard of care. Many are members of organizations with strict Codes of Conduct, such as the Financial Planners Association (issues the CFP designation), and the CFA Institute (issues the CFA designation). Both organizations have strict standards of practice to which advisors must adhere to maintain their designations.

Bernie Madoff proved to be a very destructive force. In short order he damaged the financial security of numerous investors, including his own family, damaged the credibility of financial advisors and, in doing so, damaged the trust implicit in the financial industry and necessary to investors long-term success. However, he also provided very real lessons which when applied, can ensure you won’t share his company.

Should You Refinance?

Mortgage interest rates have fallen significantly in recent months as a result of the economic recession and decline in the housing market. Challenges do remain regarding refinancing. For example, while interest rates are low, housing prices have fallen, in some area dramatically. Further, while money is available from mortgage lenders, standards have returned to the more stringent requirements of the pre-2000 era. That means, among other criteria, strong credit scores and lower loan-to-value ratios. I'm hearing and reading that very few banks are willing to lend with an LTV greater than 80%. Finally, even if you meet these standards, you should consider how much you still owe on your current mortgage and how many years remain on that mortgage. If you're nearly done paying it off or your balance is very low and it's the only mortgage you have, you might consider retiring rather than refinancing it.

Conversely, if you have years to go, a higher balance and/or more than one mortgage, it might be beneficial to pursue refinancing. Consider the following example, let's assume you have one 30 year mortgage with an original balance of $475,000. You bought your house, a really nice house, in 1999, the interest rate was 6.75% (about what it was in February 1999) so you have 10 years remaining on a mortgage with a monthly payment of $3,081 (excluding insurance and taxes). The remaining balance is now $405,180. Over 10 years, thanks to the 30 year amortization schedule, you've succeeded in paying down only $70,000 (15%). However, the good news is you now have a loan balance that qualifies for the conforming loan category, so you can refinance using a conforming loan (better rates). The objective here is to match or shorten the term of the loan so don't take a mortgage with a term greater than 20 years. A 15 year mortgage with an initial balance of $405,000 at 4.5% (prevailing rate today) would be a monthly payment of $3,098. For effectively the same payment, you've cut 5 years off the original loan and, most importantly, saved over $182,000 in future interest. Imagine what you can do in retirement with an additional $182,000!

This scenario can be reworked in several ways - you can refinance 2 mortgages so that both fit the conforming loan category, refinance to 20 years and reduce your current payment, etc. The bottom line is it makes sense now to review your options. If you can reduce the term at the same payment or matching the remaining term but cut your monthly payment you're benefiting by taking action. You'll reduce future interest paid, and potentially free up current income. Either way, you win. Remember, this discussion is not applicable to everyone - consider your personal situation before pursuing any changes. This link is to an online mortgage amortization calculator that can help you model potential loans. Consider your options in light of your personal financial position; this won't work for everyone. By the way, this calculator is good for any amortizing loan, such as a car loan, so its a good bookmark for future needs.

5 Stages of Grief

We're all aware that the economic and investment markets news over the last half of 2008 was unrelentingly negative. Equity markets were down in late October almost 50% from the level at which they entered the year and the fixed income markets offered almost no safety. Aside from cash and Treasuries, there were precious few safe havens. Consequently, many, if not most, investors have suffered rather significant losses. If you did have in place an effective asset allocation, you mitigated some of the losses but still, you were probably underwater for the year. You're not alone.

I believe market participants are moving through the 5 stages of grief originally proposed by Elizabeth Kubler Ross in 1969. She applied the five stages to any traumatic life event. I think it's fair to say that 2008 was a traumatic life event for most everyone:

Consider:

Stage 1 - Denial - as the crisis began to build in early 07 and into 08 (really it was earlier than that but it reached national consciousness in 07), most investors either overlooked or ignored the news assuming the fallout would not reach them. Even Fed Chairman Ben Bernanke denied the depth of the impending crisis by suggesting they had the sub-prime crisis well contained. However, the reality, in retrospect, is that we, as market participants, were simply in the denial stage.

Stage 2 - Anger - as we entered the fall, we moved from denial to anger as first Bear Stearns, then Lehman, then Wachovia, Merrill Lynch, Citigroup, Washington Mutual, and so on, failed or approached the brink of failure. We watched as the first "bailout" vote failed and our representatives expressed anger regarding the "socialization" of the financial sector. Further, we watched as certain members of Congress refused to acknowledge their own roles in the unfurling crisis and anger and resentment grew. The Anger stage lasted at least through early November (really, this one isn't over yet!).

Stage 3 - Bargaining - post-election, many thought the new President-elect would solve everything, that the bail-out funds would get banks lending again, that the coordinated global action would release pent-up liquidity. Market participants began to bargain - more regulatory oversight for more liquidity, etc. Whatever it takes!

Stage 4 - As we entered 2009, the unrelenting drumbeat of negative economic data continued. Poor retail sales, more layoffs, recession, depression, double-digit unemployment, etc, etc. How could it get any worse? Why bother even trying to make things better? What's the point? Give up on the markets and invest everything in cash!! Sounds familiar, right? Whether you or someone you know, you've heard those comments somewhere over the last month. We're now in stage four of grief - depression. This is, I think, the point at which market participants are scraping the bottom. That doesn't mean we're done, but I do think it's time to move on to stage 5.

Stage 5 - Acceptance. Some participants have gotten to this stage and are searching for opportunities to move forward, some at still moving through the Anger stage, some may never leave the Anger stage. Wherever you are in this process, whether you have losses you don't want to realize or you're dissatisfied with the advice or service (or utter lack of service) you've received to date, it's time to accept the financial tragedy that 2008 embodied and move forward.

As the first quarter of 2009 draws to a close, now is the time to sit down and review your financial plan, implement a new plan, change your asset allocation, and develop a process for gradually implementing the plan over the course of 2009. Do so deliberately, methodically and rationally. Losses can be realized responsibly, if necessary, and new strategies, designed with an intent to get you back on track, can be implemented. If you're not happy with your current advisor, or with yourself as your advisor, consider bringing in a new one or schedule a meeting with your current advisor and express your concerns. Doing so doesn't mean liquidating your portfolio, realizing all of the losses and starting from scratch. A competent advisor will work with you to transition your portfolio constructively and on your timeframe. Don't let the sense of fear driving the current economic and investment climate paralyze you.

It's time, finally, to let go of the grief you feel for your current portfolio, and challenge yourself and your advisor to start back on the road to recovery!

Investment Policy Statements

This article discusses Investment Policy Statements and makes several excellent points. IPS are commonplace among defined benefit plans and endowment/foundations in the institutional world. They are the foundation upon which the Trustees, as fiduciaries, build, manage and monitor their portfolios. The IPS states the return objectives, risk tolerance, time horizon, liquidity needs, investment parameters and benchmarks and any special items that must be considered. From this document, every party involved in managing the portfolio can derive their responsibilities. It matters.

Yet, it is almost non-existent for individual investors and for defined contribution plans. I've noted before it is at the top of the list of DOL requests when the DOL audits a DC plan. So, it should be top of mind for the fiduciaries involved in managing the DC plan - management, consultant, managers, etc. It is just as relevant to individual investors, who I believe, should view their portfolios as endowments. The IPS lays out the same critical guidelines as for institutional plans and provides the reference material for all participants. If you have not created an IPS yet, do so. If you have, review it and make sure its up to date. If your advisor hasn't suggested creating one or has dismissed suggestions to do so, consider a new advisor. Many are loath to admit, but once we assume responsibility for managing client assets, my believe is we assume fiduciary duty to perform in the best interests of our clients (individual or plan participants in a DC plan). The IPS should be step 1.

My Company Just Cut it's 401k Match?!

Regardless of your belief about the rate of taxation at retirement, the advantages of tax-deferred compounding are significant and shouldn't be overlooked simply because your employer no longer matches. While other tax-advantaged investments exist, if the 401k was well designed and the plan sponsor adhered to its fiduciary duty, the plan will likely have lower expenses than other tax-advantaged options and will have more than adequate diversification. Staying with your contributions forces you to continue saving for retirement and enables you to continue to enjoy the benefits of tax-deferral. Of course, don't neglect your asset allocation. That's critical to long-term success.

You may have other options and they're worth exploring. Does your plan offer a Roth account? If yes, consider funding this account. Your contributions are after-tax but all growth is tax-free even when you withdraw it during your retirement years. If you don't have the Roth option, you could open a self-directed IRA and max your contribution. Upside is you control the investments, downside is the max is less than in your 401k. So, consider all of your options carefully but make a point, as long as your personal situation enables you to do so, of continuing to contribute to some form of a tax-deferred account.