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“The bankers and Wall Street traders. Just because you showed ridiculous incompetence in lending doesn’t mean that you, and the hideously exposed like me, don’t deserve a second chance. God bless America! And its hard-working backbone! And there’s still their pensions for next time!” Joke attributed to George W Bush |
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Elderly investors are natural targets of investment scams in part because they may be more susceptible to fraud. A 2008 study by researchers at the Georgia Institute of Technology found that older adults are significantly worse than younger people at detecting whether someone who may have stolen money is telling the truth.
Investment scams are a real danger for those close to retirement and all people already in retirement. Sometimes scamsters are often represent "reputable" financial companies, sometimes they are seniors themselves. They can even live in the same community and/or attend the same church.
The most common case, though, is when they are representatives of "reputable" Wall Street firms peddling some disastrous new financial instrument, the instruments that brings high fees to the institution. If the investment it too good to be true is usually is. Stories of retirees who lost one million of more due to financial scams promoted by slick financial advisers recently became popular topic in major newspapers so the size of the phenomenon is probably substantial and those cases are more like a rule then exception. After all financial companies badly want fees and want to sell high fee product oblivious to the personal circumstances and consequences of their actions on your financial wellbeing.
In any case please understand that we cannot be all robbers, there should be some victims too and the natural balance between robbers and victims was distorted after Reagan due to reregulation and later rolling back the Great Deal. Robber barons returned and they returned in quantity that will amaze future historians. For all practical purposes 401K is taxable account, the only difference is that it is taxed by Wall Street, not the government. At some point the share of financial firms profits in S&P500 above 40%: we talk about crisis of overpopulation among robbers ;-)
| Often scamsters are seniors themselves and live in the same community and/or attend the same church. If the investment it too good to be true is usually is. Now in order to survive, many financial advisers are faced with tough choices. And that is not limited to sleazy "cold-call" financial advisors. |
The fact that retirement advice comes from a big Wall Street firm dies not guarantee that it is not a scam. For example, both Morgan Stanley and Merrill Lynch have well publicized stories which are as close to criminal as one can get. With $16 trillion in retirement accounts, baby boomers and their parents have become a prime target for scam artists who push overhyped investment returns, unsuitable annuities and Ponzi schemes. Early-retirement pitches to employees — especially those with minimal investment experience — surged as baby boomers age.
Essential steps to protect yourself from scam calls
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Also major Wall Street banks are "fraud friendly" and in case fraud was perpetrated against a senior citizen they often try to drag their investigation as collection of stolen funds is a difficult and expensive procedure. See Banks Enabling Fraud Against Retail Customers « naked capitalism for a couple of stunning examples.
Roman Berrt said: “It took the services of a lawyer to bring the bank to its senses.
[....]
The banks are not our friends. They will do only what they are forced to do, and that included complying with the law.”
Naiomi Wolf said: “…the bank’s reasonable assumption that most customers in this situation will not be able to hold them accountable. And indeed, since legal action is time-consuming and expensive, most defrauded bank customers do eventually give up and go away…”
The sad truth is that most people can’t afford legal action.
The appropriate term to describe the modern-day bank is “bully.” I’m going to pick on you. It’s not right. But there’s nothing you can do about it.
With companies eliminating traditional pensions, workers are shouldering all the responsibility for their own retirement savings. Hungry for advice, baby boomers are drawing the attention of legitimate advisers as well as scamsters. A typical scam is the fairy tail that some investment promoters tell people that they can retire and make more money than they did when they were working. So they encourage people to take money out of the company pension plan or the 401(k) and give it to them. You need not walk, you need run from such "advisers".
Even if advisers are legitimate and do not promote outright scam, they will do anything to generate fees for the firm they represent. For example they can put all your money in fixed deferred annuities that has high costs, high surrender charges and high up-front fees. Principal-Protected Notes is another nice instrument for fleecing naive baby boomers. If they Ponzi schemers or swindlers they will just spend your money. Then you're are not just fleeced, you are completely broke.
| Although individuals aged 60 or older make up just 15% of the U.S. population, they account for 30% of fraud victims |
The Financial Industry Regulatory Authority (FINRA) outlines the following 10 tips investors can use to avoid getting taken for a ride by financial sharks:
Here is one typical story from USA Today (The pitch Retire early):
Rusty Gilardi, a 24-year Chevron veteran, says he had "no savvy when it came to investments." That's why he sought investment advice in the mid-1990s for the $1 million in 401(k) and pension assets he'd built up.Through co-workers, Gilardi was introduced to Dominick Musso, a broker at Morgan Stanley. He says the broker won his trust by playing golf with him, asking about his wife and daughters and talking about his own family. Then, Gilardi says, "Dominick told me flat out, 'I can make you at least 15% (return a year); you'll never touch your principal for the rest of your life. You're set.' " --[ Note how brokers use social engineering on their victims -- NNB]
Gilardi says Musso also told him to cash out his pension because he could earn more in the stock market than from the guaranteed stream of pension income. The lure of spending more time with his family in retirement led Gilardi, then 51, to take Musso's advice. He began withdrawing $85,000 a year, about 8.5% of his portfolio value.
After the tech bubble burst and the roaring stock market tanked in 2000, Musso urged him to stay in the market, according to Gilardi, saying, "You've got to be in position for when the market comes up."
As his portfolio shrank to about one-third of its original value, Gilardi took what remained of his money to another adviser. Now, at 60, he's working full time as a helicopter pilot for a sheriff's office in Jefferson Parish, La.
"I don't know if I'll get another retirement back," says Gilardi, who, along with Lirette and dozens of other Chevron workers, has arbitration claims pending against Morgan Stanley. "I might be working for the rest of my life now."
Through Morgan Stanley, Musso, who retired from the firm in 2005, declined to comment.
But the firm, in response to Gilardi's arbitration claim, says Gilardi was provided with mutual fund prospectuses that explained the "characteristics, potential risks and expenses associated with the investments," which were made with Gilardi's "approval and consent and were fully consistent with (his) investment objectives." He also received monthly account statements detailing the investments' performance, Morgan Stanley said.
Gilardi "suffered losses of the same type and extent as the losses experienced by millions of investors during the historic market downturn that began in March 2000," the firm said.
No guarantee on returns
Morgan Stanley spokeswoman Christy Pollak says the company can't discuss individual arbitration cases because of client-confidentiality policies. However, in a written statement, she said, "None of these clients were improperly induced to retire early, nor is there any evidence that they were guaranteed a specific rate of return."
Yet a 1999 note obtained by USA TODAY, containing handwritten notes from colleagues and acquaintances — including what appears to be a message from Dominick Musso — congratulates an oil company worker on his retirement. The note includes this phrase at the top: "20% Guaranteed …! Dom."
USA TODAY couldn't independently confirm the authenticity of the note. But when asked about it, Pollak said the firm "has seen this. It's a retirement card. It's a joke. This in no way represents any guarantee about investment returns."
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May 13, 2008 | www.zerohedge.com
In medicine, they have something called the Hippocratic Oath. It requires physicians to swear to uphold certain ethical standards. In modern fund management, there is no Hippocratic Oath. Whereas doctors are expected to "First, do no harm", in modern fund management, iatrogenic illnesses hold sway. An iatrogenic illness is one that is caused by the physician himself.
Fund management doctors seem to be doing the best they can to kill their own patients. Science has a word for this, too. It's called parasite. There is a solution to all this insanity.
... ... ...
There is a solution to all this insanity.The chief investment officer of the Yale Endowment, David Swensen, has written an excellent book entitled 'Unconventional Success'.
The title is an allusion to Keynes' famous observation that fund managers, courtesy of endemic groupthink, tend to prefer (and consequently often deliver) conventional failure as opposed to unconventional success. Swensen himself has steered the Yale Endowment through many years of impressive investment returns.
Swensen pulls few punches.
The fund management industry involves the
"interaction between sophisticated, profit-seeking providers of financial services [Keynes would have called them rentiers] and naïve, return-seeking consumers of investment products.
"The drive for profits by Wall Street and the mutual fund industry overwhelms the concept of fiduciary responsibility, leading to an all too predictable outcome: except in an inconsequential number of cases where individuals succeed through unusual skill or unreliable luck, the powerful financial services industry exploits vulnerable individual investors."
The nature of ownership is crucial. To Swensen, the more mouths standing between you and your money that need to be fed, the poorer the ultimate investment return outcome is likely to be.
In a rational world, investors would be well advised to favour smaller, entrepreneurial boutiques, or private partnerships, over larger, publicly listed full service investment operations – especially subsidiaries of banks or insurance companies – with all kinds of intermediary layers craving their share of your pie.
The rather sickening fight over the bonus pool at Pimco now being gleefully reported in the financial media is just one example of a large fund management organisation that appears to have entirely forgotten what its core purpose is, or should be.
This past week, and the conjunction of the Bill Gross lawsuit and the Investment Association's Daniel Godfrey debacle, is likely to go down as one of the biggest fund management public relations disasters in history.
Before buying any fund, ask yourself some questions:
- How big is it? The tree cannot grow to the sky. But try telling that to Pimco, or to the average member of the Investment Association. Managers' pay is invariably linked to the size of funds under management. The more assets, the more pay. It takes guts, and principles, to turn money away and concentrate solely on investment performance. But that's precisely what many smaller investment boutiques do on a regular basis. And it's why we only invest with smaller investment boutiques.
- Has the manager invested his own money? If he hasn't, why should you? Meaningful personal investment is by itself no guarantee of investment outperformance, but it shows the most basic alignment of interests between manager and investor.
- Is it independent, and owner-managed? David Swensen has gone on record saying he prefers the smaller, private partnership over the larger, listed full service operator. How many mouths must your fees feed?
- Is it an asset manager, or an asset gatherer? This gets to the heart of the challenge facing investors today. The investment world is polarised between asset managers, who focus their energies on delivering the best possible returns for their clients, and asset gatherers, who just want to maximize the number of clients.
Most fund management firms fall into the latter category. Favour the former.
How to distinguish between the asset managers and the asset gatherers? Try to find managers like the celebrated investor Jean-Marie Eveillard, who once remarked:
"I would rather lose half of my shareholders than half of my shareholders' money."
The managed fund marketplace is clearly much larger than it should be. It is oversupplied, and there is insufficient genuine talent and integrity to support the grotesque number of spurious, me-too funds out there all chasing a finite pot of capital.
After a disastrous week in the spotlight, asset management companies might wish to start cutting their fund ranges before the regulators force them to. >
Muddy1Working in a brothel? Working in finance?It's the same thing. You take people's money and then they get screwed.
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May 13, 2008 | www.zerohedge.com
In medicine, they have something called the Hippocratic Oath. It requires physicians to swear to uphold certain ethical standards. In modern fund management, there is no Hippocratic Oath. Whereas doctors are expected to "First, do no harm", in modern fund management, iatrogenic illnesses hold sway. An iatrogenic illness is one that is caused by the physician himself.
Fund management doctors seem to be doing the best they can to kill their own patients. Science has a word for this, too. It's called parasite. There is a solution to all this insanity.
... ... ...
There is a solution to all this insanity.The chief investment officer of the Yale Endowment, David Swensen, has written an excellent book entitled 'Unconventional Success'.
The title is an allusion to Keynes' famous observation that fund managers, courtesy of endemic groupthink, tend to prefer (and consequently often deliver) conventional failure as opposed to unconventional success. Swensen himself has steered the Yale Endowment through many years of impressive investment returns.
Swensen pulls few punches.
The fund management industry involves the
"interaction between sophisticated, profit-seeking providers of financial services [Keynes would have called them rentiers] and naïve, return-seeking consumers of investment products.
"The drive for profits by Wall Street and the mutual fund industry overwhelms the concept of fiduciary responsibility, leading to an all too predictable outcome: except in an inconsequential number of cases where individuals succeed through unusual skill or unreliable luck, the powerful financial services industry exploits vulnerable individual investors."
The nature of ownership is crucial. To Swensen, the more mouths standing between you and your money that need to be fed, the poorer the ultimate investment return outcome is likely to be.
In a rational world, investors would be well advised to favour smaller, entrepreneurial boutiques, or private partnerships, over larger, publicly listed full service investment operations – especially subsidiaries of banks or insurance companies – with all kinds of intermediary layers craving their share of your pie.
The rather sickening fight over the bonus pool at Pimco now being gleefully reported in the financial media is just one example of a large fund management organisation that appears to have entirely forgotten what its core purpose is, or should be.
This past week, and the conjunction of the Bill Gross lawsuit and the Investment Association's Daniel Godfrey debacle, is likely to go down as one of the biggest fund management public relations disasters in history.
Before buying any fund, ask yourself some questions:
- How big is it? The tree cannot grow to the sky. But try telling that to Pimco, or to the average member of the Investment Association. Managers' pay is invariably linked to the size of funds under management. The more assets, the more pay. It takes guts, and principles, to turn money away and concentrate solely on investment performance. But that's precisely what many smaller investment boutiques do on a regular basis. And it's why we only invest with smaller investment boutiques.
- Has the manager invested his own money? If he hasn't, why should you? Meaningful personal investment is by itself no guarantee of investment outperformance, but it shows the most basic alignment of interests between manager and investor.
- Is it independent, and owner-managed? David Swensen has gone on record saying he prefers the smaller, private partnership over the larger, listed full service operator. How many mouths must your fees feed?
- Is it an asset manager, or an asset gatherer? This gets to the heart of the challenge facing investors today. The investment world is polarised between asset managers, who focus their energies on delivering the best possible returns for their clients, and asset gatherers, who just want to maximize the number of clients.
Most fund management firms fall into the latter category. Favour the former.
How to distinguish between the asset managers and the asset gatherers? Try to find managers like the celebrated investor Jean-Marie Eveillard, who once remarked:
"I would rather lose half of my shareholders than half of my shareholders' money."
The managed fund marketplace is clearly much larger than it should be. It is oversupplied, and there is insufficient genuine talent and integrity to support the grotesque number of spurious, me-too funds out there all chasing a finite pot of capital.
After a disastrous week in the spotlight, asset management companies might wish to start cutting their fund ranges before the regulators force them to. >
Muddy1Working in a brothel? Working in finance?It's the same thing. You take people's money and then they get screwed.
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A recent decision in a lengthy legal case involving two certified financial planners was hailed as a victory for consumers.A husband and wife, Jeffrey and Kimberly Camarda of Fleming Island, Fla., had been marketing themselves as "fee-only" financial planners, a term for those who charge clients a fixed rate for their services and don't earn commissions or bonuses when recommending financial products. But that wasn't true, according to the Certified Financial Planner Board of Standards, which filed a disciplinary action against the pair. It claimed that the Camardas were selling insurance products from which they earned commissions without disclosing that potential conflict of interest, a violation of CFP Board rules. Then the couple sued the board, saying they were unfairly disciplined. But in July, a judge dismissed their lawsuit.
"Some advisers use 'fee-only' for marketing purposes instead of as a pledge to their clients," says Eleanor Blayney, a consumer advocate on the board. There's no way to tell just how many financial advisers misrepresent how they're compensated, she adds. What's clear is how much working with the wrong kind of adviser can cost you. A study from the White House by the Council of Economic Advisers, published in February, estimated that financial advisers who have conflicts of interest cause $17 billion in losses every year to Americans, many of them in working and middle-class families. And that's just for those who are using IRAs to save for retirement.
Read more about how to manage your financial planning in your 40s, your 50s and your 60s.
Part of the problem is that there's no governmental regulatory body that polices all financial planners. Investment advisers and brokers who sell bonds, stocks, and other financial products must be registered with the Securities and Exchange Commission or in some cases with state regulators. There's no such oversight for financial planners, who help clients with retirement planning, estate planning, saving for college, and other matters.
The CFP Board, however, will investigate complaints it receives or violations the organization uncovers itself. It can suspend or revoke the use of the certified financial planner designation, but it can't stop financial planners from giving advice.
The best line of defense against unscrupulous planners is to educate yourself. That can be confusing at first, because there are more than 150 designations for financial planners. But many of the titles are dubious; they can be earned after just a few hours of study and an open-book test. Adding to the confusion is that many suspect designations sound similar to legitimate ones.
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May 11, 2015 | FINRA.org
Even if you have never been subjected to an investment fraudster's sales pitch, you probably know someone who has. Following the legendary Willie Sutton principle, fraudsters tend to go "where the money is"-and that means targeting older Americans who are nearing or already in retirement.
Financial fraudsters tend to go after people who are college-educated, optimistic and self-reliant. They also target those with higher incomes and financial knowledge, and have had a recent health or financial change. If you believe you've been defrauded or treated unfairly by a securities professional or firm, file a complaint. If you suspect that someone you know has been taken in by a scam, send a tip.
To entice you to invest, fraudsters use high pressure and a number of "tricks of the trade." Here are some common tactics:
- The "Phantom Riches" Tactic-dangling the prospect of wealth, enticing you with something you want but can't have. "These gas wells are guaranteed to produce $6,800 a month in income."
- The "Source Credibility" Tactic-trying to build credibility by claiming to be with a reputable firm or to have a special credential or experience. "Believe me, as a senior vice president of XYZ Firm, I would never sell an investment that doesn't produce."
- The "Social Consensus" Tactic-leading you to believe that other savvy investors have already invested. "This is how ___ got his start. I know it's a lot of money, but I'm in-and so is my mom and half her church-and it's worth every dime."
- The "Reciprocity" Tactic-offering to do a small favor for you in return for a big favor. "I'll give you a break on my commission if you buy now-half off."
- The "Scarcity" Tactic-creating a false sense of urgency by claiming limited supply. "There are only two units left, so I'd sign today if I were you."
Protect yourself with these strategies:
- End the conversation. Practice saying "No." Simply say, "I'm sorry, I'm not interested. Thank you." Let them know you'll think about it and get back to them. Have an exit strategy so you can leave the conversation if the pressure rises.
- Turn the tables and ask questions. Before you give out information about yourself, ask and check.
- Talk to someone before investing. Be extremely skeptical if the salesperson says, "Don't tell anyone else about this special deal!" A legitimate professional will not ask you to keep secrets. Even if the seller and the investment are registered, discuss your decision first with a family member, investment professional, lawyer or accountant.
- Take your name off solicitation lists. To reduce the number of sales pitches you receive, use the Federal Trade Commission's National Do Not Call Registry.
FINRA offers an array of information and resources to help you outsmart investment fraud.
- Red Flags of Fraud
Knowing the important warning signs of financial fraud puts you in charge.- Ask and Check
Ask the right questions and verify the answers before you work with an investment professional or buy an investment product.- How Social Pressure Cost One Family $30,000
It's often hard to resist an investment tip from someone in your social circle. Before handing over any money, you need to check out the investment and the person selling it.- Spot a Scam in 6 Steps
Financial fraudsters use sophisticated and effective tactics to get people to part with their money. Here are six steps you can take to help you spot an investment scam.- Investor Alerts
Don't be taken in by these frauds and scams. Learn how to protect yourself and your money.More
- Risk Meter
Use our Risk Meter to see whether you share characteristics and behavior traits that have been shown to make some investors vulnerable to investment fraud.- Scam Meter
In just four questions our Scam Meter will help you tell if an investment you are thinking about might be a scam.
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Bloomberg
While retirees can generally leave their savings in 401(k) plans, financial firms entice them with cold calls, Internet ads, storefront signs and cash incentives to switch to IRAs. They tout the advantage of the IRA's wide variety of investment choices over the typical 401(k) plan's limited menu.Yet that appeal can also be a pitfall for retirees offered expensive and high-risk investments. IRAs often charge higher fees than those associated with 401(k) plans, giving brokers an incentive to promote rollovers.
"You're going into the wild, wild west when you take your money out of a 401(k) and put it into an IRA," said Karen Friedman, executive vice president and policy director of the Pension Rights Center, a Washington-based group representing retirees.
Tarr's clients paid higher fees in their brokerage accounts than they would have in their AT&T plan. There's no way of knowing exactly how they would have fared if they had left their savings behind. Employees in 401(k) plans, including AT&T's, also faced losses during the 2008 financial crisis, though the market has since rebounded to reach new highs.
Tarr, who left Royal Alliance in 2010, stands by her advice, saying the investments held up well in a difficult market. She said she didn't even know about the commissions each investment paid and wanted to do what was best for her clients.
'Forever Besmirched'
In a more than two-hour interview, Tarr said she often tried to talk customers out of rolling over their pensions, but that many were eager to have the lump sum to generate higher returns and leave money to their children. She always made clear that she worked for Royal Alliance, not AT&T, she said.
"I am forever besmirched, and that is really hard for me," said Tarr, fighting back tears. "I am a minister's daughter and granddaughter. If anyone thinks I would do anything illegal, immoral or unethical, that hurts me where I live."
Tarr's strategy of focusing on one big company isn't unusual. A broker for another AIG unit, FSC Securities Corp., cold-called employees of UPS (UPS), the world's largest package-delivery company, in the area around its headquarters in Atlanta, according to a June 2013 complaint. Nine customers, including six UPS employees, lost more than $1 million when broker Brian G. Brown rolled over their retirement money into high-risk investments, including oil and gas private placements, they said.
Experienced Customers
AIG, based in New York, declined to comment on the complaint against FSC. In a filing responding to the allegations, FSC said most of the customers were multi-millionaires "with decades of investing experience" who understood the risks.
Brown left FSC in 2010 and works for another brokerage company in Atlanta.
The complaint "hasn't been arbitrated, and all of it is not true," he said in a telephone interview.
Federal regulators are targeting rollover abuse. Last year, the U.S Government Accountability Office, Congress's investigative arm, found that a conflict of interest was fueling IRA growth. Financial companies that administer 401(k) plans misled GAO investigators posing as departing employees, telling them they would almost always be better off if they shifted to IRAs that the companies also managed.
Fiduciary Standard
The U.S. Labor Department has said it will propose rules in January that brokers and other advisers act in clients' best interests during rollovers, a so-called fiduciary standard. The agency had announced a similar plan in 2010. Brokers are generally held to the lower standard of selling products that are suitable for their customers, meaning that they don't have to put their clients' interests first as long as they select appropriate investments. In January, Finra, the Wall Street self-policing group, warned members that it would heighten its scrutiny of IRA rollovers.
The Securities Industry and Financial Markets Association, which represents brokers, banks and money managers, opposes stricter regulation. It would hurt commission-based brokers, limiting consumer choice, according to the group. Disclosure rules are already sufficient to protect customers, said Ira Hammerman, the association's executive vice president and general counsel.
"Let the customer decide," Hammerman said.
Bank of America Corp (BAC).s' Merrill Lynch and E*Trade (ETFC) Financial Corp. offer as much as $600 up front to anyone who rolls over a 401(k) into an IRA.
"If someone offers you $600 to roll over your IRA, you can be sure you are going to be paying a lot more additional expenses later," said Mercer Bullard, an associate professor at the University of Mississippi Law School who heads Fund Democracy, an advocacy group for mutual-fund shareholders.
Incentives 'Commonplace'
Kristen Georgian, a Bank of America spokeswoman, said such incentives are "commonplace for many leading brokerage firms." The company informs clients about their options, "including keeping their assets in place," she said.
"We believe strongly in rollovers," said Mike Loewengart, E*Trade's director of investment strategy. Clients benefit from more transparent fees and broader investment options in an IRA with E*Trade, he said.
In a 401(k), an employee sets aside money -- often with a company match -- in a menu of mutual funds, which aren't taxed until withdrawal and, in some cases, at all.
Cheaper 401(k)s
Once workers exit a company, they generally can leave the money behind, roll it over into an IRA, transfer it to another 401(k) or cash out and suffer a huge tax hit. In a rollover, customers set up IRAs with financial companies, preserving their tax deferral.
Though 401(k)s offer fewer choices than IRAs, large companies such as AT&T negotiate for institutional discounts on the funds they select. As a result, 401(k) participants paid less than half the average 1.4 percent annual expenses charged to all U.S. stock mutual-fund investors, according to a 2013 study from the Investment Company Institute, a Washington-based mutual-fund industry trade group.
Still, almost 18 million U.S. households hold IRAs that include rollover money, estimated a recent report from the Investment Company Institute.
After he lost his job in 2009, Manuel Gonzalez Martinez, a mechanical engineer for Hewlett-Packard in Puerto Rico, rolled over $150,000 from a 401(k) and a lump-sum pension payment to an IRA with UBS AG (UBS), the Swiss financial-services company.
'Stuck' With Bonds
His broker, Luis Roberto Fernandez Diaz, recommended Puerto Rico municipal bond funds with a 3 percent upfront sales fee and 1 percent annual expenses, according to his arbitration complaint with Finra, which lists 17 customer disputes against Fernandez from 2009 through 2014. Six of them have been settled.
Financial advisers generally frown on investing an IRA in municipal bonds because their main advantage is tax avoidance, something that is already a feature of an IRA. Worse, the bonds plunged in value because of the deteriorating finances of Puerto Rico and are now worth only $90,000, Gonzalez said.
"I am stuck with the bonds," said Gonzalez, 51. "They are a just a number on paper."
UBS doesn't comment on individual arbitration cases, said spokesman Gregg Rosenberg. In a filing responding to the allegations, UBS said Gonzalez "invested very profitably in the funds" for years before the municipal bond market deteriorated.
Fernandez now works as a broker for Popular Securities. Teruca Rullan, a spokeswoman for Popular Inc., the parent company, said he would not be available for comment.
Vulnerable Workers
At the time of leaving a longtime employer, workers are often confused and vulnerable to unsound financial advice. In 2010, Albert Grathwol stopped by a hotel to attend a seminar organized by Raymond J. Lucia Sr., a radio personality who also ran an investment firm. Grathwol was about to retire as a structural engineer for Aecom Technology (ACM) Corp., a Los Angeles-based engineering design company.
Signing up with Lucia's firm, Grathwol and his wife, Sandra, a former schoolteacher, invested $300,000 of retirement savings into non-traded real estate investment trusts. These REITs, which invest in property such as apartments and shopping centers, aren't traded on a public exchange, which means they can't easily be sold.
Finra Alert
An alert on the Finra Website first posted in 2011 warns that non-traded REITs are hard to cash in, may not be a diversified real estate investment and that commissions and other expenses can be as much as 15 percent.
Grathwol said his REITs' value fell by $100,000. "We were depending on it as our life's savings," said Grathwol, 69.
The couple has filed an arbitration claim against San Diego-based First Allied Securities Inc., which acted as broker for Lucia's firm.
In 2013, the Securities and Exchange Commission's enforcement division moved to bar Lucia from the industry for allegedly misleading investors about the historical performance of the strategy he was promoting. Lucia has appealed. Marc Fagel, an attorney for Lucia, declined to comment because Grathwol's complaint is still in arbitration.
Joseph Kuo, a First Allied spokesman, also said the company doesn't comment on pending arbitration cases, while noting Lucia is no longer affiliated with the brokerage. In a filing responding to the allegations, First Allied said they were "baseless," because the REITs were "only one part of a layered investment strategy" and the Grathwols were fully informed of the risks.
Employees at AT&T faced similar quandaries about where to entrust their savings.
AT&T Ranking
Based in Dallas, the telecommunications company, with 246,000 workers, is one of the largest private employers in the U.S. AT&T's 401(k) ranks among the best 15 percent of U.S. plans in terms of fees, according to BrightScope, a financial information company that rates retirement offerings. AT&T funds, which are available only to employees, charge expenses as low as .01 percent.
Typically, when employees retire or lose their jobs, they have the option of rolling over their 401(k)s or, in most cases, leaving them behind in the same low-cost investments. At AT&T, they often have another big decision. Along with their 401(k), they can take a pension -- a monthly fixed payment for life -- or an equivalent payment that could amount to hundreds of thousands of dollars.
Business Opportunity
Sensing a business opportunity, broker Richard McCollam, a West Point graduate and former U.S. Army captain who had worked for insurer MetLife (MET) Inc., began marketing to AT&T employees with 401(k) rollovers and lump-sum pension payments.
Starting in 1994, McCollam worked for Royal Alliance, part of AIG's Advisor Group, one of the largest networks of independent brokers in the U.S., with about 6,000 representatives. While McCollam handled the back office, Kathleen Tarr, who joined him as a broker in 2002, prospected for clients.
"If you are like most AT&T retirees, you probably feel that you are drowning in information that may be confusing and frustrating," according to marketing material saved by a former customer.
Tarr had an unusual background for a financial adviser. She has a Ph.D. from the University of California at Berkeley, where she studied invertebrate physiology. She taught briefly at UC-Irvine before quitting to raise three boys. She then went back to work as a private-school teacher and then in finance after her husband lost his job as a biochemist.
Chaplain's Daughter
Like many at Royal Alliance, Tarr and McCollam worked out of their homes, in Contra Costa County, near San Francisco. Tarr, who had just turned 50 when she teamed up with McCollam, had an easy manner with soon-to-be retirees. The daughter of an Army chaplain and granddaughter of a Congregational minister and missionary, she would invite clients to hear her sing at a local Episcopal church, where she led the soprano section.
Tarr won referrals by word-of-mouth, meeting clients both at their homes and, by appointment, at AT&T offices across the San Francisco area.
Mark Siegel, an AT&T spokesman, said the company provides information about benefits, but doesn't endorse specific financial advisers, which aren't affiliated with the company.
Siegel said the company periodically sends alerts to employees, such as an e-mail from last October, which warned: "You should research the individuals contacting you and their organizations before doing business with them."
Non-Traded REITs
McCollam said they recommended that clients put 60 percent to 70 percent of their money in variable annuities. The balance would end up in non-traded REITs, including Oak Brook, Illinois-based Inland American Real Estate (IARE) Inc. The REITs generated dividends of 6 percent to 8 percent a year, providing an alternative to the vagaries of the stock market, Tarr said.
In variable annuities, customers invest in mutual funds within an insurance wrapper, which offers a death benefit, typically providing heirs a minimum payout. Earnings are tax-deferred.
Investing in a variable annuity within an IRA "may not be a good idea" because it provides no additional tax savings over an already tax-advantaged IRA, according to a Finra alert originally posted on its website in 2003 and updated in 2009. The annuities will increase costs, "generating fees and commissions for the broker or salesperson," Finra says.
Variable Annuities
Customers often choose variable annuities because they offer a guaranteed minimum lifetime income, which is assured no matter how their investments perform, said Andrew Simonelli, a spokesman for the Washington-based Insured Retirement Institute, which represents companies that offer annuities.
"While tax deferral is certainly part of the value proposition of annuities, it's not the only reason," Simonelli said.
McCollam said he, Tarr and Royal Alliance would generally receive a total commission of as much as 6 percent or 7 percent of the money that clients invested in variable annuities. The mutual funds they selected would charge customers 2 percent to 3 percent a year in fees. Those fees were no higher than those of many mutual funds sold by brokers, Tarr said.
Broker Commissions
The brokers and Royal Alliance also received commissions totaling 6 percent to 7 percent for selling non-traded REITs, McCollam said. Typically, Tarr and McCollum kept 90 percent of their commissions, giving 10 percent to Royal Alliance, McCollam said.
Over time, the pair signed up as many as 500 customers, most from AT&T, McCollam said. Overseeing about $90 million in investments, their business generated about $600,000 to $700,000 in annual commissions -- and $1 million in its best year, he said. As the founder of the operation, he would keep 90 percent and Tarr, 10 percent, McCollum said. He said they won sales awards, with Royal Alliance sending one or both to resorts in the Bahamas; Boca Raton and Orlando, Florida; Arizona and Texas.
Doug Beal, a $32-an-hour mechanic specializing in air-conditioning and fire detection, heard about Tarr from his union steward. Tarr visited Beal in his shop, where he worked outside San Francisco.
"I wanted something where I wouldn't lose a whole bunch if the market went crazy," said Beal, a disabled Vietnam veteran.
When he retired in 2009, Beal invested $320,000 in variable annuities and REITs, rolled over from his pension and 401(k). He has since lost $60,000 because of a decline in the REITs' value, said Frank Sommers of Sommers & Schwartz LLP in San Francisco, who represents 17 of Tarr's former clients.
Paying Bills
Beal is deferring his dream of moving up to Spokane, Washington, where he hopes to set up a shop to tinker with motorcycles and old cars, including a 1926 Model T Ford in his garage.
"It's making it a little harder to pay bills," said Beal, 67, who also receives disability payments related to military service. "Thank God for my VA pension."
Tarr cultivated some employees for years, such as Mae Holloway, who started her 40-year career at AT&T as a telephone operator and ended up overseeing maintenance in Oakland. Tarr would stop by Holloway's desk, encouraging her to come up with a budget for her retirement.
In 2008, Holloway, then making $69,000 a year, decided it was time to leave. She was 62 and figured she needed her investments to generate $3,000 a month. So, hoping she could have money left for her children after she died, she turned down the guaranteed $2,500 a month pension and took a $600,000 lump sum payment from her pension and 401(k). She rolled it over into an IRA, invested in variable annuities and REITs.
'No High Risk'
"If I do this, can you guarantee I won't go broke before I leave this world?" Holloway remembered asking Tarr. "And she said yes. I told her no high risk. I didn't want to be aggressive."
Tarr said she would have never made that kind of statement.
"I used to call it the G-word," she said. "I could never guarantee anything. That is the first rule of investing."
Holloway lost about $90,000 because of the reduced value of her REITs, according to Sommers, her attorney.
"I'm losing sleep over it," Holloway said. "I should have just left it. I wanted to leave money for my kids."
Lew's Mortgage
Lew, the former administrative assistant with the hole in her kitchen ceiling, has a more immediate worry: paying her mortgage. An immigrant from Central America, she retired from AT&T in 2003 with an IRA set up by Tarr. Afterward, they often discussed investments over coffee at Lew's kitchen table, as her prized green parrot squawked in a cage with a sweeping view of the parched hills surrounding San Francisco.
Lew started her withdrawals at $2,000 a month, then bumped them to $2,500. Lew said Tarr blessed the move -- something Tarr disputes, saying she had warned against it.
By 2010, Lew noticed losses in her account. Her REITs have plunged $145,000, according to Sommers. To make ends meet, she is caring for neighbors' children. She will run out of money in three or four years, which could force her to sell her house.
"I was old-fashioned like my mom about planning for the future," said Lew, 61. "I never thought I'd end my years worrying about money."
'Good Advice'
McCollam said that Lew, Beal and Holloway showed modest gain in their account, when the dividends from REITs are taken into account.
"We feel like we gave as good advice as we could have given," McCollam said.
In 2010, Royal Alliance dismissed Tarr and McCollam, citing a failure to follow a policy for pre-approval of variable annuities, according to a Finra filing.
"No client was adversely impacted by any omission by either Mr. McCollam or Ms. Tarr -- all transactions were ultimately reviewed and determined appropriate," Linda Malamut, a Royal Alliance spokeswoman, said in a statement. "Further, the terminations were unrelated to any transaction by a client who filed a complaint with Royal Alliance." Malamut declined to answer more detailed questions.
Tarr Dismissed
Before Tarr was fired, she said she had already left Royal Alliance to join a competitor because of frustration with the backlog in approving the annuities. Royal Alliance put a black mark on their record because the company was upset about losing their business, Tarr and McCollam said. Royal Alliance then contacted clients, sparking the flurry of arbitration complaints, which came after their dismissal, according to Tarr and McCollam.
As investments soured, 37 customers complained about Tarr to Finra, which logs disputes with brokers in public records. Fifteen of these complaints are pending, four were settled, and 18 were closed without action. The agency lists 11 complaints against McCollam. Eighty-eight percent of brokers do not have any complaints, disciplinary proceedings or other adverse actions listed with Finra.
Brokerage customers typically sign a contract giving up their right to sue in court and requiring them to submit to Finra arbitration. These proceedings are generally confidential. Sommers said ten of his clients have filed arbitration claims against Royal Alliance, Tarr and McCollam, and he expects at least two more will too.
Lawsuit Filed
Last week, seven of Sommers' clients, including Lew, filed suit against Royal Alliance in state court in Alameda County, California. The complaint alleges breach of fiduciary duty, fraud and failure to supervise its brokers, leading to more than $1 million in damages. The former employees were placed "in totally unsuitable investments" that were "designed to maximize the commissions and fees" paid to the company and the brokers, according to the lawsuit.
In 2012, arbitrators awarded three former AT&T employees a total of $1.4 million in damages and interest from Royal Alliance, according to a filing with a California court, where the company unsuccessfully appealed. Darlene Peterson, Karen LaBuda and Sherry Leach-Warth each worked at AT&T for more than 30 years.
McCollam and Tarr said they did not appear at the arbitration to defend themselves and that losses suffered by the three customers were modest.
Tarr, 61, is now working as president of AeroComputers Inc., an Oxnard, California aviation company catering to law enforcement. She took over from her brother-in-law, who died in January.
Tarr said she believed in the products she sold at Royal Alliance, but would have changed course if the brokerage had objected.
"Royal Alliance could have said to me five years ago, we've been looking through your book of business, we think you're a little heavy on variable annuities, let me suggest alternatives," Tarr said. "They never said anything. Nothing."
(An earlier version of this story was corrected to show that a payment is one-time, not annual)
To contact the reporter on this story: John Hechinger in Boston at [email protected]
To contact the editors responsible for this story: Daniel Golden at [email protected] Anne Reifenberg
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Telegraph
Elderly computer users are being warned about a "hugely distressing" telephone scam that can leave victims hundreds of pounds out of pocket and vulnerable to identity theft.
The Telegraph has been contacted by readers who have fallen for the scam, in which conmen make cold calls to homes and tell victims they need to buy expensive antivirus software for their computer. They then request remote access to the computer and can steal personal data.
One 86-year-old reader from Surrey, who wished to be identified only as Peter, lost £121. It was not the first time he had been cold-called by conmen – but this was the first time he fell for the trick."The trouble was he was so convincing," Peter said. "I was conned into thinking he really was from the technical department of Microsoft and they had been receiving copies of my emails, which meant my security was failing."
He was also told his security licence had expired and Microsoft would shut down his computer unless he took out another security plan. "He asked me for my bank details and – this is where I'm so annoyed with myself – I gave my credit card details, which I should never have done," Peter said.The man then said he would take remote access of the computer to install the software and suddenly "reams of numbers were covering the screen and the cursor was moving all over the place".
Peter then looked at his printer and saw an email printout the conman had sent from Peter's email account confirming the £121 payment for a year's cover, even though he had not revealed his email address or password.
Peter contacted his bank, HSBC, immediately, but the money had already left his account. As he had authorised the payment, Peter was told the money would not be refunded. The Telegraph intervened and HSBC has since paid a full refund "as a gesture of goodwill".
"At HSBC we take fraud very seriously, and use market-leading detection systems in our efforts to prevent it. However fraudsters also target customers directly and we recommend customers are vigilant at all times and only enter into a transaction and divulge their card information when they are confident with what they are purchasing and from whom," said an HSBC spokeswoman.
Peter has now had his bank cards and bank passwords changed, as well as his computer security details. "It was really quite a traumatic experience and I feel so guilty for being such a fool," he said. "At 86, I should know better."
Consumer watchdog Which? is warning computer users, and particularly elderly ones, to be on their guard for such scams.
Figures from Microsoft show that one in five people in Britain has received a similar call since the scam emerged in 2010. A survey conducted in January this year found that half of the victims of the scam were over the age of 55, and the average amount lost was a painful £745.
Richard Lloyd, the executive director of Which?, said technical support scams were criminal and could be "hugely distressing".
"Our investigation into the Microsoft scam revealed they can put people at risk of ID theft or fraud and leave victims seriously out of pocket," he said. The scam was also affecting the elderly's trust in technology.
Microsoft's chief security adviser, Stuart Aston, said:
"In essence, this scam is a confidence trick by often quite sophisticated criminals, who are adept at gaining their victims' trust by using a name like Microsoft, adopting industry jargon to make them sound professional and using apparently personal information to appear legitimate."
Microsoft insists it will never call customers "out of the blue".
Mr Lloyd said: "Be vigilant to the threat from scammers and protect yourself by never giving an unsolicited caller remote access to your computer.
"If you think you've been scammed in this way you should run a virus scan, alert your bank and contact Action Fraud to report it."
Essential steps to protect yourself from scam calls
- Always be suspicious of unsolicited calls or emails offering help with a security problem, or any other computer problem. Microsoft never calls in this way or asks for money for fixing a problem.
- Do not go to a website, install software or follow any other instruction from someone who cold-calls.
- Take the caller's details and pass them to your local authority.
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Yahoo/Associated Press
In this Feb. 28, 2013 photo, Sarah Chavez, center, sits with her son Bidal, right, and daughter Sarahi, front, at her home in Lexington, N.C. Desperate to raise money for their …more 6-year-old daughter's cancer treatments last summer, friends told Jose and Sarah Chavez of a way to quickly turn their meager savings into a small fortune. But what the Chavez family and many others didn't know was that state and federal regulators for months had received complaints that ZeekRewards was a scam.
LEXINGTON, N.C. (AP) - In the hardware store on South Main Street, the owner pulled Caron Myers aside to tell her about the best thing to happen in years to this once-thriving furniture and textile town.
Did she hear about the online company ZeekRewards? For a small investment, she could make a fortune. He had invested. So had his grandsons. And so were more and more people in Lexington, including doctors, lawyers and accountants.
Skeptical at first, Myers drove a few blocks to the company's one-story, red-brick office and spotted a line of people circling the building. She was sold, and plunked down several thousand dollars. But months later, Myers, like hundreds of thousands of others, discovered the truth: ZeekRewards was a scam.
"I was duped," Meyer said. "We trusted this man. The community is still in shock."
Authorities say owner Paul Burks was the mastermind of a $600 million Ponzi scheme - one of the biggest in U.S. history - that attracted 1 million investors, including nearly 50,000 in North Carolina. Many were recruited by friends and family in Lexington, a quintessential small town where neighbors look out for each other.
But what investors didn't know was that regulators had received nearly a dozen complaints about ZeekRewards and the related site Zeekler.com, but failed to take action for months, leaving the company free to recruit tens of thousands of new victims.
The Securities and Exchange Commission, which closed the operation Aug. 17, said Burks was selling securities without a license. The Ponzi scheme was using money from new investors to pay the earlier ones.
Burks has agreed to pay a $4 million penalty and cooperate with a federal court-appointed receiver trying to recover hundreds of millions of dollars.
Investigators say Burks, a former nursing home magician, siphoned millions for his personal use. But he has not been charged.
In his first public comments, Burks told The Associated Press he couldn't discuss details because of lawsuits by victims trying to recoup money.
"Everything will come out in time," said Burks, 66, standing in the doorway of his home.
Asked if he had anything to say to victims, he shook his head.
"I never told anyone to invest more money than they could afford," Burks snapped. "I didn't tell them to do that. Never."
He said if they lost money, "it's their fault. Not mine. Don't blame me."
But Cal Cunningham, a former prosecutor representing investors in a lawsuit, slammed Burks - and regulators for taking so long to act.
"It's why we need a full hearing on what happened in a court of law - whether that be our civil case or a criminal proceeding. A lot of people were hurt," he said.
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Burks started Zeekler in early 2010 as an online penny auction site. His business experience included nearly four decades in multilevel marketing programs - such as Amway - including failed attempts to launch similar businesses of his own.
In penny auctions, consumers compete to pay pennies on the dollar for name brand products such as iPads. Each bid costs as much as $1, so participating can become expensive and the sites can earn nice profits when multiple users bid against each other.
In January 2011, he incorporated aspects of multilevel marketing into the business when he launched ZeekRewards. The program offered a share of the penny auction's profits to people who invested money, promoted the company on other websites and recruited other participants. Under a complicated formula, investors were issued "profit points" that grew every day.
Investments were capped at $10,000, but people could invest on behalf of their spouses, children or other relatives. Some mortgaged homes to raise their investment.
At first, ZeekRewards complied when investors sought to cash out. And that became the best ad of all: happy investors with their checks in Facebook photos.
People who didn't trust the mail traveled long distances to drop off checks at the cramped office building where security guards allowed only seven inside at a time. Employees collected money and wrote out receipts at the office cluttered with dozens of plastic mail bins stuffed with check-filled envelopes. To withdraw money, investors filed an online request - or called - and then had to wait for a check.
By the end of 2011, it seemed like everybody in Lexington was talking about ZeekRewards. Many saw it as a way to make extra cash to pay bills or help family.
"No one was in it to get rich," said Mary Bell, a 75-year-old seamstress from Lexington who scraped together money to invest.
Sarah Chavez wanted extra money for her daughter's frequent hospital visits for leukemia. Her husband worked in a factory, and they invested $7,000.
"It's hard to believe in something like that. But everyone told us it was a sure thing," she said.
Burks mostly kept to himself, and few locals knew anything about the quiet, balding man with thick glasses.
In the 1980s and early 1990s, the Shreveport, La., native toured nursing homes in the South as a magician with country singer David Houston. Burks moved to Lexington in the early 1990s because his wife was from the area. In 2000, Burks ran for the state House as a Libertarian, but he collected only 330 votes. Then he became a local celebrity. Most afternoons, he ate lunch at the same downtown restaurant with an entourage of managers. Conference calls with investors were posted on YouTube. He produced glossy brochures touting the company.
"In addition to the mind-blowing savings, you can create more wealth than you have ever thought possible with ZeekRewards' geometrically progressive matric compensation plan," the brochure said.
Burks also hired some of the industry's top attorneys and analysts to promote his company.
The publicity paid off. When the Association of Network Marketing Professionals held its annual convention in March 2012, it called ZeekRewards the model of legal compliance.
___
But behind the scenes, there were troubling signs, according to documents, company emails and consumer complaints reviewed by the AP.
In early June, the state of Montana gave ZeekRewards the boot. Montana requires multilevel marketing companies to register. But ZeekRewards didn't submit any paperwork - even after warnings, said Luke Hamilton, a spokesman for the attorney general's office.
"We started getting a lot of complaints," he said.
In August, a North Carolina employees' credit union warned customers not to invest in ZeekRewards because it was a "fraudulent company."
But regulators received complaints long before then.
In a Nov. 23, 2011, complaint filed with the North Carolina Attorney General's office, Wayne Tidderington of Florida called ZeekRewards an "illegal" Ponzi scheme. He said a relative had invested $8,000 and the company guaranteed a return of 125 percent every 90 days.
The attorney general's office can ask a judge to shut down a business because of deceptive trade practices. But it forwarded Tidderington's complaint to the secretary of state's office because it looked like it might involve securities. The secretary of state's office, however, declined to take action because it didn't believe it had the jurisdiction, spokeswoman Liz Proctor said.
The complaint died.
"I put it all together," Tidderington told the AP. "I gave them the roadmap. I said, 'Here's a snake. Here's the gun. Here's the bullets. Shoot the snake.' But they ignored me."
Over the next seven months, the attorney general's office received nearly a dozen more complaints.
But it wasn't until July 6 that it issued an order giving Burks until the end of the month to turn over all Zeek-related documents. He missed that deadline.
Kevin Anderson, senior deputy attorney general for consumer protection, insisted his agency correctly handled the case, saying his office receives thousands of complaints a year.
"We have to have more concrete evidence than a couple of consumer complaints before we go to court," he said.
The SEC received similar complaints during the same period, but the agency didn't begin its investigation until the summer.
SEC spokeswoman Christine D'Amico declined to comment on the investigation, except to say the agency took action "as soon as we believed we had sufficient evidence to obtain an emergency court order to halt the fraud."
___
Months later, people in Lexington are wondering what's next.
Kenneth Bell, the court-appointed receiver, said ZeekRewards may have taken in $800 million. So far, he's recovered $312 million. Hundreds of millions were paid out to investors. Just how much is missing? He doesn't know.
Myers said the community is still recovering - but the wounds are deep. People are wondering why investigators didn't act more quickly and why no one, including Burks, has been charged.
"There are thousands and thousands of victims who might not have lost a penny had the government intervened more quickly," she said.
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Regulators across the country are confronting a wave of investor fraud that is saddling retirement savers with steep losses on complex products that until a few years ago were pitched only to the most sophisticated investors.
Mary Beck and her husband invested $470,000 in a part ownership of a fleet of luxury cars, a venture that later went bankrupt.
The victims are among the millions of Americans whose mutual funds and stock portfolios plummeted in the wake of the financial crisis, and who started searching for ways to make better returns than those being offered by bank deposits and government bonds with minuscule interest rates.
Tens of thousands of them put money into speculative bets promoted by aggressive financial advisers. The investments include private loans to young companies like television production firms and shares in bundles of commercial real estate properties.
Those alternative investments have now had time to go sour in big numbers, state and federal securities regulators say, and are making up a majority of complaints and prosecutions.
"Since the crisis, we've seen more and more people reaching out into different types of exotic investments that are a big concern to us," said William F. Galvin, the Massachusetts secretary of the commonwealth.
Last Wednesday, Mr. Galvin's office ordered one of the nation's largest brokerage firms, LPL Financial, to pay $2.5 million for improperly selling the real estate bundles, known as nontraded REITs, or real estate investment trusts, to hundreds of state residents from 2006 to 2009, in some cases overloading clients' accounts with them.
LPL said it agreed, as part of the settlement, to reform its process for selling such alternative investments.
There are few good statistics on the extent of the problem nationally. But cases are mounting in the offices of regulators like A. Heath Abshure, the securities commissioner in Arkansas, where a majority of the 66 open securities cases involve complex investments sold to less sophisticated investors looking for a steady return.
J. Bradley Bennett, chief of enforcement at the Financial Industry Regulatory Authority, or Finra, Wall Street's self-regulatory group, said that for the last two years, 10 staff members have looked at the "proliferation of these products, to understand how they are being sold."
"It's got our attention," he said. "We recognize the trends."
Brokers promoting bad investments to unsophisticated investors is nothing new. But while the easy prey used to be people looking to get rich quick, the pool has widened to include savers looking for ways to earn the kind of income once reliably available from traditional investments.
Regulators are warning investors that the dangers are unlikely to recede, given the Federal Reserve's pledge to
keep interest rates near zero and the push among financial firms to earn more revenue from so-called alternative investments marketed to retail investors. Brokers are eager to sell these investments because they often bring in higher commissions than standard mutual funds and stocks.The money that retail investors have in alternative investments in the United States, ranging from baskets of commodities to mutual funds that employ sophisticated trading, more than doubled from 2008 to 2012, to $712 billion from $312 billion, according to McKinsey & Company. Many of the products hold out the promise of higher returns while ostensibly being immune to the volatility of stock markets.
The phenomenon of investors' actively moving money in pursuit of higher interest rates, known as chasing yield, is reverberating through the economy. Jeremy C. Stein, a Federal Reserve governor, said in a speech on Thursday that he worried that investors desperate for yield
could be creating a bubble in widely available investments like junk bonds.Mary Beck, a furniture business consultant in Pasadena, Calif., said that in 2008, as the stock investments in her husband's
I.R.A. began to fall quickly, the couple moved $470,000 to a new product recommended by their broker.While the offering was unfamiliar - part ownership in a fleet of luxury cars - Ms. Beck bought the pitch because her broker had been around for years, and the product offered what seemed to be a modest annual interest rate of 7 percent.
"We knew that 12 percent wasn't realistic, but 7 percent seemed realistic," Ms. Beck said. "To us, it was a very conservative way to ensure that we'd increase our savings."
Soon after they stopped receiving interest payments, the Becks lost their money when the venture went bankrupt in 2012. Ms. Beck and her husband have been reconfiguring their retirement and are planning to work longer.
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Regulators across the country are confronting a wave of investor fraud that is saddling retirement savers with steep losses on complex products that until a few years ago were pitched only to the most sophisticated investors.
Mary Beck and her husband invested $470,000 in a part ownership of a fleet of luxury cars, a venture that later went bankrupt.
The victims are among the millions of Americans whose mutual funds and stock portfolios plummeted in the wake of the financial crisis, and who started searching for ways to make better returns than those being offered by bank deposits and government bonds with minuscule interest rates.
Tens of thousands of them put money into speculative bets promoted by aggressive financial advisers. The investments include private loans to young companies like television production firms and shares in bundles of commercial real estate properties.
Those alternative investments have now had time to go sour in big numbers, state and federal securities regulators say, and are making up a majority of complaints and prosecutions.
"Since the crisis, we've seen more and more people reaching out into different types of exotic investments that are a big concern to us," said William F. Galvin, the Massachusetts secretary of the commonwealth.
Last Wednesday, Mr. Galvin's office ordered one of the nation's largest brokerage firms, LPL Financial, to pay $2.5 million for improperly selling the real estate bundles, known as nontraded REITs, or real estate investment trusts, to hundreds of state residents from 2006 to 2009, in some cases overloading clients' accounts with them.
LPL said it agreed, as part of the settlement, to reform its process for selling such alternative investments.
There are few good statistics on the extent of the problem nationally. But cases are mounting in the offices of regulators like A. Heath Abshure, the securities commissioner in Arkansas, where a majority of the 66 open securities cases involve complex investments sold to less sophisticated investors looking for a steady return.
J. Bradley Bennett, chief of enforcement at the Financial Industry Regulatory Authority, or Finra, Wall Street's self-regulatory group, said that for the last two years, 10 staff members have looked at the "proliferation of these products, to understand how they are being sold."
"It's got our attention," he said. "We recognize the trends."
Brokers promoting bad investments to unsophisticated investors is nothing new. But while the easy prey used to be people looking to get rich quick, the pool has widened to include savers looking for ways to earn the kind of income once reliably available from traditional investments.
Regulators are warning investors that the dangers are unlikely to recede, given the Federal Reserve's pledge to
keep interest rates near zero and the push among financial firms to earn more revenue from so-called alternative investments marketed to retail investors. Brokers are eager to sell these investments because they often bring in higher commissions than standard mutual funds and stocks.The money that retail investors have in alternative investments in the United States, ranging from baskets of commodities to mutual funds that employ sophisticated trading, more than doubled from 2008 to 2012, to $712 billion from $312 billion, according to McKinsey & Company. Many of the products hold out the promise of higher returns while ostensibly being immune to the volatility of stock markets.
The phenomenon of investors' actively moving money in pursuit of higher interest rates, known as chasing yield, is reverberating through the economy. Jeremy C. Stein, a Federal Reserve governor, said in a speech on Thursday that he worried that investors desperate for yield
could be creating a bubble in widely available investments like junk bonds.Mary Beck, a furniture business consultant in Pasadena, Calif., said that in 2008, as the stock investments in her husband's
I.R.A. began to fall quickly, the couple moved $470,000 to a new product recommended by their broker.While the offering was unfamiliar - part ownership in a fleet of luxury cars - Ms. Beck bought the pitch because her broker had been around for years, and the product offered what seemed to be a modest annual interest rate of 7 percent.
"We knew that 12 percent wasn't realistic, but 7 percent seemed realistic," Ms. Beck said. "To us, it was a very conservative way to ensure that we'd increase our savings."
Soon after they stopped receiving interest payments, the Becks lost their money when the venture went bankrupt in 2012. Ms. Beck and her husband have been reconfiguring their retirement and are planning to work longer.
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Leona Miller, an 84-year-old retired beautician, says she was seeking safe and steady income from bonds two years ago when her Wachovia Corp. broker recommended she buy securities paying 9 percent interest.
Within six months, Miller had lost about 30 percent of her $20,000 investment and the bonds were converted into shares of Merck & Co. in a falling stock market. The San Diego resident, who still doesn't understand what happened to her money, had purchased bonds known as structured notes that include built-in derivatives.
Sales to Miller and thousands of other individuals have driven structured note offerings up 58 percent to $31.9 billion through August, according to data compiled by Bloomberg. With U.S. interest rates near zero percent, investors are snapping up bonds such as reverse-convertible notes with knock-in put options or Leveraged CMS Curve and S&P 500 Index Linked Callable Notes, some with face values of as little as $10.
"People develop a product which makes a modicum of sense, then they extend it to the point of ludicrousness until it blows up," said Satyajit Das, a former Citigroup Inc. derivatives banker. Das, the Sydney-based author of "Traders, Guns & Money" (FT Press, 2006), said investors are often "seduced" into purchases without understanding the risks.
The Securities and Exchange Commission's enforcement division started a group this year focused on investigations into structured products, including those marketed to individual investors.
Hard to Understand
"We're concerned about the sale of complex structured notes to retail customers because people don't always understand the risks they're exposed to," said Kenneth Lench, head of the SEC's Structured and New Products unit. "It's very difficult for a person who isn't immersed in this world to pick up a prospectus and really understand what are the different scenarios that would make an investment work out for them."
Miller and Wells Fargo & Co., which acquired Wachovia in 2008, are in arbitration, according to her San Diego lawyer, Ronald Marron. In a February 2009 letter, the bank's legal department told Miller that the broker "explained very thoroughly his recommendation."
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Yahoo! Finance
A grim category of crime is on the rise: senior-on-senior financial fraud.
According to regulators and prosecutors, there has been a significant increase recently in the number of cases in which older investors have been taken advantage of by elderly scam artists.
"That's a definite new trend," says Denise Voigt Crawford, the Texas securities commissioner. "We're seeing more cases of older people ripping off other older people. Someone joked that seniors ripping off their peers is becoming 'the new retirement plan.'"
In Texas, John F. Langford, 76 years old, is expected to go on trial in Amarillo next year on charges that he fraudulently sold about $6 million in promissory notes and what he called "private annuities" to a circle of his fellow senior citizens. "We dispute all the state's allegations," says Mr. Langford's attorney, Tim Pirtle.
In Louisiana, meanwhile, Judith Zabalaoui, 73, pleaded guilty in February 2009 to five counts of mail fraud and is now serving an eight-year prison sentence after persuading at least 35 clients, many of them elderly, to invest in two nonexistent companies that promised "safe" returns of 13% to 26%. She had clients sign a power of attorney, giving her access to their funds - and spent more than $3 million of their money on her own expenses, including clothing and vacations, according to court documents.
Anthony Joseph, Ms. Zabalaoui's attorney, didn't respond to requests for comment.
Many financial planners who got into the business during the bull market of the early 1980s are senior citizens themselves now. With their own wealth ravaged by the bear market of the past decade, many of these people can no longer afford to retire. That, say regulators, may be prompting some older financial advisers to engage in riskier and less ethical behavior.
Elderly investors are natural targets in part because they may be more susceptible to fraud. A 2008 study by researchers at the Georgia Institute of Technology found that older adults are significantly worse than younger people at detecting whether someone who may have stolen money is telling the truth.
[More from WSJ.com: Too Wealthy for Your 401(k) Plan?]
What's more, according to research by Harvard University economist David Laibson and his colleagues, the typical person's ability to make astute financial decisions peaks at about age 53, then wanes with each passing year; another study found that investing ability takes a steep drop after age 70.
Brian Knutson, a neuroscientist at Stanford University, has monitored the brain activity of dozens of older investors. "When they encounter a risk," says Prof. Knutson, "they will be more likely than younger people to focus on the upside of that risk." That can lead older investors to play down the downside.
According to Mara Mather, a psychologist at the University of California, Santa Cruz, older adults also seek less data than younger people do when making complex decisions - and will go out of their way to avoid negative information or confrontations. This "high avoidance," Prof. Mather says, can lead older investors to get sucked further into a scam, throwing good money after bad.
Some older financial advisers use their age as a selling point, telling clients they understand the challenges that older investors face. In many instances, say prosecutors, unscrupulous advisers also tout their professional designations, or credentials, as further evidence of their expertise.
Professional credentials have exploded in popularity among financial advisers in recent years. Some credentials are difficult to obtain, but many of the newer ones can be gotten easily - often with minimal study and just a few hundred dollars.
The Wall Street Journal has identified more than 200 credentials available to financial-services professionals, including at least six with the word "senior" in their name: certified senior adviser; certified senior consultant; certified senior specialist; certified senior financial planner; chartered senior financial planner; and chartered adviser for senior living.
Mr. Langford, the Texas adviser, marketed himself by telling prospective clients that he was a certified senior adviser and even showing them the number on his membership certificate, says Ludie Stone, 89, who invested $211,000. "That gave me confidence," she says. The Society of Certified Senior Advisors permanently revoked Mr. Langford's designation in October 2008 after receiving a complaint, a spokesman says.
Some advisers find that credentials are so effective in winning new clients that they don't even need to keep the designation current.
The certified financial planner designation, for example, is among the industry's most stringent and respected. It requires a bachelor's degree, 15 credit hours of college-level courses in certain subjects, 10 hours of exams over two days, adherence to an ethical code and 30 hours of continuing education every two years in order to qualify for biannual renewal.
Yet Ms. Zabalaoui, the Louisiana adviser, marketed herself as a CFP, say clients, even though her credential lapsed in 2000. Among the burned investors were Rex and Jackie Hall, an Albany, La., couple ages 58 and 60, respectively, who lost $24,000. Mr. Hall says his wife met Ms. Zabalaoui at a seminar and was impressed. "When you see the letters [CFP] after her name," Mr. Hall says, "you assume she has an enhanced position."
It is important for older investors to run financial decisions past a younger relative or someone who can resist the emotional pull of the situation, says Prof. Knutson. In some states, such as Alabama, "sentinels" trained by securities regulators seek to attend any free lunch or dinner seminars hosted by financial advisers. If the sentinels see anything awry, they report it to state or federal investigators.
At the very least, older investors should never attend such events unless they are accompanied by a trusted younger friend or family member. And younger relatives should periodically ask their older family members whether they have been pitched any products or services by financial advisers, say regulators and consumer advocates.
The husband-and-wife team of Thomas and Susan Cooper, ages 69 and 67, respectively, have hosted several such seminars over the years. Securities regulators in Illinois allege that the couple improperly sold annuities to 15 elderly clients. Last week, testimony concluded in administrative hearings through which the state is seeking to revoke the investment-adviser registrations of the Coopers and their firm.
The Coopers, according to the state's investigation, generated more than $400,000 in commissions in the first half of 2008 by persuading clients to buy fixed indexed annuities. According to the state's investigation, the Coopers' clients incurred more than $125,000 in early-surrender charges when they exchanged out of existing insurance products.
"The state's allegations are completely unfounded, and its numbers are inaccurate and not proven," says the Coopers' attorney, Thomas Kelty. "The state failed miserably to prove any of its allegations." A decision is expected in the case early next year.
Mrs. Cooper is a CFP. George Keller, a 69-year-old retired factory worker, says the professional credential raised his comfort level. "Oh my goodness, yes, I was impressed by that," recalls Mr. Keller of their first meeting, an informational seminar the Coopers hosted over dinner at the Hilton Garden Inn in Kankakee in 2006.
"Her husband, Tom, stood up before we ate and gave a very solid, God-honoring prayer," Mr. Keller says. According to Mr. Keller, the Coopers had asked several of their existing clients to attend the dinner. "Some were friends of ours," he recalls.
"We felt that because [the Coopers] were close to our age, they would understand and would have dealt with a lot of the problems that we face at our age: health setbacks and that sort of thing," he says. "Isn't that supposed to be a plus - to get somebody who understands your problems?"
According to Mr. Keller and state investigators, the Coopers prematurely switched him out of an insurance policy and into a fixed indexed annuity. That allegedly earned the Coopers a commission of $3,519 while costing Mr. Keller roughly $27,000 in insurance death benefits and a surrender penalty of more than $1,100.
Mr. Keller says he realized something had gone wrong when he noticed that his insurance death benefit had dropped to less than $5,000. Even so, Mr. Keller says he "felt bad about pushing this" with investigators.
As with many senior-on-senior fraud cases, a sense of loyalty kept the alleged victims from complaining even after losses were sustained. Illinois investigators say they had to subpoena many of the alleged victims to gather information from them. Mr. Kelty, the Coopers' attorney, says that during testimony in the hearing, "to a person, they testified that they were satisfied, fully informed and have no complaints whatsoever against the Coopers."
"We were feeling guilty," recalls Mr. Keller about raising his complaint in the first place. "We thought we'd somehow started it."
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Bloomberg
Leona Miller, an 84-year-old retired beautician, says she was seeking safe and steady income from bonds two years ago when her Wachovia Corp. broker recommended she buy securities paying 9 percent interest.
Within six months, Miller had lost about 30 percent of her $20,000 investment and the bonds were converted into shares of Merck & Co. in a falling stock market. The San Diego resident, who still doesn't understand what happened to her money, had purchased bonds known as structured notes that include built-in derivatives.
Sales to Miller and thousands of other individuals have driven structured note offerings up 58 percent to $31.9 billion through August, according to data compiled by Bloomberg. With U.S. interest rates near zero percent, investors are snapping up bonds such as reverse-convertible notes with knock-in put options or Leveraged CMS Curve and S&P 500 Index Linked Callable Notes, some with face values of as little as $10.
"People develop a product which makes a modicum of sense, then they extend it to the point of ludicrousness until it blows up," said Satyajit Das, a former Citigroup Inc. derivatives banker. Das, the Sydney-based author of "Traders, Guns & Money" (FT Press, 2006), said investors are often "seduced" into purchases without understanding the risks.
The Securities and Exchange Commission's enforcement division started a group this year focused on investigations into structured products, including those marketed to individual investors.
Hard to Understand
"We're concerned about the sale of complex structured notes to retail customers because people don't always understand the risks they're exposed to," said Kenneth Lench, head of the SEC's Structured and New Products unit. "It's very difficult for a person who isn't immersed in this world to pick up a prospectus and really understand what are the different scenarios that would make an investment work out for them."
Miller and Wells Fargo & Co., which acquired Wachovia in 2008, are in arbitration, according to her San Diego lawyer, Ronald Marron. In a February 2009 letter, the bank's legal department told Miller that the broker "explained very thoroughly his recommendation."
... ... ...
Racetrack Bets
JPMorgan Chase & Co. sold $223,000 of three-month reverse convertible notes on Aug. 26 that pay 12.3 percent annualized interest and are tied to the stock of Pittsburgh-based U.S. Steel Corp. Buyers were charged a fee of 5.1 percent, more than half of which compensated other brokers, the prospectus shows. The fee is five times the annual rate on stock mutual funds, according to the Investment Company Institute, a Washington- based trade group.
Justin Perras, a JPMorgan spokesman in New York, declined to comment.
"The whole marketplace is set up to be unfair and inefficient by design," said Whalen. "It's like betting with the touts out on the edge of the racetrack instead of going to the window in the clubhouse."
Bundling Rule
Wall Street began selling the notes to individuals in the 1990s. At the time, government officials questioned whether the securities should be subject to the same rules as the derivatives they contain, which would have barred sales to the public, according to Philip McBride Johnson, a former Commodity Futures Trading Commission chairman. The passage of the Commodity Futures Modernization Act in 2000 settled the issue in the banks' favor.
The law, which excluded most trades between institutions from oversight, allowed banks to sell OTC derivatives to individuals as long as they were bundled with bonds into so- called hybrid securities, said Johnson, now a lawyer at Skadden, Arps, Slate, Meagher & Flom LLP in Washington.
In the Lehman case, the notes were designed to pay interest dependent on market movements, with principal returned at maturity as long as the issuer didn't fail.
"UBS properly sold Lehman structured products to UBS clients," said Allison Chin-Leong, a bank spokeswoman. "Any client losses were the direct result of the unexpected and unprecedented failure of Lehman."
'Rotten Deal'
In April, New York-based Citigroup offered to buy Lehman notes back from more than 2,700 investors in Spain for 55 cents on the dollar, without admitting liability.
In Hong Kong, Lehman bond investors staged protests with bullhorns blaring a looped chant, "Rotten Deal -- Money Back." Buyers included the elderly and poorly educated, according to a Hong Kong Monetary Authority investigation. Last year, banks agreed to pay investors at least 60 cents on the dollar in compensation.
Banks aren't required to make markets for structured notes, just as they didn't have to buy auction-rate securities, Whalen said. That $330 billion market collapsed in early 2008, leaving investors who sought higher-yielding alternatives to checking accounts with paper they couldn't sell.
Seeking to settle with state and federal regulators, banks including Citigroup have since repurchased some of the securities, which are municipal bonds, corporate debt and preferred stock whose rates of return are periodically reset through auctions.
'More Can Be Less'
"If you're dealing with an unsophisticated person, and you're selling them a very sophisticated product, how do you satisfy your regulatory obligations?" said Harvey Pitt, a former SEC chairman.
Risks should be disclosed clearly and concisely, he said. "More can be less" because long documents may confuse investors, said Pitt, founder of Washington-based consulting firm Kalorama Partners LLC.
Miller started managing her finances when her husband died and invested in structured notes in May 2008 at the recommendation of her broker, Robert Baldacci.
'Like Anybody Else'
"I just wanted him to make some money for me, like anybody else," Miller said. "You depend on them to take care of you. I assumed that bonds were safe."
Miller lost money because the securities, issued by Eksportfinans ASA, an Oslo-based export-credit agency, were tied to the performance of Merck. A decline in the Whitehouse Station, New Jersey-based company's share price to below $32 from $40 triggered the knock-in put option built into the note, allowing Eksportfinans to pay the debt with Merck shares worth $26 each.
Wachovia denied Miller's request for compensation, according to the letter from the legal department, which also said Miller signed the prospectus and received a guide to structured notes.
"Mr. Baldacci recalled that you were familiar with Merck & Co. as they manufacture one of your medications," Wachovia said in the letter, which was provided by Marron, Miller's lawyer.
Last week, Miller chose to pursue the arbitration claim and withdrew a separate lawsuit against Wells Fargo and Eksportfinans that was filed in July, Marron said.
'Suitability' Questions
Kathryn Ellis, a spokeswoman for San Francisco-based Wells Fargo, and Baldacci, who no longer works for the bank, declined to comment. Jens Feiring, Eksportfinans's general counsel, said he's pleased Miller chose not to pursue legal action against the firm.
Most structured notes are more complex than the products Miller bought, Tontine Capital's Kelly said. Morgan Stanley's CMS Curve securities offer a fixed 10 percent rate for two years. The yield for the next 13 years is five times the difference between long-and short-term constant maturity swap rates, not to exceed 18 percent annually, earned when the Standard & Poor's 500 Index doesn't dip below 875, according to a regulatory filing.
If stocks plunge or short-term rates rise, the notes could pay no interest for more than a decade. Morgan Stanley also has quarterly options to unwind the transaction starting in 2012.
"It raises questions about suitability for the investor when you have products that are that complicated," said Daniel Bergstresser, a Harvard Business School professor who's studied structured notes. "Is that complexity a response to a legitimate desire the investor has or is it a smokescreen?"
The 'D' Word
Mark Lake, a spokesman for New York-based Morgan Stanley, declined to comment on the CMS Curve notes or sales practices. Bank of America, whose Merrill Lynch unit has the second-most brokers after Morgan Stanley Smith Barney, has underwritten $8 billion of structured notes in the U.S. this year, the most of any bank, Bloomberg data show. Morgan Stanley has sold $7.6 billion, the second most.
John Klock, 66, bought about $200,000 of structured notes starting in late 2007. He said he wouldn't have made the purchase had his Merrill Lynch broker mentioned derivatives.
"He told me it was an index of stocks," said Klock, a Newark, New Jersey-based lawyer. He said he's waiting for a statement from his broker totaling the losses when he sold the notes back to Bank of America, which bought Merrill in 2009.
Selena Morris, a spokeswoman for Charlotte, North Carolina- based Bank of America, declined to comment.
"They don't tend to mention the 'D' word very often," Das, the author, said of the banks. "One of the reasons these products exist is to avoid having to tell the person that you're dealing with that they're trading in derivatives."
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naked capitalism
Then the same officials who had directed me to keep the accounts open, disappeared - systematically, for just over six months. When I sought to talk to the fraud department, I still could not get records - including my own missing bank statements - even to see the full extent of my losses. The bank officials who had directed me to keep my accounts open were unavailable at the branch - over the course of many attempts to speak with them. The police at the Sixth Precinct needed to see the missing documents, but even they could not force WaMu to hand over their - my - records. (WaMu's own internal emails cite a $300,000 figure for my loss from fraud - I still did not have enough of my records to identify the loss. It is illegal, by the way, to withhold from an account holder his or her own records).
At eight months after the fraud discovery was confirmed - eight months of trying to communicate with officials and a fraud department who were oddly unavailable or unresponsive - I received a form letter from the WaMu Fraud Department advising me that according to the regulations, I had had a six month window for taking action; and (since WaMu had played out the clock for eight months) the letter asserted that I had waited 'too long' and my case was closed.
Inadvertently, subsequent to that, a WaMu bank official handed me the wrong file - wrong from his point of view; illuminating from mine, and from any consumer's. It contained emails, some of which you can see at TheSmokingGun.com, from WaMu bank officials to one another - and including emails from and to their counsel, PR department and and the fraud department - that take as given that stonewalling a client with a fraud claim on the bank is standard practice; and yet one freaked-out bank official in the emails warns his colleagues that if their mechanisms in this regard became known, their practices would be all over the newspapers.
I was stunned by what seemed from the emails to be a systemic practice. Why would a bank want to perpetuate bank fraud rather than fight it?
As I researched the issue and spoke to other consumer bank account holders whose accounts had been corrupted by fraud, and to consumer advocates, I learned how systemic experiences such as mine - and worse experiences - are becoming. I heard from consumers across the country from all walks of life who had also been misdirected by their banks, or told that for various technical reasons their corrupted accounts could not be closed, and then faced difficulty reaching fraud departments or officials once the fraud was confirmed….
Customers assume that banking regulation and Congressional oversight means that if they find fraud on their checking accounts, there is accountability - which is not in fact the case; strong bank lobbyists translate into weak protections for consumers and, as you can see from the emails, the bank's reasonable assumption that most customers in this situation will not be able to hold them accountable. And indeed, since legal action is time-consuming and expensive, most defrauded bank customers do eventually give up and go away…..a bank's fraud investigation department is actually likely fraudulently representing itself as the customer's, rather than solely the bank's, advocate. Banks such as WaMu - and now Chase, which bought WaMu - expect such people to simply go away. They - and we - should, rather, reach out to our elected representatives for wholesale reform - and put each and every such case online, so consumers can see the worst offenders for themselves, and, with the power of the internet and their own consumer choices, protect themselves and demand accountability.
Roman Berrt:
I am (sadly) not surprised. About three years ago my mother, invalid and confined to a hospital bed in her home then and still, had a situation where a part-time caregiver took her credit cards and some checks and spent thousands of dollars of my mother's money in a matter of days. When the fraud was discovered and my sister and I (on my mother's behalf) notified the card issuer and bank of the fraud, they launched an "investigation" to determine if in fact fraud had occurred. It dragged on for months and at the end of that time their initial finding was that no fraud had occurred and that my mother was responsible for the charges and checks.
It took the services of a lawyer to bring the bank to its senses. In the end, it turned out that they had video surveillance from ATM machines, point of purchase locations (like the local MegaMart) and so on which showed the caregiver using the stolen card and checks but apparently they knew they'd never recover the money from the caregiver and decided that it would be easier to steamroll an old and frail woman who they thought would not be in a position to fight back.
Let me re-state that concisely: The bank/card issuer knew positively that fraud had occurred and yet chose to deny that fraud had occurred.
The banks are not our friends. They will do only what they are forced to do, and that included complying with the law.
In the end, with the services of an attorney, the bank admitted that fraud had occurred, reimbursed my mother and turned over the results of their investigation to the local DA who in turn brought charges against the thief who in turn entered a plea of guilty and wound up in jail (for a short time.) But like I said, we had to essentially force the issue. If I and my sister had not intervened, they'd have stuck my mother with the loss.
Bobbo:
Sometimes it helps if you cite UCC 4-406, the specific provision of the Uniform Commercial Code that imposes liability on the bank.
The customer's duty is to diligently review statements and report any errors or fraud to the bank. As long as the customer promptly notifies the bank, it's the bank's problem.
The bank has the burden of proving that the customer was not sufficiently diligent, and that the losses could have been prevented if the customer had been diligent. Here is the text:
Mike:
She failed to notice $300k leaving her account over a period of two years?! Sorry, I'm with the bank on this one. There is clearly fraud at play here but it is the customer, not the bank.
smells like chapter 11
The law is plain - banks are not the fiduciaries of their depositors, the relationship is one of creditor and debtor, with the bank being the debtor.
As the California Court of Appeal noted in 1991 in connection with a depositor's claims against a bank arising out of unauthorized transfers:
Commercial Cotton 's [an older case] characterization of a bank-depositor relationship as quasi-fiduciary is now inappropriate. While some aspects of that relationship may resemble aspects of the insurer-insured relationship, there are equally marked differences between those relationships. Since appending the quasi-fiduciary label to the ordinary bank-depositor relationship runs counter to both pre- and post- Commercial Cotton authority, and such a label provides no analytical framework against which to evaluate the propriety of extending tort remedies for contractual breaches, we no longer approve the denomination of the ordinary bank-depositor relationship as quasi-fiduciary in character. Copesky v. Superior Court, 229 Cal.App.3d 678, 280 Cal.Rptr. 338 (1991)
Should it be otherwise? Maybe so. The rule arose in the 1800's and was based upon a banking systemn based entirely paper era where the ability of a third party to unlawfully extrract money from one's account was far more difficult that it is in today's electronic world.
However, current technoogy may provide a practical solution. I get a text everytime when even $1.00 is withdrawn from my account. The bank provides this service for free. That service would probably helped stopped the fraud described becuase almost anyone could pretty easily spot an unauthorized withdrawal within the 30 days of the mailing of a statement as required by UCC 4406.
If someone can't manage this type of communication, such as an elderly or otherwise impaired person, then maybe the rules need to be adjusted to take that into account.
DownSouth:
What we are witnessing is the descent of the United States into third-world status, or into a culture of distrust and noncooperation. I call it the Mexicanization of the United States.
And I'm not sure most Americans fully understand where this all leads. In Mexico, not even the mid-level government authority (police chief, mayor, congressman) dare venture out into public without an army of bodyguards. And even then they are frequently gunned down. The assassinations are almost always marked up by the authorities as being motivated by "the drug war," but I suspect the motivations are much more complex than that. Either way, you're talking about a decent into a culture of violence and social chaos.
Dan Kahan in "The Logic of Reciprocity: Trust, Collective Action, and Law" describes how the descent into perdition occurs:
A relatively small fraction of the population (consisting, perhaps, of those who've been trained in neoclassical economics) consists of committed free-riders, who shirk no matter what anyone else does, and another small fraction (consisting maybe those who've read too much Kantian moral philosophy) of dedicated cooperators, who contribute no matter what. But most individuals are reciprocators who cooperate conditionally on the willingness of others to contribute. Moreover, some reciprocators are relatively intolerant: they bolt as soon as they observe anyone else free-riding. Others are relatively tolerant, continuing to contribute even in the face of what they see as relatively modest degree of defection. And a great many more--call them neutral reciprocators--fall somewhere in between.
Under these circumstances, individuals are unlikely fully to overcome collective action problems through reciprocity dynamics alone. No matter how cooperative the behavior of others, the committed free-riders will always free-ride if they can get away with it. Indeed, their shirking could easily provoke noncooperative behavior by the less tolerant reciprocators, whose defection in turn risks inducing the neutral reciprocators to abandon ship, thereby prompting even the tolerant reciprocators to throw in the towel, and so forth and so on. If this unfortunate chain reaction takes place, a state of affairs once characterized by a reasonably high degree of cooperation could tip decisively toward a noncooperative equilibrium in which only the angelic unconditional cooperators are left contributing (probably futilely) to the relevant public good.
As Kayan goes on to explain, the only way to stop the descent into perdition is that free-riders be punished:
Maximum cooperation, then, probably requires that reciprocity dynamics be supplemented with appropriately tailored incentives--most likely in the form of penalties aimed specifically at persistent free-riders. Although trust and reciprocity elicit cooperation from most players, some coercive mechanism remains necessary for the small population of dedicated free-riders, who continue to hold out in the face of widespread spontaneous cooperation, thereby depressing the contributions made by relatively intolerant reciprocators. In the face of a credible penalty, however, the committed free-riders fall into line.
In the United States, however, neoclassical economic theory and its ugly twin in the fields biology and psychology--the New Atheism preached by the likes of Ayn Rand and Richard Dawkins--have become so dominant that we no longer believe in punishment of financial or economic crimes, or that altruistic punishers or strong reciprocators even exist. Everything is about the self, about the individual and individual fitness, and the group and group fitness be damned.
But the altruistic punishers and strong reciprocators haven't gone away. They're still out there, despite what the neoclassical economists and their New Atheist allies profess. And as a criminal defense lawyer in San Antonio told me many years ago, when the authorities--the legislature, law enforcement and the courts--don't deliver justice, what you get is street justice.
For more on the interaction of the individual and the group (the system or the culture) and how it is the combination of these two that shapes behavior, there's this intriguing lecture
by Amanda Pustilnik.Here's a link to Kahan's essay.
Yearning to Learn:
Thank you Down South, excellent post and link. I obviously agree fully.
You call it the "Mexicanization" of America. I call this the "caveat emptorization" of America.
the caveat-emptor free-market ideologues are fools.
they laugh at financial victims as 'sheeple' and cloak themselves in a "well they should have known better or at least learned the information". but life is simply not long enough to learn everything.
I am a doctor and I laugh myself to pieces every time I hear them claim how smart they are and how they are able to make "informed" medical decisions. I'm sure mainly based on GoogleHealth web searches or whatever.
I have 11 years of medical training AFTER college (so not including all the pre med courses), and yet I have to rely on my own doctor's recommendations since I am not an internist. I know that I am in her hands and that in the end I have to trust her. I am not so foolish as to think that I am "fully informed". I am a financial dork, so am relatively informed there. But what about when I fix my car? or when I buy a house? or when I contract for legal services? In the end, I have no choice but to TRUST my counterparty.
The caveat emptorization of America is breaking that trust, and thus eventually all commerce beyond dark-ages technology will break down.
we have a very long road ahead since we can't even trust our fiduciary agents.
koshem:
Banks rely heavily on the enormous cost a defrauded customer lawsuit incurs on the defrauded. This modern version of the Wild West takes the law out of the equation and substitutes it with raw force the banks possess.
The government itself uses the same raw force when suit by its own employees. Government agencies are, by and large, organized according to the 50s organizational practices (e.g. three employees have a supervisor who enjoys almost absolute power and doesn't do anything but supervision).
As a result, abuse and harassment are prevalent. Many government employees injured by these abuses cannot afford to complain and internal reform is impossible. Customers and employees will be protected from abuse only when following the law will be enforced by swift and affordable reaction to violation.
nilys:
It's a dog-eat-dog kind of climate out there. How what banks do is any different from what other companies and individuals do?
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Apr 19, 2009 | NYTimes.com
It's hard to thwart someone intent on committing a crime. But you can at least put your advisers on notice by not letting them trade on your behalf at all. That's what we did with Mr. Weitzman, simply because we don't think it is a good idea to give anyone that authority. If, for any reason, you need help putting an adviser's plan into action, have the adviser show you how to make the trades or transfers yourself on the Web site of the firm where you keep your money. Or, at the very least, make it clear, in writing, to your advisers that they are not to make any trades or transfers without your permission.
Janice Fetsch, head of compliance for Smith Barney and its fleet of stockbrokers, also warns people never to sign blank or even incomplete documents. And she tells her branch managers to be on the lookout for financial advisers who are suddenly living beyond their means. Smith Barney's brochure for clients on how to protect their accounts, which I've linked to on the Web version of this story, reads like a mini encyclopedia of investor paranoia. And I mean that as a compliment.
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July 2008 | www.fraud-magazine.com
Interview with Dr. Robert D. Hare and Dr. Paul Babiak
Not all psychopaths become fraudsters, but some fraudsters are psychopaths. A fraud examiner's job is to help deter fraud by discretely noticing those employees who might be exhibiting psychopathic tendencies. Psychologists Robert D. Hare, Ph.D., and Paul Babiak, Ph.D., experts in psychopath studies, explain how these aberrant characters can infect organizations and provide ways to deal with them.
Sam strode into the lobby of Bacme Manufacturing. Impeccably dressed in a tailored suit, carrying a burnished leather briefcase, he smiled at the receptionist. "Hello. I'm Sam Smithson, here to see Mr. Tolliver for my second interview." "Yes, Mr. Smithson. Mr. Tolliver is ready to see you." Eyes turned as Sam walked up the stairs.
"Sam! So good to see you!" "It's great to be here again, Mr. Tolliver!" During the national economic downturn, Bacme was suffering and needed a few "white knights." Sam had the requisite resume, leadership qualities, and enthusiastic spirit the company needed to boost morale and the bottom line as a vice president.
Unfortunately, Mr. Tolliver didn't know that Sam was a textbook psychopath. Behind his smile and relaxed manner, he was dishonest, devious, and manipulative. He pretended to be an empathetic listener, but most of the time he had only one person on his mind.
Within a year, Sam had ingratiated himself to staffers who could benefit him: top executives but also the "informal leaders" - middle managers and administrative assistants who got the real work done. Soon he was controlling vast areas of the company and began embezzling funds. By the time the corporation realized it was missing millions of dollars, smiling Sam, "the white knight," was on to the next corporation.
Not all psychopaths become fraudsters, but some fraudsters are psychopaths. A fraud examiner's job is to help deter fraud by discretely noticing those employees who might be exhibiting psychopathic tendencies.
Robert D. Hare, Ph.D. and Paul Babiak, Ph.D., authors of "Snakes in Suits: When Psychopaths Go to Work" (available in the ACFE Bookstore), have been studying psychopaths and their effects for years. Babiak is an industrial and organizational psychologist and president of HRBackOffice, an executive coaching and consulting firm specializing in management development and succession planning (www.HRBackOffice.com). Hare, the creator of the standard tool for diagnosing psychopathy and author of "Without Conscience: The Disturbing World of the Psychopaths Among us," is an emeritus professor of psychology at the University of British Columbia and president of Darkstone Research Group, a forensic research and consulting firm (www.hare.org).
"Psychopaths invest energy in creating and maintaining a facade that facilitates their careers," said Hare. "During the hiring process they convince decision makers of their unique talents and abilities - albeit based upon lies and distortion.
"Executives are always looking for the best and brightest ... but there are not that many from which to choose," Hare said. "As times goes on, the psychopath will continue to manage this positive reputation for as long as it is useful to him or her. ... Executives view themselves as good judges of people, and few want to be told that they were wrong about something as basic as honesty and integrity. This aspect of human nature works in favor of the psychopath."
Hare will be a keynote speaker at the 19th Annual ACFE Fraud Conference & Exhibition in Boston in July. He spoke to Fraud Magazine from his home in Vancouver, B.C., and Babiak from his home in Dutchess County, N.Y.
Do you believe that most fraudsters are psychopaths or do they just exhibit anti-social behavior?
Hare: There are many reasons why people engage in fraudulent behavior, some related to economic necessity, cultural, social, and peer pressures, special circumstances, opportunities, and so forth. Many of these people are small-time criminals just "doing their job," and their victims are relatively few in number. Much more problematic are fraudsters whose activities reflect a virulent mix of personality traits and behaviors including grandiosity; sense of entitlement; a propensity to lie, deceive, cheat, and manipulate; a lack of empathy and remorse; an inability to develop deep emotional and social connections with others; and the view that others are merely resources to be exploited - callously and without regret.
These white-collar psychopaths often are heavily involved in obscenely lucrative scams of every sort. They lead lavish lifestyles while their victims lose their life savings, their dignity, and their health - a financial death penalty as one law enforcement officer put it. The public and the courts have difficulty in appreciating the enormity of the damage done by these social predators, and because their crimes often do not involve direct physical violence, they may receive comparatively light fines and sentences, and early parole. The money obtained from their depredations is seldom recovered, leaving the victims and the public bewildered and convinced that crime certainly does pay when committed by those whose charm, egocentricity, and deception disguise a flabby conscience.
You've designed the "Psychopathy Checklist - Revised" (PCL-R), the standard tool for diagnosing psychopathy. Can you briefly describe its methodology and how it differs from other forms of measurement?
Hare: The PCL-R is a 20-item clinical construct rating scale for the assessment of psychopathy in forensic populations. Qualified professionals use interview and detailed file/collateral information to score each item on 3-point scales (0, 1, 2) according to the extent to which an individual matches explicit criteria for the item. The resulting total scores can vary from 0 to 40 and reflect the extent to which the individual matches the "prototypical psychopath." One derivative of the PCL-R, the Psychopathy Checklist: Screening Version (PCL: SV), often is used in community and civil psychiatric research on psychopathy. It has 12 items, with total scores that can vary from 0 to 24. The items in each instrument are grouped into the same four factors or dimensions, each of which contributes to the measurement of psychopathy. For example, the items in the PCL: SV dimensions are: Interpersonal (Superficial, Grandiose, Deceitful); Affective (Lacks remorse, Lacks empathy, Doesn't accept responsibility for own behavior); Lifestyle (Impulsive, Lacks goals, Irresponsibility); Antisocial (Poor behavioral controls, Adolescent antisocial behavior, Adult antisocial behavior). The PCL-R and the PCL: SV are strongly related to one another, both conceptually and empirically and have much the same psychometric, explanatory, and predictive properties. Because of their demonstrated reliability and validity, they are widely used in basic and applied research on psychopathy and for clinical and forensic evaluations.
The personality disorder measured by the PCL-R is similar to antisocial personality disorder (ASPD), described in the American Psychiatric Association's DSM-IV. The difference is that the PCL-R places considerable emphasis on the interpersonal and affective traits associated with psychopathy, whereas ASPD is defined more by antisocial behaviors. As a result, ASPD fails to capture the traditional construct of psychopathy and is much more prevalent in community and forensic populations than is psychopathy.
Self-report personality inventories also are used for the assessment of psychopathic traits and behaviors. The information provided by these instruments reflects the individual's self-understanding and evaluation, what he or she is willing to disclose to others, and impression management. It may be difficult to obtain accurate self-reports of affective experiences associated with psychopathic tendencies. Further, self-report measures of psychopathy are only moderately correlated with the PCL-R and its derivatives. Nonetheless, they provide useful information from the individual's perspective, and contribute to our understanding of the psychopathy construct, particularly in the general population. One derivative of the PCL-R is the B-Scan or Business Integrity Scan, which includes both a self-report version and a supervisor's rating version. We developed the scan out of our experiences with, and research on, the lack of integrity and honesty of corporate psychopaths. Although not a clinical measure of psychopathy, it is designed to tap into the behaviors, attitudes and judgments relevant to ethical business practices.
You've written that many people, after reading or hearing you speak, begin wondering if their bosses and co-workers are psychopaths - or even themselves! I imagine all of us exhibit psychopathic traits at various times, but what are the prevailing characteristics that you believe a person must exhibit to actually be diagnosed as a psychopath? How do you distinguish a psychopath from a difficult person?
Hare: Television constantly describes the symptoms associated with an endless list of diseases, some real, some contrived. The viewer may have one of the symptoms of disease X, say a sore throat, and worry that he or she has the disease. But this symptom is shared by scores of conditions other than disease X, and sometimes a sore throat is simply a sore throat. What people don't take into account is that a given disease or medical condition is defined and diagnosed by a set of symptoms, a syndrome, and that one or two of the defining symptoms may be of little diagnostic value. One symptom does not a disease make, nor does being impulsive, egocentric, irresponsible, and so forth make someone a psychopath; difficult, perhaps, but not psychopathic.
Psychopathy is defined by having a heavy dose of the features that comprise the disorder. How heavy? Like blood pressure, the construct measured by the PCL-R and PCL: SV is dimensional. The threshold for "high blood pressure" or for a label of "hypertensive" is somewhat arbitrary, but typically falls in a range where there is increased risk to the individual's health. The threshold for "psychopathy" also is somewhat arbitrary, but generally is set rather high, at a level where the individual's manipulative, callous, egocentric, predatory, irresponsible, and remorseless behaviors begin to infringe upon the rights and safety of others. For example, researchers often adopt a PCL: SV score of 18 (out of 24) for "probable psychopathy," and a score of 13 for "possible psychopathy." To put this into context, the average PCL: SV score is less than 3 for samples from the general population, and around 13 for samples from forensic populations. Most of those in the general population receive a PCL: SV score of 0 or 1. So, even those who appear to exhibit a few psychopathic features would fall well below thresholds for possible or probable psychopathy. This does not mean that such individuals are saint-like; they could still be very "difficult" for reasons other than psychopathy. Their values, beliefs, or personal style may not be appealing to us, but they may be honest, have integrity, experience emotions at a real level, and contribute to the success of the organization. These "difficult" people also can make sincere efforts to moderate their attitudes and behaviors so as to fit more comfortably into the corporate culture or social norms of their work group. Psychopaths, on the other hand, lack integrity, are dishonest and manipulative, and do not experience deep-seated emotions. They may go through the motions of change in order to achieve their goals, but it will be little more than play-acting. Like Iago in Shakespeare's Othello, psychopaths can be "good" or "bad," depending on what is likely to work best at the time.
What do psychopaths want? What are their motivations?
Hare: They want many of the same basic things that the rest of us want, but, in addition, have an inordinate need for power, prestige, wealth, and so forth. They differ from most of us in terms of how much they "need," their sense of entitlement to whatever they want, and the means with which they are willing to achieve their ends. They also differ dramatically from others in the communal nature of their needs and goals. That is, the sense of altruism, concern for the welfare of family, friends, and society, and the social rules, expectations, and reciprocity that guide most people are irrelevant to psychopaths. They operate according to their own self-serving principle: look out for number 1, no matter what the cost to others, and without guilt or remorse.
Do psychopaths feel emotions and respond to emotions in others?
Hare: The emotional life of psychopaths lacks the range and depth found in most individuals. It often is described as shallow and barren, consisting mostly of "proto-emotions," somewhat primitive responses associated with their own needs and experiences. Their displays of anger, hostility, envy, and response to frustration are likely to be much more intense and genuine than their feelings of empathy, love, shame, and sorrow. While at times they may appear cold and unemotional, they are prone to dramatic, shallow, and short-lived displays of feeling. They are able to mimic emotions rather convincingly, but an astute observer may be left with the impression that they are play-acting and that little is going on below the surface. This, of course, raises an interesting question. If their own emotional life is relatively barren how are they so adept at "reading" and responding to the emotions of other people? The answer seems to be that they have learned that what others describe as a given emotional state is reflected in a distinct pattern of verbal cues and body language. Psychopaths are able to use this information to intuit an emotional state that they don't really understand. In this sense, they are like a color-blind person who "recognizes" color because of the context in which it occurs (the red light is at the top of the traffic signal) and therefore gives the appearance of color perception. However, no amount of training and practice will allow the color-blind person to really understand color or the psychopath to really understand the emotional life of others, except in a vague intellectual, inferential sense. To put it simply, they don't know how you feel, nor do they much care.
You've written that some researchers have said that psychopaths "know the words but not the music." What does that mean?
Hare: It means that psychopaths understand the denotative, dictionary meanings of words but do not fully appreciate their connotative, emotional meaning. Their language is only "word deep," lacking in emotional coloring. Saying "I love you" or "I'm truly sorry" has about as much emotional meaning as saying "have a nice day." This lack of emotional depth in language is part of their more general poverty of affect as described by clinicians and observed in neuroimaging studies.
What are the differences between psychopaths, sociopaths, and those with narcissistic personality or histrionic personality disorders?
Hare: The terms psychopathy and sociopathy refer to related but not identical conditions. Psychopaths have a pattern of personality traits and behaviors not readily understood in terms of social or environmental factors. They are described as without conscience and incapable of empathy, guilt, or loyalty to anyone but themselves. Sociopathy is not a formal psychiatric condition. It refers to a pattern of attitudes, values, and behaviors that is considered antisocial and criminal by society at large, but seen as normal or necessary by the subculture or social environment in which it developed. Sociopaths may have a well-developed conscience and a normal capacity for empathy, guilt, and loyalty, but their sense of right and wrong is based on the norms and expectations of their subculture or group. Many criminals might be described as sociopaths. Narcissistic and histrionic personality disorders are described in DSM-IV, and their differences from psychopathy are outlined in "Snakes in Suits." Briefly, narcissistic personality disorder involves an excessive need for admiration, a sense of superiority and entitlement, and a lack of empathy. It does not necessarily include the lifestyle and antisocial features of psychopathy, outlined earlier. Histrionic personality disorder is defined by excessive and overly dramatic emotionality, attention-seeking, and a strong need for approval. It lacks the lifestyle and antisocial features of psychopathy.
Do we have research that indicates that a person is a psychopath because of genetics, the environment, or both? If it's partially environmental, what could happen to a person so he or she develops into a psychopath?
Hare: All personality traits are the result of genetic-environmental interactions. Recent research in behavioral genetics indicates that callous-unemotional traits and antisocial tendencies, likely precursors to the dimensions of psychopathy described earlier, are highly heritable. There is no evidence that psychopathy can result solely from social or environmental influences. This doesn't mean that some people are destined to become psychopaths, only that the process of socialization is much more difficult for those with early indications of the precursors of the disorder.
Do male and female psychopaths practice their deceptions in different ways? If so, how?
Hare: There are many clinical accounts of female psychopaths but relatively little empirical research. The available evidence suggests that male and female psychopaths share similar interpersonal and affective features, including egocentricity, deceptiveness, shallow emotions, and lack of empathy. All will make maximum use of their physical attributes to deceive and manipulate others, but female psychopaths may be less prone than males to use overt, direct physical aggression to attain their ends. The term femme fatale comes to mind.
What are some ways that companies can screen out psychopaths during the interview and background check processes? This has to be extremely hard because psychopaths exhibit all the right qualities (and fake the rest) when companies are vetting them for jobs.
Babiak: Psychopaths make great first impressions and have extremely effective interviewing skills, so relying on employment interviews alone when making hiring decisions can lead an organization to make the wrong choice. The risk is increased by the use of untrained or inadequately trained interviewers who are unaware of the psychopath's skill at lying and deception, and therefore don't take the necessary extra steps to verify all information collected.
Improving one's chances of detecting psychopathic lying during the employment process requires verification of all details presented (knowledge, experience, expertise), and exploring and challenging discrepancies. Psychopaths talk a good game on a surface level, and will use technical jargon and glib, superficial charm to convince the interviewer of their experience and expertise. As much as possible, rÈsumÈ data should be checked before the interview. Then, by using structured interviewing techniques and multiple interviewers from different functions and levels in the organization, inconsistencies can be explored further and details drilled down.
It is critical that all interviewers get together to share their findings and impressions before an offer is made. During this important meeting, the discrepancies noted and possible deceptions will be uncovered. Relying on a group decision removes the psychopath's advantage in manipulating just one interviewer successfully.
Can you talk briefly about the "three personalities" that are within all of us?
Babiak: Deep down we all have a private experience of ourselves, our personality, which consists of our needs, values, emotions and so forth. This self-perception includes things we know about ourselves that we are comfortable sharing, other characteristics we wish to keep private, and even some parts that are unknown even to us. This is our inner or private personality. When we deal with others, though, we tend to limit the presentation of our personality to those things we like, are socially acceptable, and can positively influence those around us. This is our persona, or public self. We wear this mask in public. The third point of view of the personality is our reputation among those who know or interact with us; that is, our attributed personality.
In a business world, where "perception is reality," this last view of our personality - our reputation - is the most important. It influences how others will treat us and how decisions are made about us, and can ultimately foster or derail our careers. Unfortunately, many people are unaware of or discount this view of themselves. Sometimes it is only upon receipt of hard data, often in the form of "360-degree" feedback given during training programs, that they learn how others really perceive them.
The psychopath operates on the surface level, presenting a mask or persona that is in keeping with the expectations of the organization and its members. Typically, this mask is: "I am the ideal employee and leader." The psychopath invests considerable effort creating and managing this faÁade through impression management techniques. Those who have power and authority will be shown only this mask - that is, the faÁade of an employee who is honest, productive, caring, with leadership potential, and so forth - and will integrate it into their evaluation of the psychopath - in effect, the psychopath's reputation. Those who are of little value to the psychopath will not receive such careful impression management, and may come to see the psychopath for who he or she really is. Unfortunately, however, they are often in positions least likely to influence the thinking of those in power.
In a nutshell, how do psychopaths judge the personalities of others?
Babiak: Psychopaths often come across as good psychologists, but in reality they are just more observant of others and are motivated to take advantage of the traits, characteristics, and personal situations of those around them. Psychopaths use the same three-part personality model to build strong relationships with others. They initially present a charming, charismatic mask, persona, which is often quite likeable. When they want to deepen the relationship (because the target has something they want), they first convince the target that they truly like him or her (that is, like his or her own persona or outward self). Then, they convince the target that they are more similar than different in many ways (including at the deep psychological level). Thirdly, they convince the target that they fully understand and accept the target's own true, private, and inner personality (the one with all of its secrets), and, therefore, because of this acceptance, they can be trusted. Finally, they convince the target that they (the psychopaths) are the ideal friend, partner, coworker, and so forth; this forms the "psychopathic bond." This bond is quite seductive, as few people reach this level of psychological intimacy with others in the work environment. Once this bond is formed, it is very difficult for the target to see the truth about the psychopath as he or she continues to be manipulated.
In business situations, do psychopaths target particular individuals? If so, what kinds of persons?
Babiak: Psychopaths are always on the lookout for individuals of whom they can take advantage. We often correctly assume that they target those with high status and power in the organization, but they also identify those with subtle, informal power in the organization. For example, many secretaries control access to their principals whom a psychopath will want to influence. Middle-level managers control the flow of materials, information, and processes that might prove useful to a psychopath. Individual contributors in professional positions (for example, those in IT, finance, and auditing), despite the lack of authority over staff, have great amounts of influence over information and other resources useful to the corporate psychopath. Any person with perceived utility to the psychopath will be targeted.
I know this is complex, but how are psychopaths able to manipulate people within an organization to be, as you call them, "pawns," and "patrons"?
Babiak: This model evolved out of our observations of how the "psychopathic drama" unfolds. It captures the theatrical nature of the psychopaths' view of organizational life. Psychopaths see themselves as the writers, directors, and producers of the dramas that are their lives - on and off their jobs; other people only exist to fulfill the supporting roles required of them - the pawns, and patrons.
Psychopaths form bonds with many people in the organization; that is, psychopathic bonds, not real ones. The psychopath views as pawns those who have the power, status, or access to desired resources, to be used until their utility is gone, and then dispensed with or even sacrificed. Patrons are those key power holders whom the psychopath relies upon for protection and defense when things get uncomfortable, much like the "mentors" or "godfathers" who exist in many large companies to assist high potentials negotiate their way through the political minefields to the top.
In addition, there is the patsy - a former pawn or patron whose organizational power and influence has been effectively neutralized by the psychopath. Finally, there are the organizational police, those in control positions such as accounting, HR, IT, and security who are in the best position to unseat the psychopath, but who often are not listened to by those in power, and who have already been trapped in the psychopathic bond. The psychopath prefers to avoid the organizational police (they tend to have ethical and professional values which are anathema to the psychopath), but having one in his or her vest pocket can be invaluable.
It makes sense that psychopaths would try to influence recognized top managers, but how do they manipulate and use "informal leaders," those who wield influence but might not be high on the organizational chart?
Babiak: While formal power holders are credited with leading their organizations, it is often a group of informal leaders who gets things done on a day-to-day basis. Unfortunately, in many companies, these informal leaders are the unsung heroes - and feel as such. What better person to convince that they have value and a friend in high places, as the psychopath moves up, than these individuals? They are the perfect targets from the up-and-coming psychopath's point of view.
How can a person avoid becoming ensnared in a one-sided relationship with a psychopath?
Babiak: Knowledge certainly is power in this case. It is important to learn as much as one can about psychopaths - their traits and characteristics, and how they operate. Furthermore, one should learn more about oneself, particularly those things that would make one attractive to a psychopath. These can include power and control of resources (formal and informal), as well as any psychological or emotional weak spots or hot buttons that can be used to unduly influence you. Psychopaths don't operate in a social vacuum, and those with whom they have worked or interacted can be valuable sources of information.
You've written that once psychopaths are within an organization, they revert to their natural three-phase behavior pattern - assessment, manipulation, and abandonment. Can you briefly describe those three steps? Can you also describe the ascension phase?
Babiak: In society, psychopaths exhibit a fairly consistent pattern of behavior. They identify targets (assessment phase), use them (manipulation phase), and dispense with them when their utility is used up (abandonment phase). In organizations, the abandonment phase is difficult to manage, as the psychopath cannot just move on, in the physical sense. This can lead to confrontations with former pawns who now feel like patsies. But the psychopath has already prepared for this, having spread disparaging information about these individuals - that is, "poisoned the water" - among those in positions of power. Those who ultimately confront a corporate psychopath often come to find themselves on the chopping block.
In some cases, psychopaths see opportunities to move up in the power hierarchies by unseating those who have mentored or protected them, their patrons, in the ultimate acts of betrayal. This form of ascension can be particularly rewarding to a psychopath who has played both the patron and other members of the organization.
Are most corporate and organizational psychopaths loners or do they sometimes team up with other psychopaths to pull off fraud schemes?
Babiak: Most of the individuals we have met have been "loners" in the sense of only thinking of themselves; however, they do surround themselves with supporters and followers to facilitate their activities. To the degree that the psychopath can get these naÔve supporters to believe that their actions are consistent with their own personal values, the game remains in play.
Occasionally, two psychopaths may work as a team in the same organization, at least for short periods. Inevitably, there will be a falling out: two stars is one too many. In one case, two corporate psychopaths worked in the same company but were in different divisions and rarely interacted. Historically, there may have been instances of psychopaths working together. One wonders who was "more" psychopathic: Joseph Stalin or his henchman, Lavrentiy Beria, chief of the secret police.
Have the Internet and other technological developments aided psychopaths?
Hare: Immeasurably! The Internet and technology have given psychopaths and other predators access to a virtually unlimited pool of potential victims. They can promote phony stocks, circulate crooked investment schemes, siphon off bank accounts, commit identity theft, and so forth, all with little risk to themselves. They also can promote themselves by constructing fake or greatly embellished Web sites and credentials in order to lure unsuspecting victims. In a very real sense, the Internet and associated technology represent a paradise on earth for fraudsters, with even better things to come.
The business world of the 1980s and 1990s went through startling changes after decades of relative stability in culture and procedures. And now we're in an economic slowdown or possible recession. Have these changes helped or hindered psychopaths in organizations?
Babiak: While economic slowdowns can lead to layoffs and plant closings, there is still the need for seasoned, experienced leaders who have the wherewithal to meet the challenge of recovery and turnaround. These individuals are rare. What a perfect scenario for the psychopath to enter as the "solution," replete with the skills (faked), abilities (faked), and background (faked) necessary to take over and makes things right.
There is also greater access to higher education in general than before, as well as questionable online degrees that can be bought and used by psychopaths to pad their resumes. Losing one's job no longer bears the stigma - or provokes as much concern - as it once did; layoffs and plant closings have left many truly stellar executives with gaps in their employment histories. Economic conditions can be a convenient explanation for short tenures listed on the resume. While a psychopath would be expected to blame the former boss's personality or colleagues' underhandedness for losing his or her job, a really clever one can feign some sadness at having to leave "a great job at a great company" due to economic conditions.
You've written that organizations have become more "psychopath friendly." What do you mean by that?
Babiak: The change of organizational structures from large and bureaucratic to lean, mean, and flat has inadvertently made companies more attractive to psychopaths (fewer rules) and, at the same time, easier to negotiate (faster progression). There is more opportunity for a motivated psychopath to stand out amongst his or her peers, less hoops to jump through, and shorter distances to the top. Changes in work values among employees have also facilitated entry by psychopaths. Many companies, initially puzzled by the demands of "younger" workers for large sign-on bonuses and promotions at least every two years, are beginning to accept this as part of a new work style that needs to be accommodated in some way. A young psychopath would fit in quite nicely in this culture.
You've written that you doubt that psychopathic individuals would be very successful in a highly structured traditional bureaucracy. Why is that?
Babiak: Bureaucracies, by design, are rule-bound structures. They are the result of a stage of organizational development in which companies attempt to systematize their operations in pursuit of consistency, quality, and productivity. An unfortunate outcome also is that they can become quite boring, slow to respond, and intolerant of creativity and innovation.
During the 1980s and 1990s, the speed required of businesses to maintain their positions, and perhaps grow market share, increased. This put a tremendous strain on organizational systems - the bureaucracy - as well as on employees and managers - the culture. The mantra became "do more, better, faster with less" - a difficult task, at best. In response to accelerated market demands, organizations began to jettison parts of their bureaucracy - policies and procedures - in the interest of speed. Entire levels of management were eliminated under the theory that communications would improve from top to bottom. Systems once thought to be helpful were eliminated or "reengineered" away. By eliminating those policies and procedures that could help uncover psychopathic behavior - formal performance appraisals are a good example - and systems that help prevent their hiring - structured employment practices - it became much easier for someone with psychopathic tendencies to slip in and look successful.
Unfortunately, this is where the psychopath has an advantage; these new structures are always in a state of flux and never reach the "ideal" state. We call them "transitional organizations" because the transitioning never ends. This frustrates and confuses those who have grown accustomed to the stability that large organizations used to provide. Being a thrill seeker by nature, the psychopath relishes the chaos. On a practical level, a constantly changing work environment provides the psychopath an endless source of new coworkers to target and many opportunities to move from project to project when boredom sets in.
Can you talk about how psychopathic fraudsters use affinity groups (religious, political, or social entities in which all members share common values or beliefs) to pull off their schemes?
Hare: We refer to these schemes as affinity fraud. They rely on the fact that members of an affinity group typically are very trusting of others who profess to share their values, beliefs, and interests. Those who are most adept at perpetrating affinity fraud are psychopaths who gain entry into the group by developing an acquaintance with a member who then introduces the fraudster as "one of us." The result is a "fox in the henhouse," with predictable results. Religious groups, are particularly vulnerable; belief in the inherent goodness of others and uncritical acceptance of professions of faith are tailor-made for an enterprising psychopath. Sadly, even after being victimized, many members of a group will refuse to face the truth, continuing to believe that the scamster is basically good at heart or that there must be a reason why he or she took advantage of the group. Even sophisticated members of financial and business groups - such as investment clubs - often are no match for the charm and seduction of a good-looking, well-dressed, and apparently well-connected psychopath. A suspicious view of newcomers might help but is no guarantee of immunity to infiltration by someone intent on doing the group harm. Even organizations that by their very nature are extremely cynical and suspicious - such as intelligence agencies and criminal gangs - cannot protect themselves completely from those who misrepresent their credentials, connections, and intentions.
Joseph Wells, the founder and chairman of the ACFE, has concentrated on teaching not just about fraudsters' actions but their psychological motivations and aberrations. How can a group like ours aid its members in spotting possible psychopaths and prevent them from transforming their behaviors into crimes?
Babiak: Increasing the professional standards and training of fraud examiners is a good foundation. Knowledge about the nature of psychopaths and of the strategies and tactics they use is important. Even so, it can be very difficult to spot them without detailed information from a variety of sources about their behavior and manipulations especially if you are the one being targeted. It is also important for examiners to understand themselves and how their own personality traits and vulnerabilities may play into the hands of a psychopath. A confidential "hot line" could be made available to members who have suspicions and need coaching and advice on how to proceed.
Are most psychopaths in organizations exposed or do they remain or go on to greater positions?
Babiak: With one exception, all of the psychopaths that we have studied are still in positions of authority in their companies. In some cases, they have risen within the ranks, and in others, they have solid positions from which they continue to use their organizations for personal gain. The one psychopath we studied who was fired ended up leaving with a sizeable financial package and a company car. He was hired by a competitor at a significantly greater salary. Unfortunately, in their effort to rid themselves of problems and to avoid embarrassment in front of corporate or financial communities, some organizations will cover up their messes and even write favorable letters of recommendation thus facilitating psychopaths' devious journeys up corporate ladders.
Since the publication of "Snakes in Suits," we have received an increased number of calls from executives, entrepreneurs, and principals who now suspect that someone on their staff - or even an equity partner - is a corporate psychopath. We see that awareness of the problem has increased, as has the willingness to take action to remove or otherwise deal with the problem person.
How does a fraud examiner identify possible psychopaths after they're hired? I imagine it's a sensitive issue to put the psychopath label on anybody, but how should a fraud examiner proceed to prevent a possible fraud or should they even try? Is it ever possible to discern the potential for fraud in a suspected psychopath?
Babiak: In business situations, it is rarely useful to label someone a psychopath; organizations can only respond to the overt behaviors of fraudsters and others. Suspecting that a client (or even a coworker) has psychopathic traits can help sensitize an examiner to search out and investigate subtle forms of lying and deceit. If the client is highly psychopathic, the odds are that some form of corporate misbehavior, perhaps fraud, is underway, but hidden from view. If inconsistencies and improprieties begin to surface, it is important that the examiner's focus remain on the facts of each case, as the psychopath will try to distract him or her through flattery, misdirection, questioning the examiner's competence or authority to investigate, and so forth.
What steps lead to the confrontation of a psychopath and how is it carried out? Can a psychopath ever be rehabilitated?
Hare: Like anyone suspected of corporate misbehavior or fraud, confrontation of a suspected psychopath should occur after all the facts have been obtained, verified, digested, and interpreted, and in accordance with corporate policies and due process. In addition, however, it is important to anticipate the potential reactions of the psychopath, which may include "plausible" indignation and denial, diffusion of blame and responsibility, appeals to a "higher" authority, verbal abuse, and threats of litigation. In such cases, it is essential to ensure that the case against the individual is factually and legally sound and to "stand one's ground."
A somewhat different tactic sometimes employed by those accused of misbehavior is to admit it, claim that the behavior was out of character, and solemnly pledge to change. However, when dealing with a suspected psychopath such tactics should be treated with a healthy dose of skepticism. There is little evidence that psychopaths can be, or even believe that they should be, rehabilitated. Their behavior reflects a well-established, stable personality structure. Most people have some insight into the motivations for their own behavior, and will accept that changes need to be made in order to be a good corporate citizen. Unfortunately, psychopaths already are aware of their own motivations, see little wrong with them, and do not believe they need to change. However, if they think that "rehabilitation" can serve their own selfish, pragmatic ends, then they are quite capable of playing the game, portraying themselves as a "saved" or "redeemed" sinner.
Dick Carozza is editor-in-chief of Fraud Magazine.
The Association of Certified Fraud Examiners assumes sole copyright of any article published on www.fraud-magazine.com or www.ACFE.com. ACFE follows a policy of exclusive publication. Permission of the publisher is required before an article can be copied or reproduced. Requests for reprinting an article in any form must be e-mailed to: [email protected].
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Sep 02, 2008 | Forbes.com
After reading about it in the local newspaper, you decide to attend a seminar at a neighborhood steakhouse where a broker will offer a lecture on how to retire early, earn high investment returns and enjoy steady annual cash withdrawals, all while you finish off that complimentary, medium-rare T-bone.
The broker is dressed sharp while pitching his difficult-to-resist game plan. The catch of course is that you will have to roll over your 401(k) plan and open an individual retirement account at his firm. There is brief mention of risk associated with stock market volatility and of fees, but you focus on the promise of capital growth and juicy annual withdrawals of 9%
Sounds too good to be true. And it is.
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HOUMA, La. - After 30 years of toiling in oil fields, Ray Lirette was told in 1997 that he could retire at 52 and buy a camper so he and his wife could travel across the USA.Lirette says he trusted the advice because it came from an investment broker used by other Chevron workers. That's why he turned over his retirement savings - $335,000 - to the broker to manage, bought a camper and truck, then borrowed against a nearly paid-off mortgage to pay off credit card bills and auto loans.
"He showed me this projection that I'd have $1.3 million in 10 years," Lirette, 63, said as the sun glinted off the 28-foot camper parked on his lawn. "I thought, 'I guess we can retire.' "
Retirement didn't last long. Lirette says his nest egg shrank to $43,000 over eight years as his portfolio - concentrated in fairly risky stocks - plunged. The broker, he says, still guaranteed returns of 15% and said the market would rebound. About five years ago, Lirette and his wife were forced back to work, into jobs paying a fraction of what they used to earn.
COMMENTS: Have you ever received an early-retirement pitch at work? Whether you have or not, are you planning for an early retirement? If so, how?
It's a nightmarish lesson in investing that regulators say will become increasingly common as 79 million baby boomers inch toward retirement. Across America, a growing number of financial advisers are targeting the portfolios of the swelling number of want-to-be early retirees through their employers. Advisers are crashing company retirement parties, holding seminars in the workplace - sometimes with little oversight by employers - and persuading employees to pass along their co-workers' contact information.
From one case to the next, the pitches are similar: Employees are urged to retire early by brokers who claim they can earn them more money in retirement than they could make if they continued working. The employees are told they can withdraw up to 9% of their nest eggs a year in retirement because their portfolios - often invested in high-cost, high-commission products - will gain 15% or more a year. In many cases, they're persuaded to do so because some co-workers have done the same.
... ... ...
Under the Employee Retirement Income Security Act, which governs retirement-plan assets, employers could be held responsible if they "endorsed" or "selected" a financial provider, knowing it wanted to give advice related to a retirement plan, says Robert J. Doyle, director of regulations and interpretations at the Labor Department's Employee Benefits Security Administration. But if an employer made clear it didn't endorse that provider, Doyle says, the employer would likely not be responsible under ERISA.
The law is unclear, though, about what constitutes an endorsement. Does it include advertising a financial seminar on company property or including an adviser in a company newsletter?
"There's no case law that addresses" whether employers can be held liable in early-retirement cases where advisers solicited workers on company property, says Doug Hinson, a partner at Alston & Bird law firm in Atlanta.
Even when advisers have no official tie with employers, their ability to tout their knowledge of the company or their relationship with workers can lend them credibility. In one investigation Massachusetts is conducting, a broker obtained a list of workers who had been offered early retirement, Secretary Galvin says; it's unclear how the adviser got the list.
In New Orleans, Brian Hyver, 61, says he decided to entrust Musso, the Morgan Stanley broker, with his money after Musso showed him a list of two pages of Chevron employees to persuade him to invest, according to Hyver. "It helped sway me to go with him," he says.
Back in Houma, a tight-knit community of oil-field workers an hour's drive from New Orleans, Ray and Cheryl Lirette's misfortunes have rippled through to their colleagues, relatives and friends.
In the first few years after Ray handed over his nest egg to Morgan Stanley, his portfolio soared as the market boomed. That's when he referred Chevron co-worker Roy Oncale and his wife's brother and sister-in-law, Wade and Jerylyn Bergeron, to Morgan Stanley.
Like the Lirettes, Oncale eventually had to return to work. The Bergerons say they're living day to day because Musso lost much of their $90,000 - which came from a settlement check Wade received after a motorcycle crash partially paralyzed him - in risky investments.
"It makes you feel sick," Ray Lirette says. "At our age, we should be sitting back. But … we're fighting to pay bills."
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With $16 trillion in retirement accounts, baby boomers and their parents have become a prime target for scam artists who push overhyped investment returns, unsuitable annuities and Ponzi schemes. Kimberly Lankford, contributing editor of Kiplinger's Personal Finance Magazine, shares tips that can help you avoid retirement rip-offs:
- Ignore the hype Be suspicious of any sales pitch that promises unrealistic returns. Anyone who guarantees annual returns of 12% or higher isn't in the ballpark - that's even higher than the long-term average return for large-company stocks, and much higher than guaranteed investments. Be particularly wary of claims that you can retire early based on those high returns - a common pitch salespeople use when they hear that a company is making early-retirement offers.
- Be skeptical of 'free lunch' seminars Salespeople often make their initial contact with seniors in "free lunch" seminars. But in a sweep of these types of seminars, the Securities and Exchange Commission found unethical business practices in nearly half. And don't trust a salesperson just because he or she has a professional designation that focuses on seniors. Such credentials sometimes require little more than paying a fee and passing an easy take-home test.
- Do background checks Before doing business with a broker, check his or her background using the Financial Industry Regulatory Authority's BrokerCheck tool at www.finra.org. Look for disciplinary actions taken against the broker, as well as red flags, such as if the broker has frequently changed firms. For insurance and annuities, check whether the agent is licensed with your state insurance department (see www.naic.org for links). And check on certified financial planners at the CFP Board of Standards (www.cfp.net).
- Get investment information in writing Maintain notes of conversations with salespeople about your investments and keep copies of broker mailings and sales presentation handouts. After speaking with a broker about your investment goals, ask him or her to summarize your discussion in writing. Ask the broker to rate an investment's risk on a scale of one to 10 and put the answer in writing, too.
- Ask about surrender charges and guarantees --[those are usually bogus; think about deferring retirement till 70 if you need annuity -- Social Security is the same thing but a much better deal]
Before buying an annuity, ask specifically about surrender charges and how much money you can withdraw each year. Many deferred annuities levy a surrender charge if you try to withdraw your money within the first seven to 10 years. Also ask about interest guarantees. Some annuities offer a bonus in the first year, after which the minimum guarantee drops to 2% or 3%. Ask for a written summary of everything you discuss with the salesperson.- Set up an account To avoid falling prey to a Ponzi scheme, establish an account at an independent financial institution (typically a brokerage) to hold your money. Never write a check directly to an individual - only to the custodial institution, which must send you quarterly statements.
- Don't feel pressured Consult with your adult children or another financial adviser before investing your money.
- Ask regulators for help If you have questions or discover that you or your parents have been sold an unsuitable investment, contact your state securities department (go to www.nasaa.org for links) or contact your state insurance department ( www.naic.org) for complaints about unsuitable insurance or annuities
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Annuities. Reverse mortgages. Life insurance pools. Principal-protected notes. The options being offered to senior citizens hoping to ensure a comfortable retirement are dizzying. And in a growing number of cases, that may be the intention as more scammers--often elderly themselves--try to con retirees. Though hard numbers are difficult to come by, many lawyers and advocates for the elderly say more seniors than ever are being lured into investment schemes that are unsuitable for people of their age or are outright swindles. says Steve Riess, a San Francisco attorney who represents elderly victims of con artists peddling bogus investments.
One out of five Americans over the age of 65 has been the victim of a financial scam, according to the Washington-based Investor Protection Trust, a nonprofit that promotes shareholder education. That means more than 7.3 million seniors have been taken advantage of financially through inappropriate investments, high fees, or fraud, which insurer MetLife says comes at a cost of more than $2.6 billion a year. "Older people are being targeted because, as 1930s robber Willie Sutton said when asked why he robs banks, 'that's where the money is,'" says Kathleen Quinn, executive director of the National Adult Protective Services Assn. in Springfield, Ill.
Many of today's scammers have a particularly good understanding of their victims--because the fraudsters themselves are of retirement age, if not exactly retired. More elderly con artists than ever seem to be preying on retirees, perhaps because senior citizens put more confidence in someone their age, says Denise Voigt Crawford, president of the North American Securities Administrators Assn. "It's astounding that you can't even trust older people anymore," Crawford says.In November, William Kirshner, 84, a financial adviser in Corpus Christi, Tex., was sentenced to five years in prison for stealing more than $100,000 from senior citizens and other clients who invested in promissory notes issued by his company. Ronald Keith Owens (above), 74, was sentenced to 60 years in prison in January 2009 for persuading investors, including retirees, to put more than $2.6 million into nonexistent bank-related investments. And William Walter Spencer, 68, a Franklin (Tenn.) financial adviser, sold elderly members of his church promissory notes that turned out to be bogus. He pleaded guilty to fraud in May and is expected to be sentenced in August.
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May 30th, 2010constantnormal:
Kind of a deceptive chart … applicable ONLY if one is generating their entire retirement income from savings (as in IRA/401K). But that is rarely the case, as most people (at least for a little while longer) will be able to get something out of Social Security (a damn sight less than they put in, to be sure, but then Social Security never has been a savings plan - it is instead and always has been - a literal Ponzi scheme, dependent upon new contributors to pay the benefits of existing retirees), and again most people will have some meager pension income, despite the severe whackage that corporations have delivered to their pension plans in the past several decades (at least the employee pensions, executive pensions remain robust).
Instead of looking first at how much you need to save, I think it is much better to try and estimate how much income you will require, then set about building some sort of financial scheme to deliver that income. And as for the amount needed to live on in retirement, I can tell you to expect to spend AT LEAST as much as you were spending when you were working. That old canard about needing less money to live on in retirement is bunk, having been shattered by rising taxes, soaring health care expenses, and a general unpredictability about the future. This may not apply to the uppermost 1%, but they already have their retirement covered, courtesy of a societal money pump that has operated for many decades, delivering a sizable advantage to the wealthy over those less fortunate.
And as you are constructing your personal models of where your income will arrive from, you may as well steer toward the safe side, and omit Social Security, as about the only remaining approach to preserve that system is to implement later retirement ages, and tax the bejesus out of any individual savings you have managed to accrue.
And in your retirement planning, don't forget to consider spending your retirement outside the USofA, in some nation with a working health care system, that doesn't tax you to death, and has a considerably lower cost of living. Such places exist.
gorobei:
With 30 year TIPS yielding 1.8%, you can pretty much give up on the financial planners that talk about "average 8% growth" or whatever. The current world is not constrained by a lack of capital, so don't expect excess returns because you have $100K to offer for the long term: we arbed that out years ago, and the move to IRAs, etc, was a one-time boost.
So, you have 50 years (age 20-70) of work to support yourself for 20 years (70-90.) You should be saving around 30% (call Social Security 13%, so please sock away 17% extra per annum.)
Feel free to adjust if you are in a special situation, e.g. real income growth potential (most people do not.)
constantnormal:
Another thing that strikes me as nonsensical is the assumption in the chart that people will be able to postpone retirement indefinitely. At some point, the inability of the senior employees to change with the business, and learn new ways of doing their jobs (which can be counted on to change radically), will push them out the door into a retirement they are not prepared for, or into a pointless and fruitless quest for minimum wage work, competing with high school kids and illegal aliens.
CitizenWhy:
I wonder about the numbers in this scheme. My retirement savings (at 67) shriveled to a piddling $175,000. This gives me a guaranteed minimum of nearly $10,000 per year (higher this year). I get a much higher amount from Social Security. If I play things right I pay no taxes. I have no work expenses, like suits. So my take home income is pretty good, especially since I moved to a nice, big, cheap apartment in a nice minority-majority neighborhood that is gentrification-resistant. And I have no car, with the pubic bus stopping at my door. I do not use prescription drugs but buy certain supplements. I live very modestly but can afford events in the arts, eating out often enough, small luxuries, a gym membership. I never owned a house.
I am the poor relation but I get along fine. I'd much rather live in my neighborhood than in "prestigious" neighborhoods. People can live more modestly, and better, than they think. Keep things simple.
RW:
The living solely on savings AKA million bucks model is simple minded and probably not a good fit for most people or at least those who would consider being sent out to pasture rather tedious.
For example, accepting the 4% drawdown figure for the moment (not unreasonable), it's obvious that earning $1000 bucks a month from any other source - part-time work, hobby, eBay, etc. - means you would only need $700,000 in savings to make the same monthly $ nut a million bucks would generate (12,000/yr = 300,000 x 4%).
If you can reliably (and pleasurably) earn money going forward and have accumulated an adequate disaster fund - major medical, inability to work, go to hell money, that kind of thing - then fretting about how far away you are from a net-worth of a million bucks doesn't make much sense; it's not the model you are following.
Tarkus:
I think it is a misnomer to use the word "Save" anymore. What they really mean is "Are you INVESTING properly for retirement?" With rates so low on saving accounts, the Fed is basically forcing you to seek risk just try and maintain parity ("try", as all investments will entail some risk of loss). Also, the hidden tax of inflation is an incentive to spend now before it is worth less (a "savings" disincentive). It is a treadmill that continues to speed up, and according to Wall St, you must also now become a good, knowledgeable financial analyst because they do not provide good advice (translation – you must do whatever job you happen to be doing, AND do their job better than they do – for yourself).
franklin411:
I wonder if this chart takes the difference in life expectancy into account. People live about 15 or 20 years longer now than they did in the 1920s. This means that the people who made it to retirement in the 1920s either died quickly or they had really good genes (meaning they had low medical costs in retirement).
Today, people live longer and having a few bad genes isn't automatically a death sentence, meaning that medical costs are higher.
How the Common Man Sees It :
I think CitizenWhy laid out one of the best benefits of retirement. Because you are no longer dependent upon a stationary job you have mobility. Most of the best jobs also are in large population areas which tends to increase your cost of living. By moving to a place that has a smaller population you can reduce your costs. If you move to a warmer climate you can reduce your expenses that way too.
The chart also lays out what costs look like in 2010. Buy the time most of us are retiring in 10 – 40 years that number will be closer to 2 – 8 million but it is the cash flow that matters most. It is better to get a 20% return on 1 million than it is a 4% return on 3 million.
rileyx67:
Always saved 10% of income, which was the "advice" some years back, and when unable to do so, worked a second part-time job to cover and meet the "deficiency". Spent last 5.5 years with my company taking a 25% pay cut "building an ESOP, whose value reached over $400,000, but by the time I retired and able to sell, was less than $40,000. Same company( United Airlines) subsequently, in bankruptcy court was permitted to void themselves of all Defined Benefit pension plans, so thus left with one third former from the PBGIC! Am completely comfortable and anxiety free, thanks to that 10% "rule", plus some sound investing advice from this and other sites.
... AND for those "thinking" will need to work past the normal retirement age, good luck with your health to be able to do so…but "good luck" is hardly a PLAN!
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Looks like 401K investors are being taken further and further out to sea without a life jacket. And all they will be hearing from the crew when the boat go overboard, are going to be recommendation like "have a nice swim, suckers".
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Q: With the current market turmoil, what's the easiest way to make a small fortune?
A: Start off with a large one.
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sm_landlord :
Rob Dawg wrote:
The other problem is that every form of wealth accumulation has ultimately been stolen from the middle classes and they are not inclined anymore to play those games. You cannot steal from people with inflation and then taxes and then stagflation and then debt encumbrance and then... you know that list too.
Worst of all, the middle class is counting on transfer payments to bail them out. Wait until they discover that the value of the transfer payments will be inflated away. Even if they have an alleged inflation tracking mechanism in their pension, the bogus CPI calculation will assure that it doesn't track actual living expenses.
The government must be planning on a deadly epidemic or a meteor strike to bail it out, because there's going to be a lot of very unhappy middle-class boomers hitting retirement over the next 20 years, and no way to keep them fed and housed.
Mr Slippery :
sm_landlord wrote:
there's going to be a lot of very unhappy middle-class boomers hitting retirement over the next 20 years, and no way to keep them fed and housed.
I met a lady at a volunteer function Thursday whose father, age 74, was forced out of retirement after losing half his retirement funds in 2008 melt down. She told me he was 100% in stocks at the time.
Byzantine_Ruins:
Mr Slippery wrote:
I met a lady at a volunteer function Thursday whose father, age 74, was forced out of retirement after losing half his retirement funds in 2008 melt down. She told me he was 100% in stocks at the time.
Yah. After the meltdown in 2008, I got to talk with a lot of well-off people due to lucky circumstances.
70 year old men, mourning they had been wiped out.
WHAT ARE YOU DOING IN STOCKS, GRANDPA.
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May 21, 2010 | NYTimes.com
BROKERS selling complex securities that they once contended were safe and sound have saddled individual investors with billions in losses since the credit bubble burst. Remember auction-rate securities? Those were peddled to investors as just as good as cash - until they no longer were after that market seized up in 2008.
Questions about how Wall Street marketed yet another complex product, sold as solid and secure, are now emerging in investor arbitration cases. The instrument is named, inaptly as it turns out, "100 percent principal protected absolute return barrier notes."
These securities are essentially zero-coupon notes sweetened by tying the return, in part, to the performance of an equity index, like the Standard & Poor's 500 or the Russell 2000. The securities promise to return an investor's principal, typically at the end of 18 months, with the added gain from the index's performance if that index trades within a certain range. Brokerage firms often issued these securities.
For an investor in one of these notes to earn the return of the index as well as get the principal back, the index cannot fall 25.5 percent or more from its level at the date of issuance. Neither can it rise more than 27.5 percent above that level. If the index exceeds those levels during the holding period, the investors receive only their principal back.
Convoluted enough for you?
Yet, these securities appear to have been sold to conservative individuals whose financial market forays were usually limited to certificates of deposit. Many of these investors, to their great misfortune, bought principal-protected notes issued by Lehman Brothers. They are now worth pennies on the dollar.
CORINNE and Gregory Minasian were two of these investors who, at the suggestion of their broker at UBS, sunk almost $100,000 - more than half of their savings - into Lehman notes in early 2008. They lost everything and have filed an arbitration case against the firm to recover their losses.
The Minasians are a retired couple who live on Long Island. They contend that their UBS broker pushed the investment when one of their C.D.'s matured. The broker failed to explain the risks in the security, the Minasians said, and did not provide them with a prospectus. They did not even know their investment had been issued by Lehman Brothers until the firm collapsed.
"I am not a sophisticated investor," said Mr. Minasian, a former engineer who is 68. "Many years ago I dabbled in the stock market, but I learned my lessons. Over the past 10 to 15 years my wife and I invested in C.D.'s."
But that approach changed in January 2008, when, according to the Minasians, their UBS broker began calling with an investment idea - principal-protected notes. "We questioned him over and over," Mr. Minasian said. "We initially told him we weren't sure and that we wanted to think it over. Maybe the next day he called us and told us he was putting his father into the same notes and his father is very conservative."
The Minasians said they decided to buy the instrument because they were assured by UBS, a financial adviser they had dealt with for years, that it was safe. The thing was called a "principal protected" note, after all.
Eight months later, Lehman went bankrupt. The note was virtually worthless.
Mrs. Minasian, 67, said she and her husband did not receive notice of problems with the investment until mid-October, when they received a form letter from UBS saying the value of their investment was "unavailable."
"I opened the letter and said, 'Why are we getting this?' " Mrs. Minasian said. "As I read it and we were wondering if it in fact did pertain to us, my heart sank. I almost fell on the floor."
UBS sold $1 billion of these notes to investors. Commissions were 1.75 percent, far higher than those generated on sales of C.D.'s. When Mr. Minasian asked about the commission, he says, his broker said there was none.
A spokeswoman for UBS, Karina Byrne, said, "UBS properly sold Lehman structured products to UBS clients, following all regulatory requirements, well-established sales practices and client disclosure guidelines." Client losses, she added, were the result of the "unprecedented failure" of Lehman Brothers.
... ... ...
Add these securities to the growing pile of Wall Street inventions that benefit ... wait for it, wait for it ... Wall Street.
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Yahoo! Finance
How much -- when the time comes -- should you withdraw from your accounts earmarked for retirement? Answer that question correctly and you get to enjoy the retirement of your dreams. Answer it incorrectly and you either outlive your assets or you leave more money to your heirs than planned.
More from MarketWatch.com: • Cash-Balance Pension Plans Growing Fast
Conventional wisdom suggests that you withdraw on average 4% adjusted for inflation. Now comes a paper co-authored by William Sharpe, the winner of the 1990 Nobel Prize in Economics, challenging the conventional wisdom.
"It is time to replace the 4% rule with approaches better grounded in fundamental economic analysis," wrote Sharpe in his paper "The 4% Rule -- At What Price?" (That paper appeared in The Journal of Investment Management in 2009, but resurfaced last week in the financial-adviser community and is sparking debate anew.)
"Supporting a constant spending plan using a volatile investment policy is fundamentally flawed. A retiree using a 4% rule faces spending shortfalls when risky investments underperform, may accumulate wasted surpluses when they outperform and, in any case, could likely purchase exactly the same spending distributions more cheaply."
Having a surplus is a problem. It means that you spent less than you could have in retirement, that you short-changed yourself. It means you could have spent more traveling to exotic places or visiting family and friends or splurging on your hobbies and philanthropic endeavors.
Having a shortfall is a much bigger problem, however. It means that you lived too large, too fast. And while it might not mean eating dog food late in life, it sure as heck could mean a much lower standard of life as you age.
According to Sharpe, who is also the founder of Financial Engines, the typical 4% rule recommends that a retiree annually spend a fixed, real amount equal to 4% of his initial wealth, and rebalance the remainder of his money in a 60%-40% mix of stocks and bonds throughout a 30-year retirement period.
What's more, he shows the price paid for funding what he calls "unspent surpluses and the overpayments made to purchase its spending policy." According to Sharpe, a typical rule allocates 10%-20% of a retiree's initial wealth to surpluses and an additional 2%-4% to overpayments.
By the way, the improvements to the strategy include changing the amount to withdraw based on market performance, or the length of the plan, or the portfolio mix, or the rebalancing frequency, or the confidence level.
Sharpe's study, in essence, shows that retirees waste money by adopting the 4% rule. "The 4% rule's approach to spending and investing wastes a significant portion of a retiree's savings and is thus prima facie inefficient," Sharpe wrote.
Instead, he suggests that retirees consider "maximizing their expected utility," an approach advocated by financial economists. "While we still may be far away from such an ideal, there appears to be no doubt that a better approach can be found than that offered by combinations of desired constant real spending and risky investment. Despite its ubiquity, it is time to replace the 4% rule with approaches better grounded in fundamental economic analysis."
These are points, said Boston University economics professor Zvi Bodie, "that have long been known to academics."
The only problem with what academia knows to be right and what's practical in the field -- even by Sharpe's own admission -- is this: "Many practical issues remain to be addressed before advisers can hope to create individualized retirement financial plans that maximize expected utility for investors with diverse circumstances, other sources of income, and preferences," Sharpe wrote in his paper.
Nothing Better Than 4% Rule
E. Tylor Claggett, a finance professor at the Perdue School of Business at Salisbury University, said the question of whether it's time to toss the 4% rule in the circular file is an old one and it has always been perplexing.
"The truth is, no one has a crystal ball," he said. "Therefore, no one knows how long the retiree will live, what his or her actual future financial needs will be (due to health issues and the like) and the future year-to-year performances of the various capital market components. If all of these were known, we would not have to have this discussion. Instead, we are left with looking for 'rules-of-thumb' to increase the probability that a retiree's needs will be met given his or her asset base at the time of retirement."
Others agree.
"It may be true that from an academic standpoint the 4% rule is less efficient than a more fine-tuned, more complicated approach that adjusts the withdrawal percentage based on time horizon and ongoing performance," said Rande Spiegelman, vice president of financial planning, Schwab Center for Investment Research. To Spiegelman, any rule of thumb, no matter how useful for long-term planning purposes, has limitations when applied to individual facts and circumstances.
So instead of slavishly following any approach, Spiegelman says it's always a good idea to remain flexible. "The 4% rule is easy to understand and follow, and provides a good starting point for the average investor looking for a ballpark idea of how much they need to save or, conversely, a ballpark estimate of how much they can safely withdraw," he said.
Meanwhile, Stephen P. Utkus, a principal with the Vanguard Center for Retirement Research, agrees that the 4% rule is flawed. But he also notes, as did Sharpe, that there's no practical mechanism to replace it with and that further research is required.
In the paper, Sharpe hinted at one strategy, which involves the purchase and sale of a complex set of options, but this, said Utkus, is "a technique that is not practical today and doesn't not exist in the real world of consumer finance."
Right now, Utkus said there's a big gap between academic theory and practice.
"Until academic methodologies come to a more practical set of solutions for households, they remain conceptual approaches, not strategies that can be implemented today with real-world clients and investors," said Utkus. "Over time, of course, the challenge is for academic models to become more real-world, and for real-world practitioners to learn from the academic models. Right now, there is a sizeable gap."
Meanwhile, academics are debating various models of what optimal draw-down methods should be, though by no means is there any settled consensus on the issue. What Sharpe's statement is saying is that, according to an economic model we have constructed, the 4% rule is flawed. Fair enough.
Robert Powell is the editor of Retirement Weekly.
Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.
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Free Money Finance
Here's an exercise I did. I assumed $50k salary, 28% income tax bracket, 3.5% inflation, and 10% investment return over 30 years. I considered 4 scenarios: contributing $5000 to each of a 401(k) with no match, a 401(k) with a 50% match, a Roth IRA, and regular taxable accounts. For comparison, I calculated the future value of the income tax that is paid today in each scenario. The math shows that a 401k without a match really isn't worth it. Let me know if you find an error in my calculations.
$5000 contribution to 401k with a $2500 match.
Taxes are 28% of $45000=$12,600.
In 30 years, that investment is worth ~$119k. Taxes are $33,312 (28% income tax)
The future value of the $12,600 income tax you paid is $35,366.
NET FUTURE INCOME: 118,973-33,312-35,366 = $50,295$5000 contribution to Roth.
Taxes are 28% of 50000=$14,000.
In 30 years, that investment is worth ~$79k. Taxes are $0 (not taxable)
The future value of the income tax you paid is $39,295.
NET FUTURE INCOME: 79,315-39,295-0 = $40,020$5000 contribution to Taxable account.
Taxes are 28% of 50000=$14,000.
In 30 years, that investment is worth ~$79k. Taxes are $11,897 (15% capital gains)
The future value of the income tax you paid is $39,295.
NET FUTURE INCOME: 79,315-39,295-11,897 = $28,123$5000 contribution to 401k.
Taxes are 28% of 45000=$12,600.
In 30 years, that investment is worth ~$79k. Taxes are $22,208 (28% income tax)
The future value of the $12,600 income tax you paid is $35,365.
NET FUTURE INCOME: 79,315-35,365-22208 = $21,741
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December 28, 2009 | MarketWatch.com
Calculating the best age to take Social Security benefits is tricky, but critical.
Many Americans take Social Security early, at age 62, because they really need it. They're in poor health or unemployed or both. Others take benefits early because they're worried they'll lose out on what's rightfully theirs if benefits are reduced. But few people try to figure out the best age to take Social Security -- and that's a serious mistake.
Even though it's challenging, calculating the best time to take benefits is well worth it, especially given that Social Security represents about one-third of the average retiree's income.
What's key is evaluating the so-called break-even period to determine whether it would be better to delay Social Security benefits (delaying them means a higher monthly benefit), take a reduced benefit early, or start them at "normal" retirement age. Of course, there's a good reason why so few people really do the calculations.
"When to begin Social Security retirement benefits is a challenging question that vexes many financial planners and clients," Michael Kitces, editor of The Kitces Report, wrote in a recent issue.
Living beyond the break-even point can produce large amounts of wealth relative to the risk. But delaying Social Security benefits does represent a serious risk, Kitces said: If you wait and then die before claiming your benefit, it really messes things up for your widow. Still, there are situations in which delaying Social Security retirement benefits can pay off significantly.
"Is it better to begin payments early, or to delay Social Security and forfeit current payments to receive a larger income stream in the future?" he said. "Although the analysis of such a question would seem relatively straightforward, the complex rules of Social Security make the evaluation more difficult, especially when evaluating the implications of living beyond the so-called 'break-even' point."
Putting It Off Can Pay Off
One of the biggest risks to your retirement plan is unexpected longevity -- living longer than you expect and having to fund additional years of retirement. "The decision to delay Social Security provides tremendous additional value, at the exact time that it is needed," Kitces said.
Another risk: High inflation. "To the extent that inflation turns out to be unexpectedly high, delaying Social Security benefits also turns out to be an effective inflation hedge, because the value of delaying increases in higher inflation environments," he wrote. Though not the case now, during high inflation, which many predict on the horizon, you would get larger cost-of-living adjustments.
Also, a low rate of return on investments poses a risk. "The decision to delay [benefits] also turns out to be an indirect hedge to poor returns in the portfolio," Kitces wrote.
How to Decide
"At the most basic level, the decision about whether or not to delay Social Security retirement benefits represents a very straight-forward trade-off," Kitces wrote. "You can either receive cash payments now, in your pocket, to spend or invest however you choose, or you can give up those payments in exchange for receiving a higher stream of income for life at a future date."
Here are the things you should consider to make a more informed decision.
1. What's Your Normal Retirement Age?
The first order of business: You need to know what your normal retirement age, or NRA, is. If you were born in 1937 or earlier it's 65. If you were born in 1970 or later it's 67. And if you were born between 1938 and 1969, it's somewhere in between. Of note, if you were born in 1943, your NRA is 66. And since it's now 2009, that means anyone born in 1943 is now at NRA, the age at which you can receive your full Social Security benefit.
Once you know your NRA you can calculate how much Social Security benefits will be increased or decreased if you choose to take your benefit later or earlier than your NRA. Take your benefit before NRA and it's reduced by 5/9ths of 1% for each month the benefits begin early, up to a maximum of 36 months before your NRA. Take your benefit after your NRA and the benefit is adjusted upward, depending on the year in which you were born, due to the "delayed retirement credit." With delayed retirement credits, at least under current law, a person can receive his or her largest benefit by retiring at age 70. A person born in January of 1943, for instance, who waited until 50 months after reaching full retirement age would have a benefit 131.25% of their primary insurance amount.
2. Will You Be Working?
Next, you need to determine whether you'll be working, especially if you have not yet reached full or normal retirement age, according to Kitces. Because of Social Security's earnings test, Kitces says it's almost always a bad idea to take Social Security benefits early if you have earned income greater than the earnings test threshold. Social Security withholds benefits if your earnings exceed a certain level, called a "retirement earnings test exempt amount," and if you are under your NRA.
But it's also important to note that one of two different exempt amounts applies, depending on the year in which you reach your NRA. Under the earnings test, your Social Security benefits are reduced by $1 for every $2 of earned income that you have in excess of $14,160 per year. But if your NRA is 2009, your benefit is reduced $1 for every $3 of earned income in excess of $37,680.
3. How's Your Health?
At the end of the day, Kitces said the most significant factor in the entire process of evaluating the decision to delay Social Security is whether you're likely to live long enough to receive value from higher monthly benefits. The shorter your life expectancy, be it because of health, genetic, or other relevant factors, the less prospective value to delaying Social Security. If you're not expected to live long enough to reach the break-even point or you're so unhealthy that you may only live a few more years, "it will virtually always make sense to begin benefits as soon as possible, and get as many payments as possible," Kitces said.
Now the tricky part here is two-fold: First, what's your life expectancy? In 2006, life expectancy at birth for the total population reached 78.1 years, according to the Centers for Disease Control and Prevention. But a man aged 62 has a life expectancy of about 19 years, and a woman of the same age has a life expectancy of 22 years.
Besides calculating your life expectancy, you need to calculate your personal break-even number. According to Kitces, once you factor in such things as the time value of money with an appropriate discount rate and the inflation adjustments for the increased benefits when delaying Social Security benefits, break-even points vary from 15 years to 23 years. So don't blindly accept some rule of thumb that you've read -- crunch the numbers.
The Tradeoffs
Now, if you don't plan to automatically defer benefits or start benefits early, Kitces said, "you have to evaluate the prospective tradeoffs between electing benefits early, or delaying benefits with the risk of not living to the break-even period and the opportunity for wealth creation by living beyond it."
To do this, you first have to pick a conservative growth rate, as well as an assumption for inflation. What's more, you need look at your retirement cash-flow needs and other income sources and investments, the risks you might face in retirement, and your longevity. Once you have a sense of the tradeoffs, you can come up with the best possible answer for your situation, rather than the rule-of-thumb case.
The Caveats
If you're married, you'll need to figure out what impact your decision regarding the timing of your Social Security benefits will have on both spousal benefits and widow's benefits. Also, you'll need to figure the effect of taxes on your decision.
"Social Security benefits have their own unique rules for determining the amount of benefits that will be subject to taxation, and there is significant interplay between the taxation of Social Security benefits and other aspects of the client's planning situation that may create taxable income and affect the taxability of Social Security," Kitces said.
There you have it. You can certainly take Social Security early if you want. Goodness knows many do. But given that Social Security might represent one of your largest assets and perhaps your most dependable income stream, wouldn't you rather know that you had it as close to right as possible?
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So I was intrigued to see this piece in Foreign Policy by George Akerlof (left), an economist at Berkeley, and Robert Shiller (right) at Yale. (Thanks once again to Jag Bhalla for the link.)The two argue that stories also influence the optimism and pessimism of, and toward, entire nations and economies.
They give the fascinating example of José López Portillo (left), a Mexican president of the 70s and 80s, who presented his country, Mexico, in the context of an ancient story about the Aztec god Quetzalcóatl (also the title of a novel López Portillo had once written). The god was expected to reappear at a special time to make Mexico great again.
As it happened, this was during the oil shocks of the 70s and oil was being discovered in Mexico. Perhaps Quetzalcóatl's time was now? It did not go unnoticed that the presidential jets were named Quetzalcóatl and Quetzalcóatl II. The country and foreign investors liked the story, and Mexico's economy surged.
Until it stopped surging, of course. That's when a different story took over.
The point, as Akerlof and Shiller put it, is this:
Great leaders are first and foremost creators of stories…
Indeed, the power of stories is such that
Jag:We might model the spread of a story in terms of an epidemic. Stories are like viruses. Their spread by word of mouth involves a sort of contagion.
Hi Andreas – firstly thanks for getting the etymology of idiot into the august pages of the Economist…. and in your excellent Hannibal blog born article no less (loved your phrase "speciousness of the speech").
Secondly since sending the link to the FP article, have read the book it was excerpted from and thought you might enjoy additional snippets/nuances from the relevant chapter.
Social psychologists Schank & Abelson argue "peoples' memories of essential facts are… indexed in the brain around stories". Implying facts that don't fit the dominant story are often not remembered. Hence such inconvenient truths become less factive. Put another way denial isn't just an individual psychological mechanism and collective denial, in the form of dominant but distorting narratives, is why democracies need Socratic needling… and to borrow a phrase from your profession – why we must always be on guard against "narrative bias".
Schank and Abelson also say "human conversation tends to take the form of reciprocal story telling". And that we take deep seated delight in telling stories that provoke a reaction. A motive I sense is strong in your blogging.
Re ur-stories – Polti 1916 only 36 basic dramatic plots, Tobias 1993 only 20 fundamental stories
Finally – re viral stories, sticky truths and in the words of one of our ages most successful story tellers (there has been no week when at least one book of his was not in the NYT bestseller list for the last decade) and himself noted for having altered the language and metaphor (=simple analogous story) we use to describe viral spread of memes….
Gladwell's Stickiness Problem
There's a danger in crafting ideas that are more compelling than accurate http://bit.ly/5y6qOp from Psychology Today
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Forbes.com
You just received a call from your financial adviser. After a few pleasantries and a brief discussion about the weather, he lays this on you: "I've made a slight change to the way I manage investment portfolios. Rather than selecting mutual funds that try to beat the markets, I'm starting to use index funds." He continues: "But I'll only use index funds for efficient markets. In inefficient markets, I believe actively managed funds will provide superior investment performance."
Welcome to "Core and Explore", also known by "Core and Satellite," "Barbell," "Core Plus" and a variety of other witty names. The theory suggests that index funds (or ETFs) work best in large and liquid markets and that actively managed funds work best in small and less liquid markets. Accordingly, a combination of index funds and active management generates higher returns than an all index fund portfolio.
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November 11th, 2009 | The Big Picture
Here's something that oughta give the marketing wizards at traditional Wall Street firms a heart attack: Timing beats buy and hold, according to a study by finance professors at the New York University Stern School of Business.
I doubt its pure timing - my best guess is, the fund managers involved more likely used aggressive risk management tools and capital preservation strategies. To the unknowing, these look like timing but are not.
The profs found that fund managers who invest based on macroeconomic trends - and are willing to adjust their portfolios as those trends change - are the managers most likely to add value for investors.
How you define "macroeconomic trend changes" and the basis of portfolio adjustments is a key factor - one that is not delineated all that clearly:
"By analyzing data from January 1980 through December 2005, the study identified the top 25% of actively managed equity mutual funds based on their ability to select stocks during expansionary economic periods. The report noted that this same group showed proficiency at market timing during recessions as well.
This group outperformed other funds in both risk-adjusted terms and after expenses, according to the study."
Cash has beaten stocks for the past 10 years; Even worse, Bonds have beaten Stocks since 1966. To me, this suggests that an active asset allocation program (rather than pure market timing) is the way to go for most high net worth investors.
Despite the weak stock performance, expect massive pushback on this from the long-only, fully-invested, fee-based actors on the street.
Already, we see critiques from Morningstar. Russel Kinnel, the director of mutual fund research, carped that "the 1980s were littered with funds that blew up because managers tried to follow macroeconomic trends."
The Street will this line of thought tooth and nail, but given the horrific performance if the LOFIFB firms, they have their work cut out for them . . .
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The second problem is that losses of 401K investors using stocks (even without self-defeating moves like selling low and buying high) for the last 15 years are substantially higher then the author assumes. My calculations had shown that for 401K investors who started in Jan 1996 and used cost averaging investing 100% in S&P500 underperformed Vanguard stable value fund approximately 30% (assuming today's S&P500 value 1100). For PIMCO Total Return it's even more. That tells us something about Siegel.
If we assume that stable value returns match average inflation, 401K investors who use S&P500 can lose close to half purchasing value of their savings before retirement. So assumption of positive returns (after inflation) in 401K in my view is pseudo-science and assumption of positive returns in S&P500 in case of cost averaging is even worse (Lysenkoism ?).
The article below first appeared in our Washington Post column yesterday. I'm reproducing it in full here because there is an important correction, thanks to a response by Andrew Biggs. I've fixed the mistake and added notes in brackets to show what was fixed. Also, I want to append some additional notes about the data and some issues that didn't fit into the column.Recent volatility in the stock market (the S&P 500 Index losing almost 50% of its value between September and March) has led some to question the wisdom of relying on 401(k) and other defined-contribution plans, invested largely in the stock market, for our nation's retirement security. For example, Time recently ran a cover story by Stephen Gandel entitled "Why It's Time to Retire the 401(k)."
However, the shortcomings of our current retirement "system" predate the recent fall in the markets, will not be solved by another stock market boom. The problems are more basic: we don't save enough, and we don't invest very well.
We ran several scenarios of what a typical two-adult household that entered the job market last year at age 22 might expect to receive on retirement at age 65 in 2051. For each scenario, we assumed that our household would earn the median amount for its age group every year. We began with data from the U.S. Census Bureau on 2008 earnings by age group, and assumed that real incomes would grow by 0.7% per year (the average growth rate for the 1967-2008 period). According to analysis by Andrew Biggs, medium earners typically accumulate Social Security benefits equivalent to 52% of their pre-retirement income, which comes to $40,265 per year. (All figures are in 2008 dollars.) For our scenarios, we used different estimates of the household's savings rate and of the rate of return it would earn on its savings. [Correction: I initially used the online Social Security Social Security benefits calculator, which says it provides estimates in "today's dollars," but actually uses wage-indexed dollars. See Biggs's explanation of the difference.]
For the first scenario, we assumed the average economy-wide savings rate of 2.4% over the last ten years (1999-2008) and a real rate of return of 6.3% - the long-term average real return for the stock market. (In his book Stocks for the Long Run, Jeremy Siegel calculates the annual real rate of return from 1871 to 2006 as 6.7%; updating that figure through 2008, we get 6.3%.) At retirement, this yields accumulated savings of $298,064. Today, a 65-year old couple could convert $298,064 into a joint life annuity of $18,467 (we did an online search for annuity rates), meaning that they would receive that amount each year (not indexed for inflation, however) as long as either person were still alive. (Anything other than buying an annuity is gambling that you won't outlive your money.) $18,467 is only 24% of the household's income at age 64. Combined with Social Security, the couple would receive $58,732 per year, or a respectable 76% of its pre-retirement income of $77,432. [Correction: Originally this was 59%; all later figures were also 17 percentage points too low.]
Savings were unusually low over the past decade. The current savings rate (first three quarters of 2009) is 3.6%. Plugging this into our spreadsheet, we get an annuity of $28,092 and retirement income of $68,357, or 88% of pre-retirement income.
But this overlooks the fact that people do not earn the rate of return of the stock market. Even assuming that people are investing in stocks, most do so via stock mutual funds which, on average, do worse than the stock market as a whole. For example, in the 1990s the average diversified stock fund had an annual return 2.4 percentage points lower than the Wilshire 5000 Index (which reflects the performance of the overall market). The main reason for this underperformance is that mutual funds have to pay fees to their managers - who, on average, do not earn those fees through superior stock-picking (to put it mildly).
If we use a 3.9% annual return instead of a 6.3% annual return, now our annuity is only worth $15,347 per year, and combined with Social Security our household is only earning 72% of its pre-retirement income. But wait - it gets worse.
The average investor in mutual funds does not even do as well as the average mutual fund. The reason is that investors tend to chase returns. They take money out of funds that have recently done badly and move it into funds that have recently done well. Because of mean reversion (the tendency for trends away from the average to return back to the average), this means they take money out of funds that are about to go up and put it into funds that are about to go down. Among large blend stock funds (the category that includes S&P 500 index funds), research from Morningstar shows that the gap between mutual fund performance and investor performance ranges from 0.9 to 2.2 percentage points, depending on fund volatility. (It can be much higher - over 10 percentage points - for other types of funds.)
Taking an average gap of 1.6 percentage points, our expected annual returns are now just 2.3%. Now our cumulative savings are only $172,853 and our annuity is only $10,709; combined with Social Security our household is only earning 66% of its pre-retirement income.
Now, you can get close to that 6.3% expected return through a simple strategy: buy a stock index fund and don't touch it. But this has another problem - you are 100% invested in stocks, the riskiest of the major asset classes. Whatever your expected cumulative savings, there is a 50% chance that your actual savings will be lower, and they could be a lot lower.
Since we're talking about survival in old age, ideally our household would not take any risk at all. The closest you can get to this is to invest in inflation-protected Treasury bonds. 20-year TIPS (Treasury Inflation-Protected Securities) currently yield 1.96% on top of inflation. [Note: In the Post column I used 2.4%, the yield at the latest auction; however, that was back in July, and long-term bond yields have come down since then, so this is the current yield according to Bloomberg.] This provides a final annuity of $9,925; combined with Social Security, that's 65% of pre-retirement income. That's not very much. And the only way to get higher returns is by taking on risk.
Bear in mind that we're assuming that Social Security will be around in its current form, as will Medicare (or else seniors will have sharply higher health care costs than they do today). Also, we've made a number of optimistic assumptions along the way: that life expectancies do not increase by 2051 (this would reduce the annuity you can get with the same savings); that median-income households save money at the average rate for all households, which is untrue (richer households save at a higher rate, making the average savings rate higher than the median savings rate); and that the savings rate is constant over age (since older people in fact save at a higher rate, the money has less time to build up). In addition, we haven't started talking about below-median households, who save at a lower rate. [Note: I assumed you can get an annuity yielding 6.2%, from this online site; Biggs, who probably knows better than I, uses 5.4%, which yields lower annuities for the same amount of savings.]
The problems, in short, are that we don't save enough and we don't invest very well. One could argue that these are a matter of choice. People could save more, and they could make smarter investing decisions. But given that they don't, we could very well see tens of millions of seniors without enough money to live decently in retirement. Given that prospect, perhaps we should question leaving retirement security to individual choices and free markets.
***
Andrew Biggs argues that the numbers show that the retirement system is doing OK. After all, if you assume just a 2.4% savings rate and a 6.3% real return, you get 76% of your pre-retirement income. The system is doing better than I thought it was before Biggs pointed out my error, but that's almost entirely due to Social Security. Social Security is replacing 52% of pre-retirement income (not 35% as I initially calculated) and private savings are replacing anywhere from 13% to 24%, depending on the scenario. I think the 13% scenario is the most accurate, since is the lowest-risk option; anything else is not retirement saving, it's retirement gambling.
Biggs also thinks (email to me) that my savings rates are too low, especially with auto-enrollment into 401(k)s on the rise. This is a plausible point; we don't really know where the savings rate will end up after this recession. If the median worker is auto-enrolled in a 401(k) - and, even better, if he gets an employer match - he may be OK. Then we may be talking about a problem that affects a significant number of lower-income households (who are less covered by 401(k)s and employer matches than higher-income households), though not the median household.
This is the spreadsheet with the scenarios. WordPress.com won't let me upload an Excel file, so I embedded it in a Word file and uploaded that.
There's a legitimate question about 2008 vs. 2051 living standards. For example, in our most pessimistic scenario, we still end up with an annuity of $50,190 in 2008 dollars. That might not seem so bad. After all, median income in 2008 was only $53,303, and this is all in real terms, right? However, I don't think that's the right approach to take. Living standards will improve on average between now and 2051, and therefore an income of $50,190 2008 dollars will feel very different in 2051 than it felt in 2008. This is why I think the right comparison is to pre-retirement income; that tells you the drop in living standards that people will suffer at retirement. (In practice, most people probably won't buy annuities, and won't adjust their living standards down immediately - but that just means they have a higher chance of outliving their money.)
Another possible objection is that we're leaving out capital gains from housing. Even if the average return that investors get from stock mutual funds is only 2.3%, the fact is that many people invest in their houses and seem to get higher returns. However, I think that we can't count on these higher returns. First, these returns are largely a product of leverage and subsidized interest rates; real housing prices underperform the stock market. Second, a given house doesn't really change in real value (the utility it provides to people), even if its price changes; in general, its value goes down, unless you put money into it for maintenance and improvements. If the price of equivalent houses goes up in real terms, that just means that (on average) one generation of home owners is taking money from the next generation of home buyers in the form of higher prices. In other words, it's a multi-generational Ponzi scheme that can't go on forever. Third, of course, not everyone owns a house.
In doing the research for this column I came across a paper by Andrea Frazzini and Owen Lamont called "Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns." They find that, at least when looking at historical data, you can make money by doing the opposite of what investors do with their mutual funds. That is, money flowing into mutual funds is a valid predictor that the stocks in those funds will, on average, go down relative to the market. The real beneficiaries are corporate issuers of stock, who are able to issue stock at high prices when demand for it is high. I also like the way they put their findings into context: "These facts pose a challenge to rational theories of fund flows. Of course, rational theories of mutual fund investor behavior already face many formidable challenges, such as explaining why investors consistently invest in active managers when lower cost, better performing index funds are available."
Finally, I hate making mistakes. So I wholeheartedly endorse Biggs's call for the Social Security Administration to fix its misleading calculator.
By James Kwak
spencer
By using current real data you are ignoring inflation that would make the situation worse than you describe.
You are assuming a savings rate of 2.4%.
If you ignore inflation that yields a constant saving stream in real terms.
But in an inflationary environment of for example 2% to 3% annually, and go back and apply a 2.4% savings rate to nominal earnings some 20 years the dollar savings you get are only about half of current earnings in real terms. To achieve the 2.4% average real savings in an inflationary environment in savings rate in earlier years has to be higher to offset the impact of inflation on averages wages.
jake chase
When you assume the financial future will be roughly like the past, you disregard the sea change in financial markets caused by swaps and OTC derivatives: over leveraged risk is a guerrila army bearing nuclear grenades moving in quantum jumps through the investment landscape. They can blow up anywhere, any time. Exposure is entirely hidden. No published financial statement of any bank or public corporation is anything but a trap for the gullible, a convenient fiction, an outright fantasy. Any investment decision is nothing but a bet, and we might as well all be monkeys throwing darts at the financial pages.
In the past ten years, a stock index fund returned nothing. To the extent corporations achieved growth in profits, the dough was siphoned off in executive stock options. Today, you get nothing in government bonds, unless you want to take thirty year risk. If you want a good investment, buy a laundromat (and a gun).
Tom S
I think the biggest mistake in your estimate is that you assume people will begin saving at age 22. From what I have seen of the typical college graduate, they will often spend maybe six months unemployed and often spend the first couple of years paying off debt and getting on their feet. Alternatively, there are many young people (like myself) getting graduate degrees which means more years of no saving. If I did such a calculation I would assume no saving begins until at least age 25, maybe 28. This will really crunch your already low values.
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Even after suffering significant losses last year, many remain overly optimistic about their investment returns and the ability of their savings to fund their expenses after they stop working.
... ... ...
Perhaps even more startling is the extent to which their savings are falling short of their goals. On average, these pre-retirees expected they would need $800,000 to fund their retirement. However, most had only saved about $300,000.
Despite their inadequate savings, nearly two-thirds of the group lack any formal plans for retirement savings or spending strategies.
Of the 35 percent of those who had a written plan for retirement, only slightly more than half - about 52% percent - say they had updated it in the past year during the market downturn.
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A friend sent this along, and we thought it was worth publishing an extended excerpt. This is Part 1 of the essay, and we look forward to Part Two – Managing Your Own Money – Take Action Now.
That is really the challenge isn't it. Most people are financial non-specialists. Their lives are full enough as it is, with things that they understand and that are important to them.
Too often the call to 'take control of your own money' is a prelude to 'and buy into my advice, what I wish to sell to you.'
Financial advice is a difficult thing to provide in a blog. It would be like a doctor writing a prescription for the public at large, fitting for some, inappropriate for others, potentially deadly for a few. This is why I do not do it. Ever.
The prescription I use for my personal situation is the most that I will share, in addition to general opinions and analysis of the markets and the economy. I am 58 years old, and have amassed a fair amount of savings over the past twenty years. My general rules for the current period now are:
1. Get liquid. Have little or no debt. Be in cash and diversified. Reduce living expenses to essentials.
2. Get as far away as you can from Wall Street and riskier assets as is practical.
3. Put something you can spare from discretionary retirement savings into long term assets that are not directly contingent on anyone else whom you cannot trust:a. Personal food production, preservation, and preparation4. Above all be flexible. If this stagflation we are in becomes a protracted deflationary spiral or an emerging hyperinflation, both possible outcomes, we will see it happening and may need to adjust. This is where being light on debt and long on liquidity is most helpful. There is no one right plan for the unexpected, ever.
b. Precious metals as insurance against monetary inflation / breakdown
c. Essentials for daily living and personal health care
d. Investments in practical education
e. Personal infrastructure and efficiency
f. Have a contingency plan for a systemic shock.If you have 401k plans you cannot cash in, you might consider some very long term 'leap' puts to hedge them. But Cash or short term Treasuries is preferable. I have all my discretionary cash scattered across several very highly rated banks within FDIC limits. I have some money available for investment in foreign currencies although I have cashed in my loon and aussie dollar positions now. I have sold some 'collectible assets' that might have done very well if we get a prolonged period of high inflation similar to the 1970's in order to raise cash levels. I may regret this, but so be it. The cash can be deployed as the situation develops. Cash can otherwise be kept your home currency which you use on a daily basis, as long as it is safe and liquid.
If you wish raise your voice or to peacefully demonstrate, be prepared with a simple set of coherent positions and specific demands, avoiding anger. The mainstream media likes nothing better than to portray demonstrators as cranks or fools. In general they are not sympathetic to the less powerful. They will not lead change, but they will eventually follow.
Try to avoid squabbling amongst yourselves. When the reformers fight over fine points and petty egotistical issues, the status quo rejoices, often formulating and encouraging the bickering. Debate television where no serious discussion occurs, but plenty of sound bites and ad hominem attacks get thrown, is the model for media distraction. But it 'works' for the short term opportunists, and generally adds to the bread and circuses atmosphere masking an historic wealth transfer and the decline of an empire, as it has done in the past.
And as always, the banks must be restrained, and the financial system reformed, and balance restored to the economy before there can be any sustained recovery.
Reality Arbiter
The Extinction of Ethics in Finance – The Falloutby Greg Simmons
October 13, 2009
"...To revisit my original intention in writing this article, I cannot stress to you the importance of understanding exactly what is going on in the world. No one is to be trusted with your money. Not Wall Street, not the banks, not the government – nobody is to be trusted! Does the investing public not realize that Wall Street almost lost every penny of American wealth? Now we're supposed to believe they've saved the day? I beg to differ. Those parasitic liars nearly took us to zero. Who knows, they still might.
The grossly deluded public has been at the mercy of brokers, financial advisors, Wall Street, the Fed, congress, and the US Treasury far too long. This moral hazard and subsequent uneven playing-field created by the current financial structure (the trifecta of the Fed, Treasury, and the "Banksters") wherein the scales of balance tip only upward, hence siphoning this nation's wealth into the coffers of those that create such hazards. Their current solutions to this crisis, a crisis of their own making, is nothing more than a replication of the same idiotic practices that got us here in the first place; corporate bailouts, homebuyer tax-rebates, foreclosure moratoriums, cash-for-clunkers, all designed to forego the inevitable sanctification of sins past and deliver them on to the US taxpayer.
The difference between the past and present is that now we have a government willing to set up shop and take over entire industries; mortgage lending, auto, banking, and who knows going into the future. Just wait, we'll be in the airline business in no time. I feel like I'm in a perpetual state of Déjà vu - with a repeat of September 2008 barreling headlong around the next bend.
That we exist in a quasi public-private financial system wherein the government in collusion with the Fed and the "Banksters" take your money essentially by force (specifically through the leverage of ZIRP) or otherwise and shove it into new toxic instruments, bailouts, and ill-conceived stimulus programs that even these so-called best-and-brightest have no concept of the inherent risks, or hazard of unintended consequences, is proof that the entire game is rigged against you.
It is time to take control of your money.
Now, with regard to the subject of managing one's own money, the rules of the game have officially changed. The EXTINCTION OF ETHICS in today's financial markets IS the new rule. You must take total responsibility for the management of your own money and you must do it now! I don't know how to make it any more clear. I could probably write an entire thesis about the utter abandonment of morality by today's so-called investment community. I mean, does everybody have to cheat each other to make a dollar? The subject literally brings into question the human thread that binds our social fabric together.
Given the dire state of the global economy and the fact our collective economic situation has gotten significantly worse, not better, creates an opportune time to shift any misplaced philosophy of trust in a corrupt system and recognize that we're in the middle of a COVER-UP, NOT A RECOVERY!
A comment I always appreciated and have tried to take credit for but know I plagiarized from somewhere is this; ANTICIPATING BAD LUCK IS GOOD LUCK; DEPENDING ON GOOD LUCK IS BAD LUCK. This so-called recovery is merely a papered-over facade made possible by trillions of newly created dollars. The time to prevent getting thrown back into the ditch is now. Remember, do not fall victim to the CNBC-induced epidemic of economic amnesia."
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Can you make the risk of stocks go away just by owning them long enough? Many investors still think so.
"Over any 20-year period in history, in any market, an equity portfolio has outperformed a fixed-income portfolio," one reader recently emailed me. "Warren Buffett believes in this rule as well," he added, referring to Mr. Buffett's bullish selling of long-term put options on the Standard & Poor's 500-stock index in recent years. (Selling those puts will be profitable if U.S. stocks go up over the next decade or so.)
As the philosopher Bertrand Russell warned, you shouldn't mistake wishes for facts.
Bonds have beaten stocks for as long as two decades -- in the 20 years that ended this June 30, for example, as well as 1989 through 2008.
Nor does Mr. Buffett believe stocks are sure to beat all other investments over the next 20 years.
"I certainly don't mean to say that," Mr. Buffett told me this week. "I would say that if you hold the S&P 500 long enough, you will show some gain. I think the probability of owning equities for 25 years, and having them end up at a lower price than where you started, is probably 1 in 100."
But what about the probability that stocks will beat everything else, including bonds and inflation? "Who knows?" Mr. Buffett said. "People say that stocks have to be better than bonds, but I've pointed out just the opposite: That all depends on the starting price."
Why, then, do so many investors think stocks become safe if you simply hang on for at least 20 years?
In the past, the longer the measurement period, the less the rate of return on stocks has varied. Any given year was a crapshoot. But over decades, stocks have tended to go up at a fairly steady average annual rate of 9% to 10%. If "risk" is the chance of deviating from that average, then that kind of risk has indeed declined over very long periods.
But the risk of investing in stocks isn't the chance that your rate of return might vary from an average; it is the possibility that stocks might wipe you out. That risk never goes away, no matter how long you hang on.
The belief that extending your holding period can eliminate the risk of stocks is simply bogus. Time might be your ally. But it also might turn out to be your enemy. While a longer horizon gives you more opportunities to recover from crashes, it also gives you more opportunities to experience them.
Look at the long-term average annual rate of return on stocks since 1926, when good data begin. From the market peak in 2007 to its trough this March, that long-term annual return fell only a smidgen, from 10.4% to 9.3%. But if you had $1 million in U.S. stocks on Sept. 30, 2007, you had only $498,300 left by March 1, 2009. If losing more than 50% of your money in a year-and-a-half isn't risk, what is?
What if you retired into the teeth of that bear market? If, as many financial advisers recommend, you withdrew 4% of your wealth in equal monthly installments for living expenses, your $1 million would have shrunk to less than $465,000. You now needed roughly a 115% gain just to get back to where you started, and you were left in the meantime with less than half as much money to live on.
But time can turn out to be an enemy for anyone, not just retirees. A 50-year-old might have shrugged off the 38% fall in the U.S. stock market in 2000 to 2002 and told himself, "I have plenty of time to recover." He's now pushing 60 and, even after the market's recent bounce, still has a 27% loss from two years ago -- and is even down 14% from the beginning of 2000, according to Ibbotson Associates. He needs roughly a 38% gain just to get back to where he was in 2007. So does a 40-year-old. So does a 30-year-old.
In short, you can't count on time alone to bail you out on your U.S. stocks. That is what bonds and foreign stocks and cash and real estate are for.
In his classic book "The Intelligent Investor," Benjamin Graham -- Mr. Buffett's mentor -- advised splitting your money equally between stocks and bonds. Graham added that your stock proportion should never go below 25% (when you think stocks are expensive and bonds are cheap) or above 75% (when stocks seem cheap).
Graham's rule remains a good starting point even today. If time turns out to be your enemy instead of your friend, you will be very glad to have some of your money elsewhere.
Write to Jason Zweig at [email protected]
Comments
The hypothetical scenario of an investor with a $1 million portfolio who retired at the peak of the market in 2007 assumes that he was invested entirely in stocks and was taking monthly withdrawals by liquidating stocks month to month at a 4% withdrawal rate. This would be ill advised under any situation, as the article implies.
Retirees planning to draw down their portfolios must maintain at least three to five years of withdrawals in cash or short term bonds (ideally, using a bond ladder over five years). This reduces, but does not eliminate, the risk of having to liquidate stocks at a bad time. Once this is accomplished, all that remains is the need to not panic during market declines and avoid the temptation to sell out at lows.
If the investor with a $1 million portfolio simply had a ladder of bonds representing spending for years 1 to 5 in the amount of $200K in total (five years of $40K withdrawals), he could have invested the remaining $800K in more volatile assets without risk of having to liquidate at the March 2009 lows. [ Why take additional risk if you a million ? -- NNB]
I believe that this is precisely why Ben Graham stated that investors should have a limit of 75% stock allocation - he knew that having more than that in a portfolio intended to be drawn down over time could result in poorly timed forced sales of stock.
This was a very timely article and maybe in the future the five year ladder concept could be fleshed out in more detail. That would be a practical example and actionable plan for retirees concerned with volatility.
Well said. If you pay 1.4% to a fund you are giving them 14% of your expected return of 10%. Most people don't tithe that much to their church, why give it to a big financial firm that is not going to equal the indexes.
If someone is afraid of individual stocks, look at plain vanilla index ETF's.
Note: The Supreme Court is getting ready to rule that investors don't have the right to object to obscene fees in court; that its the exclusive jurisdiction of the directors appointed by the people charging the obscene fees to decide if the fees are "fair" even if twice what they would charge in a competitive situation. Oh and you have to pay a 12b-1 fee too to pay for the marketing to lure in new investors so that the firm doesn't have to pay its own marketing costs.
The 10% average return is a compound geometric return which is only achieved by reinvesting all dividends, something the average financial advisor failed to understand in the 1990's. Once you start taking distributions you do not have reinvestment. The long term rate of return for appreciation only, without reinvesting dividends is only about 6%. Financial planners have been arguing the rate of return you can "safely" withdraw since the 2000 crash. If you don't get it from a dividend or interest payment you shouldn't spend it unless its an emergency because you are dipping into principal.
The next big issue may be bonds for those that buy bond mutual funds which never mature. If interest rates spike, holders of long-term bond funds will have losses similar to that of stocks. With the huge budget deficits and the rest of the world getting tired of the ever shrinking vallue of the dollar, some smart people think its when, not if. If you want bond income, do not buy funds, buy individual issues so that you know when you will get your principal back.It's important to note that almost all financial advisers would like to bury this column under the Titanic - and for good reason. The mantra of buy-and-hold has been a financial fiction for as long as I can remember. And I agree the the last two sentences offered by Dean Anderson. I'll take it one step further: Insist that your market broker or financial adviser place either stop-limit or stop-market orders on your entire stock portfolio. The sad truth is that many brokers and advisers failed to protect client accounts from the catastrophic market sell-off in March. If your broker or adviser can't - or won't - service your accounts properly, it's time to fire them and find a new one that can. Fool me once, shame on you. Fool me twice, shame on me.
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The amazing disappearance of the individual stockholder as the backbone of the U.S. stock market has been one of the least recognized but most profound trends of the last half-century. As shown in the chart nearby, direct ownership of stocks by American households has declined from 91% in 1950 to just 32% today. The 9% ownership stake held by financial institutions in 1950 crossed the 50% mark in 1983, and now totals 68% of all stocks. It is hard to imagine that our earlier society dominated by individual stock ownership will ever return.
![[Going, Going...]](http://s.wsj.net/public/resources/images/ED-AD435_bogle10022005160412.gif)
Of course, individual investors remain major participants in the stock market, but now do so largely through mutual funds and public and private pension plans. But such participation lacks the traditional attributes of ownership such as selection of individual stocks and engagement in the process of corporate governance.
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But aren't our financial institutions owners of stocks? Not really. They are owners in name -- agents, in fact, with a duty to act on behalf of their principals, including our mutual fund owners and beneficiaries of our retirement plans. Today's agency-dominated investment society is overwhelmingly composed of those two groups of underlying owners.
At first, the march toward institutionalization was led by pension plans. Holding less than 1% of all stocks in 1950, they shot up to 19% in 1980 and 27% in 1989-95, only to ebb to today's level of 21%. Growth in mutual-fund ownership, on the other hand, was stagnant in the early years, holding at 3% in 1950 and 1980 alike, rising to just 8% by 1990. Since then, fund ownership of stocks has risen relentlessly to a record high of 28% currently. Within the pension segment, public plans are holding steady while private pension plans are gradually receding. But the secular decline in defined-benefit pension plans has been matched by an offsetting rise in defined-contribution thrift and savings plans in which mutual funds are the major component. So today's dominant stock ownership by mutual funds seems destined for continued growth.
Institutional investing is now largely the business of giants. America's 100 largest money managers alone now hold 58% of all stocks. When such a relative handful of professional managers substantially displaces a diffuse group of millions of inchoate individual investors, one might have expected the managers to more aggressively assert their rights of stock ownership and demand more enlightened corporate governance focused on shareholder interests. With few notable exceptions, however (some state and local pension plans, unions, and TIAA-CREF), our institutional investors have refrained from active participation in corporate affairs.
What explains the passivity of these institutions that in fact hold effective control over corporate America? First, too many of our financial agents have their own interests to serve, often conflicting with the interests of their investor-principals. It is a truism that principals are likely to watch over their own money with far more care than they take in watching over the assets entrusted to them as the agents of others. When there are many masters to serve, it is the master who pays the servant whose interests are most likely placed front and center. Corporate pension plans, for example, are controlled by the same executives whose compensation is based on the earnings they report to shareholders. During the 1990s, they arbitrarily raised their projections of future pension plan returns, enhancing operating earnings to meet "guidance" targets, even as interest rates tumbled and prospective returns eroded.
Similarly, mutual fund managers are compensated by separate corporations seeking to maximize the return on their own capital (i.e., to enhance their own wealth), in direct conflict with their duty to maximize the returns on the capital entrusted to them by their fund shareholders. The excessive advisory fees, expenses, hefty sales loads, and huge commissions on portfolio transactions paid to brokers in return for their sales support consumed something like 45% of the real returns earned on fund portfolios during the past two decades.
Second, unlike their predecessors in the '50s and '60s, financial institutions focus on investment strategies that emphasize short-term speculation in evanescent stock prices, rather than traditional long-term investing based on durable intrinsic corporate values. From 1950 to 1965, equity mutual funds turned over their portfolios at an average rate of 17% per year; in 1990-2005, the turnover rate averaged 91% per year. The old own-a-stock industry could hardly afford to take for granted effective corporate governance in the interest of shareholders; the new rent-a-stock industry has little reason to care.
To further complicate matters, today's typical giant private financial institution -- managing both pension plans and mutual funds -- faces serious conflicts in its exercise of the rights and responsibilities of ownership. When a proxy proposal is opposed by the management of a corporate client, the money manager is unlikely to vote in its favor. It is not surprising, then, that governance activists among large private money managers are conspicuous not merely by their scarcity but by their absence. And it gets worse. Today, it is difficult to separate the owners from the owned. Through its defined-benefit pension plans, corporations own 12% of all stocks, and dominate another 11% through defined-contribution savings plans. What is more, most of our largest money managers are themselves now owned by giant financial conglomerates. Arguably, this circularity of ownership allows corporate America to control itself.
The problems created by this new and conflicted world of financial intermediation are hardly trivial. Excessive return projections for pension plans have played a major role in creating the current shortfall of $600 billion in private pension plan liabilities relative to plan assets. The shortfall in public plans has been estimated at $1.2 trillion, bringing the total deficit to $1.8 trillion, and rising. Individual retirement savings are also at dangerously low levels. Only 22% of workers participate in 401(k) savings plans and only 10% in IRAs (9% have both). Despite having had a quarter-century-plus to build assets in these tax-sheltered plans, investors have accumulated balances of but $33,600 and $26,900 per participant respectively, a trivial fraction of what would be required for a decent retirement.
With today's agency society arrogating to itself far too large a share of market returns, the outlook for future individual retirement savings is dire. A citizen entering the work force today has an investment horizon of at least 60 years. If the stock market were to earn an average nominal return of 8% per year, $1,000 invested today would then be worth $101,000 -- the magic of compounding returns. But if our financial system consumes 2.5 percentage points annually of that total return -- a conservative estimate of today's reality -- that $1,000, growing now at 5.5% net, would be worth just $25,000, a minuscule 25% of the accumulation that could have been obtained simply by owning the stock market itself. The magic of compounding returns, it turns out, is simply overwhelmed by the tyranny of compounding costs at today's exorbitant levels.
The serious shortfalls in retirement reserves that represent the backbone of the nation's savings have arisen importantly because our manager-agents have placed their own interests ahead of the interests of the investor-principals they are duty-bound to serve. Our financial institutions have failed to exercise the rights and responsibilities of corporate citizenship; to adequately fund pension reserves; and to deliver to fund shareholders their fair share of the returns generated by the financial markets themselves.
* * *
Why? Largely because the radical change from an ownership society dominated by individual investors to an intermediation society dominated by professional money managers and corporations has not been accompanied by the development of an ethical, regulatory and legal environment that requires trustees and fiduciaries, as agents, to act solely and exclusively in the interests of their principals. In addition, we have developed a patchwork of tax-deferred retirement programs -- Social Security, corporate and public pensions, deferred compensation plans, 401(k)s, 403(b)s, individual IRAs, and Roth IRAs -- and are now considering the addition of Personal Savings Accounts to the list. We need to undertake a careful appraisal of this often costly mix, and develop an integrated retirement system that will enhance savings.
The overarching need is for a clearly enforced public policy that honors the interests of our citizen-investors and puts these beneficiaries in the driver's seat where they belong. The ownership society is over. The agency (or intermediation) society is not working as it should.
Mr. Bogle, founder and former CEO of Vanguard, is author of "The Battle for the Soul of Capitalism," published this week by Yale.
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Living-standard shock
Of course, people's retirement outlooks vary widely. Some 20 million workers still participate in a traditional pension plan, and employers pay pension benefits to millions more retirees (that doesn't even count government-sponsored public plans), according to Boston College's Center for Retirement Research.
Those workers are sitting a lot prettier than the more than half of U.S. families who aren't covered by any kind of pension at their current job, according to the Employee Benefit Research Institute, a nonprofit, nonpartisan group. Still, even a well-prepared person may get thrown off by a job loss or unexpected health-care costs. (Average medical costs in retirement can run into the six figures even for those covered by Medicare, according to EBRI.)
And those lucky people with traditional pensions likely are wondering how long the money will last as the financial crisis shreds employers' ability to fund such plans for the long haul. See related story on PBGC.
Defined-contribution plans such as 401(k)s have largely taken the place of traditional pensions: 67% of workers say they have a DC plan, up from 26% in 1988, while 31% of workers participate in a traditional pension, down from 57% in 1988, according to EBRI.
But, while lower-income workers face a worrisome retirement reality all their own, middle- and upper-middle class workers likely face the biggest living-standard shock. That's because lower-income people can replace a good chunk of their preretirement income with Social Security, and high-income people generally have enough personal savings. But middle-class workers may see their relatively comfortable life change drastically come retirement.
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July 20, 2009 | http://globaleconomicanalysis.blogspot.com
From the 2002 bottom until the 2007 market top it was hard to go wrong no matter what you did. Everything from junk bonds to commodities to emerging markets to the major market indices were all headed up. This made people feel they were protected from harm. It was an illusion.
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Off To The Races?
People are expecting it's off to the races again with the rally since May. Not so fast.
Fundamentally the market is very overvalued here. Expected earnings growth is unlikely to happen for many reasons. Clearly that does not preclude a further rally, but the above chart shows what happens to market rallies based on speculation as opposed to fundamentals.
Perhaps the market has bottomed, but perhaps it hasn't. Even if it has bottomed, where is it going? Consumers are 70% of the economy and consumer attitudes toward debt, consumption, and risk taking reached a secular peak. Moreover unemployment is still rising and consumer balance sheets are in shambles.
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Nearly 30 years ago James Fries at Stanford University School of Medicine put a ceiling of 85 years on the average potential human life span. More recently a team led by Jay Olshansky at the University of Illinois at Chicago said it would remain stuck there unless the ageing process itself can be brought under control. Because infant mortality in rich countries is already low, they argued, further increases in overall life expectancy will require much larger reductions in mortality at older ages. In Mr Olshansky's view, none of the life-prolonging techniques available today-be they lifestyle changes, medication, surgery or genetic engineering-will cut older people's mortality by enough to replicate the gains in life expectancy achieved in the 20th century.
That may sound reasonable, but the evidence points the other way. Jim Oeppen at Cambridge University and James Vaupel at the Max Planck Institute for Demographic Research in Rostock have charted life expectancy since 1840, joining up the figures for whatever country was holding the longevity record at the time, and found that the resulting trend line has been moving relentlessly upward by about three months a year. They think that by 2050 average life expectancy in the best-performing country could easily reach the mid-90s.
Rises in life expectancy have been habitually underestimated because it seemed unlikely that the improvement could go on for ever, and just as regularly the figures have had to be revised soon afterwards. Some experts now think there may be no theoretical limit at all, pointing to the huge rise in the number of centenarians in the past few decades. In America they are the fastest-growing section of the population, with an increase from 3,700 in 1940 to over 100,000 now.
Why are people living ever longer? Robert Fogel at the University of Chicago, a Nobel prize-winner in economics, reckons that improved medical care and technology are only part of the answer. Another part, he thinks, is something he has dubbed "technophysio evolution". Over the past few centuries humans have developed more resilient physiques because they gained unprecedented control over their environment and their living conditions. Western people's average body size has increased by 50% over the past 250 years. Larger body size (but not obesity), Mr Fogel's research has shown, is associated with better health and longer life.
But modern life has its downsides too. Stress is often seen as a life-shortening factor-though perhaps the effects are not as lethal as some people think, or else the Japanese, who are famous for working long hours, would not have the highest life expectancy in the world.
Another hazard of affluence is getting fat. Around 10-20% of the adult population in many rich countries, and over 30% in America, are now clinically obese. Overweight people are at greater risk of cardiovascular and respiratory diseases, cancer, type-II diabetes and other life-shortening ailments-though it is not yet clear whether the effects are strong enough to cancel the trend to greater longevity.
And life expectancy can go down as well as up. In much of eastern Europe it started dropping in the 1980s in response to the upheaval in the region, and despite a subsequent slight recovery it has still not regained the level of the 1960s.
People almost everywhere could extend their life spans further just by doing a few sensible things, such as not smoking, drinking only in moderation, eating lots of fruit and vegetables and taking regular exercise. Educated folk are better at keeping to such rules, and as a group they live markedly longer than those with only basic schooling. Richer people, unfairly, also live longer than less well-off ones, even in the developed world.
But all this is tinkering at the edges. Mankind's dream has been to conquer ageing altogether, and scientists are working on it. Spare-part surgery to replace worn-out bits of the anatomy is already well-established and will get better with the use of stem-cell technology. For a more general effect, experiments on rodents have shown that a severely restricted but balanced diet can increase their lifespan by about 30%. But nobody knows whether this would work in humans, and even if it did, there might be few takers.
The longer-term hope is to find a way of switching off the ageing process by manipulating the appropriate genes, which in theory could make people near-immortal (though they could still die of accidents and diseases). But if that were feasible, the consequences would need to be carefully thought through. In Jonathan Swift's "Gulliver's Travels", the hero meets a tribe of immortals, the Struldbruggs, who far from being wise and serene turn out to be a miserable lot: "Whenever they see a funeral, they lament and repine that others have gone to a harbour of rest to which they themselves never can hope to arrive."
Hale and hearty
People in the rich world can now expect to live, on average, more than a quarter of a century longer than they did 100 years ago. Is that a blessing or a Struldbruggian curse? Clearly it depends on whether they become old and frail at the same age as before and just limp on for much longer, or if the extra years are hale and hearty ones.
Most of the evidence supports the more cheerful view. Research led by Kenneth Manton at Duke University found that in recent years disability above the age of 65 in America has been falling significantly. In other rich countries the picture is more mixed. When the OECD recently looked at 12 member countries, it found clear signs of a recent decline in disability in elderly people in only five of them (including America). But other studies produced more optimistic results.
By and large, people do now seem to remain in good shape for longer. Moreover, the period of ill health that usually precedes the final goodbye has got shorter in the past few decades, which demographers call "compression of morbidity" (as a rule of thumb, the bulk of spending on an individual's health care is concentrated in the last year or two of life, and particularly in the final six months). This compression has a variety of causes, including the shift from manual to physically less demanding white-collar work, rising levels of education and much-improved health care and medical technology, from keyhole surgery to heart pacemakers. Eighty, it is said, is the new 65.
But even fairly fit older people need more health care than younger ones, not least because they often suffer from chronic diseases that are expensive to treat. In the EU, one estimate puts health-care spending on the elderly at about 30-40% of total health spending. So will the better health of an ageing population, good as it has been for so many, impose unaffordable costs on public-health budgets?
Over the past few decades all OECD countries have seen their health spending grow considerably faster than their economies. Ageing populations will add further momentum to that growth. Howard Oxley, a health-care expert at the OECD, reckons that increased spending on health and long-term care for the elderly could amount to an extra three-and-a-half percentage points of rich countries' GDP by the middle of the century-and a lot more if spending on medical technology continues to go up at current rates.
Measured by spending on health care as a share of GDP, America already tops the list, shelling out the equivalent of more than 15% of GDP (see chart 4). The American government's health-care spending will be hugely affected by ageing because of Medicare, the state-funded health-care programme for the elderly and disabled, and Medicaid, the programme for the poor (and often also old, because it covers long-term care).
President Barack Obama is determined to reform his country's health-care system to improve coverage and, eventually, drive down costs. More money does not always produce better results. People in America are less healthy and die sooner than in Britain, which proportionately spends little more than half as much on its health care. According to David Cutler, an economics professor at Harvard who has advised the president on the reform, even doctors believe that around 30% of money spent on health care in America is wasted.
Peter Orszag, head of the Office of Management and Budget, has recently been praising the work of a group of medical experts at Dartmouth Medical School, led by Elliott Fisher, which has been compiling an atlas of regional variations in American medical practice and health-care spending, mainly for people on the Medicare programme. It found that in 2006 Medicare spending varied more than threefold across American hospital referral regions. Again, higher spending does not seem to result in better care or greater patient satisfaction. Because the system has encouraged the provision of lots of doctors, specialists, hospitals and expensive diagnostic kit, all of them are kept busy without much regard to results.
The trouble with health care in America, says Muriel Gillick, a geriatrics expert at Harvard Medical School, is that people want to believe that "there is always a fix." She argues that the way Medicare is organised encourages too many interventions towards the end of life that may extend the patient's lifespan only slightly, if at all, and can cause unnecessary suffering. It would often be better, she thinks, not to try so hard to eke out a few more hours or weeks but to concentrate on quality of life.
Take care
But long before they get to that point, growing numbers of old people will become less able to look after themselves and need more care. Across the OECD, spending on long-term care is already equivalent to around 15% of total health spending and is rising fast. The great bulk of that care-an estimated 80%-is still provided by family and friends, the traditional source of support for the elderly. But more women are going out to work, so fewer of them have time to look after old folk and formal help is becoming increasingly important.
In most developed countries only a small minority of over-65s-between 3% and 6%-live in institutions. Keeping old people in nursing homes or hospitals is expensive, staff is hard to find, and in any case most people would much rather be looked after at home. Many countries are now providing grants to adapt homes, paying families for the care they provide and supplying helpers to give a hand with things like dressing and bathing.
With far more people reaching a great age, a lot more such care will be needed in future. How will it be paid for? A few far-sighted countries-including Germany, the Netherlands, Luxembourg and Japan-have already introduced mandatory long-term-care insurance schemes. Others may have to follow.
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Jun 11, 2009 | WSJ
Want to know why GM stock is above zero? Look to hedge funds and short-term trading.
Long before the June 1 negotiating deadline, it became quite clear that General Motor s Corp. was headed for bankruptcy. Its debtholders were going to get crushed. The shareholders were wiped out.
Except that they weren't. As the deadline neared, shares of GM did a funny thing: They kept trading at more than $1 each. They didn't disappear.
Last month, shares rose a few pennies during a given trading day and fell a few pennies the next. Taken as a whole, GM shares reflected nearly $1 billion in value that did not exist. Even today, with GM in bankruptcy, the automaker's shares are trading around $1.50.
Market analysts seem baffled, but trading in GM reflects the sea change that's taken place in the markets during the last decade. Simply put, the market has slowly given itself to short-term traders. The traders control volume, and whoever controls the volume controls the price.
The old notion that profitable companies with good growth prospects should have rising share prices -- and that failures like GM should be gone, or at least trading in the pennies -- is history.
Today, a hedge fund investing billions using a quantitative formula can stall a stock; a couple hedge funds aligned can turn a profitable company into a Dow laggard. Toss in a few short sellers and you have the great Wall Street collapse of September 2008.
It wasn't always this way. Before the machines and the shorts took over Wall Street, stocks were evaluated by an underlying company's prospects. Buy-and-hold investing ruled the day. Investors such as Warren Buffett and Bill Miller were the models.
Those fellows are a far cry from this generation's masters of the universe. Traders are in charge now. They rule the market. They dominate volume. That stock you bought because you thought the company was in good shape? It's a pawn in the hands of a computer model or some supertrader like Steven Cohen at SAC Capital Partners or Bridgewater Associates' Ray Dalio.
To move a security, they don't need to own it. They can have a short position. They can put an order to sell 1 million shares in a dark pool, those anonymous marketplaces that operate outside the walls of the exchanges. They can own options or futures contracts. Buy enough GM puts and watch the price begin to fall under the pressure.
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NYT
"If another decline in the market is going to bankrupt you or put you out of business or destroy your retirement account, you should not go back into the stock market," said John C. Bogle, the founder of Vanguard and viewed by many as the father of index investing. "It's not complicated. The stock market can go up and down a lot and nobody really knows how much and when."
What's worked for Mr. Bogle may not work for you, but his method isn't a bad place to start. "I have this threadbare rule that has worked very well for me," he said in an interview this week. "Your bond position should equal your age." Mr. Bogle, by the way, is 80 years old.
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As to those investors who got out of stocks, Mr. Bogle said it might be time for some of them to get back in. "But I would take two years to do it," he said. "Maybe average in over eight quarters, and do an eighth each quarter. I am just not in favor of doing things in a hurry or emotionally."
And then? "Don't touch it," he said, emphatically. "One of my rules is don't do something. Just stand there."
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There are different ways to invest your cash and bond holdings.
Rick Rodgers, a financial planner in Lancaster, Pa., invests 10 years of annual expenses in a bond ladder, with an equal amount coming due every six months. The ladder can include high-quality corporate bonds, Treasury notes, certificates of deposit or municipal bonds, depending on the retiree's tax bracket. Mr. Simon takes a similar approach using a 15-year ladder of zero-coupon bonds. He says that investors can start building the ladder in their 50s, with the first rung coming due the year they retire.
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Through the end of April, the 10-year annualized return on the S&P 500 was negative 2.5%, according to Standard & Poor's.
Meanwhile, an index fund tracking long-term U.S. Treasury bonds, Vanguard Long-Term Treasury Fund, gained 7.2% annualized over the same period.
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May 4, 2009 | msnbc.com
For more than two decades, as income inequality increased and job security decreased, Americans lapped up personal finance columns, books, and television shows. We thrilled to stock tips and swooned at sensible strategies for using dollar-cost averaging to invest in no-load index funds. Buy and hold, my friends! The annualized gain for the S&P 500 stock index over time is more than 10 percent! You, too, can turn into the millionaire next door. Carpe diem, folks! Seize the financial day!
The advice proffered by the vast majority of analysts, would-be gurus, and television pundits came down to one word: stocks. Some, like CNBC's infamous Jim Cramer, advocated stock-picking strategies. Others encouraged mutual funds. But very few - at least of those that could get publicity via mainstream outlets - doubted the efficacy of the market.
That our personal finances weren't fully ours to seize didn't seem to occur to many of us until recently, when the stock market plunged almost 40 percent in a mere year, housing went into free fall, and the unemployment rate began to climb perilously toward double digits. All these facts suddenly left the personal finance industry facing a conundrum of its own making. The backbone of the self-help complex is the idea that you can do it. You. Singular. But what happens when you lose your job and can't find a new one before your six months of recommended emergency savings runs out? Or a good chunk of your retirement income is in the form of a pension from your former employer - and that employer is named Chrysler? What then?
"Personal finance has come to substitute for the role government should play for people," observes Nan Mooney, author of (Not) Keeping Up with Our Parents. "In the past 20 years the myth of the person succeeding on their own has gotten bigger and bigger. This myth is dangerous. It tells you if you can't balance everything and you are in debt, it is your fault."
Sounds harsh, but if you are laid off and at the end of your resources, what other message can you take away from people like mega-personal finance guru Suze Orman, who continues to argue that people's main problem with money is ... emotional. (Orman also urges people to invest for retirement in the stock market, while admitting the bulk of her savings is in municipal bonds.)
Or Jean Chatzky of everywhere from NBC's Today show to Oprah's couch, who helpfully tells people in her latest book, The Difference: How Anyone Can Prosper in Even the Toughest Times, "Overspending is the key reason that people slip from a position of financial security into a paycheck-to-paycheck existence." (Note: Italics original to Chatzky.)
Chatzky forgets to mention that studies have demonstrated the problem most likely to land one in bankruptcy court isn't an addiction to designer clothes but, instead, overwhelming health care expenses.
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CNBC.com
"Buy and hold" is an age-old investment strategy that made many people money in years past, but some investment advisers now say that philosophy is a losing proposition. Gerald Jordan, of Hellman Jordan Management; and Jack De Gan, of Harbor Advisory; and Doug Kass, of Seabreeze Partners, discuss.
"We've long had a buy and hold strategy, but that's a strategy only in a secular bull market, which we're not in right now," said Jack DeGan of Harbor Advisors. He suggested investors be "more opportunistic around valuations and trade in a core position."
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By ELEANOR LAISE
Some investors in 401(k) retirement funds who are moving to grab their money are finding they can't.
Even with recent gains in stocks such as Monday's, the months of market turmoil have delivered a blow to some 401(k) participants: freezing their investments in certain plans. In some cases, individual investors can't withdraw money from certain retirement-plan options. In other cases, employers are having trouble getting rid of risky investments in 401(k) plans.
When Ed Dursky was laid off from his job at a manufacturing company in March, he couldn't withdraw $40,000 from his 401(k) retirement account invested in the Principal U.S. Property Separate Account.
That fund, which invests directly in office buildings and other properties, had stopped allowing most investors to make withdrawals last fall as many of its holdings became hard to sell.
Now Mr. Dursky, of Ottumwa, Iowa, is looking for work and losing patience. All he wants, he said, is his money.
"I hate to be whiny, but it is my money," Mr. Dursky said.
The withdrawal restrictions are limiting investment options for plan participants and employers at a key time in the markets. The timing is inconvenient for the number of workers like Mr. Dursky who are laid off and find their savings inaccessible.
Though 401(k) plans revolutionized the retirement-savings landscape by putting investment decisions in the hands of individuals, the restrictions show that plan participants aren't always in the driver's seat.
Individual investors mightn't even be aware of some behind-the-scenes maneuvers causing liquidity problems in their retirement plans. Many funds offered in 401(k) plans lend their portfolio holdings to other investors, receiving in exchange collateral that they invest in normally safe, liquid holdings.
The aim is often to generate a small but relatively reliable return that can help offset fund expenses. But in recent months, many of the collateral investments have gone haywire, prompting money managers to restrict retirement plans' withdrawals from the lending funds.
Some stable-value funds also are blocking the exits. These funds, available only in tax-deferred savings plans such as 401(k)s, typically invest in bonds and use bank or insurance-company contracts to help smooth returns. But in cases of employer bankruptcy and other events that can cause withdrawals, these funds can lock up investor money for months at a time.
Investors in the Principal U.S. Property Separate Account said they understood the risk of losses, but didn't think their money could be locked up for months or years. Most participants in the 15,000 plans holding the fund haven't been able to make any withdrawals or transfers since late September.
"To sell property at inappropriately low prices in order to generate cash for a few would hurt the majority of investors and violate our fiduciary obligations," said Terri Hale, spokeswoman for Principal Financial Group Inc., the parent of the fund's manager. The fund, which had $4.3 billion in net assets at the end of April, still is making distributions for death, disability, hardship and retirement at normal retirement age.
As of April 28, redemption requests that had yet to be honored totaled nearly $1.1 billion, or roughly 26% of the fund's net assets. Principal doesn't anticipate that it will make any distributions to investors who have requested redemptions until late 2009 or beyond, Ms. Hale said. Meanwhile, the fund continues to fall, declining 25% in the 12 months ending April 30.
Some investors have lost hope of recovering their money. Judith Sterner, a 69-year-old part-time nurse, had more than $12,000 in the fund when she tried to transfer that balance to a money market last fall. But her transfer was denied, and her stake has since declined to less than $10,000.
"This $12,000 represents a year of my retirement money that I don't have," said Ms. Sterner, of Morton Grove, Ill.
Principal still allows new investors into the fund. It categorizes the U.S. Property account as a fixed-income investment, alongside much stodgier funds holding high-quality bonds. New investors are warned of potential withdrawal delays, Ms. Hale said. As for the fixed-income categorization, she said, "a substantial portion of the account return is based on income streams from rents, and its returns have been comparable to fixed-income funds."
While the problems selling real-estate investments are relatively straightforward, withdrawal restrictions related to securities lending stem from far more obscure practices.
Funds often lend out portfolio holdings, through a lending agent, to other investors. These borrowers give the lender collateral, often amounting to about 102% of the value of the securities borrowed. Some of the collateral pools in which funds invest this collateral held Lehman Brothers Holdings Inc. debt and other investments that plummeted in value or became hard to trade in the credit crunch.
Though agents who coordinate funds' lending programs share in profits from securities lending, the risk of such collateral-pool losses falls entirely on the funds that have lent the securities and, ultimately, retirement plans and other investors holding those funds.
The problems have limited retirement plans' ability to get out of securities-lending programs, though participants' withdrawals generally haven't been affected.
Retirement plans offered to employees of energy company BP PLC last fall tried to withdraw entirely from four Northern Trust Corp. index funds engaged in securities lending. Certain holdings in Northern's collateral pools had defaulted, been marked down, or become so illiquid that they could only be sold at low values, according to a BP complaint filed in a lawsuit against Northern Trust.
The BP plans halted new participant investments in the funds and asked to withdraw their cash so it could be reinvested in funds that don't lend out securities.
But under restrictions imposed by Northern Trust in September, investors wishing to withdraw entirely from securities-lending activities would have to take their share of both liquid assets and illiquid collateral-pool holdings, according to a Northern Trust court filing. BP rejected that option, and the companies still are trying to resolve the matter in court.
Northern Trust's collateral pools are "conservatively managed" and focus on liquidity over yield, the company said.
State Street Corp. in March notified investors of new withdrawal restrictions in its securities-lending funds. Until at least the end of the year, plans can make monthly withdrawals of only 2% to 4% of their account balance, the notice said.
Plans wishing to withdraw entirely from lending funds will have to take a slice of beaten-down collateral-pool holdings.
"Given the current state of the fixed-income market, we felt it was prudent to put some well-defined withdrawal parameters in place," said State Street spokeswoman Arlene Roberts.
Write to Eleanor Laise at [email protected]
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Years ago, when I wrote a popular financial makeover feature for a major national newspaper, one of our subjects asked if he should be plowing his more than $50,000 in savings into gold. It was 1997 and gold was trading at a little more than $300 an ounce. The financial planner assisting with the piece laughed dismissively, and the question never made it into the final write-up. Well, my bad. As I write, gold is hovering around $900 an ounce.For more than two decades, as income inequality increased and job security decreased, Americans lapped up personal finance columns, books, and television shows. We thrilled to stock tips and swooned at sensible strategies for using dollar-cost averaging to invest in no-load index funds. Buy and hold, my friends! The annualized gain for the S&P 500 stock index over time is more than 10 percent! You, too, can turn into the millionaire next door. Carpe diem, folks! Seize the financial day!
The advice proffered by the vast majority of analysts, would-be gurus, and television pundits came down to one word: stocks. Some, like CNBC's infamous Jim Cramer, advocated stock-picking strategies. Others encouraged mutual funds. But very few-at least of those that could get publicity via mainstream outlets-doubted the efficacy of the market.
That our personal finances weren't fully ours to seize didn't seem to occur to many of us until recently, when the stock market plunged almost 40 percent in a mere year, housing went into free fall, and the unemployment rate began to climb perilously toward double digits. All these facts suddenly left the personal finance industry facing a conundrum of its own making. The backbone of the self-help complex is the idea that you can do it. You. Singular. But what happens when you lose your job and can't find a new one before your six months of recommended emergency savings runs out? Or a good chunk of your retirement income is in the form of a pension from your former employer-and that employer is named Chrysler? What then?
"Personal finance has come to substitute for the role government should play for people," observes Nan Mooney, author of (Not) Keeping Up with Our Parents. "In the past 20 years the myth of the person succeeding on their own has gotten bigger and bigger. This myth is dangerous. It tells you if you can't balance everything and you are in debt, it is your fault."
Sounds harsh, but if you are laid off and at the end of your resources, what other message can you take away from people like mega-personal finance guru Suze Orman, who continues to argue that people's main problem with money is ... emotional. (Orman also urges people to invest for retirement in the stock market, while admitting the bulk of her savings is in municipal bonds.) Or Jean Chatzky of everywhere from NBC's Today show to Oprah's couch, who helpfully tells people in her latest book, The Difference: How Anyone Can Prosper in Even the Toughest Times, "Overspending is the key reason that people slip from a position of financial security into a paycheck-to-paycheck existence." (Note: Italics original to Chatzky.) Chatzky forgets to mention that studies have demonstrated the problem most likely to land one in bankruptcy court isn't an addiction to designer clothes but, instead, overwhelming health care expenses.
All in all, these might not be the right messages just now. While Orman's book, no doubt propelled by her continuing celebrity and television show, remains at the top of the New York Times best-seller list, Chatzky's book is languishing listless, a very different fate than the one met by her last book, which was released in a different era-2006, to be precise.
In the current economic climate, a new group of au current advisers is coming to the fore. Many of them, like Peter Schiff, received their initial boost of fame by predicting various aspects of the current meltdown and are now trying to make money by telling people how to survive and thrive in the post-crash world. Schiff's Crash Proof, currently in its 11th printing, urges consumers to buy gold to hedge against coming hyperinflation. At the other end of the spectrum is Martin D. Weiss' recently published The Ultimate Depression Survival Guide. Weiss, a Florida-based investment adviser, advocates that many people should cut their stock losses and sell off, as we are entering a period of deflation.
Online gurus are also seeing spikes. ITulip.com's Eric Janszen says he received 12,000 new subscribers last year. George Ure, a business consultant who runs the free site UrbanSurvival.com and the subscription site Peoplenomics, makes predictions about future events based on a linguistics theory applied to Internet postings and has seen an increase of more than 20 percent in unique visitors year over year. Nonetheless, it's not looking like the new gurus will be any more helpful than their more conventionally minded peers. After all, the online world has been abuzz with accusations that many of Schiff's personal clients suffered losses of between 40 percent to 70 percent in 2008.
Which leads to another question: What's next for personal finance? The past two years have demonstrated over and over again that bad things can happen to good savers and investors. Very few of us have the wherewithal to fund both retirement savings and a large enough emergency fund to sustain us through a bout of unemployment lasting, say, more than a year. No one, it turns out, really knows what an individual stock, mutual fund, or commodity like oil or precious resource like gold will be worth in six months, never mind six years.
Nonetheless, personal finance is unlikely to crawl away and die anytime soon for a simple reason: We think we need it. "We're kind of screwed but we don't have a choice but to take care of ourselves because no one else is helping," admits MSN's personal finance columnist, Liz Weston.
A number of personal finance gurus have been moving, some ever so slowly, over toward the idea of pressuring the government for change. Weston, who has written extensively about what should be and isn't in pending congressional legislation putting brakes on the credit card industry, is begging her readers to contact their representatives about the plan. Others have gotten more ambitious. Schiff used his burst of fame to endorse presidential candidate Ron Paul. Weiss is currently circulating a petition to stop further bank bailouts.
Me, I'd settle for a few mea culpas from our finance gurus. After all, I am aware I owe my gold-loving dude an apology. Unfortunately, I know the planner assigned to the case won't be eating crow any time soon. I recently received a copy of his latest book in the mail. It's all about how if you can just identify your money archetype, financial success will be yours. Oh, and one other thing. The press release quotes him as advising, "Don't rush out to buy gold."
- Helaine Olen's work has appeared in the The Los Angeles Times and The Washington Post. She's the co-author of Office Mate: The Employee Handbook for Finding and Managing Romance on the Job.
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Executive Summary
Impact varies by account balance: ... those with more than $200,000 in account balances had an average loss of more than 25 percent.
Impact varies by age and job tenure: 401(k) participants on the verge of retirement (ages 56–65) had average changes during this period that varied between a positive 1 percent for short-tenure individuals (one to four years with the current employer) to more than a 25 percent loss for those with long tenure (with more than 20 years).
Short-term vs. long-term: While much of the focus has been on market fluctuations in the last year, investing for retirement security is (or should be) a long-term proposition. When a consistent sample of 2.2 million participants who had been with the same 401(k) plan sponsor for the seven years from 1999–2006 was analyzed, the average estimated growth rates for the period from Jan. 1, 2000 through Jan. 20, 2009, ranged from +29 percent for long-tenure older participants to more than +500 percent for short-tenure younger participants.
Recovery time and future stock market performance: This analysis also calculates how long it might take for end-of-year 2008 401(k) balances to recover to their beginning-of-year 2008 levels, before the sharp stock market declines. Because future performance is unknown, this analysis provides a range of equity returns: At a 5 percent equity rate-of-return assumption, those with longest tenure with their current employer would need nearly two years at the median to recover, but approximately five years at the 90th percentile. If the equity rate of return is assumed to drop to zero for the next few years, this recovery time increases to approximately 2.5 years at the median and nine to 10 years at the 90th percentile.
Near-elderly with very high equity exposure: Estimates from the EBRI/ICI 401(k) database show that many participants near retirement had exceptionally high exposure to equities: Nearly 1 in 4 between ages 56–65 had more than 90 percent of their account balances in equities at year-end 2007, and more than 2 in 5 had more than 70 per-cent. As a result of the Pension Protection Act of 2006, many 401(k) plan sponsors appear to be offering lifecycle/ target-date funds, which automatically rebalance asset investments into more "age appropriate" allocations. Had all 401(k) participants been in the average target date fund at the end of 2007, 40 percent of the participants would have had at least a 20 percent decrease in their equity concentrations, and consequently, may have mitigated their losses, sometimes to an appreciable extent.
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April 24, 2009 | ETFguide.com (Yahoo! Finance)Millions of mutual fund investors have been sold a pipedream and they don't even know it. Others know it and they simply don't care. If you own mutual funds, isn't it time you found out how your funds have really performed versus corresponding index funds and ETFs?
To that end, Standard & Poor's has just released its analysis of active mutual fund managers compared to S&P indexes. And the data is a stunning blow to all would-be market beaters.
S&P's research discovered the majority of active funds in 8 of 9 major stock categories failed to beat corresponding S&P stock indexes. The S&P 500 (NYSEArca: SPY - News) beat 71.9% of active managers while the S&P MidCap 400 (NYSEArca: MDY - News) and S&P SmallCap 600 (NYSEArca: IJR - News) outperformed 79.1% and 85.5% of managers in matching categories. The data was recorded over a five-year period ending in 2008.
'The belief that bear markets favor active management is a myth,' stated the S&P report. The analysis also revealed similar results of bear market underperformance by mutual fund managers during the last downturn from 2000 to 2002.
What does all of this mean?
It means the statistical evidence continues to show that investors would be better off investing in dumb index funds and ETFs than investing with dumb fund managers.
Rewarding Failure
One of the key problems with mutual fund management is their convoluted business practices of rewarding failure. Instead of punishing bad behavior, they reinforce it. For example, in 2008, Mario Gabelli vacuumed in a $46 million paycheck from GAMCO Investors (NYSE: GBL - News) even though client assets at the firm fell by 33%. Despite the worst economic and market conditions of our generation, Wall Street's fund executives are still cashing in like a bear market never happened. Mr. Gabelli is a Barron's roundtable contributor and he presides over funds such as the Gabelli Equity Trust (NYSE: GAB - News) and the Gabelli Asset Fund (Nasdaq: GABAX - News).
'Having a mutual fund management company is like having a toll booth on the George Washington Bridge all for yourself,' is what Marty Whitman, manager of the Third Avenue Value Fund (Nasdaq: TAVFX - News) told Forbes Magazine. If that's true, it looks like John Bogle's 'Designing a New Mutual Fund Industry' will have to wait a few more decades. Sorry Jack. In the meantime, all investors should immediately start re-designing their own investment portfolios to avoid getting victimized.
Who's Protecting Who?
Instead of protecting mutual fund shareholders as they should be, mutual fund titans have resorted to 4th grade techniques, namely, finger pointing. In a recent letter to mutual fund shareholders, the Chairman of Fidelity Investments Edward C. 'Ned' Johnson III, gave the financial services industry a severe verbal licking.
'Although we ended 2008 better than a number of financial firms, it was a year of painful experience for the financial services industry, a period laced with toxic investment waste and the casual use of other people's money by a number of institutions,' Johnson said.
What Johnson failed to mention in his criticisms was the most interesting of all.
Did you know that Fidelity's fund managers more than doubled their ownership stake of floundering bailout kid, Citigroup (NYSE: C - News) during the fourth quarter of last year? As Citi was sinking, so were Fidelity's equity mutual funds. In 2008, 64 percent of the firm's stock funds were beaten by its peers. I wonder if this is this the 'toxic investment waste' Fidelity's Chairman was referring to.
In contrast, index funds and ETFs have been 'protecting' their shareholders during this vicious bear market. How? Quite simply, by not doubling and tripling up on dead-beat stocks like Citigroup. Now that Citi's market cap has collapsed, so has its rotten-apple influence on the performance of major stock benchmarks that contain it. By design, stocks with the lowest market capitalizations have the least amount of influence on the performance of an index.
The Performance Chasing Mafia (PCM)
There are others who claim they can find mutual funds that do beat the market. I classify them as official members of the performance chasing mafia or 'PCM' for short. They remain utterly defiant (and aloof) about the relevant statistical facts, because they know better.
Take for example, Adam Bold, founder and chief investment officer of The Mutual Fund Store, a chain of 70 fee-only financial advisers. He recently told Bloomberg, 'I'm a believer that by indexing, you're accepting mediocrity. There are a limited number of people who have shown an ability to consistently beat the market year after year.' Earth to Adam! Earth to Adam!
The problem, which Mr. Bold doesn't address, is that it's next to impossible to accurately pre-identify top performing fund managers before they become top performing fund managers. That leaves people like Bold with one choice: To chase historical performance. Investors almost never get what they bargained for and performance chasing advisors get lots of fees. Nevertheless, Bold has made himself a very successful Wall Street career in helping people to identify yesterday's winners, as his $4 billion monstrosity illustrates.
Finding Better Alternatives
Index ETFs are the solution to avoiding underperforming mutual funds. If you don't want to be limited to ETFs that follow S&P stock indexes, there are other excellent choices to consider.
For example, Vanguard's ETFs follow MSCI constructed indexes, which generally tend to be broader and more diversified because they own more securities. See the Vanguard Large Cap ETF (NYSEArca: VV - News), the Vanguard MidCap ETF (NYSEArca: VO - News), and the Vanguard SmallCap ETF (NYSEArca: VB - News). All of these Vanguard ETFs charge rock bottom annual expenses that range from 0.07% to 0.13%.
If you need ideas on how to build a successful all-ETF portfolio, check out ETFguide's Ready-to-Go ETF Portfolios. Our ETF Portfolios just finished their third straight year of outperforming major benchmarks like the S&P 500 and MSCI EAFE (NYSEArca: EFA - News) stock index. Which ETFs can help you reach your investment goals? Take the time to learn more.
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April 22 | Yahoo
Mutual funds have provided a wide variety of investment styles and strategies for many years. In fact, the number of mutual funds has almost eclipsed the actual number of stocks traded in the stock market. This broad offering of products has presented a challenge to both retail and institutional investors, as they try to determine the best funds to reach their desired results in each respective asset class.
The mutual fund rating business has blossomed from a quarterly rating service to a multimillion dollar industry. Rating agencies provide a valuable service to customers and keep the fund managers on their toes with constant scrutiny, which can make or break a fund's success. Still, while the ratings are important to investors, they can be deceiving. In bear markets, a high-rated fund can perform just as well (or a badly) as a low-rated fund can, regardless of strong performance in a bull market.
The Lipper Rating System
Lipper provides mutual and hedge fund reviews, commentary and tools used for screening and analyzing data. While Lipper services the institutional and asset management industry, its mutual fund services are provided in detail for retail investors of all levels. Lipper's proprietary rating system, Lipper Leaders, covers more than 80,000 funds and uses consistency, capital preservation, peer performance and expense management as its tenets, among other factors. The Lipper ranking system is based on a scale of one to five (with five being the highest rating). Lipper Leaders are the funds that rank in the top 20% of their peer ratings, with the next 20% receiving a rating of four, and so on.
The Morningstar Rating System
Morningstar also uses a ranked system, but it uses stars instead of numbers as the rating standard. Also similar to Lipper, Morningstar offers both online and hard copy reports tailored to specific investors' preferences. Morningstar also created a nine-square style box for both equity and fixed-income funds, which depicts styles and size categories. Morningstar presents breakdowns for equity funds into 12 industry groups inside three primary economic sectors to compare weighting decisions.
Chasing Performance
Performance is likely the most recognizable component of mutual fund ratings. This component by itself is easy to follow and does not require in-depth knowledge of the market. However, "chasing performance" has led many investors into what is known as the "performance trap." This is when money flows heavily into a fund that was highly rated in the previous year. More often than not, that same fund does not repeat such impressive numbers in the following period. In this situation, consistency comes into play and rating firms add some value. Ratings firms will apply expertise and evaluate a fund's performance on a relative and absolute basis.
Because different investing styles tend to display varying results over market cycles, new styles can be extremely important to an investor. The rating companies can add much value here, as it is not a good idea to leave style analysis up to the fund manager.
The Downside of Ratings
One of the biggest problems with mutual fund ratings is that during a long-term bull market, investors and those who rate funds can easily become complacent. During volatile market times, mutual funds managers are susceptible to any temptation to try to increase performance or protect against downside risk; both factors can lead to rogue trading, or even fraud.
Also, due to the lengthy process of becoming a highly-rated fund, up-and-coming funds may not be recognized in time to make a substantial investment in their early period.
The Bottom Line
The business of evaluating mutual funds has evolved into an industry in itself. Mutual funds are evaluated on many levels beyond just performance, including peer group comparisons, sector weightings and cash holdings. Though not infallible, ratings systems can provide investors with relative guidance and direction that can lead to decent returns.
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naked capitalism
Ed Mendel of Capitol Weekly writes that public pension funds' rosy forecasts pose problems:
Pension funds have been hit hard by the stock market crash, losing about a third of their value in some cases, and there may be another problem.
Before the crash, some financial experts warned that pension funds were making overly optimistic projections of investment earnings in the decades ahead, often assuming about 8 percent a year.
Investment earnings, the heart of a modern pension system, are usually expected to provide two-thirds or more of the revenue needed to pay retiree benefits in the future.
In public employee retirement systems, a rosy forecast of future earnings means that fewer taxpayer dollars have to be spent to provide generous retirement benefits.
The giant California Public Employees Retirement System assumes annual earnings averaging 7.75 percent in the decades ahead. The California State Teachers Retirement System assumes 8 percent.
Lowering the projection of earnings by even a percentage point or two would create a funding gap of tens of billions of dollars.
CalPERS, an industry leader, warned its 1,500 local government members last fall that their employer contribution rates may increase from 2 to 5 percent of payroll in July 2011 if the stock market does not recover by June 30, the end of the current fiscal year.
Beyond raising rates to plug the big hole punched in pension funds by the stock market crash, the problem could get even bigger if forecasters decide that the critics are right, lowering projections of future earnings.
After the big drop in the stock market last fall, the CalPERS investment portfolio, once a high flier, had an average annual return of 3.32 percent for the last 10 years, well below the forecast of 7.75 percent.
A prominent critic of the high earnings forecasts, David Crane, was a rare appointee to a pension system board, CalSTRS, with a big-league background in investments.
Crane, an adviser to Gov. Arnold Schwarzenegger, helped build a small San Francisco business, Babcock & Brown, into a global investment firm, becoming personally wealthy along the way.
After the governor put Crane on the CalSTRS board and he had served almost a year, the Senate refused to confirm the appointment in June 2006, ousting a board member who had repeatedly questioned the 8 percent earnings forecast.
Legendary investor Warren Buffet, in his annual letter to Berkshire Hathaway shareholders in February of last year, questioned the 8 percent earnings forecast common among the pension funds of major corporations.
"How realistic is this expectation?" Buffet said. "Let's revisit some data I mentioned two years ago: During the 20th Century, the Dow advanced from 66 to 11,497. This gain, though it appears huge, shrinks to 5.3 percent when compounded annually."
[Note: On the above calculation, a senior pension fund manager wrote me: "Don't believe everything you read, take out your calculator."]
The founder of Vanguard mutual funds, John Bogle, told a congressional hearing on retirement security last month that corporate pension funds raised their assumed earnings from 6 percent in 1981 to 8.5 percent by 2007, far above historical norms.
"And the pension plans of our state and local governments seem to be in the worst condition of all," Bogle said, adding parenthetically: "Because of poor transparency, inadequate disclosure, and non-standardized reporting, we really don't know the dimension of the shortfall."
The plight of the public employee pension funds has drawn a creative proposal from U.S. Rep. Gary Ackerman, D-New York, to shore up two of the nation's troubled institutions.
Public pension funds would pool some of their money and buy $50 billion to $250 billion worth of stock in banks. In exchange, the federal government would guarantee the pension funds an annual return of about 8.5 percent.
Earnings forecasts were not a problem in the early days of California public employee pension funds, when investments were limited to fixed-income bonds and mortgages.
In 1966, a ballot measure, Proposition 1, allowed the pension systems to put 25 percent of their funds into blue-chip stocks. Advocates said the change would enable increased retirement benefits and lower employee and taxpayer contributions.
A measure to allow 60 percent of pension funds to be invested in stocks, Proposition 6, was rejected by voters in 1982. But two years later voters approved a far broader measure, Proposition 21, simply requiring that investments be "prudent."
The ballot pamphlet argument said the measure, still in effect today, is similar to federal law covering private pension funds and is needed to prevent inflation from eroding the value of pension funds.
The ballot argument said pension fund trustees are "personally liable" if they invest funds without "the degree of care expected of a prudent person, who is knowledgeable in investment matters."
The lifting of the restrictions on investing in stocks in 1984 came a few years after legislation allowed public employees to form unions and bargain collectively for labor contracts, which usually include retirement benefits.
A state labor law in 1968 covered local government employees. Teachers were added in 1975 under the Educational Employment Relations Act, state employees in 1977, and University of California and California State University employees in 1978.
Many public employee labor unions went on to negotiate contracts providing generous benefits - up to 90 percent of the final salary at age 50 for some police and firemen - that are expected to be paid mainly by pension fund investment earnings.
Retirement benefits provided by a labor contract have strong legal protection. In a widely watched test case, the City of Vallejo declared bankruptcy last year and asked a federal bankruptcy judge to overturn its labor contracts.
In hindsight, after a historic market crash that may force taxpayers to bail out pension funds, was it prudent to lift the restrictions on investing in stocks?
Calpensions asked an expert, Alicia Munnell, director of the Center for Retirement Research at Boston College.
"In the old days (before the mid 1980s), many public plans had limitations on equity investments," Munnell replied by e-mail. "Virtually all have eliminated those constraints. Allowing more freedom to the investment managers is probably a positive development.
"The controversial area is the rate of return assumed in the actuarial valuation of pension plans. Public sector sponsors tend to assume high returns (8 percent or more), which makes the taxpayers' commitment for future benefits seem small and encourages major expansion.
"Bottom line: a free hand for investment managers is a good idea; more cautious assumed rates of return would help check major benefit expansions."
I always wondered where that 8% came from. With long-term bond yields at historic lows, this figure is pie-in-the-sky because pension funds will be lucky to get 8% a year in the next few years.
In fact, Reuters reports that fund investors see the slump continuing to 2010:
Investors overwhelmingly hold negative views toward credit rating agencies and the Securities and Exchange Commission, and they expect the market slump will continue into next year, a survey by the Greenwich Roundtable and Quinnipiac University found.
The survey of 89 wealthy private and institutional investors in late January and early February found confidence in regulators and in hedge funds was shaken during the credit crisis. It will take six to 12 months of healthier markets before investors jump back in, the survey reported.
"Leverage, liquidity and lack of confidence are still keeping the sophisticated investor on the sidelines," Steve McMenamin, executive director of the Greenwich Roundtable, said in a statement.
As a result, he said, unprecedented numbers of limited partners refuse to make new commitments to alternative investments, such as hedge funds.
Greenwich Roundtable is an organization for investors who allocate capital to alternative investments, with members representing more than $6.4 trillion in assets.
Among other findings, more than one-third of those surveyed said they lowered allocations to hedge and private equity investments during the past quarter, though more than one-half left allocations unchanged.
One-third reported that as many as 40 percent of their fund managers suspended redemptions, while close to one-quarter were dissatisfied with the way redemption gates were currently structured. Ten percent of investors complained gates were being abused.
These LPs should have checked those gait clauses more carefully before committing the big money to hedge funds. It's too late to whine about it now!
If investors want cheap exposure to hedge funds, they can now invest in Deutsche Bank's new exchange-traded fund (ETF) giving investors direct access to hedge funds through a managed account platform.
[Note: I am skeptical of any hedge fund ETF that charges 0.9% per year. Investors should ask who is on this platform and how they performed over the past 12 months. A better solution for investors looking for "passive" liquid exposure to hedge funds is to replicate hedge fund indexes using a few futures contracts (this is tricky too; contact me for more details).]
But that 8% projection of investment earnings needs to come down. Pension funds and their stakeholders need to reassess their growth projections and realize that overly optimistic projections will only aggravate their pension deficits.
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Rita Hritz knows several people who have lost more than $100,000 in the stock market recently, and she's not taking any chances.
She pulled out of the market in 2005 because she was tired of the ups and downs, and she has no plans to invest in anything again except real estate.
"I would like to invest in the future, but it's so volatile, I don't know that I would," said Hritz, 50, an ultrasound technician in Chardon, Ohio. Hritz submitted her story to CNN's iReport.com.
Hritz is just one example of an American who has lost confidence in the stock market, which has plummeted in recent months. Confidence among investors as a whole is a key factor in determining how the market behaves, economists say; when investors collectively lose confidence in the market, it is more likely to drop.
In fact, confidence is an example of an "animal spirit," a term referring to the psychological factors that move the market. British economist John Maynard Keynes coined the term.
"One of the reasons this recession was not foreseen was that people didn't perceive the role of animal spirit in how the economy works," said George Akerlof, winner of the 2001 Nobel Prize in economics and co-author of the new book "Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism."
Stories about the nature of the economy that pass from person to person are another reason why markets go up and down, he said.
The stories that friends tell one another or that are propagated through the media influence people's confidence in the market and therefore affect the market itself, he said.
For example, in the late 1990s, the "story" was that there was a dot-com bubble: People bought stocks in Internet and technology-related companies that seemed to be rising in value rapidly. When people realized that they'd been overconfident and that some of the stocks were overvalued, the bubble burst.
"These stories get passed from one person to another, and because they get passed from one person to another, it acts like an epidemic," Akerlof said.
Another animal spirit is "money illusion." Capitalism produces not only what people want but what people think they want, Akerlof said.
A person seeking to buy medicine in the 19th century might end up buying snake oil, a product without curative properties. Similarly, "snake oil" financial instruments are often sold in unregulated markets.
"We've just been through a period in which people have been buying assets on the basis that they were overconfident," he said. "They had too much trust."
It's only now that people are seeing that they had made poor investment choices, he said.
Where's the bottom?
Some people, like David Lowery, recently decided that they've had enough of losing money in the market. The 56-year-old truck driver in Euless, Texas, closed his IRA on Thursday. He had cut his 401(k) contribution from 7 percent to 1 percent of his paycheck Monday.
"What money you've got, better get it out and put it under the mattress," said Lowery, who also shared his views on iReport.com. Read his iReport
Lowery had hoped to retire in nine years, but now he thinks he may have to work until age 70. He may put his money in bonds or CDs instead of stock-based funds.
Some economists say you should take a good look at your job security before making investment decisions.
People who are facing layoffs or are unemployed should be more careful with their investments, but those with secure jobs can afford to take greater risks, said Lubos Pastor, professor of finance at the University of Chicago.
"People should not succumb to their fears. They should rationally assess whether they are able to bear the risk of the stock market," he said.
But while it's anyone's guess when the market will pick back up again, rest assured that it most likely will not hit zero.
"It's implausible that it would be zero unless we're hit by a comet or the government nationalizes everything," Pastor said.
Expecting history to repeat
Experience with recessions also affects people's investment behavior, some economists say.
Hritz got laid off and went bankrupt in 1981, a year that saw a recession. Her previous financial struggle has made her more cautious about putting money in the market today, she said. Read her iReport
Her experience is consistent with research that shows people who lived through the Great Depression tend to be more cautious with their stock market allocations, but younger people who did not live through that recession are more optimistic.
That means that, after this current recession, everyone will be more cautious than before, Pastor said.
Those who do stay in the market will reap the benefits of any future rebound, Pastor said. In fact, the market will rally several months before the end of the recession, but those who sell everything will miss out on that.
"Going just by on your instincts by fear and by your confidence, that is usually misleading," he said. "That type of investing leads people to buy at the peak and sell at the bottom."
As for Hritz, she maintains a cautious distance from the stock market. Her husband, Jim Schaefer, was originally going to retire this month, but he has no plans to stop working, she said.
"We're seeing a decline in value of the house we're in, but I'm not panicking like I would if I would have played the stock market," Hritz said.
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March 13, 2009 | Kiplinger
Your best bet is to keep on contributing, stick with stocks and try not to raid your account.
The economic funk has made virtually everyone anxious about retirement. In fact, 83% of Americans worry that the recession will have a major impact on their retirement plans, according to a recent poll by the National Institute on Retirement Security.
More from Kiplinger.com: • Quiz: How to Revive Your Retirement Plan
Don't let economic jitters change your savings habits. Sticking with the tried-and-true practice of socking away as much as possible in your 401(k) or IRA -- or both -- should still put you on track for retirement. But we don't blame you for being concerned that your 401(k) has turned into a 201(k). We answer some common questions about how to pump up your depleted accounts.
My employer has stopped contributing to my 401(k). Should I stop contributing, too?
Absolutely not. Particularly now, with Standard & Poor's 500-stock index down 33% over the past year, you don't want to miss the chance to pick up stock-market bargains. Plus, if you stop putting money in your 401(k), you'll miss out on a valuable tax deduction. Say you're in the 25% federal tax bracket. If you contribute $4,000 to the plan, you'll save $1,000 in income taxes -- and even more when you include state tax savings.
I've already lost so much in my 401(k). Wouldn't it be better to keep my savings in cash until the market bounces back?
You're in good company. Nearly one-third of those who participate in a 401(k) plan lost 30% or more last year, reports Mercer, a consulting firm.
But if you sit on the sidelines and venture back into the market only after it turns around, you risk missing out on the market's top-performing days, which tend to come at the beginning of a recovery. For instance, if you were fully invested in the S&P 500 from December 31, 1997, through December 31, 2007, you would have received an annualized return of 4.2%. But if you missed out on the index's 30 best days during that time period, you would have suffered average annual losses of 7.2%, according to an analysis by T. Rowe Price. No one knows exactly when the market will recover in the future, so it is better to keep your long-term money invested in stocks for the long haul.
I thought my tolerance for investment risk was pretty high -- until the stock market collapsed. What should I do now?
Investing and risk go hand in hand. How much volatility you can stand depends on your age, your investment goals and your ability to sleep at night. If you are within a few years of retiring or close to reaching the dollar goal you've set for your retirement kitty, lock in your savings by reducing your risk, says Richard Ferri, chief executive officer of Portfolio Solutions, an investment adviser in Troy, Mich.
For instance, if you've determined you need $1 million by the time you're 65 and you have accumulated $900,000 by age 60, take your foot off the gas and cut your portfolio's stock holdings by 10%. You'll feel as if you're taking action, but, in reality, the move won't affect your portfolio that much. Then don't touch it again for at least a year. "There's nothing you can do about a bad economy except wait for it to get good again," Ferri says.
The volatile market has left my retirement portfolio completely out of whack. How do I rebalance?
Decide on a rebalancing schedule -- quarterly or annually works well -- and stick to it. By rebalancing at regular intervals, you avoid subjective decisions based on emotion. Plus, you force yourself to sell investments that have performed relatively well and buy laggards to re-establish your original asset allocation. About half of all employer-based retirement plans offer an automatic-rebalancing feature, according to a new study by Hewitt Associates, an employee-benefits consulting firm.
Or consider investing in a target-date retirement fund, which adjusts automatically as you approach retirement. More than three-fourths of employers now offer target-date funds in their 401(k) plan, Hewitt says. Although these funds suffered in the market meltdown, too, they generally beat the S&P 500.
My retirement portfolio fell 35% last year. How long will it take for it to recover?
Unfortunately, it could take years. Let's assume you had a portfolio of $250,000 that fell 35%, to $162,500. If you don't add anything and earn pretax annual returns of 5% -- about half of the stock market's long-term rate of return -- it would take more than nine years for your account to recover, according to calculations by T. Rowe Price. However, if you add $4,000 a year and your investments earn 5% annually, your account would rebound to about $250,000 in six and a half years. Higher investment returns and larger contributions would produce faster results and a bigger nest egg.
I have both a 401(k) and a Roth IRA. Is that too many retirement accounts?
No. It's actually a good idea to have both types of retirement accounts to diversify your future tax liability. With a traditional 401(k), you enjoy an upfront tax deduction, but future withdrawals will be taxed at your ordinary tax rate (not the lower capital-gains rate reserved for most investments). With a Roth IRA, you pay taxes now instead of later. But to contribute, your income can't exceed $120,000 if you're single ($176,000 if you're married) in 2009. Nearly 30% of employers offer Roth 401(k)s, which provide the same tax-free income in retirement but without income-eligibility restrictions.
I need to borrow money from my 401(k). What are the pros and cons?
If you're facing a financial emergency and your only choice is between borrowing from your 401(k) plan or making a hardship withdrawal, it's an easy decision: Take the loan. You'll avoid the taxes and penalties that come with a hardship withdrawal. Most 401(k) plans allow you to borrow up to 50% of your vested account balance or $50,000, whichever is less.
Although the money and interest you repay go back into your account, a 401(k) loan can still be costly. Money not invested will stunt the growth of your retirement savings. And if you fail to repay the loan on a timely basis -- usually within five years (longer if you use the money to buy a first home) -- you will owe state and federal income taxes, plus a 10% penalty if you are younger than 59. Together, the taxes and penalty can wipe out 40% or more of your balance. And if you lose your job, you usually have to repay the loan within 60 days or it will be treated as a taxable distribution. "If you take a loan, make sure you'll be staying at your job a while," warns David Wray, president of the Profit Sharing/401k Council of America.
Is there a way to avoid the 10% penalty if I tap my 401(k) before I turn 59?
Yes. There's a special rule for workplace-based retirement accounts. If you leave your job when you are 55 or older, you can tap your retirement funds without paying the 10% penalty, although you will still owe income taxes. This early-out rule does not apply to IRAs, so if you roll over your 401(k) to an IRA, you lose penalty-free access to your money.
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January 28, 2009 | Washington Post
Millions of American workers lost an average of 27 percent of their 401(k) retirement savings in 2008, according to a study released this morning by Fidelity Investments.
The average 401(k) balance went from $69,200 in 2007 to $50,200 last year because of dramatic market declines, the study found.
Despite such losses, Fidelity's analysis of 11 million participants in more than 17,000 corporate plans showed that employees continued to contribute to their retirement savings and took out fewer loans against the plans than the previous year. In fact, they added an average of $5,600 in pre-tax earnings to their accounts, a slight increase from the year before.
"Employees are staying the course and I think this is very good news because I think it really shows that employees recognize these savings dollars are a need to have, not a like to have," said Scott B. David, president of Workplace Investing for Fidelity Investments. "This is a necessary savings for their financial well-being."
But in a sign that workers are struggling financially, the Fidelity study showed a slight increase in the percentage of workers who took so-called hardship withdrawals, from 1.6 percent in 2007 to 1.8 percent in 2008. Unlike 401(k) loans, hardship withdrawals require proof of a severe financial need and come with a hefty tax bill.
David said the people who took hardship withdrawals most likely did not have the option to take a loan against their plans. Historically, those who take hardship withdrawals have taken out loans first and many employers restrict the number of loans allowed.
"Once you've taken the loan, the next likely step is the withdrawal, which is a terrible thing to do because of the tax implications and the penalties," David said.
The average hardship withdrawal amount decreased slightly in 2008 to $6,000, but David attributed that to the fact that workers had less money to pull out of their accounts.
The report comes at a time when the 401(k) concept is under intense scrutiny from lawmakers, academics and economists. The stock market's collapse has revealed the vulnerability of America's retirement system. Increasingly, employers have abandoned traditional pensions, forcing workers into 401(k)s which tend to have more exposure to market forces. Many lawmakers also pushed 401(k)s, approving rules in recent years that, for instance, make it easier for employers to automatically enroll their employees in such plans.
David said 401(k)s are still a good retirement savings vehicle but should not be the only one that an employee relies on.
"They were designed to be one of several savings vehicles," he said. "To look at 401(k)s as the only form of retirement savings is not appropriate."
Selected comments
pjc8300892 wrote:
"To look at 401(k)s as the only form of retirement savings is not appropriate."
When the 3-5% we put into our 401K is all we can afford, and when our home also decline 25% in value, what alternatives do the common worker have? With unemployment zooming and most people either out of work of not sure they will have a job tomorrow, what do these experts suggest.
With assets decreasing by 30% a year, income decreasing by up to 90% and expenses increasing in double digits, just what should people do?
A. Wait for the banks to help us with the billions in tax dollars they have received?
B. Wait for our law makers to find a miracle cure?
C. Burry our head in the sand?
D. Blow our brains out before our insurance lapses?
E. All of the above!
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There are a handful of options for minimizing 401(k) or IRA early withdrawal penalties, but navigating the rules can be tricky.
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May 18, 2009 | Angry Bear
Middle aged men and pensions in the industries. Much wealth has vanished...I notice a lot of apathy among employees such as teachers whose state plans have not declared losses yet except generally. The MA plan declared a 29% "loss" in value, but I have yet to see a clear statement about what the "loss" implies, how much is perhaps permanent as in owning worthless paper, and how current revenue can handle the next few years of retirements of boomers. Can anyone help out in this evaluation?
Selected comments
Noni Mausa replies:
"Jay said: "...It is better for one person's mistake with other people's money to affect thousands of workers, rather than one person's mistake with their own money..."
There's so much wrong with this brief comment that I hardly know where to start.
Chief among them, though, is that it wasn't "one person's mistake" that lost Americans a quarter of their 401(k) investments. It was a network of liars and thieves and incompetents and ideologues, regulated by Lady Justice blindfolded and swordless.
Some companies, it's true, scuppered their pension plans under chapter 11 as the only alternative to complete failure. But many went into chapter 11 as the "neutron bomb" option -- wipe out (their debts to) their people, while leaving the buildings standing. And some never maintained their pension funds in the first place, or raided them for quick cash when they felt like it.
The single key to the mass collapse of the money system was the reduction of fiscal governance in almost all levels and domains.
Now, it is true the market will take care of itself over time. But it won't take care of us. The sea always seeks the lowest level, but this doesn't help when you're drowning.
What will Americans do now, to try to avoid a future skinning like this? They've been shown that in a "I will gladly pay you Tuesday" scenario, Tuesday never comes -- that cash-in-hand is the only pay they can be sure they will get. How would you bargain, Jay, in such a work environment?
Noni
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May 13, 2008 | Angry Bear
Tom's working on explaining Savings 101, so this is specifically to deal with the "issue with" retirement accounts.
Via Lawrence G. Lux, we find the A.P. (and maybe the NYT) highlighting a "study" by an investment management firm that "discovers" problems with the way people manage their 401(k)s:
Some of the diversification problems stemmed from concentrated holdings of company stock. Experts urge savers to hold no more than 10 percent to 15 percent of their accounts in company stock, pointing out that they could sustain significant losses if the company runs into trouble or goes bankrupt.The Financial Engines study found that among savers eligible to receive company stock, more than one-third had more than 20 percent of their holdings in the company's shares. Some older workers had more than half their holdings in company stock, and workers with salaries under $25,000 also held a disproportionate amount of company stock, the study found.
On the level of savings, the study found that just 7 percent of 401(k) participants were saving the maximum allowed.
Much of that is common sense. (Think Enron: the time when your company stock will be least value to you also will be the time you may need to borrow against your retirement account.)Some of it, likely, is the way the plans are offered. (Again, think Enron.) Public companies tend to offer their stock as part of a "retirement plan," and many "investors" are told to invest in "what you know."
However, the absurd claim in the lede of the AP piece ("Despite extensive efforts to educate workers about saving for retirement") is belied by two realities. One is noted by Lux:
Look, Maw, those damned Kids don't know how to manage their (401)k Funds. When are they going to learn that they have to spend 20 hrs. per Week evaluating good potential Investments. Listen to them complain that they don't have the time–between raising children and working a 50-hour Workweek. (italics removed)
the other comes from anyone who knows a bit of history and remembers that pensions have been historically underfunded (or raided) by management. If trained money managers couldn't do a good job in the Glory Days of Defined Benefit (and, make no mistake, a literal reading of economic theory would lead anyone to believe those were the glory days), then expecting people who do not specialize in managing money to allocate "appropriately" should be, on the face of it, absurd.Finally, some of the problem likely is due to constraint optimization issues. (Short version: You can only save what you don't have to spend.) Let us rewrite this paragraph:
Nearly two-thirds of those earning less than $25,000 a year don't contribute enough to get the full company match, the study found. But 24 percent of those earning $50,000 to $75,000 a year and 12 percent of those earning more than $100,000 a year didn't get the full match, either.
as
Only slgihtly more than one-third of those earning less than $25,000 a year have enough disposable income to get the full company match, the study found. Meanwhile, 76 percent of those earning $50,000 to $75,000 a year and 88 percent of those earning more than $100,000 a year were able to qualify for the full match.
But that makes it clear, as divorced one like Bush noted in a comment to vtcodger's post:
You don't invest in the market until you have money you can afford to lose.
And a lot more people making $50,000-plus-a-year have money they can afford to lose than those making less than $25,000 p.a. Which is what the data shows.Read More on "Blaming the Badly Allocated for Choices Not Necessarily Their Own"
Comments
Mcwop
Don't take this too seriously. it is the coberly investment plan:
There is a reason they pay all that interest. money now is more useful than money later. Spend it while you are young on things that will make you happy (a big tv or a big car will NOT make you happy).
when you get to be about 45 or 50, and the kids are grown and the house is paid for, start saving like mad. you are making peak earnings, you are too old for ski trips, and you have learned how to be happy while spending almost nothing. In five or ten years you can save about as much as you were going to get putting away that hundred dollars a month at 3% or less over inflation.
worked for me.
coberly | 05.12.08 - 5:16 pm |===
Whenever someone complains that the typical investor doesn't work hard enough on optimizing their investment plan, I point at that there is an entire class of people who do nothing else but manage investment plans. They subscribe to every known data source for investment plans. They have real time feeds to all sorts of financial data. They have research staffs and budgets for hiring specialized consultants. They have all that, and they still consider it good performance if they can track the market indices. No, Joe Employee cannot do better than the typical fund manager, so if he is lucky, he'll track the market indices.
There used to be a reason for buying your own company's stock under an ESOP plan. In the 1980s, at least, the deal was that you could buy stock every six months, but you got a price 15% off the lower price at either the start or end of the period. In other words, you were guaranteed at 15% one time return, even if the company was heading for the sewer. Otherwise, I tended to avoid my own company's stock, except when I had no choice. I was lucky in this. My company was sold, and the pseudo-shares I had been buying turned into real money.
Kaleberg | Homepage | 05.12.08 - 8:15 pm | #
===
The discontinuance of the defined pension plans, as potentially bad as they may have been, the rise of the 401K and IRA as alternatives has been a boon to the investment community, especially the mutual fund industry. I don't see that we individual workers have done any better under this revision. Why would we expect to do better if even the social security component were revised in the same manner?
If memory serves me correctly, IRAs were initially created for the benefit of those who did not have access to a defined pension plan. The 401K had a similar beginnig, but intended for employees of businesses too small to provide an adequate defined pension plan. As soon as both systems were in place the defined pention went bye-bye and the investment managers found themselves closing in on Nirvana.
Jack | 05.13.08 - 11:02 am | #
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By Andrea Coombes, MarketWatch
Last update: 12:02 a.m. EDT May 12, 2008
SAN FRANCISCO (MarketWatch) -- Is more than half of your 401(k) invested in your own company's stock? In an ideal world, retirement savers would scoff at that question. But the world of retirement savings is far from ideal, as revealed by the results of a new study released Monday of almost 1 million workers' 401(k) portfolios at 82 large firms.
One-fourth of 401(k) participants closest to retirement -- those 60-years-old or older -- invest more than half of their workplace retirement plan in their company's stock, according to the study by Financial Engines, a Palo Alto-based registered investment advisory firm that provides advice and account management services to retirement-plan participants at large firms.
Some of those older workers take even bigger risks: 15% of 60-year-old or older workers invest more than 80% of their portfolio in their company's stock. About one-third of the 82 companies in the study offer unrestricted stock as a 401(k) plan option.
Lower-salaried workers also tend to rely on company stock, with more than half -- or 54% -- of those earning $25,000 or less holding more than 20% in company stock.
In comparison, about 31% of those earning $25,000 to $75,000 hold more than 20% in company stock, and 27% of those earning $75,000 or more do so.
"One of the reasons people have a lot of company stock is when you're looking at 10 [investment] options, none of which you recognize, but you work for the company, familiarity makes it feel safer," said Jeff Maggioncalda, chief executive of Financial Engines, in a telephone interview. He added that studies have shown investors, when asked whether their company's stock or the S&P 500 is more risky, consistently point to the S&P 500.
Maggioncalda said the study's findings point to the importance of automatic 401(k) plans, in which savers are automatically enrolled in specified investments and their contribution rates automatically rise each year. Right now, most employers adopting automatic enrollment plans generally include only new hires rather than existing savers.
The report, Maggioncalda said, shows that "people have issues they need help with. Employers should not just apply the automatic 401(k) for the lucky people who are just starting out as new hires. They should have automatic enrollment options for existing participants who have problems right now ... and who have less time to fix those problems."
Investing in a single company can lead to dire consequences for retirement savers, according to Financial Engines. Taking a sample $30,000 invested for 40 years, a saver with 80% or more in one company's stock would end up with 66% less money, on average, than a saver who invested 20% or less in company stock, according to Financial Engines' analyses of workers' accounts.
Losing the match
Another red flag: Many workers are failing to claim free money offered by their employers, with 33% of plan participants failing to save enough to get the full matching contribution from their company. Of the 82 companies studied, 62 offer a match, and the average match is 50 cents per dollar contributed, up to 6% of salary.
And younger and lower-income workers are likelier to have low savings rates: The portion of savers failing to get the full match jumps to 48% for savers under age 30 compared with 35% of savers in their 30s, 31% of those in their 40s, 26% of those in their 50s and 28% for savers 60-and-older.
Looking at workers by salary level, 63% of those earning less than $25,000 a year fail to save enough to get their company's full match versus 24% of those earning between $50,000 and $75,000 and 12% of those with salaries of $100,000 or more per year.
"It's really tough to see folks making less than $25,000 who could effectively get a 3% to 6% raise" if they slightly increased their savings rate, Maggioncalda said.
According to a Financial Engines analysis, if a worker saving 1.9% of salary with a median account balance of $5,872 continues contributing at that same rate (and thus receiving a partial company match), that saver will have $46,779 after 20 years. But if the same worker increases the contribution to 6% of salary (thus receiving the full employer match), the expected account balance would be 158% higher, at $120,905 after 20 years.
Older workers tend to save a higher percentage of their salary than younger workers: Savers under age 30 save an average of 5.2% of their salary, according to the study, compared with an average of:
Risky business
- 6.3% among those in their 30s,
- 7% among those in their 40s,
- 8.5% among those in their 50s, and
- 9.1% among those in their 60s or older.
While some workers are holding a dangerous level of company stock, others are overly concentrated in a single asset class, or are choosing overly conservative allocations, among other potential investing mistakes, according to Financial Engines' analysis, which assessed risk level and efficiency for each individual portfolio based on the saver's time horizon and other criteria.
And, while 53% of those with incomes below $25,000 were found to be making investing mistakes, they weren't alone. Workers in higher income brackets made similar mistakes, according to the study, including:
- 37% of those earning $25,000 to $50,000,
- 34% of those earning $50,000 to $75,000,
- 31% of those earning $75,000 to $100,000, and
- 33% of those earning $100,000 or more.
Of course, in some cases, an investor's penchant for a more risky, or less risky, portfolio might not fit exactly into any one definition of best practices. For instance, a young investor could opt to stick to very safe investments.
"It could be the case that ... you're a really conservative 25-year-old," Maggioncalda said. That's O.K., he said, "as long as you know you're taking a lot less risk, which means you'll have much lower expected growth, which means you'll have to save a lot more money than someone who has more equity exposure."
The good news: 23% of those earning $25,000 or less had appropriately diversified portfolios, as did 31% of those earning $25,000 to $50,000, 33% of those earning $50,000 to $75,000, 36% of those earning $75,000 to $100,000, and 37% of those earning $100,000 or more.
Andrea Coombes is an assistant personal finance editor for MarketWatch, based in San Francisco.
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Please note that CCM Capital Appreciation C was not involved in the SEC charges of fraudulent market-timing aimed at PIMCO nor was Bill Gross, PIMCO's chief investment officer, who opines in this month's Investment Outlook that the high fees charged by hedge funds make them "generally overpriced." Bill Gross manages PIMCO's humongous Total Return Institutional Bond Fund, which has an expense ratio of 0.43% and tracks the comparable Lehman index with an R-Squared of 95%. Vanguard has an institutional fund that closely tracks the Lehman index for a 0.05% expense ratio. Therefore, Mr. Gross gets about 0.38% for the active 5% of the fund, which is a "true" expense ratio of 7.8%. It must be said that Mr. Gross delivers an impressive alpha of 0.84 on that active 5%, so he could have a bright future in hedge funds.
The term "irrational exuberance" derives from some words that Alan Greenspan, chairman of the Federal Reserve Board in Washington, used in a black-tie dinner speech entitled "The Challenge of Central Banking in a Democratic Society" before the American Enterprise Institute at the Washington Hilton Hotel December 5, 1996. Fourteen pages into this long speech, which was televised live on C-SPAN, he posed a rhetorical question: "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?" He added that "We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs and price stability."
Immediately after he said this, the stock market in Tokyo, which was open as he gave this speech, fell sharply, and closed down 3%. Hong Kong fell 3%. Then markets in Frankfurt and London fell 4%. The stock market in the US fell 2% at the open of trade. The strong reaction of the markets to Greenspan's seemingly harmless question was widely noted, and made the term irrational exuberance famous. It would seem to make no sense for markets to react all over the world to a question casually thrown out in the middle of a dinner speech. Greenspan probably learned once more from this experience how carefully someone in his position has to choose words. As far as I can determine, Greenspan never used the "irrational exuberance" again in any public venue. The stock market drops around the world that occurred after his speech on December 6, 1996 have all been forgotten, eclipsed by bigger subsequent events, but it was those stock market drops that focussed public attention on the phrase irrational exuberance and which caused it to enter our language.
The term irrational exuberance became Greenspan's most famous quote, out of all the millions of words he has uttered publicly. The term "irrational exuberance" is often used to describe a heightened state of speculative fervor. It is less strong than other colorful terms such as "speculative mania" or "speculative orgy" which discredit themselves as overstating the case. I chose this phrase as the title for my book because many people know instantly from this title what this book is about.
Often people ask me whether I coined the term irrational exuberance, since I (along with my colleague John Campbell and a number of others) testified before Greenspan and the Federal Reserve Board only two days earlier, on December 3, 1996, and I had lunch with Greenspan on that day. I did testify that markets were irrational. But, I very much doubt that I am the origin of the words irrational exuberance. Actually, Greenspan is quoted in a Fortune Magazine article in March 1959, long before he became Federal Reserve chairman, about "over-exuberance" of the financial community. Probably, "irrational exuberance" are Greenspan's own words, and not a speech writer's, and probably Alan Greenspan had written a draft of his 1996 speech even before I testified.
Robert J. Shiller
Cowles Foundation for Research in Economics
and International Center for Finance
Yale University
30 Hillhouse Avenue
New Haven, CT 06511
[email protected]
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