Do you own a closely held business? A business with a 401(k) plan? More specifically a 401(k) plan that is often called "self-directed," where each employee/participant selects how to invest his/her plan funds, usually from a family of mutual funds offered by the plan sponsor?
If you answered yes, keep reading... You'll learn how not to lose your retirement funds to Wall Street, and even better, how to improve the economic health of your company's 401(k) for you, the business owner, and your employee participants.
Your author is on the warpath: to change a system that has long-been broken, not delivered its promises and skimmed billions of dollars in unearned fees from 401(k)s.
Let's start by dealing with the "buy and hold" myth touted by many self-proclaimed Wall Street gurus to all investors, including 401(k) participants. The following is a quote from the article "A 10-Year Scam Called the Stock Market" by Michael Lombardi.
"What a decade it's been. We witnessed a terrorist attack on American soil (September 2001) … a decade of interest rates at record lows. But, through it all… stocks have gone nowhere in value.
"This morning, [April 11, 2011] the S&P 500 opens the trading day at 1,328 – the same level it traded at in March of 2001. The stock market is at the same level today that it was 10 years ago despite interest rates falling "like a rock" since 2001.
"The majority of Americans who buy mutual funds in their retirement funds with the hope of seeing that money grow through the years have followed the worst possible strategy. "Buy and hold" for the long term, I'm not sure who made up that motto, but it was terrible advice to follow over the past 10 years."
Worse yet, when you factor in inflation, instead of your retirement funds standing still, the intrinsic value (the price you must pay for goods and services) of those funds has gone down … way down.
Now, let's dig a bit further into mutual funds. The article titled, "The Market Data Against Fundamentals" by Douglas Davenport says, "An annualized return from 2000 through 2008 for large cap U.S. stocks show a market return of a negative .27%."
But, get this: "The average mutual fund return for the same period was a negative 3.25%." Why? Over two-thirds of this economic tragedy (2.04% to be exact) is directly attributable to "Loss due to [Mutual] Fund Expenses."
The article adds, "$21 billion in fees have been paid to mutual funds for no performance over the last 10 years."
Interesting … during the first decade of this century, the professionals who manage mutual funds could not increase the value of their funds. However, let me take a moment to defend the beleaguered mutual fund managers.
Each individual mutual fund has predetermined and fixed limitations that put it at a significant investment disadvantage: strictly limited in their investment choices (for example, can invest only in large cap stocks, emerging companies, gold stocks or small cap stocks); must be fully or almost fully invested even as their market area heads south; and cannot go short even if the manager thinks his market area is about to enter or is in a bear market.
Nevertheless, facts are facts: mutual funds are an expensive investment choice. Except in a long-term bull market, even the fund managers do not make money. Yet the current crazy 401(k) system dictates that each 401(k) participant makes the investment decisions for his/her own account. Makes you wonder how many, including the business owner, have investment training and/or experience?
Maybe a better question is how did the current 401(k) system get started? Well, Section 401(k) was added to the Internal Revenue Code in 1974. Then, starting in the early 1980s, all the way to the end of the century, with a few nasty hiccups in between, the market was in a delightful bull market mode. Mutual funds became the new investment darlings. Combining 401(k)s and mutual funds was a great opportunity for Wall Street and plan sponsors. Self-directed 401(k)s were born and with the rising market prospered.
The plan sponsors had a great sales pitch to encourage employers to join the self-directed 401(k) club. Since the employees made their own investment decisions, there was no way the employer could be held liable for investment failures. Sorry, but in 2008 this liability bubble was burst by the Supreme Court (LaRue v. DeWolf, 128 S. CT. 1020). The court clearly holds that a 401(k) participant can sue his employer stating, "When a participant sustains losses to his account as a result of a fiduciary breach… [the law] permits that participant to recover such losses…" Simply put, the boss (you or your company) now can be sued by participants in the company 401(k) plan.
A detailed analysis of how the typical self-directed 401(k) plan impacts the plan participants is nothing short of a national scandal. Each participant's account gets charged two management fees: one by the plan sponsor and one by the various mutual funds selected by participants.
A rising market hides the sins of the fees. But a bear market or go-nowhere market (like the past 10 years) causes the continuing fees to only exasperate the pain of investment losses suffered by plan participants. Sad! It's time for a change.
Now we know why a change is needed, but the question still remains: how? Maybe it's easier to examine the "how" as the following goals: avoid employer liability and increase to an acceptable rate of return while minimizing risk.
Avoiding liability: Actually, it's easy to do and the strategy is as old as the existence of qualified plans, including 401(k) plans. The owner(s) or trusted employee(s) become trustee(s) of the 401(k) plan. Then, the trustees hire a professional money manager to invest the plan funds and monitor the investment results.
Increase rate of return: I must confess that I am on a constant quest to seek, find and take advantage of new opportunities afforded by the best money managers that use a strategy that consistently accomplishes an acceptable rate of return, yet limits risk.
I have discovered an investment manager with a proprietary strategy, known as trend following that does the job. This strategy does not attempt to predict market or stock movements. Instead, the strategy capitalizes on natural market's movements (really the volatile ups and downs) whenever or where they occur. A trend following manager takes advantage of what is actually happening in the market, rather than trying to guess what may happen in the future.
Trend following turns volatility into a friend. A trend is a strong, sustained move that can last from several days to a number of years. A trend may be rising or falling and is applicable to any specific security or index, like the S&P, or a commodity, like oil, gold or the Euro.
Why trend following works is not a secret. The basic concepts behind the strategy are simple. For example, when the investment is gold and gold is trending up, the manager is long gold. If it is trending down, the manager is short gold. What if gold is flat (no trend)? The manager stays in cash temporarily. The real beauty of trend following is that you can make money not only when the market goes up, but when it goes down.
The rate of return numbers for the manager, who we work with and uses trend following, is indeed acceptable. In 2008 when the S&P lost 37%, the manager's trend following strategy was more than 29%. The annualized rate of return from December 2006 (when the strategy was first implemented) to March 2011 is 18.5 %. (Remember, prior results do not necessarily predict future results.)
The strategy was designed and implemented by a portfolio manager working with Sir John Templeton to manage a fund in an advisory firm owned by Sir John's family.
If you want to make a killing in the market, this strategy is not for you. However, if you want to shoot for a conservative, steady and proven return, you'll embrace this trend following strategy.
It should be noted that the trend following strategy works the same for all investments: 401(k) plans, other qualified plans, such as profit-sharing plans, pension plans or IRAs, and non-qualified investment funds, such as personal, corporate or trust funds.
Want more information? Send me (Irv) a fax to 847-674-5299 with your name, snail-mail address, e-mail address and all phone numbers (business, home, cell) on your stationery if you own a business. Indicate the type of funds (401(k) or otherwise) to be invested. Note "TREND FOLLOWING" at the top of your fax.
Irv Blackman, CPA and lawyer, is a retired founding partner of Blackman Kallick Bartelstein LLP and chairman emeritus of the New Century Bank, both in Chicago. He can be reached at 847-674-5295, e-mail BLACKMAN@ESTATETAXSECRETS.COM, or on the Web at: WWW.TAXSECRETSOFTHEWEALTHY.COM.