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Thin(k) About Your 401(k) Plan

Market Volatility Is A Reality

It is Thursday, June 24, 2021, and one of my favorite financial periodicals arrived in the mail today.  It is dated June 21, 2021, with a cover article exclaiming that last week was the worst week of the year for the DOW with the Index down 3.45% at 33,290.08.  The market seems a bit skittish to me with the pundits speculating on inflation and what the Fed might do to interest rates and when.  Volatility is real and it impacts the value of investors’ portfolios.  So, I do not take these swings lightly; but I do try to take them with perspective.

First, the DOW, while a very popular index watched by many, tracks 30 large, publicly owned blue-chip companies trading on the New York Stock Exchange and the Nasdaq Composite.  The S&P 500 which tracks the 500 largest corporations by market capitalization listed on the New York Stock Exchange or Nasdaq Composite is naturally more diversified and was down only 1.9% over the same period.  Here is a time where diversification worked to protect on the downside when the S&P 500 is compared to the DOW.  So, before you get excited or nervous, look at your portfolio to see if it looks more like the DOW or the S&P 500.

Second, the markets have periods of time where they are up or down dramatically.  We call them “corrections” and they are measured as declines of more than 10%.  In fact, the chart below illustrates very well what transpires when markets correct, which is a much bigger event than a down week.  As you can see, corrections happen fairly regularly and every year noted has a down period of time as noted as the “intra year decline.”

Now, below is a chart of the S&P 500 over roughly the same time period.  The trend is upward even though down periods occurred each year.

Back to the present. As I mentioned earlier, the periodical is dated June 21, so now it’s Thursday, five business days after the sell-off began.  The DOW just closed at 34,196.82 and is UP 2.72% for this one-week period (June 17-24).  Much is happening in the markets as we emerge from the pandemic with economies re-igniting around the world, albeit at different paces.  I fully expect volatility to remain in the markets.  However, this is good.  We are returning to normal and that means good things for the world economy and the markets over the long-term.

Just a reminder, that volatility can be positive too.  Let’s celebrate a week where the DOW was up 2.72%.

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Thin(k) About Your 401(k) Plan

Should Bitcoin Be Offered in My 401(k) Plan?

In my last post, I concluded that I do not think Bitcoin is appropriate for 401 (k) plans at this time.  Today, I will share some key risks associated with Bitcoin along with a few current, compelling arguments in favor of including it in portfolios, and my concluding thoughts on the matter.

Risks

First, Cryptoassets and Blockchain currently have several identified risks, and, in a world as nascent as Crypto, unidentified risks are sure to arise:

  • Technical issues to the Blockchain could allow security flaws.
  • Unidentified competitors could enter the market changing the landscape against current winners such as Bitcoin.
  • “Malicious Noneconomic Actors” could attempt to control a Blockchain network by amassing more computing power than the rest of the participants combined in what is known as a “51% attack.” This would cost incredible sums of money making it virtually uneconomic for anyone interested in profit.  However, a noneconomic player like a state entity could possibly pull this off.
  • Future regulation could emerge.
  • Translating and updating the ledger requires significant energy resources, something that concerns governments, especially China at present.

Arguments for Portfolio Inclusion

What does this have to do with a 401(k) plan and why would I want to buy Bitcoin in my retirement plan?  In a 401k Specialist article entitled “Does Bitcoin Belong In 401(k)s?”, John Sullivan recently interviewed Anthony Scaramucci and Brett S. Messing of SkyBridge Capital.  Those two made a seemingly compelling argument based on the three keys to Bitcoin’s performance.

Scaramucci and Messing believe that because Bitcoin offers high returns over time in exchange for its high relative volatility and because it is uncorrelated to most, if not all, traditional asset classes, there is a place for a small allocation to Bitcoin in a 401(k) portfolio.

The thinking goes that a bust from a small portion of a portfolio has little to no impact on the portfolio overall, but a massive long-term outperformance could move the needle on performance.  Messing points out that BlackRock recently “started to dabble” in Bitcoin apparently in their fixed income portfolios, presumably using a similar argument.

Other Problems

Ok, so investment professionals are making creative, compelling arguments in favor of including Bitcoin in a portfolio even in the 401(k) space.  However, plan sponsors and advisors are held to fiduciary standards of care when offering investment options in plan lineups.  Not to mention the current regulatory hurdles to offering Bitcoin to plan participants

A recent article in the The Wall Street Journal by Elaine Yu and Chong Koh Ping entitled, “China’s Latest Crackdown on Bitcoin, Other Cryptocurrencies Shakes Market” points out just how quickly fortunes can swing in Bitcoin especially when one of the key risks to its value comes into play.  Whether what is going on now is regulation by China or the precursor to a “51% attack”, all you need to do is look at this chart to understand how fragile Bitcoin’s value is.

Conclusion

At this point, I do not believe Bitcoin is an appropriate investment option for a 401(k) plan.  Even at 10+ years old, Bitcoin is a new asset, albeit one with an intriguing track record.  ERISA Law as well as regulation by the SEC regulate the 401(k) space.  I wonder if Bitcoin could withstand the necessary regulation that ERISA and the SEC would require to be able to be included in a 401(k) Plan lineup?  For now, as an advisor, I would not recommend it.  But, as they say, “never say never.

For disclosures, please click here.

 

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Thin(k) About Your 401(k) Plan

What Is Bitcoin and How Does It Work?

I have to admit, I may have been bitten by the Bitcoin bug.  To be clear, I have not invested in Bitcoin because I am unconvinced the words invest and Bitcoin should be used in the same sentence, yet.  However, my recent readings on the subject leave me intrigued.  For this and my next post, I want to examine Bitcoin as an asset class and whether or not it is appropriate for a 401(k) Plan.

First, anyone interested in learning about Bitcoin should read Matt Houghan’s and David Lawant’s Brief entitled: “Cryptoassets: The Guide to Bitcoin, Blockchain, and Cryptocurrency for Investment Professionals” published by The CFA Reasearch Foundation in 2021.  Although it’s 50 pages, I found it hard to put down and easy to understand.  A few key takeaways:

  • Bitcoin is a cryptoasset resulting from blockchain technology born from a decentralized, distributed database that is accessible to anyone. In essence the technology functions as a transaction ledger that anyone using it has access to review and verify its accuracy.  This network has incredible potential, including three current and readily identifiable possibilities that have only just begun to be developed:
    • Lightening fast transaction settlement with very low costs available 24/7.
    • The Bitcoin “mined” in the process of creating the Blockchain network acts as a new store of value often compared to gold based on its inherent scarcity. The maximum number of Bitcoin that will ever be created is limited to 21 million and the provenance of each is never in doubt.
    • The potential for digitally recording contracts and thereby creating “programmable money.”
  • Bitcoin and blockchain are just beginning, but if we compare them to the Internet in 1990, Houghan and Lawant make a startling statement

“The internet clearly represented a new way to distribute information and could have major consequences, but moving from that to predicting that people would, for example, regularly use smartphones to rent out a stranger’s house rather than staying in a hotel is a whole different matter.”

  • Bitcoin’s performance has been characterized by high returns, high volatility and low correlation with traditional assets.
    • Bitcoin’s high returns are easy to document. If one had invested $10,000 in Bitcoin on July 17, 2010, on September 30, 2020 that investment would be worth $2.2 billion.
    • As illustrated in the chart below, the value of Bitcoin is incredibly volatile even though its volatility has decreased since 2011.

    • Bitcoin’s historical returns have been very uncorrelated with the returns of all other major assets making Bitcoin appear to be an effective diversifying asset for a portfolio.

Pretty interesting and maybe enticing too? But as I said at the start, I’m still unconvinced Bitcoin is appropriate for 401(k) Plans. In my next post “Should Bitcoin Be Offered in My 401(k)?”, I’ll show you how many are now arguing for including Bitcoin in a 401(k) portfolio, and why I don’t think it appropriate, yet. Until then…

For disclosures, please click here.

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Thoughts in Charts: Retirement Ready vs Debt Free

This week’s chart illustrates why I encourage people to consider their retirement savings with the same weight as they consider aggressively paying off debt. The idea of living debt free is so catchy and liberating, but what if it’s costing you your financial freedom later in life?

The Forbes Advisor article, “Should You Pay Off Debt or Save For Retirement?” walks through a decision tree for how to prioritize your savings and debt decisions. It’s a great read, but I’d add one behavioral hack to your decision-making process: The Rule of 72.

One of the issues with deciding between paying down debt or saving for retirement is that you can’t predict the returns of the market. It’s pretty easy to calculate the interest that you owe over the life of the loan, but it’s hard to know what your investment will be worth later in life.

The Rule of 72 gives you a shortcut to help estimate how long it would take your investment today to double, given an assumed interest rate.

If you assume a rate of 5% then 72/5 = 14.4 years to double your money. If you assume 8%, then it would take 9 years to double your money.

Since you probably know how many years you have until retirement, the Rule of 72 can help you design an estimated range of probable values for your investment.

In the above example, if you have 48 years until retirement, a $10,000 investment given a fairly reasonable rate of return should have a value of between $40,000 to $160,000. In an extreme case, it could be as much as $2,560,000.

This type of table frames-up the impact of saving and gives you more information as you make your decision. If the loan interest you save by prepaying is far less than the gains suggested by the Rule of 72 table, it’s time to consider if “debt free” is really worth the cost.

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Thin(k) About Your 401(k) Plan: In-Plan Roth Conversion

The Small Business Jobs Act of 2010 modified by The American Taxpayer Relief Act of 2012 gave retirement plan sponsors the ability to offer in-plan Roth conversions.  Additionally, plans that don’t currently offer the provision can add the option.  An in-plan Roth conversion is a way to convert pre-tax savings to Roth savings.

Participants opting to do so must report the conversion amount as gross income on their tax return in the year of conversion and pay taxes due as a result.  The Roth money then grows tax deferred and can be distributed tax free as long as the participant leaves the converted money in the Roth account for five years and has reached the age of 59 ½.  This is a complex tax issue and anyone considering an in-plan Roth conversion should consult with their tax advisor.

Some of the reasons to consider an in-Plan Roth conversion are:

  • Expectation that tax rates will be the same or higher in the future
  • Taxes due can be paid from a source other than the retirement account
  • Desire to have a bucket of cash available tax free in retirement
  • Investing for the long-term, especially five-plus years to avoid penalty and taxes

If you expect your taxes to be lower in retirement, you don’t have cash available to pay taxes due at conversion or you will need access to the money in less than five years, this option may not be for you.

There are a few things to consider before you explore an in-plan Roth conversion.  First, does your plan offer the option or intend to in the future?  No need to consult your tax advisor if the answer is no.  Second, make sure you fully understand the requirements for the money to be distributed tax free (five-year holding period and age 59 ½) or you may subject yourself to a 10% penalty tax and taxes due for early withdrawal.

However, given the current chatter about higher taxes in the future, more and more savers are interested in exploring the in-plan Roth conversion option.  Vanguard provides a helpful table here, that explains in further detail the option.  ThirtyNorth Investments does not give tax advise.  You should consult your tax professional regarding in-plan Roth conversions.

For disclosures, please click here.

 

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Thin(k) About Your 401(k) Plan: What A Great Benefit!


It’s unsurprising that American workers love their retirement plans and don’t want them to change. The Investment Company Institute’s (ICI) recent research report, “American Views on Defined Contribution Plan Saving, 2020 confirms this fact in no uncertain terms. ICI has conducted this study for 13 years. Here are two key takeaways from the report.

First, American workers, who have a 401(k) plan or an IRA, like them and believe the accounts are instrumental in helping incentivize saving.

  • More than 90% of these workers agree that the plans simplified the saving process, helping them focus on the long term and
  • 86% agreed that the tax treatment was a big reason they were saving.  Almost all of these workers agreed that they should be able to choose and control their investments in the accounts. And
  • 83% felt like retirement accounts could help them meet retirement goals.

Second, there’s a lot of talk in the political arena about altering retirement benefits to generate tax revenue, and workers are paying close attention to this. They strongly oppose changes to the tax advantages, contribution limits and removing control of investment decisions that come with 401(k) plans and IRAs:

  • 87% of those saving via a 401(k) plan or IRA disagreed with the concept of the government taking away the tax advantage.
  • 89% disagreed with the idea of reducing contribution limits. And
  • 89% disagreed with the thought of giving away their ability to decide how to invest their money.

These results should clearly indicate to plan sponsors that they offer a benefit highly valued by their workers and that the workers gain financial security by receiving the benefit. The American retirement plan system is functioning well and workers do not want the benefit to change, especially when it is to their disadvantage. As my father used to say, “if it ain’t broke, don’t fix it.”

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Thin(k) About Your 401(k) Plan: ESG Investing in Your 401(k) Account

It’s no surprise that with the change of presidential administrations that we would see regulations changing. Late in the Trump Administration there were two regulations that particularly affected ESG (environmental, social and governance) investing. Many were concerned about these policy shifts, but as you’ll see, it appears that these rule changes have been put on hold at least temporarily if not permanently.

In October of last year, the Department of Labor (DOL) issued a final rule for private-sector retirement plans regarding non-pecuniary factors like ESG ,which limited these factors, stating that, “retirement plan fiduciaries are focused on the financial interests of plan participants and beneficiaries, rather than on other, non-pecuniary goals or policy objectives.”

That was big news, and it didn’t stop there.  Another policy was to limit ESG considerations in fiduciary proxy votes.  Plan Sponsors serve as fiduciary to the plan and in the selection of investment options must, therefore, take into consideration how the funds they select vote proxies.  401k Specialist reported $7.9 trillion invested in all employer based defined contribution plans, of which $5.9 trillion were invested in 401k plans.*  That is a lot of money under the watch of the DOL covered under ERISA Law.

The big news didn’t last long. On President Biden’s first day in office, he issued an executive order directing federal agencies to review existing regulations issued or adopted during the Trump administration “that are or may be inconsistent with, or present obstacles to, the policies” the new president set forth “to promote and protect public health and the environment.”+

Not long after the order, the DOL seemed to back away from its final rule from just a few months back. Here’s what it had to say about non-pecuniary factor consideration and proxy voting by fiduciaries: “Until the publication of further guidance, the department will not enforce either final rule or otherwise pursue enforcement actions against any plan fiduciary based on a failure to comply with those final rules.”+

So much for final rules. The possibility of adding ESG investment options to ERISA governed retirement plans without potentially violating fiduciary responsibility is back on the table.  Stay tuned.

 

*401k Specialist, 401k Assets Totaled $5.6 Trillion in First Quarter 2020, by John Sullivan, Editor-in-Chief, June 17, 2020.

+ ThinkAdvisor, DOL Won’t Enforce New Rules on ESG in Retirement Plans, by Bernice Napach, March 10, 2021.

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Three Key Risks of Retirement

Ready for Retirement?

As Boomers get older, we can expect that the number of retirees will grow each year.  After all, the oldest member of this generation is now 74 while the youngest is 56.  If we look at the statistics of Pew Research Center starting in 2012, the annual increase in the retired Baby Boomer population has run between 1.5 million to 2.5 million a year… until 2020.  The increase in 2020 was markedly higher at 3.2 million, for a total number of 28.6 million retired Boomers.

Some Boomers made a lifestyle choice in 2020, accelerating their retirement plans for personal reasons.  Others may have been furloughed, or lost their positions, and decided to not get back into the game.  For whatever reason, this choice is best made with preparation – emotionally and financially.

Let’s begin with our financial readiness, including the consideration of the risks during retirement. The Society of Actuaries identifies 160 retirement risks, but protecting against all of these is not possible.  Many are completely out of our control and not probable. Here are three significant financial risks, however, for which we can make plans:

  1. Longevity risk. This risk of outliving our money is a sobering one, especially considering the extension of our life expectancy.  Recent statistics are that for a 65-year old couple in relatively good health, there is a 50% chance that one in the couple will live to age 92, and a 25% chance that one in the couple will live to age 97.  Planning for 30 years of retirement is becoming the norm, and we should prepare ourselves accordingly.
  2. Market fluctuations.  If your life savings are invested in the stock and bond markets, you can expect to confront the uncertainty of market fluctuations.  Historically, 20%+ downturns in the stock market have been less frequent than people realize, but they do happen (remember March?) and create anxiety.  This is when an investment plan which dovetails with our personal needs and risk tolerance is critically important.
  3. Unexpected spending needs. It would be nice to know what negative surprise might present itself, and when it might happen, but that is not the nature of unexpected needs. What we can do, though, is model various scenarios for unexpected expenses and plan for addressing them. Stress-testing our plans also provides confidence that even an uncertain future can be handled.

Downside risks are a reality, but we can create peace of mind by addressing them. When we do, we are truly bringing together our money with the meaning it serves in our retirement lives.

Retirement planning can be an exciting process, filled with dreams of being liberated from a more structured schedule and envisioning more time to enjoy life, friends and family. Whatever our dream, planning financially and emotionally will help us enjoy it.

For disclosures, please click here.

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Thin(k) About Your 401(k) Plan: Reflections on 10 Years as An Advisor – Part 3

It’s probably not surprising that investment strategies are unique just like people. Each investment client is different in what motivates him or her to invest or how he or she feels about risk.  As a result, advisors use both science and art when working with each client to develop an investment strategy and construct a portfolio of diversified investments.

Based on my experience, I begin with two overarching goals for each client:

  1. Invest the client’s money in a globally diversified portfolio. The variety of different asset classes we consider include stock and stock like investments, bond and bond like investment, and real estate, among others.  Additionally, we consider growth and value stocks in companies of all sizes.  In the bond space, we look at bonds issued by governments, municipalities, corporations, and other issuers.
  2. Take the appropriate amount of risk for the client’s circumstances and goals. It is important for an advisor and client to have a full discussion to determine an appropriate risk level using both art and science in the process.

So how much risk is appropriate for each client?  First, there is a science to this decision that is driven primarily by the amount of time until the money will be needed.  For some this might be retirement while for another it might be to buy a house or pay for a wedding.  If there’s more time until the money is needed, the science side of investing says more risk may be appropriate.  Likewise we need to reduce the risk as we get closer to needing the money.

Stock investments generally are more volatile than bond investments.  So, we usually reduce the stock exposure as the date the money is needed approaches.

Second, there is also an art to determining the appropriate risk for a client to take.  This is the softer side of the decision.  How does the client feel about risk? Does he wake up at night worrying about the value of his account?  If so, we might recommend reducing the risk level.  Does she want to put the pedal to the metal and take as much risk as possible?  This could lead us to considering taking more risk than the science side would dictate.

As we craft a client’s investment strategy we continue to be mindful of bringing together money and meaning.  We can accomplish that when we know what each client’s ultimate goal is for his or her money.  That way, we can plot a course to reach that goal and help our clients create a globally diversified investment portfolio, take the appropriate amount of risk and adjust that risk lever as the need to use the money approaches. It’s about realizing that investment is both art and science.

Follow this link to see our core Investment Principles.

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Thin(k) About Your 401(k) Plan: SECURE Act – Treatment of Part-Time Employees

I know it seems a long time ago, but at the end of 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act.  The Act had a number of provisions, but I want to focus on the one aimed at part-time employees.  This change will require employers to permit employees who work 500 hours for three consecutive years to save using the company’s 401(k) Plan.  Employers are not required to match or make any contributions for these employees.  However, if an employer does match or contribute, relevant vesting schedules apply.

This requirement effectively begins in calendar year 2021.  Therefore 2024 would be the first year this group of employees would be allowed to contribute.  It also means that companies will have to track and monitor this employment status beginning in 2021, something heretofore likely not done.  As I type this in late October, I wonder how many companies are prepared to track this employee cohort starting in just a few months?

Let me know if I can help.

I found this article from Kiplinger very helpful: SECURE Act Basics: What Everyone Should Know

For disclosures, please click here.