Know Before You Go – Your options when you retire or change jobs

Know your choices when it comes to 401 (k) distributions.

A recent survey by Financial Engines1 found that 52 percent of workers between the age of 35 and 65 have left a job where they had money in the employer’s 401(k) plan. You may assume that you should take the money with you when you leave, but is that really your best option?

You might be retiring, or leaving to focus on family matters, or simply moving on to a new opportunity. Regardless, you will need to decide what to do with the money you have accumulated in your workplace retirement account. When the time comes, you have several choices.

Leave your money where it is
Doing nothing is always an option, and in this case, it may be the best one you have. Surprisingly, 42 percent of survey respondents didn’t know it was even possible. The greatest benefit of remaining in a former employer’s plan is having access to the institutional buying power and high-quality plan design that many leading employers have made available. The result: potentially lower fees and higher quality investment options.

In some cases, remaining in a former employer’s 401(k) plan may not be the best choice. For example, if you change jobs frequently you might wind up with multiple accounts that can make retirement planning more difficult. In this case, you might consider consolidating your accounts into your current employer’s plan. Regardless, it helps to speak with an independent financial advisor to get an unbiased opinion.

Do a rollover to an IRA
Many advisors will tell you that your best choice is to rollover or transfer your 401(k) money into an IRA. When a salesperson tells you this you need to ask one question; What’s in it for them? Most 401(k) plans do not charge a separate fee for transactions within the account. But an IRA set up with a brokerage firm may charge commissions for each transaction you make or an investment advisor where you pay and annual fee on the account value. It is also important to understand any other fees you may be charged to maintain the account. This is especially true if you are considering a rollover to a variable annuity, where high fees, lock-up periods and surrender charges can limit the availability of your funds and seriously eat into your savings.

You should also consider how you will manage your new IRA. If you are comfortable making investment decisions on your own, you might benefit from the expanded investment options available to you in a separate IRA account. But keep in mind that unlike a 401(k), IRA accounts are not covered by the Employee Retirement Income Security Act. This leaves brokers free to recommend investments that may not necessarily be in the best interest of the investor. And since many workers may not fully understand the nature of these transaction, they may end up with investments or accounts that are not in their best interest.

Withdraw the money
This is probably your worst choice. Unless you are facing severe financial stress, your 401(k) money should be used for one purpose only – your retirement. Withdrawals of pre-tax contributions, employer matching contributions and any earnings will be taxable as ordinary income. And if you are under age 59½, a 10 percent IRS penalty may apply as well.2 The Financial Engines survey found that more than 28 percent of retirement investors were not aware that they could incur such tax costs and penalties.

In some instances, you may avoid taxes and penalties if the money is deposited into a new qualified account within 60 days. This is referred to as a rollover. If you have the choice, you should opt instead for a direct transfer of funds instead of receiving a check. This avoids any possible errors, back-up withholding, or potential for incurring taxes and penalties

A Side-by-Side Comparison

If you are considering an IRA rollover or transfer, you should consider these factors:

  • The investment options available for diversification
  • Any costs and account-related fees and expenses
  • The level of service available
  • The availability for penalty-free withdrawals between ages 55 and 59 ½.
  • Whether the account offers legal protection from creditors under federal law.
  • The amount of the required minimum distribution (RMD) once you reach age 70 ½.
  • Any factors relating to employer stock.
  • Any state tax considerations.

Financial Engines research revealed that plan participants in employer plans that have adopted Financial Engines services, on average, have access to funds with fees that are below the industry average3. Comparing in-plan fees versus the industry averages, participants who keep their 401(k) savings in the workplace retirement plan, rather than rolling out to retail products, can potentially increase their retirement savings by 4.7 percent after 10 years on a $100,000 initial balance. This represents additional savings of more than $4,600 for the employee to potentially live on in retirement4.

Unbiased Advice Can Help Employees Make the Right Decisions
Every worker’s situation is different and with a range of distribution options available, how can you know which choice is best for you?  One approach is to get unbiased professional guidance from an independent financial advisor.  Nearly 80 percent of respondents to the Financial Engines survey believed it is important to get financial advice from an advisor who is a fiduciary. That is, an advisor who is required to put your interests above their own. However, 69 percent also said they had never consulted a financial professional about their retirement distribution strategies. That may be a missed opportunity, especially when nearly 80 percent of those who did consult a financial advisor said they felt more confident about their distribution strategy.

1. Reconsidering the 401(k) Rollover, Financial Engines, June 2019
3 ICI Research Perspective, Trends in the Expenses and Fees of Funds, March 2019
4 Savings on $100,000 with a 5% compound growth rate over 10 years; analyzed fees for 60/40 equity/bond portfolios and found a 0.31% differential in underlying fund fees when comparing in-plan fees at plan sponsors offering Financial Engines’ services vs industry averages; based upon Edelman
Financial Engines data as of 5/31/19 and ICI 2018 industry average.

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.


How Much Do You Need to Save for Retirement?

We hope the answer will calm you.

It’s one of the questions we hear most often, and rightfully so: Am I saving enough for retirement? The answer, of course, is: it depends. Lots of factors come into play, including how much income you’ll need, whether you’re entitled to Social Security and/or a pension, your health and life expectancy, and your attitude about inheritances for a spouse/partner, children or others.

Typically, after analyzing the situation, we discover that people need to amass savings of 15 to 25 times their current annual income. For this discussion, let’s use the midpoint of 20x. On that basis, it would seem that someone earning $100,000 a year would need to accumulate $2 million.
That’s a shocking amount.

Only it isn’t — and here’s why. If you’re married and will receive combined retirement benefits from Social Security of $40,000, you won’t need to amass enough savings to generate that entire $100,000. Instead, you’ll need only $60,000. And 20 times that is just $1.2 million — a goal that’s much easier to achieve.

Factoring in Social Security and Pensions

If you’re due a pension in addition to Social Security, that target amount is even less. And it’s less still if you plan on earning part-time income after you retire; even $10,000 a year can make a huge difference. As can deciding that you can afford to live on less than what you’re currently spending. Finally, deciding that you don’t need to leave millions of dollars to heirs further reduces the amount you need to accrue by retirement.
For all these reasons, the situation might not be nearly as dire as you think.

So, that range of 15x to 25x is merely that — a range. To get your specific answer to that important question — Am I saving enough for retirement? — there is no substitute for consulting a professional financial planner.


Hosting a Party? Consider Umbrella Insurance

It can protect you from risks you may not even know you have.

Are you planning a party anytime soon? Social gatherings are enjoyable, but have you considered the potential consequences you might experience as a homeowner and host if an accident were to occur?

The following scenarios are not uncommon at parties:

  • Someone is injured in a fall and requires medical attention.
  • A guest suffers from food poisoning or an allergic reaction to the meal you serve.
  • Somebody drinks too much and causes an auto accident on the way home.
  • A fight breaks out and one or more people are injured.

Because of such risks, it’s wise to talk to your homeowners insurance agent to verify the amount and kind of coverage you have. Make sure your liability coverage is adequate to protect you in case someone decides to sue you. An umbrella liability policy  provides coverage over and above all the standard protection you get from your homeowners and automobile policies.

An umbrella policy is extraordinarily cheap. You can easily get $1 million worth of coverage for a few hundred dollars a year. It’s so cheap, in fact, that no one will sell it to you except the carrier of your other policies because they earn so little on umbrella insurance that they don’t bother selling it except to existing customers. You should get a policy for at least $1 million.

If you’re holding a party, you can minimize your risk in other ways too. Just as you made sure your home was safe when your children were small, do the same now for your party guests. Some will arrive and leave when it’s dark outside, so remove any hazards on your property between where people will park and your front door (some will cut across the lawn). Are there steep steps? Any holes in the ground? Be on record as warning them of such things — and make sure there’s adequate outdoor lighting. If you have a swimming pool — even though it’s covered — a trampoline or a basketball court, make sure that adults are present if children are outside.

Finally, if you’re serving alcoholic beverages, be sure to have some designated drivers on hand — or the phone number of a taxicab company or the Uber app on your phone.

Better safe than sorry, right?


Don’t Let World Events Change Your Long-Term Financial Plan

Knowledge conquers superstition and fear.

Perhaps you’ve already forgotten what you were doing back on August 21, 2017. It was a big deal at the time, but it quickly came and went.

I’m referring to the eclipse — the first total eclipse of the sun in 99 years that crossed the entire country. Millions of Americans viewed it through filtered glasses, and some traveled far to view the totality. The eclipse  was fun — but eclipses weren’t always viewed that way.

Ancient cultures believed a mythical creature was taking a bite out of the sun or devouring it entirely. Some believed they shouldn’t breathe during an eclipse, or cook or clean clothing, because the air was contaminated. Eclipses were blamed for wars, diseases and deaths. In Babylon, stand-ins were placed on the throne during eclipses so any harm would come to them instead of the king.

Today, of course, we know that solar eclipses are caused by the orbiting moon passing in front of the sun, casting its shadow and briefly blocking our view of the sun. We know it’s nothing to be afraid of. For us, the solar eclipse was a good reason to throw a party — and there were lots of them around the country on August 21.

But what does this have to do with personal finance? It provides a good analogy of how some investors allow irrational fears — often stirred by news events or pundits who make wild predictions — to influence their financial decisions, especially their investing strategies.

For example, we’ve received phone calls and emails from folks nervous about the nation’s rising tensions with North Korea. Might Kim Jong-un’s bellicose actions and a U.S. response trigger a stock market crash? Others have expressed worry over recent terrorist attacks in France, Belgium, the United Kingdom and Spain, wondering if further attacks will damage our economy. Civil unrest and protests nationwide are also on many people’s minds. Ditto for political tensions with Russia, China, Iran and even Venezuela. And let’s not forget to mention tension in Congress, which appears deadlocked and dysfunctional.

Could any of these cause a sharp decline in stock prices? What does it all mean for your investment strategy How should you respond to negative news? To answer, it might be helpful to look at events that worried many investors in the past, to see how those events affected the financial markets at the time.

Remember when Greece defaulted on its debt? During the run-up to that event, Standard & Poor’s downgraded Greece’s debt to junk status in April 2010, after which the S&P 500 index fell 16 percent over the next 10 weeks. But a year later, the index was up 31 percent.

Let’s go further back:

  • Remember the Russian satellite Sputnik? (If not, ask your grandparents.) It was launched in 1957 — prompting fears that the Soviets could drop bombs on the United States from outer space. The S&P dropped 10 percent in three weeks, but six months later it was up 8 percent and by the following year it was up 30 percent.
  • When Richard Nixon resigned the presidency in 1974, the index fell 19 percent in five weeks. But it was up 30 percent after six months and up 27 percent the next year.
  • After the 9/11 attacks, the index fell 12 percent in two weeks, but it was up 7 percent after six months and up 16 percent the next year.
  • After Hurricane Katrina, the index dropped 2 percent in six weeks, but was up 7 percent six months later and up 10 percent the next year.

The lesson is simple: When unsettling events take place, don’t react like those of ancient times. Instead, stick with the long-range financial plan your planner helped you develop. Although past performance doesn’t guarantee future results, you can rely on your planner to work in your best interest if and when turbulent times arise.

An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee future results.
Originally published in The Truth About Money.

Dispelling the Myth of 10% Returns

As with many other myths, a simple fact led to misinformation.

10%? Some investors have that expectation — and they become upset when it doesn’t happen. That’s too bad, because the notion that a diversified portfolio will earn returns, on average, of 10% per year is a myth.

You’re not crazy if you think you’ve heard about 10% returns. Indeed you have heard that figure; it emanates from the performance of the S&P 500 stock index, a widely used market barometer that has, in fact, posted an average return of 10% per year since 1926, according to Ibbotson Associates. But that doesn’t mean you should expect your investment portfolio to generate that return, and here are three reasons.

First, while the S&P 500 has earned an average of 10% annually for almost 90 years, that’s only an average. In fact, it has never actually produced that return in any given year. If that’s befuddling, consider that the average U.S. household has 2.3 children — even though no individual household actually has that precise number.

Some have no kids or one, two, three or more, but nobody has exactly 2.3 kids — despite the fact that statistics say this is the average. Likewise, the S&P 500 has earned 8% and 12% in a given year. The index has been up 13% and down 13% during the past 90 years — but in no year did it ever grow exactly the 10% it has averaged.

Second, the S&P 500 represents only one specific sector of one specific asset class — the largest companies (that’s the sector) of the U.S. stock market (that’s the asset class). The 10% return the S&P 500 has earned on average since 1926 says nothing about any of the other asset classes that exist in the global financial marketplace or any of the many sectors within each of those asset classes.

Investments in the asset class of stocks may include exposure to such sectors as large companies, midsized companies and small companies. This asset class also contains the stocks of foreign countries, including both developed nations (those in Europe, for example) and developing nations (including those in South America and Africa).

And that’s just stocks. We haven’t even gotten to bonds, real estate, energy, precious metals, commodities or other financial markets. It’s worth noting that none of these other asset classes and market sectors has produced as high an average annual rate of return since 1926 as the S&P 500.

In other words, unless you’re going to own only the stocks of the S&P 500 in the exact proportion of the index itself, you can’t expect your portfolio to produce the same results as the index.

And third, like all indices, the S&P 500 is merely theoretical. It doesn’t actually exist. As regulators like to point out, you can’t buy an index. Instead, you can buy a mutual fund or an exchange-traded fund that mimics the index’s holdings. Such funds can give you returns comparable to the index — except for the fund’s fees. When you subtract them, guess what? You’re no longer earning an average of 10% per year.

So don’t be annoyed to discover that your portfolio isn’t earning the same return as the S&P 500 stock index. After all, it’s not designed to.

Keep this in mind if some slick salesperson — broker, financial advisor, insurance agent, bank rep or mutual fund marketer — claims that they’ll get you double-digit returns. If you encounter such a sales pitch, walk away,

An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee future results.


Buy or Lease Your Next Car?

We look at the eternal question: Is it better to buy or lease your next car?

It’d be easy to tell you to take the bus or keep your junker for another 140,000 miles, but that’s not realistic. Besides, you know all that stuff anyway. So, since you’re going to get a new car no matter what, let’s answer the question: Should you buy or lease that car?

Let’s take the example of a car whose sticker price is $34,000. To buy it, with a 7% four-year loan and a down payment of 20% ($6,800), your payment would be $650 a month. However, if you were to lease instead, you would pay a one-month refundable security deposit and your payment would be $450 a month. Thus, leasing would save you $200 a month, and you would need only $450 down, not $6,800 (plus, in both cases, sales tax). This is why leasing is so popular. And why the eternal question of “should I buy or lease” is not such a simple one.

Why Lease Payments Are So Cheap

Economically speaking, cars consist of three parts: equity (ownership), depreciation (loss in value over time), and interest expense (on the loan, if any). If you finance the purchase of a car, you pay for all three parts, and you will own the vehicle in, say, four years. But if you lease, you are paying only for use of the vehicle.

Therefore, you pay for the car’s depreciation and interest, not the equity, and you return the car at the end of the lease term. This is why monthly lease payments are lower than purchase payments. Leasing, quite simply, is the difference between owning a car and renting one.
Why would a car dealer want you to rent (i.e., lease)? It’s simple: If you lease the car, you pay $450 a month for four years. Then you give the car back, giving the dealer the chance to resell it. In other words, the dealer gets to sell the same car twice!

This means the dealer doesn’t have to charge you (the first buyer) the full $34,000; you pay only the difference between what the car is worth today ($34,000) and what it will be worth four years from now. The second buyer pays the rest at that time.

Say the dealer expects this $34,000 car to be worth $15,200 in four years. He would therefore want you to pay $18,800 and the second buyer to pay $15,200. Thus, your lease payments would be based on just $18,800, whereas your payments to buy would be based on the full $34,000. That’s why your monthly lease payments are $450 instead of $650. When the dealer resells the car in four years, he’ll get the other $15,200.

The Key Factor: Residual Value

Leasing, then, features lower monthly payments because dealers expect the car to retain a certain value. In reality, though, lease rates are not based on what the car’s residual value will be, but on what the dealer pretends it will be. That’s why lease payments often are so attractive. If, according to industry standards, a $40,000 car will be worth only $12,000 in four years, the dealer would have to base your lease on $28,000 worth of depreciation.

That would make the lease payment absurdly high, and no one would take the deal. So, the dealer pretends that the residual value will be $30,000, leading to lower, more attractive, lease payments. This game is dangerous for the dealer, but a bargain for you.

The key to the cost of leasing, then, is the “residual value,” or what the dealer says the car will be worth at the end of the lease. Expensive cars tend to offer better lease deals than cheaper cars, for they retain more of their value, and the higher the residual value, the lower your lease payments.

Three Money-Saving Tips When Leasing

As with most financial transactions, success or failure is found in the fine print. Here are three items to keep in mind:

Money-Saving Tip #1: Make Sure You Have Gap Insurance This is perhaps the single most important — and most overlooked — element of leasing. Say your contract says the car’s residual value at the end of the lease will be $15,200, but the car’s actual value will be only $10,000. If you wreck the car three months before your lease expires, guess how much your insurance company will pay in settlement?

The insurer will pay the dealer (who owns the car) the actual market value, which is $10,000. But your contract says the residual value is $15,200. That means you are responsible for the other $5,200. This “gap” between the lease contract’s stated residual value and the car’s actual value has caused many lessees to incur huge losses due to accidents. The solution: Make sure your lease contract includes “gap insurance” — even if you have to pay extra for it, for being without it is like driving without insurance.

Money-Saving Tip #2: Avoid the Cap Cost Reduction When someone buys a car, the more money he puts down, the less his monthly payments. Similarly, to lower your lease payments, you can make a cap cost reduction, which is a large, one-time payment made at the start of the lease. And as with a down payment, the more you pay in cap (short for capitalized) cost reductions, the lower your monthly payments. However, this is where the similarity ends.

Remember that when leasing, you do not own the car. Thus, if you make a cap cost reduction, you are making a down payment on property that is not yours. Never do that — no matter how much the dealer wants you to, and no matter how much it reduces your monthly payments — for in the long run, you are throwing your money away.

And the run might not be so long, either: Steve leased a $25,000 car and paid $3,000 in cap costs. Two months later, he totaled the car. Since he didn’t own the car, his insurer repaid the dealer $22,000; Steve lost his $3,000.
Paying cap costs is a waste even if you don’t wreck the car. Why? Because the only reason dealers want you to pay it is so they can offer you a monthly payment that sounds really low.

Would you visit a dealer who advertised a $20,000 car for just $199 a month? You bet! But would you get excited about having to pay $263 per month for the same car? Not likely. And that’s why dealers want you to pay a cap cost reduction.
You see, in one recent ad, a car dealer offered a $20,000 car for $199 per month for 24 months with a cap cost reduction of $1,525. But paying $199 per month with $1,525 down is the same as paying $263 per month with no cap cost reduction. If $263 doesn’t sound so hot (and it’s not), then the other deal isn’t so hot, either.

Instead of paying a cap cost reduction to lower your payments, ask the dealer to let you make additional security deposits. This will have the same effect as a cap cost reduction, except you’ll get the deposit back when you return the car.

Money-Saving Tip #3: Never Buy Optional Equipment in a Car You’re Not Buying When leasing, you must keep in mind that you don’t own the car. That means you must be careful when agreeing to options that the dealer offers you. Take Carmen for example. She worked out a fine deal on a car — $250 per month for 36 months, with no cap cost reduction. But then she decided to have the dealer install mats, fancier rims, an iPod adapter, and a navigation system. The cost of all these items came to $1,800, so the dealer added $50 to the monthly payment.

This not only made sense to Carmen, since $50 per month for 36 months is $1,800, she thought it was a heck of a deal — because although she would be paying for the options over three years, the dealer did not add in any interest. It was a deal all right — but for the dealer, not Carmen. When the lease expired three years later, Carmen returned the car — and with it, the mats, rims, iPod adapter, and navigation system. Carmen paid the full cost of owning those items, but she only rented them. Dumb move, Carmen.

What she should have done is incorporated the cost of the options into the overall price of the car, and then negotiated the lease price. That way, she’d be renting the options along with the rest of the car. Remember: When you lease, you are renting the car and everything in it. Don’t pay the costs of ownership when you lease.

Leasing and Taxes
When leasing, you are liable for sales tax even though you do not own the car. If your state levies a personal property tax, you’ll have to pay this, too. But to entice you to lease, many dealers offer to pay the property tax for you. Shop around for the best deal.

To Buy or Lease, That is the Question: Here Is the Answer

To determine whether you should buy or lease, answer these two simple questions:

1. How many miles do you drive per year?

In most leases, you are allowed to drive only 10,000 to 15,000 miles per year, 40,000 to 60,000 miles on a four-year lease. Anything more will cost you up to 25 cents per mile. As a result, unless you are among the relatively small number of people who drive fewer than 10,000 miles a year, it will be cheaper for you to negotiate a more expensive lease with a higher mileage limit than for you to pay 25 cents for every mile over the limit you drive. If you know you’ll drive significantly fewer miles than 10,000 to 15,000 per year, you can negotiate a lower lease payment.

2. How long do you generally keep your car?

Leasing is best for people who keep their cars for four years or less. Remember that when leasing, you never enjoy a payment-free month. At the end of the lease, you must turn in the car and get a new one, with a new lease or purchase contract.
Thus, if you like to keep cars for seven or eight years, you’ll find that, over the long run, leasing is much more expensive than buying.

Don’t Lease Beyond the Car’s Warranty
If you choose to lease, don’t lease for a term beyond the car’s warranty. If the car comes with a two-year bumper-to-bumper warranty, for example, get a two-year lease. By opting for a three-year lease, you could be stuck with huge repair bills in year three — on a car you don’t own!

Leasing for Business
Leasing makes great sense for business, regardless of how many miles you drive, because you are allowed to deduct the cost as a business expense. (If you buy a car for business, you must depreciate it instead.)

Since cars are one of the largest purchases you’ll make, talk with your financial advisor before you decide whether to buy or lease, how much to put down, and whether or not you should finance. The right decision can save you thousands!

Originally published in The Truth About Money.

Q&A: Passive Investing

Is passive investing in indexes creating “distortions” that can be exploited by active strategies?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Question: John Levin, CEO of hedge fund Levin Capital Strategies, challenged the passive approach to investing in a letter to the editor of The Wall Street Journal, stating, “The success of passive investing has created unusual opportunity because of the distortions that have developed with money flows into indexes and out of actively managed strategies.”

Further, he states, “I don’t believe the valuation discrepancies caused in part by passive investing are sustainable.” He ends with, “There will be a time when the fork gets stuck in index funds and the bubble bursts.”

Is Mr. Levin describing a possible flaw in your strategy of passive investing? Do you agree or disagree that passive investing in indexes is creating “distortions” that can be exploited by active strategies and is leading to a “bubble”? Do you think there’s merit to his argument?

Ric: I have a couple of comments. First, Mr. Levin runs a hedge fund, so he earns a living as an active manager and is therefore biased. (And if he’s like most hedge fund managers, he charges his clients 2 percent per year plus 20 percent of the profits!).

I am not aware of any data to support his contention that active managers outperform passive investing. In fact, all the data I’ve seen demonstrate just the opposite: Active managers have a horrible track record compared with passively managed funds. For example, according to the SPIVA Scorecard, 93.39 percent of large-cap stock funds underperformed the S&P 500 stock index for the three-year period ending Dec. 31, 2016. That’s a heckuva failure rate! So it’s hard to understand what the bubble is that he’s talking about, or why it might burst.

Second, he does have a point about index funds, but index funds are not to be confused with passive investing. Every year, index providers announce changes to their indices. They state the changes they are going to make and when they plan to make them. This gives investors an opportunity to buy or sell securities in advance of the changes. For example, if a stock ranked #41 is going to drop to #43, funds that mirror the index will sell shares. If a stock is to rise in the ranks, index funds will buy shares. You might try to exploit this news by trading ahead of the index funds.

I describe this in greater detail in my book The Lies About Money. Aside from this nuance, which is debatable regarding investor benefit, I don’t see what his fuss is about. (And if all he’s trying to do as a hedge fund manager is engage in such arbitrage, he’s dramatically overcharging for his services.)


Q&A: Investing in Load Funds

Ask the right questions to find the right answers.

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Question: I have about $250,000 in retirement savings from a previous job. I’m considering moving the money into a brokerage account, where I could buy a bunch of funds from one fund family to keep the load low, with low expense ratios, and rebalance them on a quarterly basis to maintain the right asset allocation. Or I could just put the funds into a managed account, where the expenses would be based on a certain percentage of assets on hand. In 20 years, wouldn’t I be better off with the first option?

Ric: It’s good that you’re asking that question before acting. The short answer is that you won’t necessarily be better off in 20 years because you’re limiting yourself to only two choices when, in fact, a third one is available.

The first choice you cited is investing in a mutual fund family that is called a load family — meaning it will have an up-front sales charge in addition to annual expenses. The second choice you mentioned is putting the money into a managed account, which will, of course, charge you for that service. The third option is that you could choose a series of no-load funds, in which case you wouldn’t have to worry about any up-front commission — called a sales charge or front-end load.

The only reason people sometimes say “I should put all my money in one single fund family” is that they’re trying to get a “break point” — a volume discount. Typically, the more you invest in a single fund family, the lower the front-end load. But why pay a load at all? I don’t understand why anybody in today’s investing environment would choose a load-fund organization, because whether you’re getting a discount or not, you’re still paying the load when so many no-load alternatives are available.

Also, the only way to get the lower load from a load-fund family is to put all your money into that family’s funds. But no fund family has the best funds in every category because of the many different asset classes — stocks, bonds, government securities, real estate, natural resources, precious metals, energy, foreign securities — the list goes on and on. Every fund family offers stock and bond funds in all these classes, but none has the best funds in every category.

So although you could reduce your frontend load by staying in one fund family, you could be stuck with subpar choices — they could be riskier, more expensive or lower in performance than alternatives. You could avoid that dilemma if you simply said, “I’m going with no-load funds, and now I can use as many different fund families as I want because none of them will charge me a load.”

Now compare that to the managed account idea. We’re talking apples and oranges here, because in a managed account you’ve got an emphasis on the word managed. If you buy funds from an advisor offering a managed account, you should get a wide variety of financial planning services beyond just the investments themselves.

That’s why I believe that you should choose the managed account, through an independent, fee-based advisor who provides you with advice for all your personal finance needs, not just your investments but also insurance, taxes, mortgages and home ownership, employee benefits, Social Security, college planning, estate planning, retirement planning and more. I would encourage you to consider this and compare it to your “load up on load funds” idea before you make a decision.


Auto Insurance Premiums Unexpectedly Going Up?

Check your accident record for errors.

Has your automobile insurance premium risen substantially even though you haven’t been in any accidents and haven’t received any tickets for driving infractions? The problem could be an error in your C.L.U.E. report. What’s that?

The database is called C.L.U.E. Auto by LexisNexis Risk Solutions. More than 95 percent of auto insurance carriers provide claims data to it — data such as policy information; names, birth dates and policy numbers; claim details, such as date and type of loss and amounts paid; and vehicle information.

There is also a field in your C.L.U.E. report called the fault indicator — where the insurer indicates who was at fault for a particular accident.
The accuracy of that indicator is critical, because when you apply for car insurance and perhaps even when your policy comes up for renewal, insurers will obtain a copy of your C.L.U.E. report. That report is a key factor in calculating your premium, said Mark Romano, director of insurance claims projects for the Consumer Federation of America.

That’s why you should periodically request a copy of your C.L.U.E. report from your insurance carrier or directly from LexisNexis Risk Solutions. Check all parts of it for accuracy — especially the fault indicator field. Also, make sure there is no claim information listed more than once and no claims that are unknown to you. If you find an error, request a correction in writing. Write both to your insurer and to LexisNexis Consumer Center, P.O. Box 105108, Atlanta, GA 30348-5108.

The Fair Credit Reporting Act requires LexisNexis Risk Solutions to then re investigate the matter and, if an error is confirmed, to delete the item from your file within 30 days from the date your letter was received.

Then follow up and obtain another copy of your C.L.U.E. report after the 30 days to ensure the changes were made. Keep a good record of your written requests, and if problems continue, contact your state’s department of insurance for assistance.


10 Things to Do Before You Retire

Here’s What to Do Now if Retirement Is on Your Horizon

1. Decide how you are going to spend your time. What are you going to do during the first six to 12 months in retirement, and what do you plan to do for the rest of your retired life?

2. Determine (realistically) how much money you will spend each month. Remember to include periodic expenditures such as gifts, vacations, taxes, an occasional new car, and emergencies.

3. Anticipate the cost of health care. You’ll have no employer to pay this for you; Medicare, MediGap, and private insurance are all up to you.

4. Buy long-term care insurance. Now.

5. Refinance your mortgage. Many people are shocked to discover that they either cannot borrow money after they retire, or they are forced to pay higher rates.

6. Boost your cash reserves. Make sure your rainy-day fund is enough to cover at least six months’ worth of expenses.

7. Evaluate your sources of income. You have already figured out what you’ll spend on a monthly basis. Now figure out where that money will come from.

8. Revise your investment strategy. The way you’ve handled your investments over the past 30 years is not how you should handle them for the next 30. While preparing for retirement, you were focused on asset accumulation. When you’re in retirement, you need to focus on income and on keeping pace with the increasing cost of living. Assets must be flexible and liquid, so you can meet needs you did not anticipate. New words will enter your vocabulary: rollovers and lump sums.

9. Review your estate plan. Review your will and trust. Don’t have them? Get them. These documents can protect you and your assets while you are alive and benefit your spouse and children when you pass on.

10. Perhaps the most important thing of all. If you are not excited about retiring, then don’t. Many people quickly become bored after retiring. It’s OK — even exciting — to return to school or the workplace. Many do this, often in completely new fields.