Financial Answers "IN SIMPLE LANGUAGE"

So you finally decided to get involved in your 401(k) or 403b plan at work.  You don’t know much about investing but you do know it is a good idea to be putting some of your hard earned money away for your future. 

You know one of the best ways to do that is through your employer’s defined contribution plan commonly called a 401(k)…the section of the Internal Revenue Code that allows this program.  If you work for a non-profit organization you would have a 403b…the section of the Internal Revenue Code that allows this program.  Either way it is a good deal for you.

 Understanding your investments

So you have opted into your 401(k) program and now you have to choose where you are going to invest your money in the wide variety of mutual funds that are available in your 401(k) plan.  This is the part that usually confuses most people because this part can be confusing.

You ask yourself which mutual fund or funds do I put my money into?  And how much do I put into each individual fund?  You say to yourself that you wish there was someone to ask to help you with these questions.

Sometimes the mutual fund company that handles the 401(k) program proves a question and answer phone line that you can call and get help.  Sometimes they have one of their professional representatives visit your company and do presentations and meetings with you one on one or as a group.  Usually you are on your own.

Here are some things to look for when choosing your investments

Ask yourself what you are trying to accomplish by funding your 401(k)?  Why am I doing this?  This answer is usually for a more secure retirement.  If that is the case then you need to find out which of the mutual funds offered in the 401(k) plan (I keep referring to 401(k) plans but this holds true for non-profit 403b plans also) will provide growth for you.

Depending on your age, the younger the better, you want to chose a mutual fund that fits your investment temperament.  Ask yourself how well will you sleep at night with your money invested in this particular mutual fund?

Another thing you want to look at is what is the cost of buying this mutual fund?  There usually is not a cost upfront for a mutual fund in a 401(k) plan but there are ongoing administrative and management costs that you need to be aware of.  These costs will directly affect what you make on your mutual fund investment.  Obviously the lower the costs the more you get to keep.  Call the 401(k) provider and ask them or ask the mutual fund representative that comes to visit your company.  It’s your money and you need to know.

Find out how often you can switch between mutual funds and if there is a cost for doing so.  Some companies may charge for this and others may not.  Again this is one of those things that is going to affect how much money you get to keep and that is what it is really about…how much money you get to keep.

I have barely scratched the surface on what you need to know about investing in your 401(k) and 403b programs but you have to start somewhere.  Do your homework and educate yourself on how these programs work and you will have a bright financial future ahead of you.

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Both defined contribution plans, the 401(k) and the 403b retirement plans, are the mainstays of the American workers future retirement needs.  A well funded retirement plan along with social security, personal assets, and personal savings will ensure a comfortable retirement for the American worker.

Let me define what a defined contribution plan is.  A defined contribution plan lets the employee define the amount of money you want to take out of your paycheck each week or every two weeks or once a month or however you are paid before taxes are calculated.  This immediately lowers your taxable income and potentially your tax bracket.

The amount taken out of your paycheck, determined by you, is usually based on your total income for the year and can vary based on your age.  If you are fifty-five and older you can contribute more into your plan.  You also have the ability to say how your money is going to be invested and where and how much of the total.  This is, of course, based on what investment options are offered within the defined contribution plan.  And there are other things offered, not always, but usually a loan provision. If offered, you can “borrow” money from your defined contribution plan.

Also most defined contribution plans offer a wide variety of investment choices such as a savings feature which pays a fixed rate of interest and a variety of mutual funds to choose from.  You can even change the mutual funds and the amount of your contribution going into those mutual funds as your circumstances change.

The best thing about defined contribution plans is the fact that your employer might match a portion of what you are putting into your plan.  As an example, your employer would match the first 3% of your money up to a certain dollar amount each and every pay or whatever the employer is offering.  This is free money and an instant return of 100% on your money.  That is as good as it gets.  If your employer offers this and you are not taking advantage of this offer you are losing money.

So what’s happening with defined contribution plans?

Because of the way most investments were devastated in 2008-09, the government and many public officials have been looking at ways to prevent you from again losing large amounts of your money in your 401(k) or 403b plans.  Note:  The 401(k) is for “for profit” companies like GM, GE, Microsoft whereas the 403b is for “non-profit” companies like hospitals, public schools, colleges, and universities.

What the concerned public officials are talking about is having an annuity feature-a monthly income for life-in all defined contribution plans.  What this would do is “guarantee” a monthly income for life for anyone with a defined contribution plan.  As it now stands if you have all of your money invested in, let’s say, mutual funds there are no guarantees that your defined contribution plan will have any money in it when you need it in later years.

An annuity feature would allow you to take a portion of your money and set it aside so that that part of your plan would “guarantee” you some sort of monthly income payment for life regardless of what would happen to the investment part of your 401(k) or 403b. 

Amazingly enough of 1,500 employees polled recently, only 44% thought the annuity feature was a good idea.  I believe that number is less than half because of the confusion, misinformation, and lack of knowledge about financial topics that permeates our educational system.  That is another topic for a further post.

What do you think about having a guarantee of a lifetime monthly income as part of your 401(k) or 403b plan?

If you read this far there may be something about this post that you are relating to.  There may be some financial related pain In Simple Language is talking about.  Tell us your story.  We really do want to know.

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Target date mutual funds have been a hot topic ever since they took such a dismal beating in 2008.  Many people, especially in their 401(k) programs, lost hundreds of millions of dollars when the stock market got wacked.  To prevent this from happening again, since target date mutual funds are so popular, congress has been looking at ways to minimize damage to people’s 401(k) programs that are using target date mutual funds.

So what is a target date mutual fund?

A target date mutual fund is a mutual fund, or basket of investments, that uses a specific date, like 2020 or 2025 or 2030, as a target date for when a person will need to use those specific funds.  That use could be, and usually is, for retirement although it doesn’t have to be. 

The idea is when you put your money into a target date mutual fund, and depending on when you will need it again, the fund will start off investing your money more aggressively.  As you approach your target date the investments in the target date mutual fund will become more and more conservative…protecting your money.  Or so it is thought.

So what happened in 2008 when the market went into a dumpster?  The portfolio managers of most target date mutual funds were not doing what they were supposed to be doing.  Many of the target date mutual funds that were reaching their target date of say 2008-2010 were overly aggressive in stocks causing the funds to lose a large percentage of their values.

People 65 years old or older, which had upcoming target dates of say 2010, where shocked to see the losses in their target date mutual funds which were supposed to be invested conservatively, yet weren’t.  Too much of their money was invested in stocks causing them to lose a great deal of money.

Congress doesn’t want this to happen again.  Target date mutual funds are very common in 401(k) plans with an estimated $245+ billion held in these funds.  That is a significant amount when you consider how many different mutual fund types are in the investment world.

Things are getting better

After the 2008 bloodbath within target date mutual funds, many of the mutual fund companies have decided that they don’t want to have that happen again.  Whether that is for your protection or their continued existence it is good to see many of the mutual fund companies taking the initiative to prevent this from happening again.

One of the methods that some of the fund companies want to put into place is to give the target date mutual fund manager more flexibility in how they invest.  The target date mutual fund, like all mutual funds, is guided by what the mutual fund’s prospectus directs. 

So if the mutual fund prospectus says that no more than 50% of your money will be invested in stocks then that is the way the fund is “supposed” to be run.  Of course this was a major part of the problem in 2008 when many mutual fund managers did not adhere to what the prospectus said.

Some fund companies are talking about re-balancing their funds more often…quarterly or monthly instead of annually.  Re-balancing refers to keeping the fund within the parameters of what it states such as 50% stock, 45% bonds, and 5% cash.  When the target date fund exceeds any of these parameters then that part that exceeds these set parameters is sold off and the money is re-distributed to bring the fund back into line with its 50%, 45%, 5% ranges.

Time will tell if these actions will help in the next financial meltdown…and there will be another meltdown.

If you read this far there may be something about this post that you are relating to.  There may be some financial related pain In Simple Language is talking about.  Tell us your story.  We really do want to know.

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Back in May, 2008, I posted my first “Target Date Mutual Fund” article.  Including today’s blog post, I have done a total of eight blog posts on “Target Date Mutual Funds”.  You can look at the other posts by putting “target date funds” in the search box feature on “In Simple Language”.

Why have I written so much about these particular mutual funds?  Based on my recent research, target date mutual funds, by the year 2018, only eight years from now, will grow to almost $3 trillion.   This will amount to almost half the total assets in defined contribution plans.

Remember, defined contribution plans are your 401(k) plans used by for profit companies and 403b plans used by non-profit organizations like schools and hospitals.  It seems that target date mutual funds are becoming even more popular today than they have been.  This is even after the fact that there have been some “serious” issues with the way target date mutual funds have been managed.  Go back and read my previous posts and you will better understand what I am referring to.

Jumping on the target date funds bandwagon

Unless you have been living in a cave for the last twenty years, I am sure you have heard of Wal-Mart…the largest retailer in the world.  It looks as though Wal-Mart is introducing target date mutual funds to its more than 1 million 401(k) plan participants. 

It sounds as though Wal-Mart did its homework on target date mutual funds because it didn’t just accept any old target date mutual funds, Wal-Mart decided to get their own custom made target date mutual funds.  This is a prudent business decision because Wal-Mart, like everything else it does, likes to control its costs.  By having these specially made funds they will be able to do just that.

Wal-Mart also made another savvy business decision as to the structure of the special target date mutual funds.  They opted to have the funds be designed to take care of their employees-not just until the time that they retire-all the way through retirement.  Way to go Wal-Mart.

What I would be concerned with is whether or not specific investment help is going to be available for the 1 million plus Wal-Mart plan participants that will not understand what a target date mutual fund is or how it works.  If they believe that most of the plan participants will understand how these funds work…good luck!

All mutual funds have their own inherent complexities and need to be explained In Simple Language.  I would venture to guess that the majority of people working for Wal-Mart do not have a financial background or are familiar with financial terms and their meanings.  So if someone is advised to go into a target date mutual fund and they start reading the prospectus about what it is, how it works, and what makes up the target date fund…once again good luck.

HELP! Is on the way

Maybe help is on the way, not just for the people at Wal-Mart but also everyone else who has an interest in being involved in target date mutual funds.  It seems that the United States Labor Department and the Securities and Exchange Commission (SEC) are working on a type of consumer alert information that will be available to help you make a more informed decision.

This information is intended to clarify what a target date mutual fund is and how it may or may not fit into your overall investment goals.  Let’s hope that they do a good job and write it In Simple Language.  We all know how easy to understand most government information is.

Unfortunately, no timeline has been set as to when these guidelines will become reality.  We can only hope it will be timely.

If you read this far there may be something about this post that you are relating to.  There may be some financial related pain In Simple Language is talking about.  Tell us your story.  We really do want to know.

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I am going to venture to guess that most of the people that read In Simple Language own, have owned, or understand what a mutual fund is.  For those of you that don’t understand what a mutual fund is let me explain.

 Mutual Funds

 A mutual fund is an investment container, similar to a bucket, in which a professional portfolio manager holds various types of investments.  Usually these investments are different types of stocks and bonds.  Now you pay this portfolio manager to watch over these investments and buy and sell what they think will make the best return or provide the most protection from loss for you the mutual fund owner.

 Now we all know what has been going on with the financial markets worldwide and especially in the United States.  It has been a financial nightmare for most of us.  The stock market dropped almost 50% and devastated our financial accounts almost overnight.

 This has created additional problems because if you have been watching the stock market it has dropped from its high of 14,164 on October 9, 2007 to a low of 7,062 on February 27, 2009.  An approximate 50% drop.  As of this writing we are only in the low 9,000 range.  This has caused everyone to become very nervous and very conservative with putting our money back into the stock market.

 That has led to many professional mutual fund portfolio managers to sit on the sidelines with a lot of your cash to invest but reluctant to do so.  You may be thinking that that is a good thing.  Maybe?  It would depend if you had picked the right mutual fund(s) to get back into.  Many funds are up from 10% to 50% in some cases.

 The Problem

 All mutual funds have expenses and you pay for them.  One of those expenses is the fees you pay for the salaries and bonuses of the professional mutual fund managers.  Did you get a notice from any mutual fund company that the fees for the salaries of the mutual fund managers were being reduced?  Fund managers are paid to buy and sell investments and make money for you.  If they are going to sit on the sidelines with your money in cash and not invest it they can’t make money for you.

 According to the Bank of America Merrill Lynch Fund Manager Survey, 41% of mutual fund portfolio managers were playing in safe by staying in cash.  That’s a safe and conservative position to take when things seem to be falling apart all around you.  But that is not what you are paying them for… especially for any lengthy period of time.

 Some fund managers have stated that they needed the extra cash because so many investors were cashing out of their mutual funds.  That is probably true to a certain extent.  But again these are professional mutual fund managers with a wealth of information and resources available to them to make these types of tough decisions.  So why are they still sitting with hundreds of billions of dollars in cash if, supposedly, the economy and things are beginning to turn around?

 Granted some fund managers have jumped back into the stock market but there is still hesitation with many of them.  Okay I don’t want to appear like I am picking on professional mutual fund managers.  Let me get to the point.

 My point is that even the investing professionals don’t really have a comfortable feeling about this market yet.  Even with all their expertise and resources many are still sitting on the sidelines.  You need to exercise caution with your own investments when you decide to jump back into the market.  Nobody seems to have a crystal ball on what to do.

 What all of this comes down to is if you can sleep at night with what you have done with your investments than that is probably the right thing for you to do.

 If you read this far there may be something about this post that you are relating to.  There may be some financial related pain In Simple Language is talking about.  Tell us your story.  We really do want to know.

•  Please ask your questions of In Simple Language and we will answer you as soon as possible in the comments section of the blog article you asked about.
•  Please give In Simple Language your comments and suggestions about this post and/or future topics of interest to you.
•  Like what you read?  Send it to a friend.  Click on “share this post” right above leave a comment below.
•  Did you remember to bookmark this blog?

 Thank you for taking the time to visit In Simple Language. 

Copyright © 2008-2009 “All Rights Reserved”

Looking for a financial speaker or financial writer?  Contact Rich today at rsowa@insimplelanguage.com or call Sowa Financial Media, LLC now at (502) 569-1714.

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