George Cones, JD's Answers and Guides

Matilda,

There are much better options for smaller plans than there were just a few years ago.

I would suggest you look for a fee-only advisor, who can hopefully show you how to build a plan using "unbundled" service providers. That means, the record keeper is separate from the custodian, and the advisor is separate from them both.

Depending on the assets in the plan, you may find that you can have a plan with significant number of choices, using a combination of index ETF's and/or best-in-class active managers.

Juanita,

You may find it difficult to go to the "big guys" because they require a pretty sizable asset base to take you on. There are Third Party Administrators (commonly referred to as TPAs that may be your best bet). Many of these TPAs work with Advisors, like the those you find on the Brightscope website. Try to find an Advisor that is fee only, and will accept fiduciary status as a ERISA Section 3(38) fiduciary or at the very least a Section 3(21)(A) fiduciary.

Good question. This is not legal advice, so if you have legal questions seek out an ERISA attorney.

To begin to understand plan costs and service quality, you should begin here on BrightScope. Look at a few plans, enter your plans information, and see how you stack up.

You can find a great study which focuses on “all in” plan cost at the following website:

        http://www.idc.org/pdf/rpt_09_dc_401k_fee_study.pdf

In addition, James P. Dowd, CFA, who is contributor to this site has offered a benchmark study to other questioners, which I am sure he would provide if you get in touch with him.

Sandy, from you question, I assume you are a trustee or administrator of a 401(k) plan or 403(b) plan.

In order to learn how to protect yourself in your role as a fiduciary , it it is important to understand that there are different types of fiduciaries under ERISA. There are Administrators and Trustees Section 402(a)(2) fiduciaries, Section 3(38) Investment Advisor Fiduciaries, and Section 3(21)(A) functional fiduciaries, such as a person or entity that:

  –  has discretion or control over plan assets
  – renders investment advice for a fee
  – has discretion over plan administration

Please seek to establish in writing what the service provider’s fiduciary responsibilities are.

Under the new 408(b)(2) regulations you will have a duty to ferret out all of the costs and potential conflicts of interest. The final regulations create potential liability for Covered Services Providers (CSPs) and Responsible Plan Fiduciaries (RPFs).

These regulations were implemented because many participants and plan sponsors (employers) have no idea how much they are paying for services.

There are several layers of fees on relating to the investments, such as:

•   Sub TA Fees (sub transfer agent fees)
 •  12(b)(1) Fees
 •  Load Fees (Front-end and Back-End)
 •  Expense Ratios:  Mutual Fund and Exchange Traded Fund (ETF) Internal Management Expenses 
 •  Redemption Fees
 •  Exchange Fees
 •  Account Fees
 •  Soft-Dollars – 28(e) Safe-Harbor
 •  Unitized Variable Annuity Wrap Fees

Some of these fees are easier to find than others.

One place to begin is to look at the share classes in the plan. Get the prospectus for each plan choice. There you will find the various share classes. If you are using the institutional share class, great, if not see what the difference in costs is and ask questions, about load fees, contingent deferred sales charges, redemption fees, 12(b)(1) fees and Sub-TA fees.

A more detailed discussion of share classes can be found om my BrightScope page at:

http://www.brightscope.com/financial-planning/advice/guide/2768/How-Different-Mutual-Fund-Share-Classes-Affect-Your-Retirment-Plan-Or-Investment-Portfolio/

Another level of fees, relating to investments are custodial fees, transaction fees, and any number of account fees. You may have to ask a lot of questions to understand the fees and expenses. Remember you are the client, and they have a duty to provide you with the information.

It would be wise to document any attempt to get information from your service providers and their responses to your requests, since you may be held accountable for their failure to provide the information later.

Many bonds have credit risk, like the bonds of corporations and some countries, like Greece. Almost all bonds have some interest rate risk. A useful took in evaluating interest rate risk is duration.

Since US Treasuries have a limited threat of default (or so we thought until last year), changes in interest rates are the biggest risk for US Government bonds. We will limit our discussion to Government bonds here.

How are bonds impacted by rising interest rates? Here is a simple example of why interest rates are important. Let's say an investor, we will call him Joe Smith, holds of a bond with a yield of 2.5%. Every year his $1,000 bond pays $25 in interest. If Joe holds this bond until it matures, we know he will make 2.5% per year on the bond.

But Joe needs to sell the bond. Since Joe bought the bond, interest rates have risen to 3.5% an otherwise identical bond. Joe has to sell his bond, but a prospective buyer can buy a similar bond that will pay him $35 per year in interest, instead of $25. Joe is a nice guy, but why a buyer purchase Joe’s bond that pays 1% less interest per year? He or she wouldn't. If Joe Smith wants to sell his 2.5% bond, he will have to discount the bond. That means he will have to reduce the price so the prospective buyer will get the 3.5% yield.

To help understand the risk in a bond or a portfolio of bonds (like a bond mutual fund) there is a helpful tool, duration. Duration is a common measure of interest rate risk in bonds. While it may be helpful to understand the theory of duration, it’s more important to understand how to use the duration information. The fact sheet or prospectuses for most bond mutual funds or ETFs will have the duration prominently listed.

With this duration number we can get some idea of how a portfolio may behave in different interest rate environments. A bond portfolio of long maturity US Treasury bonds may have a duration of 10, 11 or higher. The higher the number the more the risk (a 30 year zero coupon bond has a duration of 30). How does duration help us understand the sensitivity to interest rates?

There is a rule of thumb that helps us apply the concept of duration to understand rising interest rate's affect on a bond or portfolio of bonds. This rule of thumb provides that if interest rates go up or down by X% … one only needs to multiply the change in interest rates by the duration of the bond or portfolio of bonds to see how the market value of the portfolio will change.

For example if interest rates go up 1% and a bond or bond fund has a duration of 6, the value of the bond portfolio should go down by about 6% (1% multiplied by the duration of 6). So using our rule of thumb, a 1% increase in rates should cause the portfolios of US Treasury bonds with a duration of 10, 11 or higher to go down 10%, 11%, or more. For that 30 year zero coupon bond, the 1% interest rate rise could cause its market value to decline by 30%.

Bond mutual funds could be more risky than individual bonds, because of panic selling by some holders, which could lead to realized losses for all holders.

Monique,

There are many tools available to help you calculate your retirement needs and savings expectations, but some of these tools can get very complicated. The first place to look may be on your 401(k) plan website. There may be a “gap analysis” tool there (a web-based program that helps you figure out what your retirement and retirement savings need are likely to be versus what you are saving, as well as how changes in your savings will affect your retirement savings). You may find similar tools on websites like Morningstar. You are trying to build a nest egg that you can live on until you reach your life expectancy, which for a woman your age is about 85 years (look at the life expectancy tables on the Social Security website). Often assumed requirement needs are based on a percentage of income, like 80% of income at retirement.

Many of these programs ask your age, your income, how long you have until retirement, your assets, your life insurance, etc.

Since 1926, on an annualized basis: US large cap stocks have returned 9.8%, US small stocks returned 11.9%, World Stock Markets X US returned 7.9%, Long-Term Government Bonds returned, 5.7%, and 30 Day Treasury Bills (cash) returned 3.6%.

A useful rule of thumb to calculate how quickly an investment or portfolio will grow is the “rule of 72”, simply divide the expected return of an investment into 72, to determine how many years it would take for the investment to double.

For example, if we use the historical expected return of small cap stocks, 11.9%, using the rule of 72 (return into 72) our portfolio should double in 6 years, and again in another six years, and so forth. If we put all or part of our investment in large cap US stocks (like the S&P 500 or the Russell 1000), using the historical expected return of 9.8%, and the rule of 72 this portion of our portfolio should double in 7.35 years (72/9.8%). Following this same logic, If we invested all or a portion of our portfolio in 30 day t-bills with a return of 3.6% it would take 20 years to double the investment.

You have to understand that while we may expect long-term returns to approximate historical returns, there may be a lot of downside risk in the short run. For the 5 years ending in December 2011, small stocks returned -0.5%, large cap stocks returned -0.2%, World X US stock markets returned -3.6%.

If you were looking at your statement 5 years after you made a commitment to stocks and saw these negative returns, what would you do? Unfortunately, many investors would do the absolute worst thing, change their allocations. If you look the 10 year and 20 year numbers for these same areas of the market you will see they all did much better over the longer-term. For a person like you, who has 20 to 30 years to retire, a diversified portfolio of stocks weighted 60-70% stocks, a diversified portfolio of bonds, and some cash should provide a competitive return, while dampening downside risk somewhat. Don't panic, understand the ride could be bumpy.

As young as you are, you are able to withstand market swings, so a broadly diversified portfolio with 60-70% exposure to large cap stocks, small cap stocks, and international stocks, should give you the most bang for your buck long-term. Of course as you move closer to retirement (say within seven to ten years), your should consider adjusting your allocation reduce exposure to downside risk, and include more income producing assets in your portfolio.

Whoa, that is a good question. The ratings services, when they are being sued, say their ratings mean nothing. Based on the many of the products with AAA ratings that crashed and burned over the last several years, one might tend to agree with that assessment. The point is Caveat Emptor, let the buyer beware.

AAA rated bonds can be rated downward and lower credit quality bonds can be upgraded, so these rating regimes must not be seen as definitive. There are skilled active bond fund managers that do their own credit research, in whom we would have much more confidence. If you want to invest in bonds without an actively managed fund, bond index funds or bond index ETFs are a great choice. If you invest in a corporate bond index(s), you will be the proud owner of hundreds or thousands of securities. If one bond bites the dust, then another might get upgraded, so you have less to worry about.

Remember there are other risks in bonds (especially longer duration bonds), so become familiar with those risks as well.

Viki, There are several possibilities in this scenario. Consider seeing an attorney and/or a tax advisor soon. Before you meet with them, be sure you get the following documents.

-the will if there is one,

-the Plan Summary Description for the 401(k) plan as well as any documentation the 401(k) plan administrator will provide (including the documents which list the beneficiaries for the 401(k).

-get many certified copies of the death certificate, you will find you need these every time you turn around,

-divorce decrees or other papers that would effect inheritance rights,

An attorney can help secure the "Letters Testamentary" or "Letters of Administration" which may be required depending on the complexity of your brother's estate and the laws of your state. Your brother likely had a beneficiary for his 401(k). If the beneficiary is his wife she could roll it into a spousal IRA or Beneficiary IRA. If the beneficiary is someone else or his wife and someone else, than they could roll out their portions into Spousal and/or Beneficiary IRAs. Please consult a tax advisor prior to making any decisions concerning the distribution of the property, as a misstep could cost the beneficiaries unnecessarily.

Dear Jean,

I just wanted to add to the other good answers here. If your question involves a dispute or issue that has arisen, please consult an attorney.

In response to your question, fiduciaries have a higher standard of care than non-fiduciaries, and must avoid the appearance of conflicts of interest. ERISA sets out specific duties and prohibitions, but many of the fiduciary duties spelled out in ERISA apply in the non-ERISA context as well. Whether a broker or Registered Investment Advisor (RIA), it’s hard to go wrong if one acts solely in the interest of the client, but brokers have more leeway in that regard.

In practical terms, a big difference is liability. What may be a clear breach of fiduciary duty for the RIA, may not be actionable against a broker since they operate under a different standard of care.

As mentioned in the other answers an RIA, since his or her compensation is not based on commission, loads, and 12(b)(1) fees, may be less inclined to make decisions based on self-interest. More importantly, If one can show that the RIA acted in their self-interest, to the detriment of his or her client, there are likely grounds for redress, that may not be available against a broker.

Kurt,

I can't speak to the specifics or the quality of what your advisor is recommending, but depending on the assets under management, that may be entirely reasonable. Most institutional investors break down investments managers by market segment, for example: large-cap (capitalization) value, large-cap core, large-cap growth, mid-cap -value, core, growth, small-cap -value core growth, international developed markets, international emerging markets, Intl REITS, US REITS, and many more categories (we have even started on bonds). You may ask why I mention institutional investors, but investing like a pension fund pays dividends in the long run. If you have a strategic asset allocation and rebalance to that allocation, you are likely to do well.

Look at the class of the mutual funds, and understand the cost involved. One can get very good market diversification by using index ETFs. Cost matters.