Retirement Plan Peril

My friends in the benefits department at a local university told me about an alarming trend. After making great strides enrolling more retirement plan participants over the past few years, they have noticed that the number of loans against the plan has spiked and that participation rates this year have begun to dip. I explained that participants are operating under a double-whammy of pinched pocketbooks and scary markets. The combination can prompt some to make decisions about their retirement accounts that they may regret in the future.

As the pressures of the credit crisis and escalating prices hit household bottom lines, something has to give. For some, that has meant tapping money that has been deposited into retirement accounts. According to data from the Transamerica Center for Retirement Studies, a nonprofit corporation funded by Aegon NV's Transamerica Life Insurance, the number of loans outstanding from their retirement plans jumped to 18% at the end of last year from 11% in 2006. Other retirement plan sponsors report similar numbers.

This is the part of the article when I should scold folks for draining retirement accounts and warn that they will significantly impact their future by doing so. But for many, I understand that there are not a lot of good alternatives. Too many people counted on equity in their homes to finance lifestyles that their incomes could not justify. This is what your mother meant when she told you that reckless actions would come back to haunt you and a certain piper would need to be paid. The data indicates that the piper should feel flush right about now.

I am actually more concerned about the people who have pulled back on retirement plan contributions not due to cash flow, but because they were spooked by falling markets. Remember that if you are a long term investor, you want the market to fall sometimes—that way, you can buy stuff cheaper! One of the benefits of participating in a payroll deduction retirement plan is that it forces you be disciplined—to invest each pay period, regardless of what is going on in the markets. If you don’t upend this strategy, it will work over time. However, if you mess with it, chances are that you will stop contributing when you could be snapping up bargains and only increase your contributions after the market has already risen. By sticking to your overall retirement and investment plan, you will likely avoid retirement plan peril.

Smart Guys (and gals) can be Wrong Too

The Wall Street Journal reported this week that fund management company Legg Mason reported a quarterly loss of more than $250 million, due in large part to the credit crisis. “Legg’s flagship Legg Mason Value Trust mutual fund, managed by Bill Miller, was down 19.7% in the quarter ended March 31, its worst quarter ever relative to its peers. Mr. Miller had big misses in stocks like Bear Stearns.”

My first thought was, “it’s nice to know that the guy is human!” Before this misstep, Miller had outperformed the S&P 500 for about 900 years in a row (I think it was actually 15). So yes, even the smartest guys and gals in the business can be wrong sometimes. In fact, in the business of managing money, we should expect it and stop trying to think that any one person is the investment guru of all time.

I was thinking about this after fielding a radio show question about some of the beaten down financial service companies and their exposure to the subprime and housing messes. The caller wondered, “How could those guys have been so wrong?” The answer is that these large companies are populated with human beings, who are pushed and pulled by the same emotions that do in all mortals who confront money issues: fear and greed.

A recently-published book about the credit crisis is worth picking up if you want to better understand how experts in a myriad of financial fields fell prey to the excesses of the housing and credit boom. In “The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash,” Charles R. Morris points out what every student of markets know: in every bubble there is a seed of a good idea. But as more people catch on, the idea goes to excess.

Lending cheap money to willing borrowers who purchase assets that rise makes sense. Morris writes “When money is free, and lending is costless and riskless, the rational lender will keep on lending until there is no one left to lend to…You logged in the loans, collected your fees and sold them off to yield-hungry investors. The investors were ‘insured.’ Your fees were real money. The loans might even be paid off.” The strategy works, until it doesn’t. At that point, the smart guys and gals are just like anyone else who gets caught up in a boom and bust. They must absorb the losses, lick their wounds and move on.

Money’s cheap but hard to get!

You might have thought that after seven consecutive interest rate cuts, lenders would be begging to draw you in with juicy low-rate options. That’s sort of true, if you are among the fortunate who sport sterling credit scores. But if you actually need money and have so-so credit, it’s tough to lock in a loan that makes sense.

The problem can be summed with one image: a pendulum. We have moved out of a period where lenders extended money to anyone with a heartbeat to where lending standards are so tight that few can qualify for a loan. The shift can be seen in the Fed's survey of banks' senior loan officers. As reported yesterday by the Wall Street Journal’s Sudeep Reddy (“Banks Toughen Terms on Loans”), “About a third of the 56 domestic banks surveyed in April reported raising their standards for credit-card loans over the past three months, up from just 10% in January. Banks are being tougher on credit-score requirements and are reducing credit limits on card loans [and]…tightened standards for other consumer loans.”

This is bad news for people who are seeking relief from problematic variable loans that they had hoped to refinance “later”. We are at “later,” so here are a few tips that may get you on the road to cleaner credit. The process is a pain in the neck and requires contesting information, letter writing and a persistent follow-up effort.
Make your payments on time! There is no way that you are going to get anywhere by seeming like a deadbeat to lenders.
Obtain a copy of your credit report from each of the three credit bureaus: Trans Union, Equifax, and Experian. If you find items that you believe do not belong there or are inaccurate, write a letter to the credit bureau that provided the report. It is best to send whatever proof you have that the claim is inaccurate.
The credit bureau requests proof of the claim from the credit company and if is not provided within 30 days, the item should be removed from your report. However, the item will remain on your credit report if the creditor can prove its claim, regardless of whether they do so in the allotted time period.
Negative items on your credit report may be removed even if they are correct. If you have maintained good standing with the creditor that reported the information, you can write and request that they remove the item from your credit report. Even if this is not a possibility, items on your credit report remain there for only seven years, after which time they go away on their own.

The Market vs. The Economy

People seem to be confused of late. I have heard from radio listeners and clients alike: if the economy is so weak, why is the stock market rising? After all, it is truly perplexing that as more evidence emerges of a weak job market and housing remaining in a slump, stocks have actually gone up—and not by a small amount. What gives?

It stands to reason that what occurs in the economy should certainly impact stock prices. But there is a missing piece in this conclusion: the stock market takes into account what is happening and what will happen, or at least what investors believe could occur in the future. So the economic numbers that you see as headlines today have likely already been factored into the price of stocks. That’s why when the Federal Reserve announces interest rate decisions every six weeks or so, many are focusing on the accompanying statement for clues as to how the central bank will act going forward.

The trend works both ways. On March 17th, US stocks fell to the lows on the year because investors were concerned about the future---what if Bear Stearns was just the first of a handful of investment banks to be in trouble? How would the financial system function under the strain of additional failures? With all of the unknowns, investors sold stocks, until information became clearer. In the weeks since that scary time, we have learned that the Federal Reserve would continue to act aggressively and that there were no other institutions at the Bear Stearns level of problems. As a result, through last Friday’s close, the Dow rallied 9.1% from the March lows and the S&P 500 nearly 11%, at the same time that the US economy has continued to lose jobs and consumer confidence is in the tank.

The theory here is that investors believe that they know all of the bad news that’s out there and every day that something worse does not occur, could mean brighter days ahead. Perhaps that’s why Warren Buffett told Berkshire-Hathaway investors at the annual stockholder meeting last weekend that while bank losses “aren’t over by a long shot,” much of the damage “has already been recognized.” He also noted that a root cause of unrest in March has passed: “The idea of financial panic -- that has been pretty much taken care of.”

With all of this said, expect more negative news about the economy to dribble out, as investors look ahead in their crystal balls to divine whether or not the worst is truly behind us. In other words, don’t expect the market and the economy to move in lock-step.

Investor Independence Day

I wrote an article about Cinco de Mayo that needed a little dusting off and editing. What follows is a new and improved version in of the day! Cinco de Mayo (May 5th) is the day that marks the victory of the Mexican Army over the French at the Battle of Puebla. The "Batalla de Puebla" came to represent a symbol of Mexican unity and patriotism. With this victory, Mexico demonstrated to the world that Mexico and all of Latin America were willing to defend themselves of any foreign intervention. As a result, Cinco de Mayo is now seen as a symbol of independence.

In the spirit of the day, it’s time for investors to mark their own independence day---independence from the industry’s hype, from unrealistic expectations and from the emotions that often doom a financial plan.

Let’s start with the hype. I was at a luncheon on Friday and those who were “insiders” in the financial services industry seemed far more upbeat than the others attending the event. It seems that the mainstream media is rolling out a constant drumbeat of negativity, which is affecting how people feel. The funny part is that much of the bad news that was keeping financial folks awake at night seems to have passed. While we all acknowledged that it may not be smooth sailing, the general consensus was summed up by a 30-year veteran of portfolio management: “I have to say that I feel better today than I have in a year!”

Here’s the take-away: when the media is doing stories on flipping houses, a soaring stock market and is full of hope, file that information away into your “hype” folder. Conversely, when there appears to be only dour news on the airwaves or in print, feel free to file it into the same place. As I have said time and time again: It is rarely as good or bad as you think it is. And don’t forget, the American economy is resilient and has gone through booms and busts before. Be strong and try to sort out the noise.

Investor independence may hinge on the ability to filter information and use it to your advantage. As we all know, often the biggest enemy in achieving your financial goals stares at you in the mirror every day. Reacting emotionally when you manage your finances may lead you to a decision that is not in your best interest. To reduce the chances of making an emotional decision, turn down the noise and stick to your game plan.

If you can do that, you surely will have something to celebrate today---investor independence -- Margaritas for all!