The Tony Soprano 401k Loan....

I saw a defaulted 401k loan from earlier this century (sounds cool to say that) and thought Paulie Walnuts was going to walk around the corner and start asking me for the weekly payment for "protection"...

More on that after the jump.  For now, let's review your role as a HR pro regarding 401k Loans.

Where's your head as a HR pro on the wisdom of 401k loans?  Do you talk to employees who are asking about the procedure about the downside of the 401k loan, or do you zip it and consider it none ofPaulie_walnuts_3  your business?    How does your responsibility as a fiduciary come into play?  Does that responsibility mean you speak up or shut up?

As with all things in life, balance is probably the best approach.  For some employees, taking out a loan against their 401k may be the only source of cash they have in an emergency.  That's hard to argue with.  Employees looking to finance the second waverunner may need a financial consultant. 

Here's your checklist of talking points if you want to advise a member of your tribe of the downside of a 401k loan, provided by the 401khelpcenter:

  1. There are "opportunity" costs. According to the U.S. General Accounting Office, the interest rate paid on a plan loan is often less than the rate the plan funds would have otherwise earned.
  2. Smaller contributions. Because you now have a loan payment, you may be tempted to reduce the amount you are contributing to the plan and thus reduce your long-term retirement account balance.
  3. Loan defaults can be harmful to your financial health. If you quit working or change employers, the loan must be paid back right away. It's not uncommon for plans to require full repayment of a loan within 60 days of termination of employment. If you can't repay the loan, it is considered defaulted, and you will be taxed on the outstanding balance, including an early withdrawal penalty if you are not at least age 59 ½.
  4. There may be fees involved.
  5. Interest on the loan is not tax deductible, even if you borrow to purchase your primary home.
  6. You have no flexibility in changing the payment terms of your loan.

That's a pretty strong list, especially the one saying that if an employee leaves the company, they must payback the loan in the short term.  If an employee is taking out a loan from the 401k in the first place, they probably don't have the means to do that, which likely means default.

So back to the loan that made me flinch from visions of Tony Soprano and Paulie.. Here are the specs of the loan from 2000, which was part of another plan, a long time ago, in a land far away (enough disclaimers?):

-Original Loan Amount - $8,600 and change...
-Interest Rate - 11.5% (ouch)
-Total Payments Needed to Retire Loan - 390 (15 years)
-Total $$ Needed to Retire Loan - $18,000 and change (Meaning over 9K in interest expense beyond the $8,600 principle)..

Again, some employees won't have access to any funds other than their 401k in emergencies.  That's OK.  But coach everyone who asks about the realities related to a 401k loan, especially if the loan must be paid back immediately after the employee leaves the company. 


Why Employees Don't Come to HR When 401k Balances Are Down 10%

If you follow the Business page or even the news in general, you know we have been in the midst of a downturn in the stock market.  Over the weekend, I thought about my email, phone and office traffic over the last 2-3 weeks while the market has been going crazy and corrected down around 10%.

My conclusion?  I hadn't had a single conversation with an employee who was freaking out about the valueWallstreet460 of their 401k.  I checked mine, and it was down about 8% overall for the three-week period ending last Friday. 

Is there any other area where employees take a 8% decrease and aren't hitting you hard to determine what's going on or how to get it back?  Could it be our employees are a bunch of savvy long-term investors, with the required understanding of the long-term horizon and the confidence that comes with that approach?

Or, are they just not watching their accounts?  And if they aren't watching their accounts and the related news during market corrections, is that the best investment approach they could have?    The Frontal Cortex recently rehashed some 1980's Harvard Research that suggests less news equals less action, which produces better results.  From the summary of the research:

"In the late 1980's, the Harvard psychologist Paul Andreassen conducted a simple experiment on MIT business students. First, he let the students select a portfolio of stock investments. Then he divided the students into two groups. The first group could only see the changes in the prices of their stocks. They had no idea why the share prices rose or fall, and had to make their trading decisions based on an extremely limited amount of data. In contrast, the second group was given access to a steady stream of financial information. This was supposed to be equivalent to watching CNBC, reading The Wall Street Journal and listening to experts analyze the latest market trends.

So which group did better? To Andreassen's surprise, the group with less information ended up earning significantly more money than the well-informed group. Being exposed to extra news was distracting. Instead of focusing on the important variables - the actual movement of share prices - the "high-information" students would become fixated on the latest rumors and insider gossip. (Herbert Simon said it best: "A wealth of information creates a poverty of attention.") As a result, these students engaged in far more buying and selling than the "low-information" group. They were confident that all their knowledge allowed them to anticipate the market. But they were wrong. Too much information can induce a state of ignorance."

Of course, this research probably assumes that the participants held valid investments with the proper amount of diversification, etc, which is not always the case.   Additionally, employees obviously have to be participating in their 401ks for the "buy and hold" approach to work as a long term investment strategy.

So, get your employees to participate in the 401k, educate on indexing and diversification, then bask in the knowledge that once properly invested, not following the news in downturns is probably a good thing.

Gecko would be proud....   


Money Never Sleeps - Why Mutual Funds May Be Hurting Your Employee 401k Returns...

Think all funds in 401k's are created equal?  Think again.  Under the premise that HR people are a lot like the general population, I've been meaning to get out a post to encourage all my HR peers who have anything to do with a 401k to push for more Index Funds and less Actively Managed funds.  You don't have to be Gordon Gecko to have a firm grasp of the impact.  First up, let's get a definition of what these types of mutual funds are:

Index Fund - A passively managed mutual fund that tries to mirror the performance of a specificGecko index, such as the S&P 500. Since portfolio decisions are automatic and transactions are infrequent, expenses tend to be lower than those of actively managed funds.

Actively Managed Fund -Most mutual funds are "actively managed," meaning the mutual fund shareholders, through a yearly fee, pay a mutual fund manager to actively buy and sell stocks or bonds within the fund. Though you would think that mutual funds provide benefits to shareholders by hiring alleged "expert" stock pickers, the sad truth of the matter is that the vast majority of mutual funds under perform the average return of the stock market. Over time, because of their costs, approximately 80% of mutual funds will under perform the stock market's returns. Currently, most mutual funds do not make their fees very easy for shareholders to understand.

Expense Ratio - A mutual fund's total annual operating expenses (including management fees, distribution fees, and other expenses) revealed as a percentage of the fund's average net assets. High expense ratios decrease investors' returns. An example would be two funds that both earned an 10% return before fees. If the first fund has an expense ratio that is 2 percent higher than second fund, you lose an extra 20 percent of your expected returns each year when your money is in the first fund. High expense ratios doesn't mean better results.

So, with those definitions in mind, if your mutual fund selection doesn't include multiple index funds with expense ratios of .50% and below, you can likely do better for your employees.  The average expense ratio for mutual funds in company 401K is said to be in the 1.50% range.

How's that hurt employees?  Over time and with the magic of compounding, that seemingly small difference in expense ratios can end up hurting overall returns.  Here's a calculation I ran at Moneychip.com:

Scenario - Investing $100,000 for 20 years, Expected Annual Rate of Return - 10%

Fund A - Expense Ratio of .4%, Transaction Costs of .1
Fund B - Expense Ratio of 1.5%, Transaction Costs of .8

Results

Cost-Adjusted Return Rate - Fund A, 9.0%.  Fund B, 6.2%
Final Balance - Fund A - $560,441.  Fund B - $333,035
Difference - Index Fund outperforms Actively Managed Fund by $227,406 over 20 years...

All the more reason to rethink your 401k.  If you don't have at least 4 index funds in your 401K, you aren't providing all the tools available to enable employees to maximize their returns.

Like Gecko says - Money Never Sleeps.....

Legal Considerations - Before you start swapping funds in your plan, make sure you get full disclosure on expenses associated with employees moving money out of a fund with a high expense ratio.  Sales fees associated with funds with high expense ratios are common and a type of poison pill designed to discourage change...


When Choice Confuses Your Talent - 401k Options

Employee behavior often follows consumer behavior.  Roll out 55 versions of Tide, and what do many consumers do?  By the most basic version they can find or move to a simpler brand.  Employees make choices in similar ways, as highlighted by The Retirement Plan Blog, which recently highlighted a Workforce article on the light bulb going off at GM regarding a cluttered set of investment options:Tide

General Motors is chopping the number of investment options in its 401(k) plans from more than 70 to fewer than 40 in a streamlining that the company hopes will improve employee participation in the plans.

Preston Crabill, director of employee benefits and human resource operations at GM, noted recent academic research that indicated having too many investment choices in a 401(k) plan can lead some participants to pick the most conservative investment option and discourage others from participating at all.

“We do believe that by reducing the fund lineup, we should see an increase in participation, an increase in the savings rate and also a better diversified portfolio on the part of our participants,” Crabill said.

70 Investment Options?  Are you kidding me?  We have 21 and I feel like that is a tidal wave of choice that is difficult to explain at times.  Additionally, if you dig into the article a little bit, you'll see that GM actually owned and managed some of the funds, never a great idea from a fiduciary responsibility perspective.

70 Funds....  I am sure that made a lot of folks just play lotto....


Employees Want to Trade Stocks in your 401k? Here's Some Talking Points....

For most employees, the selection of mutual funds in your 401k fits the need - serving to offerJim_cramer_book_1 simplicity of choice as well as diversification.  Both are valid goals in the structuring of any defined contribution plan.
However, regardless of the size of your company, you have a small percentage of employees (is it 1%?  5%?  15%?) who want an open source 401K, my term for the option on your plan that allows them to open a brokerage account and trade almost any active security as a part of your 401K.  Read more about this type of option here (Note - the most actively marketed benefit of this to HR Pros is that it will meet your fiduciary liability to a greater degree, not a terrible idea..)
To make sure you are armed with the facts on active trading as you talk to these employees, take a look at the recent set of articles by Henry Blodget on Slate.com.  In these articles, Blodget takes a critical stand towards securities marketers like Jim Cramer (pictured at right), reinforcing the view by folks like Bogle from Vanguard that the smart individual investor buys a diversified set of index funds and holds for the long term.   His main point is that very few professionals beat the market while focusing solely on it full time, so how will the part-timer fare?  Additionally, he cites the numbers for the professional fund managers are worse than even the poor numbers advertised once the various costs are factored in...
Great read and should arm you with talking points for your most active group of investing employees, whether you decide to open up your 401k to a managed account option or not.  Also, note of disclaimer - Blodget is one of the most famous "flameouts" of the dot.com era....  To me, the history behind Blodget offers more credibility to his current ideas...

401(k) Rebalancing and the Role of Lifestyle Funds

Early in the year - time to bargain with yourself - you are going to get in shape, going to mendTonyrobbins3x796612 relationships, maybe even clean the hallway closet.  You are an achiever.. Kinda like Tony Robbins with a little duller teeth...

What's missing from your checklist?  Would you be shocked if I told you that rebalancing your 401k (including any you have sitting at previous companies) should be part of the mix? Often forgotten and usually misunderstood, rebalancing your 401k is a simple process - simply compare your current $$ in each asset category to your target asset allocation.  When any category becomes 5% larger than your target allocation, trim it and spread the proceeds among the other groups to restore the balance. This kind of rebalancing will probably only be needed once every few years, but a sudden rally in any market could skew your allocation in as little as a year.

A recent trend among many companies is to offer Life Cycle or "Target Maturity" funds,  which allow employees to invest in one fund, then automatically shifts the asset allocation over time so that their investments become more conservative as the target date for retirement nears.  This means that employees invested in these funds automatically get rebalancing as the fund manager changes the investment mix to reflect the target retirement date.   Life-cycle funds typically will have the retirement target date in their name, such as Vanguard's Target Retirement 2040 fund.   

Are Target Retirement funds right for your 401k and your employees?  Check out the primer on these funds provided by Pam Yip of the Dallas Morning News.   Target Retirement funds now serve as an appropriate choice for many administrators for use as a default fund, since they provide automatic allocation for the employee who chooses them.  Whether they fit all employee needs is another matter as addressed by the Yip article, since these funds almost always carry a higher expense ratio than a combination of index funds that can provide the same diversification, but have to be actively managed.  In addition, one employee may need a more aggressive investment mix to meet his/her retirement goals than another employee.  As with all things, choice seems to be the way to go to meet the needs of all....