Gyroscopic Investing

Hi,
Recently, I have been elected to participate on my Employer's 401k investment committee.  Ironically, as you may be aware from reading my recent posts, I personally have adopted a mix of active funds and the PP, however, will be a strong advocate for my employer to adopt a passive, low cost approach.

Our plan’s investment policy statement (IPS) will specify which index funds to pick for the plan. It will also specify why the Company picked index funds and how it will monitor them. In the IPS we will also explain why the Company decided not to use managed funds, and/or asset-allocation, target-date, life-cycle, lifestyle, and balanced funds. The IPS will also describe how we will set up an optional self-directed account for employees that desire to go the active route.  The following is an example of what type of funds I am considering to propose to our committee and would greatly appreciate any words of wisdom that all the Crawling Road members may have:
1)  Vanguard Total US Stock Market
2)  Vanguard FTSE all world- ex US Stock Market
3)  Vanguard Total Bond Market
4)  Vanguard Inflation Protection Securities
5)  Vanguard Prime Money Market
6)  Ishares Short Term Treasuries (SHY)
7)  Ishares 3-7 year Treasuries (IEI)
 Ishares 20+ year treasuries (TLT)
9)  Ishares Gold Trust (IAU)

Each participate would have the ability to vary their allocation percentage for the above 9 funds.

OR- since the majority of employees do not know how to manage their investments themselves, in lieu of the individual options listed above we could offer 4 "pre-set" managed portfolio options (rebalanced annually) plus Prime Money Market and Vanguard Total Bond Market.  For example:
1)  "Least Aggressive" Portfolio (25% Stocks- 75% Bonds)
    17.5% Vanguard Total US Stock Market
     7.5% Vanguard FTSE All World- ex US Stock
     37.5% Ishares 3-7 year treasuries
     18.75% Ishares short term treasuries
     18.75% Vanguard Inflation Protection Securities

2)  "Balanced" Portfolio (50% Stocks- 50% Bonds)
     35.0% Vanguard Total US Stock Market
     15.0% Vanguard FTSE All World- ex US Stock
     25.0% Ishares 3-7 year treasuries
     12.5% Ishares short term treasuries
     12.5% Vanguard Inflation Protection Securities

3)  "Aggressive" Portfolio (75% Stocks- 25% Bonds)
     52.5% Vanguard Total US Stock Market
     22.5% Vanguard FTSE All World- ex US Stock
     12.5% Ishares 3-7 year treasuries
     6.25% Ishares short term treasuries
     6.25% Vanguard Inflation Protection Securities

4)  "Permanent" Portfolio (25% Stocks- 25% Gold- 25% Short Term Treasuries- 25% Long Term Treasuries)
     25.0% Vanguard Total US Stock Market
     25.0% Ishares Gold Trust
     25.0% Ishares Short Term Treasuries
     25.0% Ishares long term treasuries

5)  Vanguard Total Bond Market
6)  Vanguard Prime Money Market

The idea is that each participant could vary their allocation such as 50% invested in the PP and 50% in Balanced portfolio and try and leave as little error as possible in relying on each participant to define their own set allocation percentage.  The con to this is that the astute investors lose some flexibility.

Your thoughts and criticism are welcome, including how you like the term "least aggressive" for the pre-set option #1 versus calling it "conservative."

Regards,
Heather

That would be the most enlightened 401(k) plan I have ever seen.

Keeping costs low is a good guiding principle.  It's one of the few things that the plan sponsor can control.

MediumTex wrote: That would be the most enlightened 401(k) plan I have ever seen.

Keeping costs low is a good guiding principle.  It's one of the few things that the plan sponsor can control.

Thanks for taking the time to comment MT.  What is your opinion of offering the "pre-set" options versus the 9 listed funds? 

hrux wrote:

MediumTex wrote: That would be the most enlightened 401(k) plan I have ever seen.

Keeping costs low is a good guiding principle.  It's one of the few things that the plan sponsor can control.

Thanks for taking the time to comment MT.  What is your opinion of offering the "pre-set" options versus the 9 listed funds? 

The pre-set portfolios are a great option.  There are, however, some compliance issues that the plan vendor should be able to walk you through as far as how participants can elect one of these portfolios, what sort of default you may want to use for participants and what sort of participant education or risk measurement tools you are going to use to guide participants toward one of the pre-mixed portfolios.

The problem with 401(k) plans, in my view, is a much more fundamental one and it relates to the basically flawed approach to retirement savings that a 401(k) plan doesn't address at all, including no lifetime income options at retirement, no way of getting a guaranteed return that would allow meaningful retirement planning to occur, no ability for participants to shift risk (as they can in a pension plan), "leakage" in the form of loans, hardship and other early withdrawals, and the ridiculous idea that the average participant is going to be able to invest skillfully enough to accumulate sufficient capital to fund any retirement income at all. 

In many ways, a 401(k) plan is the financial equivalent of an auto repair shop where they provide the tools and shop manuals and you are expected to repair your own car.  Al of these flaws will begin to be exposed on a large scale when more boomers attempt to fund their golden years through their Social Security checks and 401(k) distributions.  I would venture to say that the average retiring boomer will have levels of debt on their retirement date that exceeds the lump sum value of their 401(k) plan accounts. 

If we assume that most people have few assets of any value outside their home and retirement accounts, we are talking about millions of people who will basically be living off of whatever Social Security pays them, plus a one time loan payoff in the form of a 401(k) distribution, and perhaps some additional cash down the road from the sale of their home.

Just to remind you of what a strange world we live in, in 1974 Congress passed the Employee Retirement Income Security Act, or "ERISA".  ERISA regulates all employee benefit plans, but it was primarily aimed at protecting benefits provided under traditional defined benefit plans.  When ERISA was passed, 75% of employers provided some form of defined benefit plan retirement benefit.  As ERISA compliance has become more complex, expensive and uncertain, employers have steadily exited the defined benefit plan market, embracing the 401(k) plan model not because it is a good retirement program, but because it is cheap and easy to offer and administer compared to a defined benefit plan.  Today, fewer than 15% of employers offer defined benefit plans. 

So what is the legacy of ERISA?  Has it really provided "retirement income security" for Americans?  Of course not--it has actually provided dramatically less retirement income protection than existed before ERISA was enacted, though the deterioration of retirement income security has been so gradual and orderly that few people noticed as it was happening.

As an ERISA practitioner, I often feel like I am part of a professional class that is charged with decommissioning an entire system and replacing it with something much less robust.  Few of my colleagues see it this way, but the pattern is hard to miss once you begin looking closely and honestly. 

What's the next stop in this "decommissioning" process?  Well, health care of course.  Think of the PPO as the health care equivalent of the traditional defined benefit pension plan, and the high deductible health plan as the health care equivalent of the 401(k) plan.  It will work fine for some people, but for low income people with chronic health conditions, the high deductible health plan model is going to make these people poorer than they were already.

Hi Heather,

Your fellow employees are fortunate to have such an enlightened committee planning their 401K choices!

With respect to the international equity exposure, I would opt for the newly reconstituted Total International (VXUS etf) rather than VEU. VXUS is cheaper and more diversified.

Good luck with this!

Maestro G

Heather, this looks excellent.  Your company is very lucky to have you working on this.

The combination of those 9 funds, the optional self-directed account, and a pre-baked Permanent Portfolio (!!) would easily make this the best 401(k) plan I've ever seen or heard about.

MediumTex wrote: The problem with 401(k) plans, in my view, is a much more fundamental one and it relates to the basically flawed approach to retirement savings that a 401(k) plan doesn't address at all, including no lifetime income options at retirement, no way of getting a guaranteed return that would allow meaningful retirement planning to occur, no ability for participants to shift risk (as they can in a pension plan), "leakage" in the form of loans, hardship and other early withdrawals, and the ridiculous idea that the average participant is going to be able to invest skillfully enough to accumulate sufficient capital to fund any retirement income at all.

It's interesting to find that you have a somewhat negative view of 401(k).  I did not expect that.  I'm very much a product of the ERISA generation and as you said, defined benefit plans were already so much less common when I started working.  I find the ability to grow money tax-deferred in an investment vehicle of my choosing to be far more appealing than leaving my retirement up to the managers of a pension plan.  (This all assumes that the 401(k) plan has a good set of investment choices... many do not!)

Let's say I have two options.  Option 1 is to work at a company that will pour part of my compensation into a pension plan.  Option 2 is Heather's company who will instead hand that money to me, allowing me to buy into the PP or long-term government bonds with my tax-deferred space.  I can't imagine wanting anything but option 2 here.

I haven't spent much time thinking about pension plans, so I more or less accept that I must be missing something here.  What do you think it is?

Looks like some great choices to me.  I'd love to have those options in my current 401k.    

Lone Wolf,

The 401(k) model is a great savings plan, but it's a terrible retirement plan.

See the great story in today's Wall Street Journal about 401(k) plans for moe about why I feel the way I do.

Some people will do fine with a 401(k) plan; most won't.

MediumTex wrote: The 401(k) model is a great savings plan, but it's a terrible retirement plan.

See the great story in today's Wall Street Journal about 401(k) plans for moe about why I feel the way I do.

Good article.  However, this quote made me want to hit myself in the head with a hammer: "Eventually, she wants to retire completely. Then, to make ends meet, she plans to take bigger investment risks. Her financial adviser then will shift some of her savings out of an annuity and into high-yielding bonds and real-estate investment trusts, aiming to double the return on that money to 10% a year."

If I post on here about converting my retirement savings into junk bonds and real estate speculation, somebody please beat me senseless with a copy of "Fail-Safe Investing".

In the end, it all seems to come down to the fact that you can't simultaneously give people freedom and be sure that they won't do very ill-advised things with that freedom.  I never want anyone to lose their freedom because of something dumb that someone else might do.  What sort of a system would you favor?  Should there be some kind of waiver you sign to certify that you understand the consequences of investing in the market versus just getting some kind of annuity with your retirement savings?  

By the way, if anyone else is interested the WSJ article is here.

Lone Wolf wrote: In the end, it all seems to come down to the fact that you can't simultaneously give people freedom and be sure that they won't do very ill-advised things with that freedom.  I never want anyone to lose their freedom because of something dumb that someone else might do.  What sort of a system would you favor?  Should there be some kind of waiver you sign to certify that you understand the consequences of investing in the market versus just getting some kind of annuity with your retirement savings?  

We are touching on a sensitive and delicate issue and it relates to how best to wean people who have become overly dependent on the government and other paternal figures for their survival and livelihood.

The defined benefit plan is clearly a bit paternal in that it requires that employees do nothing except be good employees and they get a decent retirement benefit.  When you move away from this sort of system you empower people in some cases and leave them utterly defenseless in others.  A useful metaphor would be going to a zoo and releasing all of the animals back into the wild.  Some would do okay, but many would die or be killed almost immediately.

The 401(k) plan is the retirement planning equivalent of releasing all of the country's workers back into the wild.  Those who are sophisticated and independent-minded will do fine; those who know next-to-nothing about investing are simply cannon fodder for Wall Street.

As far as what kind of system would be better than the 401(k) model, I think that the traditional defined benefit plan is at one end of the spectrum and the 401(k) participant-directed model is at the other.  There is probably something in between that would allow employers to better manage cost and risk, while also allowing participants to have some predictability to their retirement planning.  This whole idea of a market crash causing millions of people to either not be able to retire or to have to delay retirement by many years just seems absurd.  The cash balance plan model is not a bad compromise, though it still has lots of problems.

I wouldn't mind requiring all retirement plan assets to be invested in a straight HB 25% x 4 PP.  That won't happen, of course, but it would address a lot of the concerns I outline above.

I agree that this would be one of the best 401Ks ever created. I would love to have a 401K with those options.

However, I suspect some unenlightened people may be critical about gold being in that 401K plan. And truthfully, someone who doesn't understand diversification and asset allocation could potentially speculate themselves into oblivion by putting too much into Gold. Most people won't know when to sell it without a predefined rebalancing strategy. I suspect this is why many 401Ks are watered down with balanced funds and few other choices. If internal politics prevent this amazing 401K plan from being implemented, you should consider offering PRPFX as one of the options instead. It will allow investors to have exposure to hard assets without high levels of speculative risk.

I would be really careful about proposing this plan inside a bureaucracy of any size. Maybe if your company is small and run by sensible people it will be accepted, but if the company is large it is by definition run by the uninformed. This type of person seeks the lowest common denominator with a vengeance, and your survival as an employee can be jeopardized by not conforming to this type of mindset.

If you work at a big company, in your situation I would propose a traditional 401K plan like that found at most large companies that includes index funds. There should be nothing on the surface to attract the attention of Bob Mediocre, Jr Vice President of Nonsense.

Build a brokerage window into the fine print. If Bob asks you about it tell him a Consultant told you to put it in the plan as a way to deal with employees who complain about the offerings. Work on the plan brochure so that sensible people can find the brokerage window.

You can't save everyone, but you can open the path to salvation to anyone who is interested in walking it.

Heather,

This is a superb offering and I would be impressed as hell if I worked for a company that had a 4x25 PP as one of it's recommended allocations.  Unlike some of the previous posters, I don't think it is ill advised at all to have a gold fund in there.  Many traditional portfolios recommend a small (5%) gold allocation for "diversification purposes."  Also, my stodgy Fortune 15 company that's been around for over 175 years had a gold fund in their 401k offering for quite some time, although it was a poor one.

I think those fund choices are excellent, and wish you the best of luck in implementing this.  One thing I have noticed, and I'm not sure why, but I think it has to do with the cost to employer - most employer plans have very high management fee funds.  I believe this is because a lot of employers are somehow getting their 401k administrative costs reduced by offering these high management fee funds.  This is just a hunch on my part, because if it cost the same for any employer to offer any fund to their employees, I think we would see a lot better options out there than the high management fee, active funds.