Friday, May 17, 2013

The Tricky Business Of Retirement: Hidden 401(K) Fees / [the fees] can have a really big effect on whether you end up with a decent-sized nest egg or are looking at it in horror at age 65 or 67 / RADIO INTERVIEW

You could end up with a lot less savings at 65 than you ever anticipated because of fees charged by the financial institutions managing your retirement accounts. Robert Hiltonsmith, who researches retirement security, says those fees were disclosed to 401(k) plan participants until only recently.

A couple generations ago, when older Americans retired they could rely on pension plans to support them. Then, in the late 1970s and early 1980s, many companies switched their retirement plans over to 401(k) accounts. The security of workers' retirement savings suddenly became subject to the vagaries of the stock market.
What's more, the financial institutions that manage 401(k)s charge a host of hidden fees to plan participants, says Robert Hiltonsmith, a policy analyst at the New York-based think tank Demos. He researches retirement security, tax policy, health care and the labor market.
"There's a good reason that people don't know they pay fees," Hiltonsmith tells Fresh Air's Terry Gross. "[It's] because when you open up your statement there's not a table right there in front of you ... — especially before some recent reforms — just saying, 'Here's the fees and here's what you paid,' or it's not like as part of your statement, 'OK, here's your returns and then minus the fees.' "

Hiltonsmith says these fees are where financial companies find the money to pay their expenses. "[T]hat's a bad thing," he says, "because [the fees] can have a really big effect on whether you end up with a decent-sized nest egg or, you know, are looking at it in horror at age 65 or 67."

All the risks fall on the individual, Hiltonsmith says. "Now," he says, "you can work as potentially hard as possible and play by the rules and still not be able to retire with some dignity."

TERRY GROSS, HOST:

This is FRESH AIR. I'm Terry Gross. If you're worried about how you're going to afford to retire, whether that's in the next few years or the next few decades, this interview is unlikely to make you more optimistic, but you'll probably learn a few things you didn't know about personal retirement accounts like 401(k)s.

For example, did you know that you pay fees to the financial services company that manages your retirement account? And those fees can add up to a lot of money without you even realizing it. My guest, Robert Hiltonsmith, is a policy analyst at Demos, a public policy research organization. He provides research and analysis on retirement security, tax policy, health care and the labor market.

You may have seen him on the recent PBS "Frontline" edition called "The Retirement Gamble." Robert Hiltonsmith, welcome to FRESH AIR. Before we talk about some of the things most people don't know about their own 401(k)s, may I ask: How old are you?

ROBERT HILTONSMITH: I am 31 years old, Terry.

GROSS: Most people aren't thinking about retirement at your age, and people who are contributing to retirement funds at your age usually are trying to contribute as little as possible. So what got you so interested in learning about 401(k)s and retirement options?

HILTONSMITH: Well, I have noticed a lot of people my age, it isn't exactly the first topic that draws them, even people who get into economics, you know. But I think it was a pretty natural draw for me. You know, my grandparents actually never went to college, worked hard their whole lives, my father's parents this is, and retired honestly to a pretty meager retirement.
They had Social Security, which is great, and it was wonderful, but that was basically all they had. My dad was the first person in his family to go to college, actually got a Ph.D., now is about to retire and is hopefully going to get to retire with at least some measure of comfort. And so just seeing what's supposed to be part of the American dream, you know, or the American middle class being able to work hard and then retire with some measure of comfort and then seeing - looking at myself and my generation and worrying about that, all of a sudden I was like, you know, people don't talk about this enough, but they should be.

GROSS: So let's start with the basics, with 401(k)s. I'm not going to assume that everybody knows what they are. I want you to explain what a 401(k) is.

HILTONSMITH: Sure, no, I think it is an often confusing topic, which is part of the problem with it, honestly. So 401(k)s are one type of these individual accounts, 403(b)s, 457s, IRAs, they're all in the same kind of class. And what they all are is, like, individual retirement savings accounts where you or your employer, sometimes if you're lucky enough, can put money every paycheck or every year into it, and it's invested in some kind of stocks, bonds, assets.
And then when you're hoping to retire, you have what you and your employer have put into it. And this is, you know, in contrast to the traditional pension, which is what my parents and previous generations had, which really promised a kind of set benefit for a number of years of service. So you work 30 years, and you get X amount, right, versus the 401(k), where you get out what you put in.

GROSS: Plus any profits from the stock market because usually in a 401(k) or any of these other plans, you're investing in a mutual fund, and if the fund goes up, you've got more money, but of course if the market tanks and your fund goes down, you've lost money, you've lost money that you put away in your retirement account.

HILTONSMITH: Right, and that's indeed one of the major problems with them and one of the real drawbacks to them when compared to these traditional pensions, right. And we've seen the weaknesses of that in the past, you know, several years especially but past 10 years really. You know, people have been looking at their 401(k) statements, those of whom are brave enough to open them even, as I am even myself not sometimes, you know, and seeing, geez, this thing isn't really going up at all, or it's going way down, you know, and that's a - that's really one of kind of the drawbacks to them is that, you know, you are completely dependent on these financial markets, which as you know can be pretty opaque and a scary place to have your money these days.

GROSS: Most people don't know that there are fees involved with their 401(k)s. What are these fees? Because there's different kinds of fees that your money in your retirement account might be subject to.

HILTONSMITH: Right, no, there are indeed many types of fees, and there's a good reason that people don't know that they pay fees because when you open up your statement, there's not a table right there in front of you, or there wasn't especially before some recent reforms, you know, just saying here's the fees and here's what you paid. Or it's not like as part of your statement you see OK here's your returns and then minus the fees. They are pretty hidden. But there are indeed on every account lots of different fees that you pay for investment management, for account bookkeeping, for the advertising of the Fidelity or E*TRADE advertisements you see on TV. You pay for all of those costs because for these mutual funds and other financial companies, that's the only place they get their revenue from is from you, is from the assets you've entrusted to them.
So there's actually a huge myriad of them, but they are really hidden, unfortunately, and that's a bad thing because they can have a really big effect on whether you end up with a decent sized nest egg or are looking at it in horror at age 65 or 67 or whatever.

GROSS: So are these fees like flat fees, or are they a percentage of everything that you have in your account, or are they a percentage of what you've earned that year in profits? How are they calculated?

HILTONSMITH: Well, in some ways it might be more appropriate if they're a percentage of the profits, since that's what we're giving our money over to these mutual funds and companies for, right, is to actually earn us a return. But unfortunately they actually area percentage of what your total assets, what you actually have, your total account balance.
So, you know, these fees are bundled, and if you dig deep into these documents, they're kind of summarized under this expense ratio, though there are actually more fees than that, and the expense ratio might be one percent, for example. So every year you pay one percent of everything you've got in your retirement account.
So if you've got $50,000, you pay one percent of that or 500 bucks.

GROSS: So if you have $50,000, and you pay 500 bucks in one year, I mean that's a lot, but how does that change over all the years that you're working, say over 30 years or 25 years or more?

HILTONSMITH: Exactly and that's where these fees really add up because you might think oh, I paid 500 bucks, well that's a lot, but it's not that much. But really you pay 500 bucks this year when you're 30 or 35, and that $500 that you paid, if you hadn't had to pay it, would have been sitting in your account hopefully accumulating returns and would have turned into much more than that by the time you got to retirement age.
So that's the real hidden part of these fees. Not only are they not out there and up front, but you don't really realize how much they can cost you over a lifetime.

GROSS: So let me see if I understand this correctly. So say I have $50,000 in my retirement account, and I've paid a one percent fee on that this year, $500. Next year, I have $52,000 in my retirement account. I'm going to have to pay that one percent fee again not only on the extra $2,000, but on the $50,000 that I paid one percent on last year, right...

HILTONSMITH: That's exactly right.

GROSS: I'm paying one percent on that same money every year that it's in the account.

HILTONSMITH: That's a really good way to think of it actually. You pay that fee on what is in essence the same $50,000 base over and over and over and over again. And not only do you pay that on that same base, but remember that $500 that you paid let's say that first year, if you hadn't had to pay it, it would have been sitting in your account, and that $500 would have turned into $1,000 or $2,000.
So it really just kind of spirals when you try to think about how much you've really paid over a lifetime. It really - you really get some kind of shocking numbers when you try to make that kind of calculation.

GROSS: What are some of the shocking numbers you came up with?

HILTONSMITH: Well in my report that I did on fees, I basically found that using some average fee numbers that I get from the industry, you could pay as much as 30 percent, basically, of your account in fees. So this means that if there had been no fees, your account is 30 percent lower than it would have been at retirement, right, if there had been no fees.
The upshot is this one percent turns into this 30 percent is kind of the magic of the - or not magic but the bad part about how this actually works out.

GROSS: So as shocking as that might sound, isn't that the way it also works for private investors in mutual funds or working through a stockbroker? I mean, you pay a fee for you money to be handled by a broker or by a mutual fund, right?

HILTONSMITH: It certainly is, you know, whether you're a private investor or an institutional investor like a pension fund, or, you know, you're investing a hedge fund, any of these things, right, you're exactly right. You pay fees on any of these transactions. But the part about it that's shocking or frustrating, I guess, is that you really don't need to be paying fees this high to get decent returns.
But because of the structure of the market and of 401(k)s as they are, you kind of get locked into paying these kind of fees when you really shouldn't have to be to get a decent return.

GROSS: Why don't I need to be paying fees that high?

HILTONSMITH: Well, so, I mean, the first thing, the easiest example, is index funds. An index fund like Vanguard, who may be the most famous company that they built their whole model on offering index funds, you can get the stock market average returns, six or seven or eight percent a year, and only pay a small fraction of what you would in fees as if you had put that money in what they refer to as actively managed funds or these other kind of funds where people, instead of just tracking like the S&P 500, they actually try to beat the market, these active managers.
So that's the issue. Most of the funds out there are actively managed funds, so you end up paying more than you need to.

GROSS: So just to clarify, an index fund is what?

HILTONSMITH: An index fund is basically, it's what the name says. It's a fund that the only investment strategy is to track a particular index. So the S&P 500 index is maybe one of the most famous ones, and that's the 500 biggest companies in the United States, right, the stocks of those companies. And so the managers of these funds, all they do is buy and sell shares just to match what this S&P 500 index did that day. So they're literally just tracking the market is another way to put it.
And so if you're invested in one of these index funds, you rise as the market rises, and you fall just as the market falls.

GROSS: And the other funds are based on the assumption that a good financial expert can beat the market and do better than the index fund would.

HILTONSMITH: Exactly, and unfortunately evidence has proven that that's just not the case, that in fact very few people beat the market consistently over time, and there's a good reason for that: because they're the ones also making the market. So if they beat the market consistently, then the market would be higher or lower, right. I mean, the market would be higher, it wouldn't be the market.
It's kind of part of the structure of the market. They can't beat the market consistently or else everyone would be doing what they're doing.

GROSS: If you're just joining us, my guest is Robert Hiltonsmith, and he is a policy analyst at the think tank Demos, and he, his specialty is retirement security, but he's also written about tax policy, fiscal policy, health care, the labor market, education. Robert, let's take a short break here, and then we'll talk some more about the ins and outs of retirement accounts and some of the things we should know, OK?

HILTONSMITH: Great.

GROSS: This is FRESH AIR.
(SOUNDBITE OF MUSIC)
GROSS: If you're just joining us, my guest is Robert Hiltonsmith, who is a policy analyst at the think-tank Demos, and we're talking about one of his areas of expertise, which is retirement security, and we're focusing in on 401(k)s and some of the things you might not know about your retirement plan.
So let's get back to fees. When you were looking to find the fees on your statement, and I should mention that as of last July there's a regulation that says the fees have to be included on your statement. Before we get to how they're included, before they were included, when you were looking to find your fees, what did you have to do to find out what the charges were?

HILTONSMITH: Well, it was a lot more digging than I thought it would be initially. I had to go into my 401(k)'s website online portal, and you had to go through a ton of layers and dig down deep into kind of a plan document statement and then go on to page 15 or something of that, and finally there was a table with all the funds in the plan. And then there's one little lonely column that said exp ratio.
And if you did a little more digging, you found out the exp ratio was expense ratio, which is most of the fees, investment management, marketing and stuff, all kind of lumped into one. I was kind of surprised myself how much digging you had to do because you couldn't find it just on your statement or as you would think, like, with a bank account it would say minus 500 for fees.
Like when you have an ATM fee, it says minus two dollars or whatever, right. You know, that wasn't the case and still isn't the case, actually.

GROSS: Well, ever since last July it's mandated that a 401(k) or another retirement plan has to tell you about the fees that you're paying, but how do they have to tell you? Is it easy to find?

HILTONSMITH: Unfortunately, again this is just my experience from talking with a lot of people, but all the people I've talked to, it generally has not been easy to find. Unfortunately, it's not too much of an improvement over the old thing. At least now, mostly there's a table of these fees in your quarterly statement if you open it up, though unfortunately I've found that a lot of people, myself included, still aren't even seeing that table, which is I guess another story itself.
But generally now if you open your quarterly statement, somewhere there'll be a table that says - saying here's what you've invested in, and here's the fees you paid on those investments this year, this quarter maybe more appropriately. But that table could be on page one of the statement, or it could be on page 24 of the statement. There's no real standardization or even how that table appears or shows up.
So unfortunately, it's only a little improvement from the situation that I found when I was looking into this.

GROSS: So we were talking about the fees in 401(k) mutual funds, and you were mentioning that some people advocate index funds, and these are funds that are basically created to just mirror what, say, the S&P 500 does. So if the S&P 500 goes up, you've gone up, if it goes down, you've gone down. What do you think are some of the pros and cons of putting your money in an index fund? The fees are going to be lower, so that's a plus.

HILTONSMITH: Right, the major plus is the fees are lower, and over time that should translate actually into higher returns for you, and it's kind of proven that it does. But the negatives, of course, is that you are still a creature of the stock market, so to say. You rise with the market, and you fall with the market.
So for example in 2008, even if you had been invested in an index fund, you still would have lost 37 percent or, you know, about like a third of your whole balance, basically. So it's better, you know, the index funds are better in that you should be getting higher returns and paying lower fees to get those returns, but you still have to deal with this real uncertainty, which is one of the many fundamental flaws of 401(k)s.

GROSS: In the pension era, when, you know, many workers had a guaranteed pension, there was somebody at the company who managed the money, and you were guaranteed a certain amount. You didn't have to worry about which funds it was being invested in or any of that. And now the individual worker has to make very complex investing decisions about which fund they're going to put their money in and whether it's going to be an index fund or not.
And it, I don't know what these funds are when I look at them.

HILTONSMITH: I don't either.
(LAUGHTER)

GROSS: And I not only don't have the time to do the research, I wouldn't understand it even if I did. I'm not at all convinced that unless I kind of went back to college...
(LAUGHTER)
GROSS: You know, that I'd really understand the difference between one fund and another and be able to figure out which fund was going to bring me the biggest returns from my money. So there's this idea that choice is a really great option, and we have choices, you know, many of us workers, in what we're going to put our retirement money in. But was the premise also that we'd understand the choices that we have before us?

HILTONSMITH: That's exactly right, Terry, and that's a really great way to put it. That's exactly what this arrangement, you know, this 401(k) would require for it actually to work for people, right, is that we would indeed all have to be literally financial experts on the side of our regular jobs, you know, and have to understand these things inside and out.
And even then, actually, there's only so far that would get us, right, because you've got a list of mutual funds, and you can look at OK, here's how it did in the past year or five years or 10 years, and you can know the fees and do all this stuff. But you don't - you still fundamentally don't know what's going to happen in the next few years, right.
You can say oh, well, this one did the best in the past 10 years. Well, unfortunately there's research showing that sometimes the funds that did best in the past couple years do the worst in the next couple years, right, exactly the opposite of what you would think, kind of a correction, almost, in a sense.
So it's really a losing battle, a losing proposition for all of us, and that's really exactly one of the problems with these things, that even if everyone were as educated as possible, and a lot of people say oh, you know, we just need to - people just need to be more financially educated, no that's not going to fix things.
You know, we - the fundamental problem is that we're on our own, and all the risk is being of retirement, you know, whether it's this risk of the market going up and down or picking the wrong investments or even outliving our savings. The risk is all on us.

GROSS: I think most of the investment companies that have 401(k)s and other retirement funds also have financial experts who can offer you advice in person or, you know, on their toll-free number. But you've pointed out they're not fiduciaries, they're financial advisors. What's the difference, and why does that matter?

HILTONSMITH: That's right, and that's another one of the big problems with this. A fiduciary is someone who is legally bound to act in their client's best interest, right, and the vast majority of financial representatives are not fiduciaries. What this means is saying they're not fiduciaries means they are not obligated to act in your best interest. Their job is to maximize the returns and the shareholder profits for their companies, right.

So in one sense they actually have an incentive to steer you to the highest fee funds because those are the funds that bring them the most money, and that's kind of one of the unfortunate things about this arrangement is that they're not required to act in your best interest.
But that doesn't mean that there aren't a lot of them out there who nonetheless are still acting in their clients' best interests. You know, there are plenty of people who really do believe their duty is to serve their clients as well as possible. But unfortunately that is not always the case, right. There are many cases where people are out there really just to maximize their own or their company's return, and that's really one of the problems of the system.
So you're saying you have to be on your guard, that if the person you're consulting with isn't, you know, a fiduciary representative, if they're just a financial representative, you want to make sure that they're not just selling you a vehicle because it has a high fee, and the company's going to make more profit.
Right, exactly. That's one of the difficult parts of this whole transaction is if they're not a fiduciary, exactly right, you do have to do your best to ascertain how much they're acting in your best interest or if they are at all, and that can sometimes be difficult to figure out.

GROSS: Robert Hiltonsmith will talk more about retirement accounts in the second half of the show. He's a policy analyst at the public policy organization Demos. I'm Terry Gross, and this is FRESH AIR.
(SOUNDBITE OF MUSIC)
GROSS: This is FRESH AIR. I'm Terry Gross. We're talking about personal retirement accounts with Robert Hiltonsmith, a policy analyst who has written about retirement security and other economic issues for the public policy organization Demos.
If you have a 401(k), you probably have to make complicated decisions about which funds to put your money in. Your employer has to make a difficult decision too, which financial services company to go with to manage employees' retirement accounts.
How does an employer go about shopping for a company? And do those companies, you know, try to entice employers to sign up with them?

HILTONSMITH: They do indeed. In fact, we've been going through this process at Demos recently.

GROSS: Looking for a 401(k) company?

HILTONSMITH: A new 401(k) company. Yeah, to switch over from our old one. That was actually, I'll tell you, on the first day that I started at Demos, I, you know, even though I didn't know that much about retirement at the time, I knew a few companies out there that I thought were better companies and we weren't with one of those. And so the first day I was there, I wrote down: goal, switch Demos' 401(k) over to this. So we've been going through that, you know, you take bids and presentations from different companies, so they all come and a bunch of people in suits come and try to tell you why their plan is the best and they have a big fancy glossy book that has dozens of pages, information in there, and 300 million different fees. If you want to talk about fees, expense ratios are one of them. There are a million more different fees especially employers have to think about. And that's exactly what happens. And unfortunately, like in an organization like Demos, we only have about 40, 45 people working for us and there's no one who works full-time on retirement who is like an HR manager or benefits manager, so it's really down to me and a couple of others to sit down with these and try to decipher which is the best bid. And it can be pretty daunting because you're like, well, this one looks better than this one way, but this one has lower fees, but this one has these funds in it, and it's a really daunting process. But unfortunately employers are exactly the ones who are legally obligated to pick the best plan, right, they are the fiduciaries. So it's not the investment advisers, it's actually employers who are legally obligated to provide the lowest fee, best return plan. And in fact, we've seen some lawsuits recently when employers failed to do that - Wal-Mart potentially most notably.

GROSS: What were they sued for?

HILTONSMITH: For failing in their fiduciary duty, right, for having a bad 401(k). They had to pay back to the people in their 401(k)s because they had high fees or poor returns or both.

GROSS: So your employer has a fiduciary responsibility to choose the best plan possible. The assumption is your HR person has the capability of choosing the best plan possible
.
HILTONSMITH: Right. Exactly. So, but yeah, I mean in many cases - especially with small businesses - this isn't the case. Again, to go back to Demos' example, the people sitting there choosing were me, the director of administration, who is a wonderful and awesomely capable person but wears 500 different hats, you know. I studied it obviously some, but even I don't certainly know all the ins and outs of it and so, I mean especially with small businesses it can really basically be an impossible task.

GROSS: So we've been talking about some of the problems with 401(k)s. It's a fairly new development in retirement, you know, in retirement law. Congress passed a law creating 401(k)s in 1978.

HILTONSMITH: Mm-hmm.

GROSS: What was the motivation back then? Can you take us back to 1978?

HILTONSMITH: So Congress passed a law. It was actually part of a tax bill that was passed. The motivation was basically the IRS came to Congress and said we want a way to better tax executive bonuses, because right now at that point bonuses were getting taxed at this very low rate and, you know, their regular tax rate was really high. So they came up with this idea that you could set aside a portion of your compensation as deferred compensation and you wouldn't pay taxes on it now but you'd pay taxes on it later. But when you pay taxes later, it would be taxed as regular income, not as this bonus income. And that's actually why they created these things, was literally to try to tax high paid executives. But because of certain nondiscrimination laws, they actually had to open up these plans, these vehicles, to everybody in the company, they couldn't just offer them to the executives. And then some very smart people realized, hey, you know, we could sell these as retirement plans and even as alternatives to a traditional pension, and that's exactly what happened throughout the '80s and '90s - especially as the economy was changing, old firms were closing, new ones were opening, when they sold these things, says hey, this is a better option than the traditional pension. And it is a better option for employers, they don't have to take nearly as much of the risk as they did.

GROSS: What kind of risk do employers take on when they have a pension fund?

HILTONSMITH: Almost all of it.

GROSS: Because they're obligated to pay you a certain amount whether the stock market is doing well or not.

HILTONSMITH: Exactly. And that's unfortunately some of the - when we've seen pensions, the pensions that are left in the news recently, that's what we've seen when the financial crash happened. A lot of them became underfunded, though it's a much more complex story than that. But basically, when there's been cases that ruled literally when you sign your initial contract with the employer, they are obligated to pay you the pension that is part of that contract no matter what. So even from day one, as you start accruing credit, they are obligated to pay that regardless of what happens in the future with investment returns and with their own profits and everything. So, you know, there are some ways in which it could be a pretty difficult arrangement for employers in some ways, you know, because they promised this big chunk of money without really knowing what was going to happen with their own finances or with the market and, you know, that did cause some problems.

GROSS: Was there a lot of lobbying in 1978 to pass this law creating 401(k)s? And if so, who was doing the lobbying?

HILTONSMITH: There was almost no lobbying back then. This thing almost passed unnoticed and it really wasn't till the mid-'80s that people almost even began noticing this provision existed. First, the people who were going around selling these plans were selling them as supplemental plans. You're selling on top of your traditional pension where your employees, particularly your higher paid employees, can save. And then it wasn't till the mid-'80s - or even early '90s -that a lot of companies started realizing, hey, we can actually use these things instead of traditional pensions. So what happens is the original thing passed almost unnoticed, but then there had been a ton of revisions in the year since, right. There's actually been a lot of tightening of rules and scrutiny with traditional pensions and continued loosening of the rules around 401(k)s and expansion of them. So once people kind of realized what these things could be used for, then there was a lot of lobbying on both sides to really make these things into these, the primary plans that we see today.

GROSS: If you're just joining us, we're talking about retirement security. It's one of the areas of expertise of my guest Robert Hiltonsmith who is a policy analyst with the think tank Demos.
You are part of a coalition called Retirement USA...

HILTONSMITH: Mm-hmm.

GROSS: ...that's concerned about inadequacies with the country's private retirement system, and Retirement USA is proposing an alternative. Give us some of the highlights of the alternative this coalition has proposed.

HILTONSMITH: There's been two ideas that have been proposed. One, of course, has been proposed for many years - which is just to expand Social Security. But as you know, that given the current climate, doing something like that would be a difficult proposition - to say the least - when mostly we're talking about Social Security cuts. So instead the coalition has come up with this plan that basically is to create an individual account that is administered by a state or by the federal government but is privately managed, right, that all the funds are invested in the private market. It's kind of a hybrid, a compromise between a traditional pension and a 401(k), right, in that it is an individual account, you know, you do - at retirement you get out what you put in and, you know, what you and your employer put in in the returns, but instead of having all these options, the funds are pooled and invested as a pool and the professional investment managers do the investing. And at retirement there's an option to kind of covert your lump sum into an annuity, a lifetime stream of income, something that kind of resembles traditional pensions. So it's kind of a hybrid between these two and one we think is a fair compromise, given the state of the U.S. economy and also the needs of individuals.

GROSS: You write that it's going to be harder for younger workers to retire comfortably than it's going to be for baby boomers. So why do you think, you know, that, you know, Gen Xers and Millennials are going to have a more difficult time retiring?

HILTONSMITH: There is a ton of reasons wrapped up in there. Everything from the stagnation of wages that we've seen, you know, wages and salaries are pretty much, have been flat for a long time, basically except for mostly very highly educated workers, and even they haven't seen much of a rise. You know, a lot of costs are increasing at the same time. We know that health care costs at least up until recently were spiraling out of control. And then couple that with, you know, specifically the demise of the traditional pension. A lot of baby boomers still had these traditional pensions and not that many Gen Xers and very few Millennials are going to have these traditional pensions. So that coupled with also, you know, threats to Social Security, the potential that it could be cut some and the potential that we might get less in Social Security benefits than our parents or previous generations did, that all of those things and others could combine to really make it a pretty difficult proposition to retire.

GROSS: Robert Hiltonsmith, thanks so much for talking with us.

HILTONSMITH: Well, thanks very much for having me on, Terry. It was really a pleasure.

GROSS: Robert Hiltonsmith is a policy analyst at the public policy organization Demos. You'll find links to a couple of his papers about retirement on our website, freshair.npr.org.

Posted on 6:31 AM | Categories:

Why I Rolled Over My 401(k) to an IRA

Joe Udo for US News World Report writes:  Last year, I left my corporate job and rolled my 401(k) over to an IRA. This was a great decision for me because the stock market did tremendously well over that period. When you retire, you need to figure out whether or not you should roll over your 401(k) to an IRA. There are pros and cons to both options, and every plan is different.  It can be beneficial to leave your money in your 401(k) plan. Here are some of the reasons you might want to keep your retirement savings in your former employer’s plan:


Low-cost funds. If your previous employer has a good plan and you are happy with the investment choices, then it might be a good idea to leave your money where it is. Many 401(k) plans have access to ultra low cost institutional funds that may not be available to individual investors.
Lawsuit protection. Your 401(k) plan is protected from most lawsuits by federal law, but IRAs are protected by state laws. You need to check with your attorney regarding the kind of protection your state provides.
Access. If you need to access your funds before you are 59 1/2, then it’s probably better to borrow it from your 401(k). Tapping your IRA could cause you to incur a 10 percent penalty, or you’ll need to set up 72(t) distributions. Check with your 401(k) plan to see if you have the option to borrow from it. If you leave your job between ages 55 and 59 1/2 you can take penalty-free withdrawals from your 401(k), but not IRA.
In my case, I wasn’t concerned about any of the above, so Irolled over my 401(k) to an IRA. Here are some compelling reasons why I did so:
Full control. The employer contribution portion of my prior 401(k) plan could only be invested in a private hedge fund. The hedge fund is pretty conservative, and I want to be more aggressive. The employee contributed portion could be invested in a few more funds, but the choices were still limited. After I rolled over to an IRA, I was able to invest in Vanguard funds and other stocks I prefer. As I mentioned above, the stock market did very well recently and my portfolio benefited from being invested more aggressively.
401(k) fees. Your 401(k) plan has expenses including administrative and record-keeping fees. In 2012, the average 401(k) expense was around 1 percent for large companies. I have to pay trading fees in my IRA account, but they are a lot lower than 1 percent.
Access. If you are older than 59 1/2, then it will be easier to withdraw money from an IRA. The withdrawal rules for each 401(k) plan vary widely, so you need to check with the plan. I’m not planning to withdraw any money until I’m in my 60’s, so access isn’t a big deal right now.
Estate-planning benefit. Your beneficiaries can take tax-deferred IRA distributions over their lifetimes and pay lower taxes. Most 401(k) plans will pay out in a lump sum, and your kids will pay a lot of tax the following April.
Consolidation. It’s easier to manage all your investments from one account. These days, we change employers frequently and it could be difficult to keep track of all your 401(k) plans from previous employers.
The main reason why I rolled over my 401(k) to an IRA is because I wanted to have full control of my retirement portfolio. I like being a self-directed investor, and it’s great to have more choices. I was able to buy low-fee index funds and reduce my $1,754.61 per year investment costs to less than $1,000. I also picked up a few individual stocks that I liked, and they did very well also.
If you decide to roll over your 401(k), be sure to follow the strict rollover rule. Ask your 401(k) plan administrator to transfer the money directly to your new IRA plan. If you get a check in your name, income tax will be withheld and it will complicate the transfer. As always, you should consult a professional if you have questions or need assistance.
Posted on 6:19 AM | Categories:

The Strategic Benefits Of ETFs / These vehicles must be transparent, tax efficient, and low cost.

Maureen Nevin Duffy for Financial Advisor writes: The ever-expanding number of exchange-traded funds attract more financial advisors each year––54 percent reported using them in 2011 versus 45 percent in 2010, according to Cerulli Associates. [Data for 2012 won’t be available until later this year.]


Despite their growing popularity among advisors and the general investing public, a lot still is not understood about ETFs, says Robert Gregov, founder and president of Roche Financial Partners, an RIA based in Princeton, N.J.
“Even now when I present a model [to clients] and say that I use exchange-traded funds to execute it, I get some confused looks,” he says. “People still are learning about ETFs and that is true among RIAs, too.”
For example, he notes, even though expense ratios for ETFs have dropped dramatically, advisors and clients still need to monitor brokerage costs and understand market pricing.
Gregov recently shared observations with two other industry principals during a webinar entitled “How You Can Benefit from the Growing Use of ETFs,” sponsored by Interactive Data, a financial data and market services company. Portfolio allocation, liquidity and price were among the topics covered during the one-hour session.
“Advisors do look at volume when choosing an ETF,” said Ugo Egbunike, a senior ETF specialist for Index Universe, an ETF news and research provider. “More important, though, is the bid/ask spread of the ETF versus the underlying securities.” He mentioned an article last year in The Wall St. Journal that said investors should consider the total entry and exit cost for holding an ETF for a full year.
Gregov said his shop compares the bid/ask spread of both the fund's holdings and the underlying stocks. “We also like to see some volume in a fund,” he noted. “You could say the bid/ask is an indication of the underlying securities' liquidity. But we like to see them in conjunction with each other.”
“Sometimes a lot of the liquidity can't be seen,” said Eric Pollackov, managing director of ETF Capital Markets for Charles Schwab. There are different markets in which to execute an order, and some may be more liquid than others. Pollakov said advisors who are unsure of where to best execute an order can talk to a professional at one of Schwab's two advisor-dedicated desks.
Pricing can get complicated since ETFs may trade throughout the day at a premium or discount to their net asset value. Gregov said he’ll take this into account when he moves into and out of a fund––particularly less liquid funds in areas such as small-cap emerging market equities. “I want to be sure when buying into the fund that we ask the [fund company] why the market price is deviating from the NAV.” he explained. “It could be that the ETF always trades at premium to NAV.”
But if the trading price is volatile and always rising and falling in relation to the NAV, he said he’ll consider buying another product.  
Gregov sets the asset allocation based on the strategy he's designed to meet a portfolio's goals. Then he assumes an active management role in choosing the asset classes, which he envisions as sleeves filled with passive ETFs. These vehicles must be transparent, tax efficient, and low cost.
Gregov's team will screen ETFs and compare their index holdings against the fund's holdings. He’s mindful of tracking error, which can disappoint clients if they expect the fund to closely track its benchmark. For this reason, Gregov said he avoids actively managed funds because “active managers can't guarantee they'll be holding exactly what they say.”
Gregov said he also avoids funds with complex investment or tax strategies that are difficult for clients to understand, as well as highly leveraged ETFs that use derivatives or debt to amplify their performance against the benchmark. He considers them to be daily trading vehicles that can rack up transaction costs and push down performance.
The webinar’s takeaway is that ETFs do have some ancillary issues to consider regarding things like bid/ask spreads and liquidity, but overall they empower financial advisors to fulfill a strategic, active management role over client portfolios in a time- and cost-efficient way.
“Assuming there’s efficient tracking [of the underlying index], ETFs will typically represent the sector or strategy intended,” Gregov said.

Posted on 6:19 AM | Categories:

Where Should You Keep Your Investment Assets? / As you plan your investment strategy, don’t forget about tax planning.

Mirada Marquit for US Newsworld Report writes:  One of the things to keep in mind as you plan your investment strategy is where you want to keep your assets. Since the income from different assets is taxed differently, where you keep your money makes a difference in the long run. As you plan your investment strategy, don’t forget about tax planning.


What assets are already tax efficient?
There are some assets that are already tax efficient, at least at the federal level. These assets don’t need to be kept in a special account, since they come with built-in tax advantages. Municipal bonds are a good example. You don’t pay federal taxes on municipal bonds, so it might not make sense to keep them in a tax advantaged retirement account. It can be a “waste” of tax efficiency to keep assets that are already tax efficient in a tax advantaged retirement account.
Choose the right assets for your tax-advantaged retirement account.
Assets that are tax inefficient should be the ones in your tax advantaged retirement account. Dividend paying stocks can be great in your tax advantaged retirement account where you either pay taxes later (as with a deferred account, like a traditional IRA or 401(k)), or you pay now, contributing with after tax dollars (as with a Roth account).
When you contribute to a tax free account, like a Roth, your earnings aren't taxed. Even with a tax deferred account, you can reap the benefits of using pre-tax dollars for your contribution and boosting the efficiency of your investment. Some investors like to keep stocks, non-municipal bonds, and other assets that are costly in terms of taxes in tax advantaged retirement accounts.

Don’t forget that it’s possible to use a similar strategy with a Health Savings Account. If you are eligible for an HSA, you get a tax deduction for your contribution, and the earnings aren't taxed as long as you use the money for qualified health care expenses. (When you are 59½, you can use the HSA as a traditional IRA for nonmedical costs.)
When do you need the money?
As important as tax planning is, it’s not the only consideration you should worry about when deciding where to keep your investments. You also need to think about when you will need the money. It might be nice to keep dividend stocks in your Roth account and avoid paying taxes on your earnings, but what if you need the income from the stocks before you turn 59½?
Consider your goals for the investment proceeds. While it almost never makes sense to hold tax efficient assets in a tax advantaged account, there are times when it makes sense to keep tax inefficient assets in a nonadvantaged account. If you know you will need the money before you turn 59½ and can take retirement account distributions without penalty, keep the assets in a taxable account. If you are 30 right now, and are building an income portfolio over the next 15 years for the passive income so that you can retire early, you’ll want to keep your assets in a “regular” taxable account. You’ll still have to pay taxes on your earnings each year, but you’ll have access to your money when you need it — without having to pay the 10 percent penalty for early retirement account withdrawals.
Also, don’t forget to consider your future tax situation. If you are deciding between a Roth account and a traditional account, you want to keep your assets in a place that offers you the best deal overall. If you think that your taxes will be higher later on (either because tax rates will rise or because you will eventually enter a higher tax bracket), it can make sense to pay taxes now, at a lower rate, and avoid paying taxes on your earnings later. However, if you think your tax burden will decrease by the time you are ready to withdraw money from a retirement account, you might prefer a tax-deferred traditional account.
Think about your assets and what you want to accomplish, and consider consulting a tax professional as you decide where to keep your investments.
Posted on 6:19 AM | Categories:

How To Get The Most Out Of Hiring An Accountant

Investopedia for Forbes writes: Doing your own taxes is a personal choice. It is usually influenced by how many and what kinds of income you earn. If you work a traditional job and only invest through retirement accounts, doing your own taxes is fairly straightforward. If you have income coming in from multiple sources and qualify for non-standard deductions, then having an accountant prepare your taxes may save you much more than it costs. In this article, we’ll look at how you can get the most value when you hire an accountant.
A Second Opinion
Hiring an accountant does not get you out of thinking about your taxes. In a perfect world, your accountant would follow you around, recording and considering all your financial transactions and advising you of the tax implications on the fly. Actually, that would be a bit creepy. Fortunately, accountants generally don’t have the time or desire to stalk their clients 24/7. Instead, they depend on you to give them a complete and accurate a summary of your financial year – and preferably do so in an hour or less.
A good accountant can usually draw out the relevant information with some basic questions, but the more effort spent on the basics, the less time you have to get what you actually came for: an informed opinion on how you did with your finances from a tax perspective and advice on how to minimize your taxes going forward. So you’re first step in getting the most out of your accountant is to create an accurate and concise snapshot of your finances.
Organize, Categorize and Summarize
You need to be aware of your tax situation to get the best tax outcome. If you are running a small business or contracting, there are common deductions beyond the standard ones for the average taxpayer. This includes expenses related to your office, materials and supplies, any wages and benefits paid to employees or subcontractors, and so on. When you are preparing for your appointment with the accountant, summarize the expenses you know are deductible and make a note any that do not have a receipt. Create a spreadsheet that categorizes relevant transactions under general headings such as “Home Office Expenses” and “Entertainment” so your accountant can easily see the totals you’re claiming in each deduction category.
If you are feeling keen, you can collate existing receipts to match the deduction summary, but this will only come into play if you are audited and asked to produce proof of your deductions. Your deduction summary should give a brief description of each item and the dollar amount. “Dinner with a client, $150” for example, is likely more than enough detail from your accountant’s perspective. That said, your accountant will probably suggest that you keep a detailed record for yourself in case of audit – in the previous example, a receipt and notes of what was discussed with whom.
Go Beyond the Basics
When you are categorizing your expenses, include other expenses that may be relevant, whether or not they fit under specific deductions you’ve taken in the past. You may not be fully aware of all the deductions you qualify for, particularly when it comes to deductions for small business income, investments and so on. When you hire an accountant to do your taxes, you are asking him or her to act as the filter and make a judgment on the acceptable level of deductions in each category. So giving the accountant more information than is necessary can be useful as long as it is organized in an understandable way.
Your accountant may trim areas where you have more than a reasonable amount of deductions, but he or she can also choose to go forward with deductions even when you don’t have the receipts to back them up. This is allowed under the Cohan Rule where “other credible evidence” can be used in the case of an audit. There is no guarantee that a full deduction may be allowed to stand, but it is possible that a taxpayer may be allowed a partial deduction rather than zero following an audit. At the end of the day, your accountant will be the first to deal with any audit and has the most experience in deciding what to include and what to trim back.
Schedule a Post-Filing Follow-Up
Good accountants don’t just file papers; they build better clients through tax planning advice – although you may have to take the first step. During your initial meet-up with your accountant, make sure to schedule a follow-up appointment after the seasonal rush is over. There are two main questions to ask in the follow-up 1) where can you maximize deductions and 2) how you can improve your summary/information. The first question ensures that you are capturing all the right deductions. This is the time to ask your accountant’s opinion on the amounts you are claiming in different categories. Although you shouldn’t change your spending plans just to get more of a deduction, it is worth getting an opinion on things like spending a little more on office upgrades, or taking clients out for dinner, or adding a trade subscription to the deductions, or donating more to charity, or any of the thousand other business decisions with tax implications.
The second question is aimed squarely at improving your relationship with your accountant. Like any service business, accountants value long-term relationships with low-stress clients. By becoming an ideal client who is organized and proactive, you’ll see benefits beyond simply having someone else do your paperwork. You’ll have a true tax professional in your corner to advise you on how to minimize your overall tax burden and keep more of your money in your pocket.
In some cases, your follow-up meeting may be a formality, especially if you’ve been with the same accountant for years and have a system worked out. However, it is still worth having a yearly follow-up because the tax code changes. The sooner you are aware of changes, the sooner you can reposition yourself to the best advantage. A rule change similar to Section 179, for example, can be the decision maker for a small business considering a computer upgrade – but only if the business owner knows about it.
The Bottom Line
If you are simply looking for a way to get out of dealing with your taxes, there are lots of tax preparers and bookkeepers out there who are willing to do a plain vanilla tax filing on your behalf. To get the most out of an accountant, you need to be organized so that he or she is able to resolve last year’s taxes quickly. This will free up time for the more important task of minimizing your taxes going forward. When you hire an accountant, getting good tax advice going forward is as valuable as – or perhaps even more valuable than – getting the previous year’s taxes filed correctly.

Posted on 6:19 AM | Categories:

A tax strategy for all seasons

Linda Stern for Reuters writes: Just when you may have thought that federal tax policy was set - that January's "fiscal cliff" deal meant you could go about your financial life with multi-year certainty - Washington is again talking of comprehensive tax reform.

Both key congressional committee heads - Senate Finance chair Max Baucus, a Democrat, and Dave Camp, the Republican chair of the House Ways and Means Committee - have hinted that the impending debt-ceiling increase could be the tree upon which a new tax code hangs.

The reform they are envisioning would jettison many tax breaks and use that revenue to lower tax rates. But it's one thing to agree on a concept and another to shake hands on all the details. Virtually every line of tax code has its own constituency, a fact made evident in a 558-page summary of opinions on various tax code measures published Monday by the Joint Tax Committee (here).

That means the smart money is still betting against personal income-tax reform. The more Congress talks about it, the more those constituencies will pony up political contributions, but it's not clear whether anyone except politicians will benefit.

Taxpayers, meanwhile, have to plan their finances so they are protected under the new rules and under a radically reformed system, in the unlikely case one emerges.

Here are some ways to make the most of the income-tax system, now and later.

- Max out your tax breaks. In general, a tax deduction is worth more now than later. That is especially true if tax rates get lowered in the future, even if your specific deduction is preserved. Direct as much of your money toward those items - health savings account contributions, retirement-plan savings, charitable donations, energy-efficient appliances - that will get you the break. Note that if you earn over $250,000 ($300,000 for joint filers), your deductions will be limited, so learn how they work beforehand.

- Keep your retirement savings tax-diversified. Even if you have a tax-deferred 401(k) account, put money into a Roth Individual Retirement Account if you qualify. (You have to make under $112,000 as a single filer and under $178,000 as a couple filing jointly to contribute to a Roth.) If you make too much, you can still pay into a traditional but nondeductible IRA and then transfer the money to a Roth later. That will give you some flexibility to manage your tax hit when you get to the withdrawal stage of retirement.

- Make a multi-year charitable donation. If you normally give a set amount of money, consider doubling or tripling it this year and putting it into a donor-advised charitable fund. That will give you the donation this year but allow you to dole out the money over a few years. You can set up such a fund through one of the major investment companies like Fidelity Investments, Charles SchwabCorp, T. Rowe Price Group Inc or Vanguard. (Most community foundations - nonprofits designed to steer charitable contributions to local organizations - also will set up personal charitable funds.)

- Be careful about your investments. Several categories of investments have long benefited from special tax breaks. That includes municipal bonds, which pay interest not subject to federal taxes,life insurance policies and annuities that allow tax deferral until the money in them is used, and good old-fashioned stocks and other securities that are subject to preferential tax treatment on their gains.

All of those breaks are on the table, though their backers have been able to protect them in one round of tax revisions after another. It may make sense to sell winning stocks and take capital gains when you can, instead of carrying those gains year after year - they may be subject to higher tax rates in the future. Be more judicious about buying annuities, permanent life insurancepolicies and other insurance products that charge high fees and might not be good investments without their tax benefits. That tax deferral could disappear or become worthless (if rates fall), so if you are using insurance as an investment, make sure it performs well and has low fees.

You can stick with muni bonds for now if you are in a high tax bracket and they make sense. But watch Washington carefully to make sure all the talk doesn't turn into fast tax reform action. If it does, be prepared to switch out of munis and other tax-protected investments and into other taxable choices.
Posted on 6:18 AM | Categories:

A Rare Bird: The Tax-Efficient Alternative / Gateway enhances a long-short strategy with tax efficiency.

Philip Guziec for Morningstar writes:  Alternative investments may have appealing attributes for investors, but tax efficiency is rarely one of them. Whether the alternative strategy is attempting to arbitrage small price differences between stocks, or shorting companies in anticipation of an imminent price decline, the nature of many alternative strategies generally leads to frequent realization of short-term capital gains. As a result, alternative investments are usually best held in tax-shielded accounts. However,  Gateway (GATEX) defies the tax inefficiency stereotype of alternative funds. Here's a deep dive into how the fund developed the tax efficiency strategy and how investors can capitalize on these tax benefits.


Harvesting Losses for Tax Benefits
Gateway follows a hedged-equity strategy that uses a combination of stocks and options to give investors tax-efficient exposure to the broad stock market with less volatility. The fund holds a basket of approximately 250 stocks optimized to mirror the S&P 500 index, but with a dividend-yield tilt. To generate income, the fund sells S&P 500 Index call options, with expirations approximately 30-50 days out and strike prices approximately at-the-money, on 100% of the notional value of the stock portfolio. The fund also protects against downside losses by purchasing S&P 500 index puts, with expirations 40-60 days out and strike prices approximately 6%-10% out-of-the-money. As the net income received from the options generates short-term capital gains, management sells losing stocks to offset option income. With the fund's current strategy and under current tax laws, investors who hold shares in taxable accounts only pay tax on the qualified dividends received on the underlying stocks (minus the expense ratio of the fund), or when they sell the fund shares. Barring extreme events on the last day of the trading year that would make tax management challenging, fund management simulations predict that the fund could avoid distributing a capital gain for at least the next two decades.


The Evolution of Gateway's Tax-Optimized Strategy
Gateway wasn't always so tax-efficient. In fact, when Gateway Investment Advisers was founded in 1977 by Walter Sall and a group of Cincinnati businessmen, the strategy was decidedly tax-inefficient. At the time the fund executed a covered-call strategy on individual stocks, without the protective puts, with Peter W. Thayer as manager (he would stay with the fund until 1997). The tax inefficiency was the result of a regulation known as the "short-short rule," which prohibited mutual funds from generating more than 30% of their income on positions held for less than three months. This regulation forced Gateway to realize long-term capital gains on some of the underlying stocks (to increase the total income denominator) and to use some less-optimal, longer-dated options. At the time, however, the strategy was so lucrative that taxes and hedging were an afterthought. From 1977 until 1985, the fund continued to sell covered calls on individual stocks, but in 1985, the fund migrated to selling options on the S&P 100, as those options became sufficiently liquid, and then to the S&P 500.


Besides the covered-call strategy mutual fund, Sall and his team also ran a separate-account strategy, which hedged some of the downside risk of the covered-call strategy with purchased put options.The stock market crash of Oct. 19, 1987, validated the protective put strategy (which was up approximately 10% that year, while the mutual fund lost about 5.7%) In light of this event, the board authorized the addition of protective puts in January of 1988. From 1988 through the first quarter of 2013, the fund has returned 7.8% with a standard deviation of only 6.6%, and an alpha to the S&P 500 of 0.9 annualized (using monthly data), a track record few long-only or alternative managers can boast.

In 1997, the short-short rule was repealed, and the fund was no longer forced to sell stocks just to meet the 30% threshold. Also in 1997, portfolio manager Peter W. Thayer left the fund and J. Patrick Rogers, who had joined the fund in 1994, took the helm. Shortly afterward, a new tax headache replaced the short-short rule. During the stock market correction of 2000, the fund's option positions profited approximately 15% and used up all of the available tax loss carryforwards from previous years. The fund distributed a 9.7% capital gain to investors for tax purposes, even though the fund only returned 6.6% for the year. Needless to say, investors were unhappy. The solution came to management the next year, when the S&P 500 fell 12%. The fund once again generated approximately an 8% profit from its option positions, which partially offset the losses of the declines underlying stocks, resulting in a net 3.5% loss for the year. Like Alexander Fleming noticing that bacteria wasn't growing near the mold in one of his petri dishes, management noticed large unrealized tax losses on a small number of high-flying tech companies that had become almost worthless. Management decided to sell some of the biggest stock losers in the portfolio to offset option income without materially impacting the returns relative to the S&P 500. The fund had almost no capital gains distribution in 2001. Over the subsequent two years, management harvested some tax losses on the stocks to offset option gains and developed a tax-optimized strategy, which launched in 2004. The strategy has avoided distributing capital gains since 2001, and as of May 10, 2013, the fund has a tax loss carryforward equal to about 12% of the value of the fund. The one material risk to the tax efficiency is the impact of redemptions. If investors were to leave the fund in scale, after the tax loss carryforwards were used up and all losing shares of stock were sold, the fund would eventually have to sell underlying holdings with capital gains in order to meet the tax redemptions, generating a tax liability that would be borne by the fundholders.

Potential Tax Legislation
As evidenced by the impact of the short-short rule on the fund, the success of Gateway's strategy is dependent on securities and tax regulations. In fact, as of this writing, a legislative proposal for the tax treatment of derivatives could put the fund's tax strategy at risk. The proposal would treat all profits from option positions as ordinary income, preventing the fund from offsetting gains with losses on the underlying shares. The proposal would also treat all option positions as if they had generated a sale of the underlying security at year-end. While this proposal may proceed no further down the legislative process, its existence highlights the vulnerability of tax-efficient strategies to changes in regulation.


Putting Gateway's Tax-Efficient Strategy to Work
For now, at least, investors can take advantage of Gateway's two value propositions: superior risk-adjusted returns to the S&P 500 and tax efficiency. For most investors, the fund can be used as a low-volatility replacement for some core equity exposure. The fund targets approximately a 0.4 beta to the market, so it won't make as much money in rallies, but it won't lose much in downturns. At 0.94% for the A-shares, the fees are lower than the average large-cap long-only stock funds.

For older investors looking for income, this fund may have even more benefits. Rather than increase one's weighting to high-yielding long-only fixed-income products, which may result in large losses in the event of a credit correction or a rise in interest rates, one could allocate to a hedged-equity product such as this one.
The fund generates an SEC yield of 1.35%, and the yield can be supplemented by the sale of fund shares, which are treated as long-term capital gains if held for a year. As an estate planning vehicle, gains in the fund will compound tax-free as long as the fund can defer distributing gains, and the cost basis in the fund will step up at the time of the fundholder's death, eliminating capital gains taxes.
Finally, for closely held small businesses that retain cash in the business as a core family holding, the combination of a low-risk profile and a material return makes the fund a potentially interesting alternative for generating return with the excess cash.
In summary, the high risk-adjusted returns, limited risk profile, manageable fees, and tax efficiency makes this unique alternative fund a handy and versatile portfolio management tool.

Comments:
Comments
1-5 of 5 Comments
9 hours, 1 minutes ago
Look at the M* fund quote page for Gateway, especially the "Growth of 10K"...S&P 500 beats it by a mile in the 10-year and Maximum views.
This fund is garbage.
10 hours, 38 minutes ago
An interesting concept but I have to agree with another poster. How in the word could the author not discuss the fund's 5.75 load?
16 hours, 38 minutes ago
Eric, Hybrid funds like VWINX may have generated better risk adjusted returns, but it holds 70% in corporate bonds. You mentioned that income stocks may have been bid up lately, but what about the corporate bonds over the last 10/5/3 years? And all the duration risk? This fund only invests in stocks and uses a covered call strategy. It's really an apple vs. oranges comparison.
16 hours, 57 minutes ago
If you look at the results for 10/5/3/1 years and compare this to VWINX (Vanguard Wellesley Income Fund) you see that VWINX beats this in every time period and with less volatility (even in 2008/2009). Sure, recently the income stocks held by VWINX have been bid up, but that doesn't explain the prior periods. One big difference is the expense ratios involved (and note that this didn't even include the 5.75% load which doesn't show on the charts). Of course, these are different animals and this one might shine in a really bad crisis, but so would gold--and that doesn't make a high-gold portfolio the best idea.
16 hours, 59 minutes ago
Apologies for an argument over semantics, but it's hard for me to define Gateway as an "alternative" investment when it's returns are completely correlated to the S&P 500. They may be good or may not be good risk-adjusted returns, but they're not really an *alternative* at all.

And, when I've looked at the fund's returns in a little bit more detail, the actual performance isn't materially any different (on the basis of either total return or volatility) than if you had a portfolio that was ~45% invested in the S&P 500 and 55% invested in short-term bonds.



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Posted on 6:18 AM | Categories: