If you’ve watched the financial industry over the course of the last decade, you’ve probably noticed some important contradictions. It’s a good indication that taking generalized investment advice and applying it to your own situation is not a smart idea. Anyone who retired at the height of the recession is going to understand exactly what I’m referring to.

For many years, particularly when the stock market and real estate industry were speeding along on their way to all-time highs, financial planners had a core view for retirement investment planning:

Because you — the average member of the general American public — are expected to live for two or three decades beyond the traditional age of retirement, you need assets that are going to provide the income you need for a long period of time. If, in retirement, you don’t plan to work to generate income (and if you do, it wouldn’t really be retirement), that income needs to come from your assets.

Therefore, planners throughout the decade leading up to the recession said, you need to remain invested relatively aggressively in equities — stocks, not bonds — to provide the kind of performance necessary to turn the average retirement nest egg into an income stream.

Then the country experienced an economic recession and a stock market crash. Financial planners backpedalled when questioned by recent retirees who saw their nest eggs lose 60 percent or more of their value at the time when they were beginning to withdraw their funds for income or convert their assets into annuities. “Well, you should have invested more conservatively as you were approaching retirement.”

So which is it? As the middle-class worker approaches the date of retirement — a date that can come sooner that expected if the boss wishes it so — should he or she maintain exposure to risky equities for the opportunity to make those assets last another thirty years or should he or she reduce risk to smooth out any potential bumps in the valuation road?

A reasonable person might say the answer is to “find the right balance.” Finding balance is a concept that sounds wonderful. We look for balance in all things: balance between our career priorities and family priorities, balance in the way we treat our own children, balance between enjoying life today and planning for the future.

In this case, however, striking a balance between the two opposing approaches to investing prior to retirement has a bigger chance of meeting neither goal: not protecting retirees from downward swings in the market and not extending the life of assets.

How do you approach the fateful event when you no longer trade your time and effort for income when those providing advice seem to be unsure themselves, more interested in telling a story that connects with people whose expectations change based on the overall economy and the general outlook in the financial media?

The realities of investing don’t change depending on whether the stock market is at all-time highs or long-time lows, but the advice does because it has to match what people are feeling. Is there a time that those who give advice are more right than at other times? Is the advice to remain invested in risky stocks while approaching retirement better than the advice to dial down the risk in favor of potential stability?

Asset allocation is important, and the advice given during the boom times makes the most sense for people who just haven’t been able to put away large nest eggs for retirement. Stay invested mostly in equities to give that nest egg the best possibility of lasting as long as you expect to live. Shift from aggressive to conservative later on.

There are two alternatives to avoiding this choice.

1. Grow a nest egg large enough for you to avoid risk.

The first alternative is to create a nest egg large enough that you can withdraw only one percent of your assets’ total value each year. If you can live off one percent or less of your nest egg, you can have a much more conservative portfolio while increasing the chance that it will survive at least several decades.

If you can retire today with $10 million, you’d probably be fine living with an annual income of $100,000 (or 1 percent that first year). But there are very few who will retire with a nest egg approaching that amount. Having sizable assets allows you to invest with much less risk while still being comfortable. That’s why Suze Orman invests her own millions much differently — more conservatively — than the way she encourages her middle-class callers to invest.

This alternative certainly isn’t easy. Even if you follow the tenets of “getting rich slowly,” saving as much money from each paycheck as possible, you might find yourself with an extra $1 million or $2 million in future money after 30 years. And $1 million in 30 years might have the same value as about $400,000 in today’s dollars — not exactly rich, but a little better off.

2. Retire at the best possible moment.

The second alternative is to adjust the date of your planned exit from the workforce. We like to think of retirement as the day you leave working behind in favor of a life of leisure, but for many people who find themselves needing to supplement their income, retirement might be a time to continue working, just at a different capacity.

If there is a day to stop working, that day would be when your assets have a high valuation, perhaps at the top of the stock market, if you plan to use any portion of your assets to purchase an annuity as many retirees do for the guaranteed income.

Timing is notoriously difficult because you never know whether you’re at a market top until after the fact. Also, your retirement date isn’t always completely up to you. The worst situation is when a country is experiencing a recession and employers react with layoffs. There you are, forced into an early retirement at the exact moment when retirement is probably the worst thing for your ability to generate the income you wanted during the next two or three decades.

Financial advice needs to be specific, relating to any one person’s own situation. The idea of prescribing an investing approach to a large group of people is inviting. And you can probably get more hits than misses when you have a good idea of your audience’s average financial situation. You’re pretty safe if you can say most people will do best by approaching retirement invested mostly in stocks.

But every so often, a recession or stock market crash comes around. It’s the situation that illustrates that the risk necessary to potentially receive financial rewards actually exists. You can’t change your advice because of this manifestation. It’s only after market crashes you hear planners saying, “Well, you should have been more conservative,” or, “You should only invest in the stock market what you can afford to lose.”

At all other times, the advice is, “Unless you are rich, investing carefully in the stock market is the best way to provide the best chance for growing wealth over the long term,” and thats the same advice that should apply at all times. Notice that the advice only offers a chance, not a guarantee, and for every risk you take, there’s also a chance that retiring at the wrong time could leave you with a nest egg a fraction of its former valuation.

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A few years ago, new regulations mandated that 401(k) retirement plan administrators change quarterly statements to include more information about expenses about each fund in which the employee is invested. This was a good move.

I have mixed feelings about 401(k) plans. Today’s world of employment is different than that from a generation ago. For those in the middle class, having a career meant, for many, sticking with the same company for a lifetime. Even after retirement, that company would take care of its employees with pensions and health benefits. With a growing middle class and some difficult periods of economic uncertainty, companies were unable to meet their pension obligations.

Wall Street stepped in. The financial industry pushed the idea of personal responsibility for retirement — it’s difficult to argue against that concept. While the industry introduced products to help individuals invest for their retirement, the government enacted legislation that created tax incentives for those who were able to put aside some of their income for later.

Today, many companies automatically enroll new employees in 401(k) plans. This can be described as an advantage, encouraging younger employees to create a more secure retirement without much effort. The first steps — deciding how much to set aside for retirement and choosing the investments — are often the hardest, and they stop many people from enrolling in retirement savings plans as early as they should. Sometimes the stopping point is just the idea that someone — particularly young employees — aren’t earning enough to set aside anything for retirement. Automatic enrollment solves these problems and moves employees forward with their retirement savings quicker than any other options.

The same automatic enrollment approach to 401(k) is a great benefit to investment companies — particularly, the managers of mutual funds, the companies they work for, and the companies that administer plans (third parties standing between investment companies and employers offering the 401(k) plans). The default enrollment often includes an investment allocation that includes funds that are more expensive than necessary.

Index mutual funds outperform actively managed mutual funds over long periods of time. Managers who attempt to beat the market just can’t. Index mutual funds, for the most part, are also much less expensive to manage than actively managed funds. Index funds change their underlying investments less often than other funds, and those other funds quickly rack up transaction fees. Add that to compensation for the mutual fund managers — which they receive whether their funds perform well or not — and the total cost of these funds doesn’t justify their performance or lack thereof.

CNN Money recently referred to a recent study that showed that some employers cost their employees $100,000 more than others for their average employee’s retirement.

For example, let’s say Employee A works for FedEx, while Employee B works for Best Buy. The employees are the same age (25), have the same salary ($55,000), same annual wage growth (3%) and put the same chunk of their salary in their employer’s 401(k) plan each year (10%).

After 40 years, Employee A would have a final account balance of nearly $830,000… Employee B, meanwhile, would start retirement at age 65 with a nest egg of roughly $743,000 — almost $100,000 less.

You can beat these averages by getting more involved in your retirement allocation. Choose the lowest cost index fund available. And if there isn’t one, raise the issue with your human resources department.

A few years into my first major job out of college, working for a non-profit organization, the company finally began offering enrollment in a 403(b) plan — the non-profit version of the 401(k). You would expect this type of fund to have better low-cost investment options than the average 401(k), but that wasn’t the case. A small organization like the one I worked for didn’t have many options for working with those third-party retirement plan administrators, and didn’t have the standing to negotiate lower fees or better deals for employees.

Although I wasn’t as experienced with personal finance as I am now, I still saw the plan as a raw deal for the employees.

Sometimes even the best investment option in a retirement plan isn’t very good. But if you’re still living with whatever the company decided you should be invested in, or if you followed your company’s automatic guidance based on your risk profile, as I did when working in the financial industry, chances are you’ll either be retiring with less money in your nest egg or you’ll be waiting longer to retire.

The other option includes evaluating your investment options, choosing low-cost index mutual funds, and doing more to take control of your retirement investments than just allowing your employer to automatically enroll you in something that benefits the financial industry more than it benefits yourself.

As I’ve seen in my own 401(k) plans, it can be hard to determine the true cost of your investments. My former company offered its employees a small-cap index fund, which seemed to be a good choice for balancing retirement funds between a variety of company sizes. Of course, what I should have done would be sticking to the low cost index fund that matches the S&P 500 or a similar index without concerning myself with company sizes, but I was strongly influenced by the company’s own model portfolios used in its risk models.

I liked the idea of balancing my investments with a small-cap fund. What I didn’t realize is that the account was actually an annuity — or a mutual fund that had some annuity features. The expense ratio, the typical measurement of a fund’s management expenses, was listed as 0%, and I thought that was a great deal.

I should have known an expense ratio of 0% was too good to be true; there were expenses built into this fund that were not disclosed in the expense ratio.

Over time, I’ve moved all of my retirement funds into low-cost index mutual funds. While the investment choice is no guarantee that I’ll have the biggest nest egg possible when I reach the age at which I’ll begin withdrawing these funds, it puts me in a better position to have a higher investment balance than I would had I remained in high-cost investments.

Keep your retirement expenses low:

• Check your quarterly 401(k) statements.
• Read your investment prospectuses occasionally, and understand how the fees are communicated.
• Don’t blindly accept the default investment allocation.
• Select low-cost index mutual funds over other options.

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I’ve mentioned Intrade here. Intrade, until recently, was an open prediction market. People from all over the world could place money — bet — on circumstances they expected to be true some time in the future. It was used to great effect during the recent presidential election here in the United States. Even as the talking heads in the media were pushing forward the inevitability of a victory for Mitt Romney, the money was on Barack Obama’s reelection.

Soon after the election, regulators forced Intrade to restrict access to customers from the United States. In this country, companies may only sell commodities options if they are registered through an exchange. By predicting the future prices of commodities like gold and currencies, Intrade was allowing its customers to trade commodities options, and there may be some room to argue that the outcome of future events not directly related to financial products — the outcome of elections or the selection of the Pope, for example — are too similar to commodities options to be excluded from the rules.

Even though Intrade and its parent companies are based in Dublin, Ireland, regulators from the United States pursued the company.

Before the beginning of the trading day today, Intrade’s operations ceased. A notice on the website’s home page indicates all customers will be able to receive the cash from their accounts based on the values of their options at the close of March 10. Customers are reporting, however, that they will be unable to withdraw their money until an investigation is complete. There’s no prediction contract indicating when customers’ money might be available again.

Had a proper regulator been able to extend its reach to Intrade, there’s probably no way the site would have frozen its customers’ funds.

It’s not clear why Intrade shut down its operations today without warning, but the message on the website indicates that it is in accordance with Irish law.

Prediction markets like Intrade can be and have been manipulated, just like commodities trading legally on exchanges. The nature of manipulation, however, is generally fair. If someone with a lot of money steps in to make a large enough trade that swings the market in one direction, usually with the intent of making an unlikely event seem more likely, others will, in theory, spot the opportunity to trade against the market manipulator. Market manipulation is illegal, and the Commodity Futures Trading Commission (CFTC) is the regulator tasked with of prosecuting those who try to manipulate markets.

Intrade is generally out of reach for the CFTC, though today’s shutdown may be an indication that the regulators, working in concert with government authorities, will go to extraordinary lengths. Is the market manipulation of Intrade any more troublesome than the manipulation that probably goes on in regulated exchange-traded commodities options? Or is it just that Intrade has positioned itself to be beyond the reach of regulators?

While Intrade doesn’t (or didn’t) offer options contracts on sporting events, there is little difference between these two types of activities. It’s gambling, and I suggest staying away. Intrade has been entertaining to watch; for events with large audiences, the predictions have proved to be generally very accurate. I wouldn’t put any of my own money into these options contracts, whether offered by a foreign company or one based within the United States with the proper exchange activity and regulation.

Should citizens all over the world be free to bet on the outcomes of future events free from regulation?

Here is the message posted on Intrade’s website as of this morning:

To Our Customers:

With sincere regret we must inform you that due to circumstances recently discovered we must immediately cease trading activity on www.intrade.com.

These circumstances require immediate further investigation, and may include financial irregularities which in accordance with Irish law oblige the directors to take the following actions:

• Cease exchange trading on the website immediately.
• Settle all open positions and calculate the settled account value of all Member accounts immediately.
• Cease all banking transactions for all existing Company accounts immediately.

During the upcoming weeks, we will investigate these circumstances further and determine the necessary course of action.

To mitigate any further risk to members’ accounts, we have closed and settled all open contracts at fair market value as of the close of business on March 10, 2013, in accordance with the Terms and Conditions of our customers’ use of the website. You may view your account details and settled account balances by logging into the website.

At this time and until further notice, it is not possible to make any payments to members in accordance with their settled account balance until the investigations have concluded.

The Company will continue the maintenance and technology operations of the exchange system so that all information is preserved properly.

We are not able to provide telephone support or live help services at this time, please contact the company by email at: accountservices@intrade.com

We appreciate your custom and support over the years. We are committed to reporting faithfully the status of things as they are clarified and hope you will bear with us as we do all we can to resume operations as promptly as possible.

Sincerely,
The Board of Directors of Intrade the Prediction Market Limited

Thanks to Consumerism Commentary reader @syllana who brought today’s action to my attention this morning. Feel free to share interesting news items with me on Twitter by following me at @flexo.

Photo: Flickr

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