Hi JP, Here's an article out of the Sunday Morning Milwaukee Journal/Sentinal about "Statement Shock" in retirememt plans. Compare the fearful discussion with my own IRA activity in the last couple of months:
execpc.com
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Statement shock looms for investors directing their own funds
Declines in retirement accounts could send some to the exits
By Douglas Armstrong
and Kathleen Gallagher
of the Journal Sentinel staff
October 11, 1998
Months into the scariest stock market that many of today's investors have ever weathered, the nastiest jolt could still be to come.
Quarterly statements are starting to arrive that translate the declines in the major stock market indexes into the hard dollar-and-cents losses that the owners of individual retirement savings accounts and 401(k) plans have actually suffered.
"Participants will freak out when they see those negative quarterly statements and pull out," warns William A. Schneider, managing director of the Chicago financial consulting firm of DiMeo Schneider & Associates LLC.
"Historically, that's the pattern. And well over half the money in 401(k) plans today has never seen a downturn like this."
It is a pivotal moment in an unpredictable time, complicated by the increased participation of individuals who are trading on their own and managing retirement savings as never before.
Can the large number of inexperienced individual investors in the market today hang on through this period for their own long-term good?
"I think another 10% drop would put people in the 'Oh my God, why did I ever buy stocks?' camp," says Richard P. Imperiale, president of Uniplan Inc., a Milwaukee money management firm.
Not all investors will panic, of course. Many, especially those who have been through a bear market before and are holding stocks or funds that were purchased years ago at lower prices, will sit tight, if only to avoid paying capital gains taxes on their profits.
But if large numbers of less secure individuals suddenly shuck any pretense of being "long-term investors" and dump equities and stock funds to be rid of painful volatility, the fresh wave of selling would likely drive stock prices even lower.
This week's news may do little to offer frightened investors comfort either, as earnings reports begin spilling out that are likely to confirm the reality of analysts' significantly lowered expectations.
And, underneath it all, the possibility of a recession looms with all of the usual implications of lower corporate earnings, layoffs and business failures.
Predictions of a recession in 1999 are beginning to circulate. In an unpublicized conference call last week to institutional investors, one Wall Street economist disclosed that he had raised his own prediction of the probability of a recession in 1999 to one chance in three.
"And it's still going up," said Bruce Steinberg, chief economist at Merrill Lynch & Co. in New York.
On the positive side is a decline in interest rates, which tends to cushion investments in any economic downturn.
Talk of possible economic trouble for anyone with bills to pay and badly squeezed life savings will do little to stiffen their resolve to ride this market out for the promise of future riches.
"Most individual investors do the wrong thing at the wrong time," says Imperiale. "The pain gets unbearable, and that's when they give up the ghost."
Which raises a public policy question about the wisdom of the evolving system in which individuals, rather than institutions, have primary responsibility for managing vital retirement savings.
Until 1982, the standard model for retirement benefits in this country was the pension plan, under which a worker was paid a "defined benefit" beginning on the day the worker got the gold watch and ending on the day the worker died.
Managing the money that supported this system was the exclusive responsibility of the employer. To put enough aside to meet the bills, an employer had to make assumptions about number of employees who would retire and when, plus how long they would live and how this pension money should be invested to grow by the necessary amount to support them over time.
The system was not perfect. "Some ended up with unfunded liabilities because they used the wrong assumptions," says Michelle Cody, a certified financial planner with CRB Financial Services Inc., of Racine.
Employers invested too conservatively or they put too little money aside. Employees were powerless to do anything about it. But then things changed.
Against a backdrop of pension fund failures -- the pension fund of Allis-Chalmers Corp., West Allis' faded agricultural equipment giant, was taken over by a federal agency in 1985 -- and tougher regulations, more and more employers began looking for ways to reduce their liabilities while offering employees opportunities to save for retirement.
In the decade following 1985, the number of defined-benefit pension plans, which are funded by employers, fell to 74,400 from 167,911. Meanwhile, the number of 401(k) plans -- retirement plans funded mainly by employee contributions -- rose to 175,000 from 29,869. The number of participants more than doubled and assets soared to $675 billion from $143.9 billion.
"When we turned to 'defined contribution' plans, it shifted the responsibility for making the investment decisions to the plan participants," Cody notes.
Are individuals any better equipped to safeguard their futures? If they understand how investing works, yes, say the experts.
"What you worry about is someone who doesn't understand risk intellectually and can't handle it emotionally," says Clare W. Zempel, chief economist and chief investment strategist at Robert W. Baird & Co.
Yet the shift toward individual self-reliance has become a theme of social change in the deregulation era.
"As a society, we're starting to do it in more and more areas, such as health insurance," says Cody. "It all comes down to personal responsibility. It's more and more imperative to make good choices in every part of life."
But it's in retirement savings where the trend is most pronounced. And it could become more so if mutual fund companies persuade Congress to partly privatize Social Security.
The switch has come without much preparation. If average Americans are not equipped to handle the periodic slides in the equity markets, perhaps it's because no one got them ready for it. Unfortunately, people have not gotten a good education on this from their parents and schools," says Cody. "But whether they like it or not, they better learn how to do it."
Mutual fund money flows show that many investors have stayed the course through this year's broad-based sell-off, which pummeled stocks. Still, with the average stock down 30% to 40%, many investment professionals wonder whether individuals would hang in there much longer if the market continues to slide.
"At some point, the typical investor panics and says I can't stand any downside risk -- it hasn't happened yet, but I think it probably will later this year," Imperiale said.
This urge to sell tends to be linked to the amount of time an investor has been in the market. The shorter the time invested, the more likely the investor experienced losses. Old-timers are sitting on stocks and funds purchased at far lower prices.
It's the "30-ish" crowd that hasn't been through a big decline before that is panicking, says one broker. Investors who have been down before are more apt to take it in stride.
Also easing the pressure on stock buyers is that many showed gains in September after August's deep drop. These investors may not be sure the market has hit bottom yet, but they believe they can weather the rest of the ride down.
The long-term price to be paid for selling out at a market bottom is a far-off consequence of more working years before retirement or a lifestyle reduction later in life.
On the other hand, some retirement plan investors are largely unscathed by the recent market downturn because they placed retirement dollars in guaranteed investment contracts that do not fluctuate with market gyrations.
It's turtle-shell protection at a price, however.
"Some plan participants show zero interest in investing," says Cody. "They often take the safe route in a guaranteed principal fund or money market account. But they are limiting what their pension is going to be."
While it avoids month-to-month market shocks, a conservative investment such as a guaranteed investment contract can be expected to return between 5% and 6% over time. Compare that to the 8% rate of return expected for a "balanced fund" comprising 50% stocks and 50% bonds.
Over a 40-year span of regular, periodic investments, the 8% return produces 120% more investment dollars than the same contributions to an account averaging 5%. So the additional risk, while it has ups and downs along the way, can more than double the amount of money available in retirement.
For example, investing $1,000 every year for 40 years in a stable value fund that yields 5% grows to a total of $127,840 over that time. Investing $1,000 in a fund with an average return of 8% produces $280,781.
Despite the perils of managing our retirement money in risky times, Schneider, at the Chicago financial consulting firm, thinks the trend toward democratization of saving is good.
It benefits mobile younger workers, for example, he says.
Leave a job after five years to go to work elsewhere and you would be handed a meager payout from a defined benefit plan under the old system.
"After five years in a 401(k), the amount is going to be substantially greater," says Schneider.
Older workers, on the other hand, are better off in the old defined-benefit plans because they have less time to save for their own futures and face greater risk from market fluctuations in doing so.
Because old-fashioned pension plans were inevitably geared toward paying benefits every year, in some ways, they never made any sense as an umbrella over everyone.
"When you have a 60-year-old who is going to retire in five years and a 22-year-old who is 43 years from retirement in the same plan, how can you have one mix of investments by the pension fund trustees that is appropriate for everyone?" Schneider asks.
Employers have been quick to adopt 401(k) and similar plans because those plans put an end to unlimited pension liabilities. But there have been some healthy nudges from the government as well, which made pension plans more unattractive by changing the rules.
Pension fund insurance premiums have risen as solvent plans shoulder the mistakes of failing plans. Firms with well-run funds cannot touch pension fund surpluses, while shortfalls must be paid up immediately, according to Schneider.
The individual investor is not alone in being punished by this volatile market.
Companies that continue to offer defined-benefit pension plans are in for a shock soon as well because the safety net of interest rates that props up their performance has dropped, as has the value of equity assets in the pension plans.
"You're going to see pension funding requirements go through the roof," Schneider predicts. "Last year, the cost of the plan might have been 1% of payroll. This year, it could be 8% of payroll."
At weaker firms, that could endanger the pension plan.
"For better or worse, the genie is out of the bottle on this," says Schneider. "You are not going to go back to a world where somebody else is going to make the investment decision for you."
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I still prefer the "self directed" approach and feel that AIM's cash reserve along with its miserly purchasing methods are enough hedge for me to survive and do well going forward.
Best regards, Tom
PS: anyone else having trouble with SI this AM? |
