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AdvisorNews - August, 2016


A bright outlook helps retirement planners shine

By Kimberly Foss

Published July 14 2016, 12:53pm EDT

Don’t blame clients for thinking that saving for retirement is all work and no play. Consider advisers’ common initial feedback to prospective clients: “You are not saving enough.” “Your portfolio isn’t diversified enough.”

And to ensure they don’t get high expectations from any investments we recommend, fund prospectuses warn, “Past performance does not guarantee future results.” Of course, that’s essential and important disclosure, but it can put a damper on any investor enthusiasm. Headlines in personal finance magazines do little to counteract the impression: “Why You Will Never Have Enough to Retire.” “How to Protect Your Portfolio in a Volatile Market.”

Recently, while discussing some post-Brexit buying opportunities with clients, I was reminded of the power of finding a silver lining — of refusing to allow potential positives to be swallowed by negativity. I sometimes worry that in our abundant caution, we sometimes squelch clients’ hope.


Doom and gloom certainly sell, of course. The Brexit vote and the United Kingdom’s decision to leave the European Union offered a recent reminder. Headlines around the world screamed: “EU Vote: Now PM warns of War and Genocide,” and “British Stun World with Vote to Leave EU.” Admittedly, I was somewhat shocked when Alan Greenspan called the market’s reaction to Brexit the “worst period I can recall since I’ve been in public service.”

Interestingly, however, although the VIX gauge of market fear did indeed hover between 24 and 25 the day after the Leave victory shocked the world, the VIX was twice as high in August of last year after China’s surprise devaluation of its currency. And although challenges still exist, the S&P 500 rebounded from its initial plummet within a week of what was billed as the Brexit calamity.


Retirement readiness: Challenges advisers face now

Key issues to consider when strategizing to protect clients' future financial health.

Full disclosure: I’m an optimist. In the darkest hours, I look for and find the light. Underscoring this was a recent talk with a friend whose wife was left with serious brain damage after a car crash. Eight months after the injury, her doctor told my friend that his wife had recovered as far as she would. The doctor suggested that my friend find a long-term care facility so that he could “move on with his life.”

Fast-forward one year and, with devoted care and ongoing therapy, his wife has a chance to return to her job in a middle school. On a recent visit with the doctor who had given up on his wife, my friend shared how deflating the doctor’s words had been, and how they nearly extinguished his hope.

By no means do I place the work of saving for retirement on an equal plane with caregiving efforts, yet my friend’s story reminds me that my job as an adviser is to keep my clients moving ahead in a positive way.


I’m no Pollyanna promoting pie-in-the-sky dreams. Clients and I set realistic short- and long-term goals, and measure their progress. In a volatile market, I emphasize what still remains in our clients’ control: how much they save, how they invest and how they can withstand market swings and remain invested in their diversified portfolios. Granted, it’s not necessarily easy to motivate clients using the joy in saving, rather than the fear of not having enough.

Both the federal government and employers understand that human behavior can be manipulated to boost savings. We have tax-advantaged savings accounts, 401(k) default participation and annual automated contribution increases to encourage workers to save for retirement. But we need to do more. The 2016 Employee Benefit Research Institute Retirement Confidence Survey found just 21% of workers were “very confident” they would have enough money to live comfortably through retirement.


How do we counter the countless negative behavioral forces that obstruct the path toward saving for retirement? Could we advance a more positive view of the practice? For example, “budget” has become a banned word for my practice. I made the change to “spending plan” after I asked my daughter’s friend how her sophomore year had gone and she responded, “My parents put me on a budget.” She could barely utter the word. Although the core of any successful financial plan, “budget” conveys the negative notion that someone else limits your spending. Conversely, the connotation for “spending plan” is positive and personal. It’s a tool to ensure that clients spend their assets in a mindful way, on what matters most to them.

There’s no question achieving short-term financial goals motivates clients to save for the long-term. Because of today’s investment challenges, I’m now asking clients to make another use of their short-term successes: that they reflect on the satisfaction and joy they feel when they successfully meet a short-term goal and convert those positive emotions into motivation to save for the future.


Instead of leaning on the old fear of not having saved enough to enjoy a secure retirement, I want clients to parlay their sense of enjoyment and accomplishment from meeting a short-term goal into retirement-savings motivation. Yes, having saved and paid for college illustrates for clients that they are capable of committing to a savings plan, but using the pride and joy they feel watching their child receive a diploma may be what it takes to advance their retirement savings efforts.

In client meetings, we’ve explored how advance planning brings about real happiness. Here’s my favorite: I asked a client who just opened her summer home how her weekend was. She responded, “It was so pleasant. I had stocked the house with essentials before I closed it up in the fall. So, instead of running around shopping for laundry detergent or the recycling bags we need to use at the town dump, my only errands were to the fish market and farm stand.”

It’s a good illustration of the principle. Recalling the wonderful summer dinner on her deck will be a far greater motivator to save than conjuring up fears of running out of money at age 75.



That 'safe' retirement investment is about to change

Money market reform paves the way for stable value in 401(k)s


Darla Mercado | @darla_mercado

Tuesday, 19 Jul 2016 | 9:00 AM

Changes may be coming to one of your retirement plan's safer investment options.

Many 401(k) plan participants aren't familiar with this corner of their investment choices. Money-market funds and others, known as stable value funds, act as cash equivalents; they provide small and steady returns, along with principal protection.

Now, new, more restrictive rules on money-market funds will be taking effect in October, paving the way for changes to 401(k) plan investment menus.

"We have used money-market reform as a gateway to re-engage retirement plans on cash equivalents and what's appropriate in a low rate environment," said Aaron Pottichen, a plan consultant at CLS Partners Retirement Services. "More of them have opted to replace money-market funds with stable value."

"Employers are being forced to make a decision [on money market funds]." -Shannon Main, retirement plan advisor, Penniall & Associates

He's not alone.

"More often than not, employers are switching over," said Shannon Main, managing director and retirement plan advisor at Penniall & Associates.

"Some record keepers are changing their money-market funds to either a government fund or they're no longer supporting them," she said. "Employers are being forced to make a decision."

At the same time, money-market funds are plagued with paltry returns amid today's low interest rates — a problem that has caught the attention of attorneys who are suing retirement plans over fees.

In one recent case against American Century, plaintiffs claim the firm's money-market funds earned a 0.01 percent annual return over a six-year period, while expense ratios exceeded 0.45 percent.

Money-market reform

The changes to money-market funds stems from new rules issued by the Securities and Exchange Commission. The regulations, which will take full effect in October, require fund managers in periods of extreme volatility to temporarily bar investors from making withdrawals. Another change: the funds' value can now float, whereas before they generally maintained a fixed $1 per share value.

These requirements will apply to institutional money-market funds, which would include the investments generally available in 401(k) plans. It will not apply to funds held by individual investors.

Some employers aren't fans of the effect the changes will have on their plan's money-market funds. As a result, they are seeking alternatives by opting for government money-market funds, FDIC-insured bank deposit accounts and stable value funds.

"Institutional funds aren't required to maintain the $1 per share NAV [net asset value]," said Stein Olavsrud, portfolio manager with FBB Capital Partners. "That's significant. A client could potentially lose money. "

Enter stable value

Stable-value funds aren't mutual funds. Rather, they are a blend of insurance and bonds. The insurance provides principal protection and a minimum guaranteed rate of interest.

To that point, 65 percent of U.S. retirement plans offer a stable-value fund, according to Callan Associates, an investment manager.

The median rate on stable-value funds was 1.93 percent in the first quarter of 2016, according Callan's data, compared with the 0.023 percent average yield for money-market funds.

Attractive yield, but at what price?

There's a trade-off for stable value's money market beating yields.

Investors are dependent on the credit quality of the underlying bond portfolio and the company providing the insurance. If the insurer fails, you may have to get in line with other creditors for your payout, said Gregory Kasten, founder and CEO of Unified Trust Company.

Questions to ask your employer

It's your employer's responsibility to choose a cash equivalent for the plan, but you should learn more about what's available.

Ask your benefits representative or HR these basic questions about your money-market or stable-value fund:

  • What is the interest rate?
  • What are the fees?
  • Can I lose money?
  • How often does the fund pay interest? If you have a stable-value fund, how often does it change the interest rate?
  • Which company is providing the fund? How has that company handled different interest rate environments?
  • Is there a market adjustment to the fund if the retirement plan wants to move the assets to another provider?



The Two Minute ERISA Fiduciary Liability Risk Management Challenge

Posted on July 20, 2016 by jwatkins

I love fiduciary law. In a world with so many legal uncertainties, indecision and “weasel words,” fiduciary law is demanding and direct. The Restatement (Third) of Trusts, specifically Section 90, the Prudent Investor Rule, sets out the basic fiduciary requirements. Good faith beliefs and/or lack of knowledge are not accepted as defenses to breaches of the fiduciary duties set out in the Restatement, or as the courts like to say, “a pure heart and an empty head are no defense” to breach of fiduciary duty claims.

I first became interested in fiduciary law in the early 1990’s and became even more interested in the subject when I took a job as an RIA specialist at FSC Securities in Atlanta in 1995. It has been interesting to see the fiduciary developments in the securities industry, as more and more commission-based stockbrokers are making the move  to the RIA side and the move to a fee-based, fiduciary practice.

Even now, there are those that want to argue that the “best interests” requirement of fiduciary law is ambiguous and therefore leaves investment fiduciaries unfairly exposed to potential legal liability. The Restatement defines one’s fiduciary duties in terms of the Prudent Person Standard, which requires a trustee or other fiduciary to use the same “care, skill, prudence, and diligence under the circumstances then prevailing” that a prudent person would use considering all of the relevant facts that the fiduciary knew or should have known based on their independent investigation and evaluation of the situation.

One of my favorite quotes is from the late General Norman Schwarzkopf, who said “the truth of the matter is that you always know the right thing to do. The hard part is doing it.” In the world of financial/investment advice, fiduciaries must make sure that personal conflicts do not overtake one’s recognized legal duties. An objective analytical tool can help them do that

In my legal practice, I provide consulting services to RIA firms and ERISA plan sponsors. Many of my clients originally complained that they had a hard time understanding and acting in accordance with the Restatement’s fiduciary standard and “best interest” requirement.

After considerable frustration with both the genuine and the bogus complaints, I decided to create a metric to help clarify the concepts of the prudence and “best interests” required of fiduciaries under the Prudent Person Rule. Today, I am proud to say that I am learning that fiduciaries and attorneys are increasingly using my metric. the Active Management Value Ratio™ 2.0 (AMVR) in their practices to determine the prudence, or lack thereof, of the decisions of RIAs and ERISA fiduciaries.

The strength of the AMVR is its simplicity, both in terms of calculation and interpretation. The AMVR is the same simple cost/benefit metric many of us learned in our college Econ 101 class. The AMVR calculates the cost efficiency of an actively managed mutual funds relative to a comparable passively managed, or index, fund based on the incremental cost incurred and incremental return, if any, produced by an actively managed mutual fund.

The AMVR is based on the studies of investment icons Charles Ellis and Burton Malkiel. Ellis introduced the concept of analyzing mutual funds based on their incremental costs and incremental returns. His argument is that index mutual funds have become, in essence, commodities,  and that the proper way to evaluate any commodity is in terms of their incremental, or added, costs and returns. Malkiel’s contribution to the AMVR is his research finding that the two most reliable indicators of a mutual fund’s future performance are the fund’s annual expense ratio and its trading costs.

Calculating an actively managed mutual fund’s incremental returns only requires that the annualized return of a benchmark/index fund is subtracted from the annualized return of the actively managed mutual fund. I prefer to use the funds’ five year annualized returns in order to get at least one period of down or negative returns and, thus,  a better picture of the funds performance patterns. In some cases I will also analyze rolling five-year returns to verify the funds’ historical trends.

In calculating the funds’ incremental returns, I rely on Malkiel’s findings and combine a fund’s stated annual expense ratio with its trading costs. Since mutual funds are not required to disclose their actual trading costs, I use a proxy developed by John Bogle, former chairman of the Vanguard family of funds. Bogle simply doubles a fund’s stated turnover ratio and then multiples that number by 0.60 based on historical data re trading costs. While the trading cost number may not exactly match a fund’s actual trading costs, the application of a uniform factor to get a proxy number is acceptable and helpful in getting a better picture of a fund, as trading costs for an actively managed mutual fund are often higher than a fund’s annual expense ratio and both reduce an investor’s end return.

The calculation process only require a couple of pieces of data, all of which are freely available online at sites such as and As an investor, fiduciary or attorney becomes more familiar with the calculation process, the entire calculation process takes two minutes or less per fund.

As I mentioned earlier, the simplicity of interpreting a fund’s AMVR score in terms of prudence and “best interests” is one of the metric’s strengths. An example will help demonstrate this fact.

Assume two funds, Fund A being the actively managed fund and Fund B being the benchmark/index fund. Fund A has a five-year annualized return of  10 percent, an annual expense ratio of 1.00 percent and a turnover ratio of 50 percent. Fund B has a five-year annualized return of 9 percent, an annual expense ratio of  0.16 percent and a turnover ratio of 3 percent.

Fund A produces  1 percent, or 100 basis points, of incremental return (10-9) and incremental costs of  1.40 (1.60-0.20). (A basis point equals .01 percent of 1 percent) AMVR calculates a fund’s cost efficiency, so AMVR is calculated by dividing the fund’s incremental costs by its incremental returns. Funds that fail to provide any positive incremental returns do not qualify for an AMVR score, as they clearly do not qualify as prudent investment choices relative to the benchmark/index investment option.

In our example, Fund A’s AMVR score would be 1.4 divided by 1.0, for an AMVR score of 1.4. The optimum AMVR score will fall between one and zero. An AMVR score greater than one indicates that the fund’s incremental costs exceeds its incremental return, resulting in a loss for an investor relative to the less expensive benchmark/index fund.

The costs and returns issues becomes even more important when one considers that each additional 1 percent in costs and expenses reduces an investor’s end return by approximately 17 percent over a twenty year period. The impact of theses costs was noted in a recent article in the Wall Street Journal, which cited a study that estimated that a working couple loses approximately a combined $155,000 over a twenty year period as a result of 401(k) fees and costs alone.

Each year I do a forensic analysis of the top ten mutual funds in 401(k) defined contribution plans, as reported by “Pensions and Investments” magazine. Using the AMVR as my primary analytical tool, the results provide a good explanation as to why so many 401(k) plans, of all sizes, could be susceptible to successful legal challenges. To view my 2016 analysis, click here.

Fidelity Contrafund is a well-known actively managed fund whose K shares appear in many 401(k), 457(b) and 403(b) plans . In fact, the fund was the number one fund in the “Pensions and Investments” article. Will Danoff, the fund’s manager has a stellar performance record and is often mentioned as one of the mutual fund industry’s best all-time managers. But does it currently pass the fiduciary prudence and “best interests” test?

Morningstar classifies Fidelity Contrafund K (FCNKX) as a large cap growth fund. For comparative purposes, we will use one of Vanguard’s leading large cap growth funds, the Value Growth Index fund. Using the same process as before, the analysis shows Contrafund has incremental costs of 86 basis points . Based on the funds’ stated annualized five-year returns, Contrafund does not produce any positive incremental returns (12.80 percent vs. Value Growth Index’s 13.14 percent) or other benefits to an investor above and beyond those provided by the comparable, and less expensive, index fund.

I deliberately chose Contrafund as an example to demonstrate another way to use the AMVR. Ellis originally suggested that in calculating incremental returns, the risk adjusted returns of funds should be used. If we substitute the two funds’ risk adjusted returns in the calculation process, Contrafund actually produces a positive incremental return of 0.69 percent, or 69 basis points (12.85 percent versus Value Growth Index’s 12.16 percent). However this would still not allow Contrafund to pass the prudence or “best interests” test since an investor would lose money by investing in the fund since Contrafund’s incremental costs exceed it’s risk-adjusted incremental returns.

A third way of interpreting the cost effectiveness of a fund’s AMVR score is by comparing the percentage of returns produced by a fund to the fund’s incremental costs as a percentage of the fund’s total costs. In the immediate example, the incremental. or added costs, of the actively managed fund equal 87.5 percent of the fund’s cost (1.40/1.60), yet such costs are only adding an additional 1 percent of return. Again, hard to argue that such results indicate a prudent investment that is in the client’s “best interests,” especially given the other findings that indicate that the comparable index fund is a better investment choice.

I think it is worth noting that the DOL adopted a prudence standard in defining “best interests” in connection with their recently adopted fiduciary standard. The SEC has recently stated that it too will consider implementing a fiduciary standard for the investment industry as a whole. When, and if, that does actually happen, I think it is safe to assume that the SEC’s fiduciary standard will adopt the same prudence and “best interest” standards that the DOL chose since it is consistent with the Restatement’s position.

The AMVR helps avoid the confusion over one’s fiduciary duties and “best interests” obligations by providing a quick and simple means of quantifying prudence and “best interests,” one that is based on the sound, proven findings of two of the investment industry’s most respected icons. As the use of the AMVR continues to grow,  plan sponsors and other investment fiduciaries will hopefully incorporate the metric into their required ERISA due diligence process in selecting and monitoring their plan’s investment options in order to reduce their risk of potential personal liability.



A Roth 401(k) Could Make a Difference in Retirement

New study shows that Roths aren't just for younger Americans

By Carla Fried

July 26, 2016

The Roth version of the 401(k), introduced 10 years ago, has yet to go viral. More than six in 10 plans offer a Roth option but fewer than 20 percent or so of employees with the option of saving in a Roth 401(k) use it.

Those that do use the Roth tend to be younger workers. Contributions to a traditional 401(k) are made with pre-tax dollars, while the Roth 401(k) offers no upfront tax break. Thus, the conventional wisdom is that older workers in their prime earning years should focus on using the traditional 401(k) given the ability to reduce their current taxable income.

New academic research “turns conventional wisdom on its head” says study co-author David Brown, assistant finance professor at the University of Arizona. “Everyone, regardless of age or income can benefit from doing some saving in a Roth 401(k).” The research found that the value of having some retirement savings in the Roth has the impact of adding an annualized 1 percent to 2 percent to a retirement account’s value.  

A Taxing Question

In retirement you must make required minimum distributions (RMD) from a traditional 401(k) beginning in the year you turn 70.5, regardless of whether you need that money or not. Every penny of withdrawals from a traditional 401(k) are taxed at whatever your tax rate is in retirement. With a Roth 401(k), there is no tax on your withdrawal and you can sidestep the need to even take an RMD by rolling over your Roth 401(k) into a Roth IRA before you reach age 70.5. If you anticipate being able to leave assets to your heirs, using a Roth will retain more money for your beneficiaries.

If you were 100 percent convinced your tax rate in retirement will be the same, or lower, than your current income tax rate, sticking with a traditional 401(k) makes plenty of sense. But the reality is that we all live with plenty of “tax uncertainty” says Brown. For starters, it’s hard to know exactly what your income will be in retirement; so you may in fact not see any appreciable decline in your tax rate. An analysis of traditional vs. Roth IRAs last year by T. Rowe Price last year found that someone 50 years old would need to see a steep drop in their retirement tax rate of at least nine percentage points before the traditional becomes more advantageous.

Moreover, assuming our current income tax code will remain static is quite a big assumption. As Brown and co-authors Scott Cederburg of the University of Arizona and Michael S. O’Doherty of the University of Missouri point out, since the federal income tax was introduced in 1913, the rate for an individual with inflation-adjusted income of $100,000 has changed 39 times. Using a Roth 401(k) is effectively adding a hedge against any future changes that might negatively impact your retirement tax burden. (For the record, the three academics have opted to divide their retirement savings between both the traditional and Roth versions.)

More Retirement Flexibility

Beyond tax-rate arbitrage, having some money in a Roth will give you more control over your taxable income once you’re in retirement.

Withdrawals from a Roth 401(k) don’t impact your adjusted gross income. That can help you minimize the “Social Security tax torpedo,” says Kevin Brown, a benefits consultant at Willis Towers Watson, referring to the fact that up to 85 percent of Social Security benefits can be counted as taxable income if your total income is more than $25,000 ($32,000 for married couples.)

Having access to tax-free withdrawals can also come in handy when an unexpected expense crops up in retirement—be it a 75th birthday splurge trip or medical expenses not covered by Medicare. Taking an extra chunk out of a traditional 401(k) or IRA will boost your adjusted gross income for that year; potentially pushing you into a higher tax bracket. That won’t be in play if the money comes out of your Roth 401(k).

And if you retire before age 65, when Medicare kicks in-and you need to purchase health insurance through the ACA exchange, using your Roth for living expenses can reduce your insurance cost. “Roth withdrawals don’t count as taxable income, so your income may be low enough to qualify for subsidies,” says Wagner.  




Protecting Plan Sponsors and Plan Participants Under the BICE Exemption


Posted on July 27, 2016 by jwatkins

Most of the litigation against 401(k) plans has focused on excessive fees and/or the poor quality of investment options within a plan. With the effective date of DOL’s new fiduciary standard and the Best Interests Contract exemption (BICE) coming in less than a  year, a question that has been raised in some legal circles is whether BICE will provide yet another basis for actions against both plan sponsors and plans.

One of the reasons cited in support of the DOL’s fiduciary standard was the need to need the conflict of interest issue that allowed plan advisers to put their own financial interests first when dealing with a 401(k) and its participants. Various studies were cited reporting the adverse financial impact of such conflicts of interest on plan participants.

When the DOL introduced the new fiduciary standard, they also introduced the BICE concept. BICE focuses on the provision of investment advice to retiring plan participants with regard to potential rollover of their 401(k) funds to an individual retirement account (IRA). Advisers who can get potential clients to enter in a BICE agreement will then be allowed to offer investment recommendations that may provide the financial adviser greater financial incentives than other comparable investment options. In principle, BICE would still require a financial adviser to put the client’s best interests first.

From a legal perspective, a couple of obvious questions beg valid response. First. why would a plan participant agree to such an agreement that allows a financial to potentially engage in the same sort of abuse marketing and sales tactics that was the motivating factor behind the DOL’s new fiduciary standard? Why would a plan sponsor not protect their plan participants, many of whom may not be knowledgeable enough to protect themselves against such abusive marketing and sales practices, making the prohibition of soliciting such BICE agreements an express condition for any and contracts with third-party service providers?

It is the second question that may form the basis for new allegations of a plan sponsors’s breach of their ERISA fiduciary duties of loyalty and prudence. While some many may argue that a decision to enter into a BICE agreement is a private matter between a plan participant and a financial adviser and does not involve a plan, it is highly doubtful that the DOL and the courts will see the issue as that cut and dried given the stated importance of protecting workers as they try to provide for a meaningful retirement. The potential liability issues become arguably even stronger given the relative ease with which protective measures could be implemented by plans and plan sponsors as part of the negotiating process with third-party vendors.

There are those that will argue that given the strong penalties imposed for violating a BICE agreement, the chance of abusive sales and marketing is minimal. With over twenty years of experience as a compliance attorney, I would suggest that that argument is extremely shortsighted.

When BICE was first announced, my immediate reaction was variable annuities (VAs) and equity indexed/fixed indexed annuities (EIAs/FIAs). According to the SEC and FINRA,  variable annuities are among the leading grounds for customer complaints. In too many cases, VAs are structured to ensure a windfall for the issuing company at the VA owner’s expense, most notably by the use of a practice known as “inverse pricing” to assess the VAs annual M&E, or death benefit” fee. Moshe Milevsky’s landmark study of VA fees clearly established the abusive nature of such fees.  Such conditions are a blatant violation of fiduciary law’s basic tenets of loyalty, prudence and equitable treatment, as “equity abhors a windfall.”

EIAs/FIAs are fixed income annuities that generally use a stock market index’s return to calculate the fixed annuity’s annual return. EIAs/FIs actually involve a solid and simple concept, were it not for the various restrictions and conditions that severely limit the actual returns an investor can receive. Those restrictions and conditions are potentially confusing to investors since the marketing of such products usually relies on the potentially higher returns possible by using market returns to calculate the returns on EIAs/FIAs.

BICE situations will also be susceptible to the same excessive fees and imprudent charges that the lawsuits typically allege today. Greed has, and always be a motivating factor to some in any business. Given the chance that most investors are unfamiliar with securities law and ERISA standards, and that regulatory sanctions for BICE violations will require consumer complaints, unethical financial advisers may engage in abusive practices based on their belief that the odds of being exposed are low, especially since the repercussions for such violations would impact their broker-dealer on a far greater scale.