Archives For August 2008

At least once a week I receive an article submission from a guy named Steven Selengut. Steven, a portfolio manager and author, runs Sanco Services, a portfolio management company. This week’s article is titled “Why 401(k) Retirement Plans Really Don’t Work,” which you can read in its entirety here. The author prefers pension plans to 401(k) plans. I have published the parts of the article below along with my thoughts.

The investments contained in a pension plan are designed to produce income, and are managed by trustees who are experienced in constructing safe, conservative, diversified programs that are just as boring as they can possibly be. Most pension plan benefits are calculated as a percentage of the amount earned while employed. The Social Security retirement/welfare plan is a tontinesque Ponzi scheme based on the government’s ability to continually abuse taxpayers. There are no investments at all, and no trustees… just IOUs.

I simply refuse to believe that people can’t manage their 401(k) plans themselves. It’s not that difficult. Employers should concentrate on bringing in unbiased educational services to help their employees learn about asset allocation and investment selection.

Defined benefit pension programs are rapidly becoming extinct— corporate America can no longer afford them, along with 50% of total Social Security contributions, employee health care, and CEOs who collect $50 million per year from their unwary shareholders. But those that have survived (notably, labor union plans, retirement annuity contracts, and the Congressional Pension System) produce monthly income checks without any problems whatsoever. And here we thought our congressional leaders were incompetent— not when it comes to their own benefit package + COLAs.

Here he hits the nail on the head: pension plans are too expensive! When companies provided pension plans for their employees, the norm was for an employee to retire at 65 and die within 5 to 10 years. Now days, that’s not the case and employers simply can’t afford to pay for a retiree’s 25 – 30 year retirement.

Still, the 401(k) plan deserves to be every bit as popular as it has become. It, and the vast array of complicated IRAs, could help save Social Security, improve the economy, and create jobs— all those good things that neither of the presidential candidates have a chance of achieving. Just two simple strokes of an Oval Office ballpoint get it done: 1) Eliminate all taxes of any kind, at any jurisdictional level, on any form of investment and/or retirement income. 2) Replace the failing Social Security system with a private pension system, funded by taxpayers only and managed by the existing insurance industry infrastructure.

I like both of his suggestions although I’m not exactly sure how they would work. For one, how does the government make up the shortfall in tax revenues if retirees no longer have to pay taxes? That’s a scary thought if the government’s not willing to make the necessary spending cuts.

I bet the insurance industry is salivating at the prospects of his second suggestion. I could go for a private pension or private fund as long as I get to choose where my money goes. I don’t see this one happening any time soon. Politicians are too scared to touch Social Security and AARP would scare the crap out of retirees.

How do we make the 401(k) plan provide more retirement security? That’s not so difficult either. Simply dictate that all plans require participants to invest at least 60% of their assets in individual (plain vanilla) income securities that can be withdrawn “in kind” at retirement.

NO, NO, NO! I HATE this idea! Instead, show people how different asset classes work and show them how to gravitate from one class to the other as they approach retirement. My wife and I have NOTHING invested in income securities at this time in our lives (we’re both under age 40) and requiring us to put 60% of our retirement assets in income securities would be ridiculous.

Finally, I’m tired of all this talk about how bad 401(k) plans are. Yes, there are bad aspects to them. They can be expensive and loaded with horrible funds, but all of this can be overcome with education. If managed properly, a 401(k) can be better than a pension plan with lots more flexibility.

In light of our discussion last week on the definitions of “rich” and “fair,” I thought I’d share this article by Bard Hem and L.M. Sixel that I read over the weekend in the Houston Chronicle:

For some it might be $100,000. Others might say it’s $1 million, $5 million or even $100 million.

Or maybe it’s simply having a happy family.

Never mind the back-and-forth squabbling between presidential candidates John McCain and Barack Obama over who owns what and how much, there doesn’t seem to be a magic number that universally defines “rich.”

I really like this quote (emphasis mine):

“It’s really in the eye of the beholder,” said Mike Kreach, chief investment officer at Houston-based Amegy Bank. “Basically, the less money you have, the less money you think you need to become rich. The more money you have, the more money you think you need.

That is so true. I remember when I was a kid, I felt ‘rich’ when I had a $10 bill in my pocket. Granted, I was a kid and didn’t know any better. I remember when my wife and I first got married, ‘rich’ to me meant a lot less money than it does now. Bottom line: wealth is relative.

Finally, think about this: An income $47,500 in the U.S. puts you in the top 1% globally.

Are You Better Off Now?

August 25, 2008

Apparently many Americans see themselves as better off now than they were seven years ago during the last economic downturn, according to an online poll administered by CNNMoney.

CNNMoney was so surprised by the positive reactions to their question that they are asking readers to talk back and share their stories.

Personally I am much better off now than I was in 2001. My savings and retirement contributions have increased dramatically, I’ve gotten several promotions and raises, and I’ve entered the real estate market – with fixed rate loans that I can afford even if I suffered a decrease in pay or short term lay off. I’m excited and optimistic about my future prospects, and I’m not really worried about the economy (most days at least). I have plenty of time to ride out any storms.

Some of the increase in my standard of living and financial status can be attributed to hard work and making financial success a priority. But I also am in my mid 20’s, so it doesn’t take as much to be “much better off” – seven years ago I was a college student working for $8 an hour with minimal retirement or liquid savings.

So what about you? Are you better off now than you were in 2001? And to what or whom to you attribute the change in your situation?

More from Meg at The World of Wealth

I need your help.

I would like to come up with a list of what you think is the absolute minimum that high school students should know about personal finance. Here’s a few things that I can think of off the top of my head (in no particular order):

1. An understanding of the time value of money and how compound interest works.

2. How to calculate the payment on a loan and what a loan amortization looks like.

3. What goes into a good credit score.

4. How to use and manage credit cards (and STAY OUT OF TROUBLE!).

5. How to set up a budget.

6. How to calculate net worth and put together a net worth statement.

7. How to measure your financial progress using various ratios.

8. The difference between active and passive investing.

9. What a 401(k) is and how to use one.

10. The difference between a Traditional and Roth IRA.

11. How to set goals and measure them properly.

12. The basics of asset allocation.

13. The costs/benefits of a college degree.

14. The importance of living within your means.

15. The best time of year to buy certain things (meaning, how to take advantage of end-of-season sales).

16. How to balance a checkbook.

17. How interest is charged on a credit card.

18. The purpose of insurance.

19. How little decisions can have big consequences (another time value of money example). The real cost of that latte.

20. How to research the job market.

21. The importance of networking.

22. The importance of that summer job.

Okay, those are some of the important points I can think of. If you have any to add, please leave a comment and I’ll add them to this list.

SPECIAL NOTE: If you’re a blogger and you have written a post about any of the above topics and would like me to link to your post, please send me a link via EMAIL (JLP – at – AllFinancialMatters – dot – com) and I’ll add it to the list. Please realize that I reserve the right to choose whether or not to use your link.

From Liz Pulliam Weston:

We personal-finance types constantly nag readers about spending too much and saving too little.

But what would happen if everybody suddenly took our advice? What if every household in America:

• Paid off credit cards in full every month and carried no high-rate debt?

• Had an emergency fund equal to at least three months’ worth of expenses?

• Saved at least 10% of earnings for retirement?

• Paid off cars before trading them in?

• Bought only as much house as it could afford?

Read the rest here.

I have often wondered this myself.

I found this quote from the article interesting:

“Right now, you want people to be spending, not cutting back,” said economist Jared Bernstein, director of the living standards program for the Economic Policy Institute and author of the book “Crunch: Why Do I Feel So Squeezed? (And Other Unsolved Economic Mysteries).”

My question is: who’s supposed to be doing this spending? Lots of people simply can’t spend any more money.

Imagine the effect of everyone saving 10% of their income. I have a hard time wrapping my brain around this one. On the one hand, I would think it would be good for the stock market. On the other hand, that money has to come from somewhere, which means someone would be hurting. Most likely it would be the retail sector.

If everyone paid off their cars before trading them in, there would be a lot less used inventory for the frugal buyers to choose from (especially those who like to buy 2-year old used cars).

Liz’s article is an interesting read.

Another reading assignment: The Next Credit Crunch (read it, it’s very interesting). The next bubble according to Geoff Colvin will be a standard-of-living bubble due to a credit card crunch.

…a big crunch is coming – and here’s why. Credit card debt, like mortgage debt, gets bundled, securitized, and sold off by banks. Citigroup, one of America’s largest credit card lenders, just reported that it lost $176 million in the second quarter through securitizing such debt. That happens when the buyers of those securities observe rising delinquency rates and rising interest rates, and decide the debt is worth less than Citi thought. More generally, the amount of credit card debt that is securitized nationwide has plunged by more than half in the past five months because it’s getting riskier. That means credit card issuers will be charging customers higher interest rates, and since the banks can’t offload as much of the debt as before, they’ll have less money to lend to cardholders.

Okay, I’m no market expert or economist, but here’s how I see this playing out:

1. Lots of retailers are going to go under. How many? I have no idea. But, I will say that those that are currently struggling are most likely going to be toast.

2. Lots of restaurants are going to follow the path of the defunct retailers. There’s too much competition and margins are being squeezed by higher costs. Couple that with customers cutting back on their budgets and not having access to credit cards and you have a messy situation.

3. Just about anything beyond necessity is going to be at risk.

I wonder if the government has a credit card bailout in mind?

Last weekend, during our trip to San Antonio, my wife and I took a short drive up to San Marcos to check out their massive outlet mall. It is unbelievable how big their outlet center is. To top it off, last weekend was our tax-free back-to-school shopping weekend so LOTS of people were out shopping.

We had to drive all the way to the end of the mall in order to find a parking spot. The section of the mall where we parked was mostly higher-end stores that we weren’t famliar with. So, we decided to start with Neiman Marcus Last Call. We walked in and started looking around. My wife decided to check out the shoe department. She walked over and picked up a pair of sandals (basically, high heels with two small leather straps). The original price was something like $264 and Last Call had them marked down to $164. My wife said something like, “I would NEVER pay that much for something like that.” I agreed but didn’t say anything.

We continued to look around and saw a bunch of nice clothes but they were still out of our normal price range, which is relatively modest. After a while we decided to leave. As we were leaving, I told my wife, “This is why we have money.”

It’s true.

No, we aren’t rich but we are comfortable and it feels nice. There was a time not too long ago when our budget was tight. It’s not that way now and I like it!

We have never been the type of people to spend lots of money on clothes and stuff. We usually shop sales or just buy cheaper clothing. Now, it does help that my wife is an engineer and therefore typically wears company-provided clothing (Nomex). Not everyone has that “luxury.” I understand that. But, for us, it has been a blessing because my wife doesn’t have to spend a lot of money on office-type apparel.

Don’t get me wrong. We do like nice things. We spent a small fortune doing our kitchen/family room renovation last year and probably spent more money than we should have. In other words, we aren’t always cheap. But, it has been our relatively frugal day-to-day activities that have allowed us to spend more money on things like our renovation. That, coupled with our refusal to upgrade our lifestyle with every raise, are the main reasons we are in the best financial shape we have ever been in.

Oh, and in case you’re wondering—we did end up buying some stuff so we do have less money than we had before we visited the outlet mall. LOL!