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5 Reasons to Beware 401(k) Retirement Plans

This article was written by Flexo in Investing. 21 comments.

Financial planners just love promoting 401(k) retirement plans. They have quite a few benefits, notably a tax deduction for contributions as well as a tax deferral for contributions and earnings. They’re also one of the most popular vehicles for introducing the working middle class to the stock market, something that might not have been accessible to this group in the decades before the 401(k) plan was established.

In addition to financial planners, fund management firms and plan administrators love 401(k) plans, and their love knows no bounds. Companies pay significant fees to other companies that operate and manage 401(k) plans. More fees are embedded in the funds within the plans, benefiting each fund’s management team.

Cubicle The tax advantages, as well as a potential matching contribution if an employer offers one, offset some of the drawbacks of 401(k) plans.

1. Fees.

As already mentioned, most 401(k) plans are subject to fees, many of which are not immediately apparent to the investor. If you bother to read the prospectus associated with each fund you choose to invest in, you may find an expense ratio listed. If you do, there’s a good chance it’s higher than a comparable index fund. My former employer included investment choices that were annuity products disguised as mutual funds, and these didn’t have expense ratios listed. It was nearly impossible to determine how much of my investment I was losing to funds each year.

While fees are higher with 401(k) plans than with pensions, pensions offer a stable, predictable return. 401(k) performance depends on the investment choices and the associated markets. Pensions, when they are fully funded, tend to be more stable.

2. Employers are hands-off.

As the popularity of 401(k) plans grew, pension plans disappeared. A 401(k) is considered a “defined contribution” plan, while pensions are considered a “defined benefit” plan. That comes from the idea that the 401(k) balance is affected each payroll period by a contribution from the employee, while the pension balance increases at regular intervals by a contribution from the employer — a benefit of working at the company.

The value of a pension also tends to increase as the length of service at one company increases. As the popularity of pensions and other loyalty benefits decreased over the last couple of decades, employees had a decreasing incentive to stay at one company for their entire career. With pensions being a smaller part of most employers’ benefits, they do not need to worry as much about the solvency of these accounts. At the same time, it is up to the employee to make the right investment choices in a 401(k).

3. Automatic enrollment.

The advent of 401(k) programs brought on an increase of the nation’s wealth tied up in the stock market. That’s more income for money managers. It also creates a higher demand for investments, raising prices somewhat artificially. But there has also been a more recent increasing trend of employers automatically enrolling new employees into 401(k) plans once they are eligible. It’s a great idea to stimulate a better possible retirement outcome, considering many employees might not bother to elect to invest in a 401(k) immediately, even if they intend to.

Usually, any mechanism that automates your finances is a good thing. But too much automation can create complacency. It’s important to be aware and know what’s going on with your finances rather than blindly accepting what someone creates for you. You might be better off with an increased deferral rate than the default, or you may need to cancel your 401(k) contribution before it begins to improve your cash flow for necessary expenses.

4. Automatic allocation.

Like automatic investment, automatic allocation can be a trap. Some plans will, if the employee doesn’t elect specific investments, direct all contributions to a money market fund. Any investor could probably be better off in a high-yield savings account than a money market fund managed by a large investment house, even taking into the tax benefit of a 401(k) plan.

Furthermore, some plans will automatically invest your funds in a mix of stocks and bonds, with the percentages based on your age or your expected retirement date. This may or may not be appropriate for your situation, and importantly, it doesn’t take your outside investments into account. For example, if you plan on retiring 35 years from now, your 401(k) plan might recommend an investment of 90 percent stock funds and 10 percent bond funds, but if you already have a significant investment in stocks, your overall portfolio may be closer to 95 percent stocks and 5 percent bonds.

5. Loans.

With a 401(k) plan, you can loan yourself money. This sounds like it should be a benefit. In some cases it is, but often 401(k) loans end up being detrimental to someone’s finances. If there is an emergency and you cannot pay back the loan either on time or at all, you can face fees and penalties. If you lose your job with a loan outstanding, the entire remaining loan balance could become due immediately.

Overall, 401(k) plans can help the working middle class retire somewhat comfortably. And there is the possibility for investors to succeed financially significantly more than they might have with a comparable pension. The burden for performance has shifted from the employer to the employee, and that requires a little bit of financial education that might not have been as necessary (though still beneficial) in the heyday of pensions.

Photo: Yo Spiff

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Money Planners Can Help You Take Control of Your Finances

This article was written by Flexo in Personal Finance, Reviews. 4 comments.

Having ready many books about personal finance and money management over the last decade, I recognize most new books as offering nothing particularly new to readers. Some of the world’s favorite money gurus rehash the same ideas repeatedly, some on a predictable yearly release schedule, and these books become best-sellers due to the names attached. There have been some notable exceptions to the endless supply of old ideas, and I try to recognize them when I can.

There is a reason for repetition, though. Here are a few:

You might have missed “Get Out of Debt 2012″ because you weren’t thinking about money at the time, but “Get Out of Debt 2013″ was released at the perfect time for you.
“Wealthy Dad, Middle-Class Dad” might not have been a book that caught your attention, but “Wealthy Sister, Middle-Class Sister” was recommended by your favorite talk show host.

Kimberly Palmer, the author of Generation Earn: The Young Professional’s Guide to Spending, Investing, and Giving Back, has decided to take a different approach with her latest project. Kimberly has been a guest on the Consumerism Commentary Podcast — twice — and she also writes for U.S. News and World Report.

The author has created a series of workbooks, meant to appeal to those of us who are more creative, designed to help guide participants through the financial aspects of life. The workbook approach transforms readers into participants, and if the workbooks are engaging, they can be much more effective in someone’s life than just reading a book.

Normally, I’m not a fan of worksheets. These are great learning tools for elementary school students, and any time I’m asked to complete an assignment like that, I begin to think that the author is treating readers like children. As I’ve discovered by maintaining this website since 2003, writing things down works to change your life. Once you complete a worksheet that asks you to write down your financial goal for the year, that goes becomes real. It adds a level of commitment. While there are no consequences for missing your goal other than self-reprimand, writing things down can add motivation.

Kimberly Palmer is offering several self-published money planners on Etsy.

The Money Planner is designed as a companion workbook for Generation Earn. The activities match the book’s chapters.
The 2012 Money Planner breaks down the coming year by month, with tasks appropriate for the time of the year.
The Debt-Free Planner focuses on the one specific task of eliminating debt.
The Baby Planner helps expecting families get ready for the new financial responsibilities of having kids.

The first three planners are also available as a bundle.

To get an idea of whether these planners are right for you, I’ve included the first page of the Money Planner. Kimberly indicates the creative and visual approach will appeal more to right-brainers like herself. Whether your mind is ruled by the logical or creative aspects of thought, anything that inspires you to take action will help improve your finances.

The key to success is maintaining your motivation over a long period of time, and workbooks can inspire success more than typical books. In the end, however, success depends on a family’s or individual’s ability to maintain focus and motivation.

If you’re interested in one or more of Kimberly Palmer’s Money Planners, visit the author’s Etsy shop.

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How to Spend Money on Fun

This article was written by Flexo in Personal Development. 13 comments.

The point of accumulating and saving money is not to die with the most money in the bank. Yes, it can be helpful to your heirs to leave a fortune for the next generation, but not at the expense of living a fulfilled life yourself. There are many opinions about what it means to live a fulfilled life, but for most people, it involves taking the time to do whatever you’d like to do without needing to be concerned about the financial consequences, or whether you’ll have enough money to buy food tomorrow.

Doing whatever you’d like to do doesn’t have to cost money, but sometimes, it does. Some people could be happy living off the land, finding their own meals, and surviving on their own without ever spending a dime. Self-sustenance is an interesting concept and I have respect for people who can manage to live their lives this way. Most of us are consumers, however, and thus earn and spend money in order to live.

You’re reading Consumerism Commentary because you’re interested in finances on a personal level, but it’s important to remember that net worth and income are not the core concepts of living life. I wouldn’t be who I am without the aspects of my life that do not involve earning income. Society could not function if the only activities its inhabitants performed were those activities that other members of society would pay them to do.

Fun Snowboarding It’s advisable to look for deals when we shop. If we’re spending money in a store, it pays to ensure we’re getting the best price. That could involve bargain hunting, negotiating, and comparison shopping. Paying attention to price and value plays a big role in everyday and occasional spending, but the usual goal in this type of frugal philosophy is ending the day with the most cash left in your pocket. I offer a different goal: ending the day with the experiences that shape you as a human being. It’s harder to measure, but at the end of your life, you’ll likely have fewer regrets and be more satisfied with how you’ve spent your short time alive on this planet.

Let’s call those experiences that add up to a fulfilled life “fun.” They might not always be enjoyable, but you collect these experiences and you can find a method of tallying and rating them. These experiences have the most meaning to you now and in the future.

Here are some tips for spending money for fun.

1. Necessities come first.

Before you can consider partaking in an experience that doesn’t have a positive effect on your net worth, you need to clear a few hurdles. These suggestions speak to the top of Abraham Maslow’s Hierarchy of Needs. I keep coming back to this cope psychological concept, and it might annoy anyone who has studied psychology beyond an introductory-level course, but I feel it’s symbolic of how to best organize personal finance, particularly spending.

The lowest level of the pyramid represents your physiological needs, everything you need in order to survive each day, namely food, water, heat, and shelter. In most communities, basic clothing is also a physiological need. It would be very difficult to rationalize spending money on anything else before these needs are met. Granted, you could avoid some of these expenses by living off the gratuity of family and friends, but that can only last so long — particularly if they see you spending money on fun things without considering moving out.

Feeding your need for self-actualization is a luxury. Climbing the Hierarchy of Needs pyramid can be tough, and focusing on enriching your life comes after your basic needs are met.

2. Define our goals and values.

Once your household has overcome any difficulties in the way of providing the basic physiological necessities, there is an opportunity to think about the big picture. There are many people stuck here, believing their goal is to earn money. Earning money is not a goal in itself, it’s only a path that allows individuals to meet other goals. A friend asked me for financial advice, and although I’m not a financial planner or adviser, I agreed to talk to him and help him think through his issues.

I asked what his goals in life were, because knowing this would be the only way to help someone plan for the future. He said his goal was to retire with $5 million in the bank. Regardless of whether that was a reasonable number, it wasn’t a real goal. I asked him why he wanted that particular sum, and he had never thought about it before. We started to work out what he would do with that money and why it was important for him to be financially independent. You need real life goals, not money goals. With real goals, you can evaluate whether the money you spend is worthwhile, and you have a purpose for saving and investing other than a big balance on your monthly bank statements.

In addition to goals, you should be aware of what ideals are important to you. A set of values defines how you live your life, where you spend your time, and an initiative for your funds beyond the selfish but necessary act of taking care of yourself.

3. Pay off debt.

Being debt-free is the most important financial goal. When you’re in debt, you’re beholden to someone else. Often, that someone else is a company with significant means to make your life miserable if you can’t pay. There are avenues for help if you need it, like bankruptcy, but for the most part, you can’t life a fulfilled life when part of the money you earn is dedicated to someone else.

If you’re earning $3,000 per month and paying $2,000 in interest to your mortgage company and credit card issuers, your income is basically owned by entities other than you. If the remaining $1,000 covers nothing other than your necessities like room and board, you are living in indentured servitude. Some might even say that debt is slavery. You should want any income you earn to be rightfully yours.

These suggestions are not necessarily in order. You can pay off debt while still determining your long-term goals because no matter what goals you choose, being debt-free will be key. In this case, debt includes mortgages and student loans, not just credit cards. Any interest obligation is a waste of your money. You don’t have to be completely debt-free to begin considering spending money for fun (that is, life enrichment), but you should have a plan in place for doing so and for emergencies that might cause trouble along the way.

4. Save for the future.

Living a fulfilled life often means striking the right balance between saving for the future and using the money you earn today for more than just necessities. Again, that’s a luxury that’s best considered only by individuals or families who have done a good job of saving for their future already.

It may be possible to save too much money, but many will not reach the point where this is a concern. There will always be more we can save for the future, but those who are on the path to a more comfortable, debt-free life have more options for spending today without sacrificing their future.

5. Compare your spending with your values.

If measuring success with saving money, the scorecard is simple. Your net worth and net income statements provide feedback. You’ll know where you stand at any moment from a financial perspective. When collecting experiences leading to a fulfilled life, keeping track of your progress is more difficult to measure. You could look at your discretionary spending and compare it with your values. Give yourself points when your expenses match the type of person you’d like to be and give you the feeling that you’ll be satisfied when you look upon your experiences. Subtract points if your spending was frivolous, not well-considered, caused regret, or prevented you from living life in the way you’d like to.

When it comes to spending money for fun, I am a big fan of spontaneity. Being impulsive or spontaneous can be responsible or irresponsible, however. If you’re striving to fill your life with rich experiences and to never look back on your time alive with regret, you can help increase the chances of creating a life you enjoy by taking a responsible approach. Everyone should get a chance to spend their hard-earned money how they want, but that freedom comes from the ability to make a few good, important choices about how to handle finances.

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What I Learned as a Financial Planner

This article was written by Neal Frankle in Financial Advice and Advisers. 6 comments.

The following is a guest post from Neal Frankle, a Certified Financial Planner in Los Angeles who owns the financial blog Wealth Pilgrim. Neal has been a financial planner for the past twenty-seven years and is writing this article on Consumerism Commentary to share what he has learned from his experiences with clients over these three decades.

Even if you’ve been pursuing in your career for only a couple of years, you’ve already learned a great deal about your profession and people in general. I’ve had the same experience. Twenty-seven years ago, one of the small business ideas I had was to become a financial planner. And over that period, I’ve learned quite a few lessons about Wall Street, my clients, and myself.

What I’ve learned about Wall Street

Everything you hear about Wall Street isn’t true –- but most of it is. I’ve found that the higher up you go in management, the more detached and greedy “the machine” becomes. In fact, I’m astounded by the depths to which some firms go to enrich themselves at the expense of investors. Having said that, I must say that I’m not sure this attitude is any different from other industries.

Since I spent very little time working in corporate America I don’t know this for sure, but my guess is that all large corporations encourage political jockeying and self-serving behavior. Wall Street is no different. Take the index annuity product as an example.

When these babies were first introduced, they were some of the best investments I’d ever seen. They allowed investors to participate in growth when the market was good and protected investors from declining markets. But over time, the fat cats got wise. They realized that they could play with the way those indexes were calculated and thereby keep more profit for themselves at the expense of investors. Now, index annuities are terrible investments. This is just one of many examples.

I’ve also learned that competition sometimes works, and the mutual fund industry is a great example of this. Mutual fund fees and expenses have been dropping relentlessly over time as competition increases from Exchange Traded Funds. In short, in the debate between exchange-traded funds and mutual funds, ETFs and index funds are wining hands down.

Last, I learned that the fee structure an advisor uses says a lot about the relationship clients are going to have with the advisor. This may be self-serving because I’m a fee-only advisor. Fee-only advisors are compensated if and only if they serve clients over time. That doesn’t mean they’re going to do it, and it doesn’t mean they know how to do a good job or that fee-only advisors are qualified. Anyone can become a financial planner.

Over the long-haul, advisors generally don’t stay in business if they don’t deliver. That’s not the case with salespeople earning commissions. They get paid up front, and there is a disincentive to serve clients. Not every commission-based advisor is a shyster of course. But when someone is compensated to sell rather than advise, that’s what they’re going to do.

My experience is that commissions put advisors and clients on opposite sides of the table. Generally, the reverse is true when it comes to fee-based planners. Again, this is a generalization and there are many exceptions on both sides of the equation, but for the most part, I’ve experienced this to be true.

What I’ve learned about clients

I’ve learned that people dislike losing money more than they enjoy making money. This aversion to losing money is unfortunately and paradoxically the very reason why many investors get wiped out. If someone has no ability to absorb investment losses, they’ll do one of two things. One potential response is to stick all the money in the bank for protection. Over time, this is a losing proposition.

The other response is to invest emotionally. When the market feels good, this investor becomes aggressive. When the market feels scary, this person goes into cash. This is a perfect recipe for disaster, of course. It’s called buying high and selling low, the opposite of how someone succeeds with investing.

I don’t believe in the buy and hold strategy. There are other strategies that are more market-sensitive, and these can help investors mitigate losses and take advantage of good opportunities. That’s how I manage money, but the method I believe in is far from perfect. It is a system and not an emotional reaction. This, like any other investment methodology, has its flaws.

Some people will tell you me that they want to be aggressive investors. That may be true — until the market turns against them. Just as I need constant education in areas I know little about, some people really need to be reminded frequently about the trade-off between risk and reward. Client understanding and education is not a one-time event.

Few clients have a financial plan and even those who do rarely execute it. They aren’t clear on their objectives and they don’t know how much they’ll need to reach their goals. (Do you know how much money you need to retire?) This is a real shame. I’ve seen people with very low salaries living their dream life because they formulated a plan and executed it, and I know multi-millionaires who are absolutely miserable and live in fear. That’s because they don’t understand the basics of financial planning and refuse to learn it.

What I’ve learned about myself

I’ve learned a great deal about myself over the last quarter century as a financial planner. The most important lesson I’ve learned is that I can’t do better than my best. I used to be harder on myself than any of my clients were. In fact, during the 2008 market melt-down, clients called because they were worried about me, not their money. While my clients’ investments happened to be performing better than the market that year, we still lost money. I didn’t like that and I felt as though I had let my clients down. I was mistaken to feel this way, but I felt that way nonetheless.

I’ve learned that if I did my best, that was good enough. If it wasn’t good enough for a client, that was the client’s problem, not mine. I’ve learned that most people are good, honest and responsible. Let me tell you, when you deal with a person’s money you really get to know them. As the years pass, I’m more and more impressed by the inherent good I see in others.

I have no plans to retire. I enjoy what I do too much. I believe that the future has a great deal of opportunities ahead, and its share of challenges, as well. The most important thing I’ve learned is that I have no idea what’s coming down the pike. That’s what makes being a financial planner so fascinating.

What have you learned about yourself, others and your profession over the last several years? Were you surprised?

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When People Get Rich Quickly: Lessons from Michael Vick’s Bankruptcy

by Flexo

A typical professional athlete may be a prime example of the situation in which an individual might find himself suddenly wealthy. The idea that a person could consider himself middle class or lower one day and wealthy the next is a recipe for financial disaster. It’s easy to look at athletes because their trials and ... Continue reading this article…

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Reader Question: Invest $100,000 or Pay Off Mortgage

by Flexo

To someone with debt, receiving an inheritance can feel like winning the lottery. Occasionally, an heir doesn’t realize money will be coming her way and hasn’t planned for the windfall or thought about her options. Even those who do plan often realize that contemplating options for managing a potential windfall is quite different from making ... Continue reading this article…

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Working With a Financial Adviser: Building Your Relationship

by Kathryn

This is a guest article from Kathryn. Kathryn has been working in the financial industry for 11 years. She is the founder and author of Kathryn’s Conversations, a money and lifestyle blog for people who like to get stuff done. This article continues the series covering working with financial planners and advisers. First dates are ... Continue reading this article…

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Working With a Financial Adviser: How to Show Up Prepared

by RJ Weiss

This is a guest article by RJ Weiss, one of the youngest Certified Financial Planners at the age of 26 and the founder of the blog Gen Y Wealth. You can download his free Financial Freedom Blueprint to create your own financial plan. RJ Weiss is contributing to Consumerism Commentary’s series on finding and working ... Continue reading this article…

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