Financial Thanksgiving 2015

Thanksgiving is a time when we count our blessings. In addition to the big stuff, I like to use the opportunity to give thanks to the resources and organizations that improve our financial lives. The Financial Planning Coalition, a collaboration of the Certified Financial Planner Board of Standards (CFP Board), the Financial Planning Association (FPA), and the National Association of Personal Financial Advisors (NAPFA) has provided a strong and unified voice promoting the recognition and regulation of financial planners and increased investor protection. The big task that the Coalition has been trying to tackle is to educate policymakers and consumers about the importance of advice that is in the best interest of the client—the so-called fiduciary standard.

The coalition’s tireless efforts may soon pay off…next on my list of thanks goes to the United States Department of Labor, which is expected to finalize rules that would require financial advisors of all retirement accounts to put customers first. Although the industry has fought hard to thwart the initiative, most believe that it will survive. Its enactment would amount to the biggest changes to the Employee Retirement Income Security Act (ERISA) since that law was drafted more than 40 years ago.

Thanks too must go to technology, which has greatly enhanced the ability to better manage personal finances. Mint, You Need A Budget (YNAB) are among the many free apps that help you keep track of your money, while Acorns and Level Money help you budget and then find even the smallest dollars that you can save or invest.

And a tip of the hat goes to the innovators of financial technology, like the folks at Betterment, Wealthfront, Motif investing and MarketRiders, who have introduced a cost efficient way for investors to better allocate and manage their investments and retirement accounts.

There are also plenty of terrific tools available to help people with their financial lives. The EBRI Choose to Save Ballpark Estimate is an easy to use calculator to help quantify retirement savings needs, FinAid is the go-to site for students and their families to help understand the various ways to pay for college; and LifeHappens helps families understand their life and disability insurance needs.

I am often asked about which financial blogs that I use to augment the multitude of publications that I need to do my job. I am thankful for the terrific work of Bill McBride of the Calculated Risk blog. In addition to his wise insights about the housing market, Bill has a wonderful way of providing much need context to a world of economic numbers. I am also grateful for Barry Ritholtz’ “The Big Picture”, with its great mix of information, humor and a healthy dose of skepticism. Although a bit wonkier, I always learn from economics professors James D. Hamilton and Menzie Chinn, who are the brains behind Econbrowser and Mark Thoma of Economist’s View.

What would I do without economic resources, like the Federal Reserve Bank of St. Louis’s Reserve Bank FRED blog, with its nifty charting features; the Federal Reserve Bank of New York’s research on Household Credit; the Bureau of Labor Statistics’ historic databases; the Bureau of Economic Analysis’ interactive data; and the IRS’ rich web site? The people at these organizations have also been incredibly generous with me.

On the research front, the folks at Pew Research Center, the Center for Retirement Research at Boston College and the Georgetown Center on Education and the Workforce are producing some of the most interesting and useful publications, which help me in my job every day.

And finally, the greatest thanks goes to you—the readers, listeners and viewers, who take time out of your days to absorb my content and who generously provide commentary, both and good and bad. To quote Alice Walker, the words thank you “expresses extreme gratitude, humility, understanding.” On this Thanksgiving, thank you.

Retirement Confidence: On the Mend

After dropping to record lows between 2009 and 2013, the percentage of workers confident about having enough money for a comfortable retirement, continues to increase, according to the 2015 Employee Benefit Research Institute Retirement Confidence Survey. 22 percent of Americans are now very confident (up from 13 percent in 2013 and 18 percent in 2014), while 36 percent are somewhat confident. That’s the good news. Unfortunately, 24 percent are not at all confident (statistically unchanged from 2013 and 2014). EBRI notes that confidence is strongly related to whether or not people have retirement plans. Among those with a plan, the percentage of very confident doubled from 14 percent in 2013 to 28 percent in 2015.

The fact that 67 percent of all workers (or their spouses) – and 78 percent of full time workers – have saved for retirement is misleading, because total savings remain low. A staggering 57 percent say total value of savings and investments is less than $25,000, including 28 percent who have less than $1,000. As you would expect, retirement savings increase with household income and education.

Lack of education has become a big problem for Americans. According to research from the Hamilton Project, the median, inflation-adjusted earnings of men without a high school degree fell by 20 percent between 1990 and 2013 and for women, earnings fell by 12 percent. In contrast, both men and women with a bachelor’s degree saw their earnings rise between 1990 and 2013, by 7 and 16 percent respectively.

With median income dropping, it’s no wonder that half of the respondents to the EBRI survey said that cost of living and day-to-day expenses were the two main reasons that they are not saving (or saving more) for retirement. Even so, it is still amazing to learn that even those who are under pressure say that they could save $25 a week more than they are currently saving.

Instead of saving more, respondents are relying on a later retirement date. In 1991, just 11 percent of workers expected to retire about age 65. This year, the number has more than tripled to 36 percent. Working longer always sounds like a great solution, but what happens if your boss hasn’t bought into your plan, or you have a job that is too physically demanding to continue late in life? In fact, while 67 percent of workers say they plan to work for pay after they retire, just 23 percent of retirees report they have actually worked during retirement.

It should also be noted that while 63 percent of today’s retirees say that Social Security is a major source of income in their retirement, about half that number (31 percent) of current workers expect Social Security to be a major source of income in retirement. That result probably speaks to a misunderstanding of the current state of the Social Security system.

According to The 2014 Annual Report of the SS Board of Trustees, the trust funds' assets are now $2.76 trillion and should keep growing through 2019. After 2033, the annual revenue from taxes will still be enough to cover 75 percent of future costs, so while many say flippantly, “Social Security won’t be there for me,” the numbers say otherwise.

Finally, the EBRI survey found that most people do not like to step on the scale to see just how much work they need to do. Just 48 percent have tried to calculate how much money they will need in retirement. For the other 52 percent, EBRI’s Choose to Save Ballpark E$timate is a great resource to crunch numbers. You can even play with some of the variables to see the impact of working longer, saving more and living longer. Retirement confidence may be influenced by a variety of external factors, but it is clear that those who take action will likely feel a lot better.

Retirement Reboot: How to Calculate Your Number

The 2014 Employee Benefit Research Institute Retirement Confidence Survey is out and the news is mixed. After dropping to record lows between 2009 and 2013, the percentage of workers confident about having enough money for a comfortable retirement, increased in 2014. 18 percent are now very confident (up from 13 percent in 2013), while 37 percent are somewhat confident. 24 percent are not at all confident (statistically unchanged from 2013). As you might expect, the higher the household income, the more confidence increased. Nearly two-thirds of all workers (or their spouses) – and 79 percent of full time workers – have saved for retirement. But the total savings level varies dramatically. 36 percent say they have less than $1,000 (up from 28 percent in 2013) and 68 percent with household income of less than $35,000 a year have savings of less than $1,000.

Why don’t we save more? More than half of respondents say that there’s nothing left after paying for general cost of living and day-to-day expenses. Data bear out the conundrum: As noted in House of Debt, real income for the median U.S. family doubled from 1947 to 1980, when the rising tide of productivity lifted all boats. However, “while the United States is producing twice as much per hour of work today compared to 1980, a small part of the gain in real income has gone to the bottom half of the income distribution,” as the share of profits has risen faster than wages and the highest paid workers are getting a bigger share of the wages that go to labor.

The double whammy of disappearing pension funds and stagnant income has put many Americans behind the eight ball for retirement. The U.S. ranked a dismal 19th in the 2014 Natixis Global Retirement Index. As it turns out, despite having one of the highest per capita incomes in the world, U.S. income inequality and health expenditures are high compared to other countries. (Four Nordic countries, Finland, Sweden, Denmark and Norway are best performers, despite relatively high tax burdens.) You are allowed to spend two minutes lamenting the fact that you don’t live in a Nordic country, before getting to work.

The first step in your retirement planning process to is to determine where you stand today. Check out EBRI’s Choose to Save Ballpark E$timate or go to your retirement plan/401(k) website, where there is likely a retirement calculator. Many of these tools require you to estimate several factors. My crystal ball isn’t perfect, but here are some sensible estimates that should help:

• Inflation assumption: 4.5 percent (significantly higher than where we are today, but most economists believe that inflation is headed up in the coming years).
• Rate of investment return both before and after retirement: Consider your risk tolerance and err on the side of being conservative. If you’re stuck, use 4-6 percent. Obviously, if you use a higher rate of return, the calculator will ultimately determine that you have to save a smaller amount.
• Life Expectancy — if you are younger than 50, use 95; if you’re older than 50, use 90. If you want a closer estimate, go to http://www.livingto100.com and use their Life Expectancy Calculator, which takes into account your personal and family medical history.
• Retirement Income Need: Many calculators will take a percentage of your pre-retirement earnings (many use 80 percent) as a baseline for what you will need in the future — sometimes called a “replacement rate.” A more precise way to determine that number is to figure out how much you spend today, isolate those expenses that won’t occur in retirement (so for example: mortgage payments; tuition; child care; commuting expenses) and poof, you have your replacement rate. Assume that the money you were paying in FICA taxes will be necessary to pay some or all of higher health care costs in the future, so leave that amount in for your calculation.

After accounting for what you have saved thus far and what you plan to contribute in the future, the calculator will spit out your retirement savings goal. The number may seem absurdly large, but do the best you can right now and hopefully, as your financial conditions improve, you will be able to contribute more. The process may seem daunting, but I promise that you will feel better by doing something.

401(k) Fee-Asco

A Yale professor is providing a perfect follow up to this year’s PBS episode of Frontline called "The Retirement Gamble." That program detailed America's retirement crisis and the financial services industry’s feasting on high fees inside of many employer-sponsored plans. Professor Ian Ayres has recently completed an exhaustive analysis of company-sponsored 401 (k) plans and found that many charge excessive fees. But Ayres has taken the research to a new level by sending about 6,000 letters to companies, saying he would disseminate the results of his study next spring and would specifically identify and expose those companies with high-cost plans.

The concept of reeling in retirement plan fees gained a bit more momentum last year, when the Department of Labor put new rules into effect, which required 401 (k) sponsors to disclose fees and performance data to plan participants. The first round of the more detailed information was sent in November 2012 and, despite all of the media hype, those disclosures did not make much of an impact.

According to the EBRI 2013 Retirement Confidence Survey, about half (53 percent) of defined contribution plan participants reported having noticed these new disclosures, and only 14 percent of those who noticed (7 percent of all plan participants) said they made changes to their investments as a result.

This data gibes with findings from consulting firm LIMRA, which found that half of plan participants do not know how much they pay in plan fees and expenses. In fact, about a fifth of all participants think they pay nothing for their retirement plans.

To review, there are a bunch of fees that participants pay, including administrative, trustee and investment fees. The average plan costs about 1.5 percent, with larger company plans coming in at closer to 1 percent and small to medium sized ones sometimes costing in excess of 2 percent.

You may think that a half of a percent does not seem like a big difference, but that fraction could cost you hundreds of thousands of dollars over time. As a baseline, if you were to start with $100,000 and invest it over 50 years at a 7 percent return (compounded monthly) with no fees, you would end up with approximately $3.2 million.

If you apply the average plan fee of 1.5 percent, the future amount is more than halved to just over $1.5 million. But if you are in an expensive plan and the fee is 2 percent, your future value drops to $1.2 million at the end. That’s $300,000 that could be falling to your bottom line! 

What should you do if your retirement plan is more expensive than the average? One benefit to the disclosure rules is that plan participants can be empowered to effect change. The first step is to review the disclosure that was sent. If your plan costs more than the average of 1.5 percent, gather as many co-workers as possible and lobby your boss for a cheaper plan. It may surprise the boss to learn that he or she could find cheaper alternatives. But it is notoriously difficult for smaller companies to get the best plans. The reason is that the financial services industry likes scale. It takes a lot of money to provide all of the services necessary to operate a retirement plan, so financial companies like to land the big fish.

If you hit a brick wall on a new plan, then at the very least, try to have cheaper investment options added to the current plan. Index funds, which carry much lower fees, can make a big difference. I recently helped a radio caller navigate her 401 (k) plan investment options. By shifting from costlier actively managed funds to index funds, her cost of investing dropped from over 1 percent to just 0.25 percent.

It can feel burdensome to stay on top of all of these issues, but hopefully the long-term benefit outweighs the short-term work involved.

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