George Cones, JD's Answers and Guides

Lionel, The following is a basic approach that may work for you. Remember one of the best means of reducing risk is investing in a broad range of asset classes in diversified portfolios.

1. You should have 3-5 years of cash flow needs in CD's, money market funds and short-term bonds, which will provide protection in the event of interest rates rises, with some extra pad for extraordinary expenses. This portion of the portfolio should provide 3-5% returns over the long-term (emphasis on long-term). This cash flow on which you live could come from social security, pension benefits, taxable assets, and your 401(k) plan.

2. You could invest the remainder of your portfolio in a very diversifed stock/bond portfolio. The portion of the portfolio should be diversified across all areas of the stock and bond markets. A good approach is investing in Index ETFs, index mutual funds, and/or low-cost, diversified, actively managed mutual funds.

3. Another way to increases cash flow is to be sure that capital gains and other income is paid to you in cash, not reinvested in the mutual funds. You can either use the cash to meet you expenses or reinvest the cash in the areas of the market where you see bargains.

The short-term portion of your portfolio should provide a less risky base or foundation. If you have 3-5 years of cash flow available, you should have time to ride out market ups and downs in your stock/bond portfolio, while increasing your long-term returns.

Edward,

Don't thow out the baby with the bathwater yet. There is a fair amoutn of complexity to these arrangements. Without more information about your situation, it is difficult to comment on your fund lineup or costs. Fidelity may be providing custody and/or the front-end (what you log into). From what we have seen, Fidelity's user interface is pretty good. Actually Fidelity has some very good, low-cost products, both actively managed mutual funds and index funds. Even when Fidelity is providing the most of the services, there can be other outside managers and funds on the platform.

You may want to learn more about the particulars, and the alternatives, before you discuss the issues with the powers that be. Real knowlege and understanding will give you a stronger position. Knowlege is strenght.

After you have done your homework, you may find that the situation is truely bad. You should begin by getting a copy of your plan summary description. On this site you will find how to ask your plan adminstrator to provide you with the information necessary to make a carefull assessment of your plan. Then you can use the information to see how your plan compares to similar plans.

You will find a factsheet on the new DOL 408(b)2 regulations athttp://www.dol.gov/ebsa/newsroom/fs408b2finalreg.html

What is clear Wesely, is that there can be a cost to market timing. According to Morningstar, an investor in large capitalizion stocks, like the S&P 500 or the Russell 1000, from 1992 to 2001(5,042 days) would have made a near 9% return. If that investor missed the 10 best days the return would have been about 4%. To carry the exaple further, if the investor would have missed the 20 best days, 30 best days, 40 best days, or 50 best days, the investor's return would have been 1.7%, -0.4%, -2.3%, -4.0%.*

Many of the missed days could have been during the period in question. This is a very good argument for staying fully invested, depending on your overall investment horizon.

There are all sorts of market observations that are usually true, until they are not.

*Source Morningstar 2012 Andex Chart.

I just want to add a bit to James's answer. Many times, plan participants answer a questionare. One of the areas addressed is the psychological aspect of risk. Your Investment Advisor may have you answer a questionnaire to help establish your risk profile. You will be asked question about your age, how long you have until retirement, your assets, your life insurance, etc. You are often asked questions like, “If your portfolio dropped 20%, would you consider changing your allocation?” These questions are attempting to get at how you can handle downside movements (usually paper losses) in your portfolio.

Did you know that since 1926, on an annualized basis: US large cap stocks 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%.

Where would you place your money to get the most return? US small capitalization stocks, right? Remember there are two sides to risk, upside and downside. 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. But since we live in the real world, we 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 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.

Of course as you move closer to retirement, your should consider adjusting your allocation.

Jim,

No one can be sure if Facebook will be the next Microsoft or Novell. There is one thing for certain, there is a lot more risk in individual securities, than in a diversified basket of securities like the S&P 500 (large cap stocks), or the Russell 2000 (small cap stocks). It will likely take Facebook a long time to get to a price that is reasonable based on any metric.

Prudent investors, like most institutions, diversify their holding to minimize downside volatility. Based on historical data, you should expect to make something like 9-12% year-on-year returns on a diversified stock portfolio over a long period (measured in decades). At 10% an investment should double every 7 years using the rule of 72 (return divided by 72). This would be a great return.

Now that the prudence discussion is out of the way, if you feel like gambling, if you don’t mind losing money, you may want to buy Facebook on a downbeat of say 10% or more.

Ben,

Santa Barbara is a beautiful place. Wherever you are buying, to answer the question about whether this is a good time to buy, first, look at the comparables over the last several years to see how the pricing has behaved. As far as interest rates, this is a great time to buy, and if there can be significant tax benefits depending on your income. So the low interest rates could be enhanced by the tax benefits you might receive. While there has been some discussion of changing the mortgage interest deduction, if that happens, 2nd and 3rd homes mortgage deductions would likely be eliminated first.

Toni,

Questions to ask, better in writing:

What are the internal expenses for the investments? What is his or her commission? When can I get out of the product?

This last question is very important. You may find that you can not get out of the product for some number of years (5, 7, 10, 12). There is often a contingent deferred sales charge if you get out prior to the date spelled out in the contract or fund prospectus.

The up-front commission could be 5%-over 10%. You are correct in assuming nothing is free, but rather the costs are hidden in the contract or prospectus.

Jory,

Unfortunately, the cost of investment choices do not necessarily correlate with performance. Many advisors that are long in the tooth might argue the opposite is usually true. The asset allocation often the more important factor. Depending on your assets, you may want to consider a SEP IRA, which could be less costly and more flexible for your company and allow a wider array of investment choices including ETFs. Once you grow the company, you could move to a 401(k) plan. Try to find a fee only advisor that will sign on as a fiduciary regardless of your choice. There are new plan designs that can get your internal management fees and administrative costs down significantly. Spend some time researching your options.

Gerrit, Edward Smith's advice is very solid. There are many other good comments here. Permit me to throw my two cents in as well.

If one looks at the most common form of dollar cost averaging, monthly contributions to a 401(k) plan, you will see that the markets are up one month and down the next month, then flat the next. Over the longer term these peaks and valleys “average out”.

When one is investing a without the constraints of a 401(k) plan, dollar cost averaging still makes sense. The trick is to be disciplined enough to stick to the plan. In investing, human nature can get the best of us. For example, we see an area of the market or a mutual fund that has done very well over the last year, and we want to jump in with both feet. Or, we see an area of the market that has done poorly so we don’t want to put our money there. The truth is we don’t know which area of the market or mutual fund is going to have the best performance this year or next year. The poor performer is at least just as likely to be the hot ticket next year as not, and today’s darling may be tomorrow’s dog.

There are numerous studies that show institutional investors, such as pension funds, fare better than individual investors. We believe that much of the difference in performance can be attributed to the fact that institutions tend to have long-term strategic asset allocations and have a more disciplined approach to investing.

We believe there are ways to reduce risk and enhance return by using a more dynamic dollar cost averaging process, but that requires ones eye to be on the markets on a day-by-day minute-by-minute basis. For example, a pension fund may commit to allocating $40 million to an S&P 500 index fund. They could decide to invest in four tranches over a one year period, a $10 million investment each quarter. They may accelerate a tranche if the S&P falls 10%, and accelerate the second payment if the S&P falls another 10%, and so forth. They are committed to being invested in the S&P 500 over the long-term, and understand that they are getting it cheaper when it is down. Not to confuse the matter, but this is a viable approach for a pension fund, advisor, or an active investor, and demonstrates the discipline necessary to stick to ones guns when the markets are choppy, and the pundits are predicting doom.

Rebalancing goes hand-in-hand with dollar cost averaging. Many investors ride an asset to the top and back down again, rather than rebalancing.

Dollar cost averaging and rebalancing the portfolio (to a strategic asset allocation) are ways to capture gains and reduce risk, these approaches lead to realizing gains and getting into relatively cheap areas of the market.

Catherine,

We don't know much about your company. If you have a small number of employees, it may be best (and importantly more cost efficient) to set up a SEP-IRA. These plans can be set up by an advisor and they are relatively simple to administer, and your investment choices may be wider. When you garner sufficient assets, you could set up a 401(k) plan. There are a lot of legal requirements for 401(k) plans, so do your homework.

A good resource for you as a business owner can be found at http://www.ici.org/research . If you work with a fee based advisor (someone who is only paid by the client, and receives no remuniration from third parties), you should have a better idea of what you are paying in fees. There are many layers of fees, which are complex and difficult to understand. High fees can detract from long-term sucess. It is important to understand the fees that you and your employees would be paying, since every dollar paid in fees is a dollar less in retirement.