My 401(k) Plan Review Meeting

I have a 401(k) plan with my employer. Today the financial advisor overseeing our 401(k) plan and representative from the financial company that manages our 401(k) plan came to our office. I signed up the one-on-one meeting with them. the reason I signed up for the meeting is because I never deal with a financial adviser face to face. And frankly speaking, some advises they gave during the meeting are helpful and the other are not depending on each individual's preference and life goals.

The overall impression to me from the meeting is that if you are not savvy enough for personal financial and investment, you could be misled. That is perfectly tangible under the current law. Under the law, the advisers need only to provide the reasonable advices which may turn out not to be the best for a client. And that is a reason why Department of Labor is trying to revise the law to let financial adviser provide the advices in a client's best interest.

First of all, I should give the financial company kudos for coming up with an online tool on its website that helps guide people to save for retirement. And again, the tool is limited to the planning and investing for retirement, so the advisor and representative in the meeting did not have enough time to make sound advises based on my overall financial picture.

They looked at my income, contribution to my 401(k) and assets in other retirement accounts - in my case, they are Roth IRA. They helped set up my ideal monthly retirement income level as a percentage of my current income level. It is 70% by default which I accepted. Then they found there is a huge funding gap between my current assets and ideal retirement income.

I contributed most of my retirement savings to my Roth IRA and contrarily very little to my 401(k). the representative asked me why. I said I like the low cost index funds available in IRA while there are no index funds in the 401(k) plan. The difference in the annual manage fee is about 0.5% between an average index fund in my IRA and an actively managed fund that I hold in my 401(k).

Then the advisor jumped in saying that I should consider more pretax contribution to 401(k) because the tax saving upfront. He illustrated for every dollar I contribute, I only pay 70 cents out of my pocket, assuming income tax rate of 30%. He said that move will cover the savings I can have with index funds in Roth IRA. Of course I will have to pay the tax later when I withdraw the money, he added.

The representative and the advisor mentioned there is a stable fund offering 3% annual return in my 401(k) which I should consider if I would add more fund into my plan. They followed by saying that every investment tool comes with a cost. There are costs for stable funds and for CDs as well.

The advisor also suggested me to consider other funds than the only funds that I invest in my 401(k) because the past performance over 5-year period of those funds are higher than the fund I hold.

Are their reasoning and suggestions all making sense? It depends on a personal view on investment. Let me continue to address my opinions in the following post.

Index fund investors are more intelligent?

Jonathan Clement, one of my favorite personal finance writer, recently returned to Wall Street Journal system, starting again posting many noteworthy comments. He is a strong proponent of index investment. I would like to quote many of his words from this article: "Are index-fund investors smarter?" http://www.marketwatch.com/story/are-index-fund-investors-smarter-2015-03-30


"It is tempting to argue that indexers are smarter. Instead of pursuing the slim possibility of market-beating returns with active funds, they realize the rational strategy is to index."

"But I suspect it is less about greater intelligence and more about greater conviction. When you buy an index fund, your only worry is the market’s performance. But when you buy an active fund, you have to worry about both the market’s direction and your fund’s performance relative to the market. That double uncertainty may make investors more jumpy—and thus more likely to buy and sell at the wrong time."

Social Security Disability Benefits

Excerpt from Social Security Administration  (SSA) publication, EN-05-10029 "Disability Benefits":

Social Security pay disability benefits through two programs:
the Social Security disability insurance program and
the Supplemental Security Income (SSI) program.
Social Security pays benefits to people who cannot work
because they have a medical condition that is expected
to last at least one year or result in death. Federal law
requires this very strict definition of disability. While some
programs give money to people with partial disability or
short-term disability, Social Security does not.
In general, to get disability benefits, you must meet two
different earnings tests:
1. A “recent work” test based on your age at the time you
became disabled; and
2. A “duration of work” test to show that you worked long
enough under Social Security.

In the quarter you turn age
31 or later

Work during five years out of the 10-
year period ending with the quarter
your disability began.

to meet the “duration of work test” if you become
disabled at various selected ages:

Examples of work needed for the “duration of work” test
If you become disabled...
Age 48
Then you generally need:
7 years

The SSA use a five-step process to decide if you are disabled.

in Step 5: Can you do any other type of work?
If you cannot do the work you did in the past, the state
agency looks to see if you would be able to do other work.
It evaluates your medical condition, your age, education,
past work experience and any skills you may have that
could be used to do other work. If you cannot do other
work, the state agency will decide that you are disabled. If
you can do other work, the state agency will decide that
you are not disabled.

Supplemental Security Income (SSI)

Excerpt from Social Security Administration publication EN-05-11000 "Supplemental Security Income (SSI)"


The Social Security Administration manages the
program, but SSI is not paid for by Social Security taxes.
U.S. Treasury general funds, not the Social Security trust
funds, pay for SSI.

SSI makes monthly payments to people who have low
income and few resources, and who are:
• Age 65 or older;
• Blind; or
• Disabled.
A note for people who are blind or disabled
If you’re blind or disabled, and working, there are special
rules to help you. You may be able to keep getting SSI
payments while you work. As you earn more money, your
SSI payments may be reduced or stopped, but you may be
able to keep your Medicaid coverage.
You also may be able to set aside some money for a work
goal or to go to school. In this case, the money you set aside
won’t reduce the amount of your SSI.
Blind or disabled people who apply for SSI may get free
special services to help them work. These services may
include counseling, job training, and help in finding work.
If you get SSI, you also may be able to get help from
your state or county.
If you get SSI, you also may be able to get help from
your state or county.Supplemental Nutrition Assistance
Program (food stamps)

Medicaid
When you get SSI, you also may get Medicaid, which
helps pay doctor and hospital bills. Your local welfare
or medical assistance office can give you information
about Medicaid.

Help paying for Medicare
If you get Medicare, and have low income and few
resources, your state may pay your Medicare premiums
and, in some cases, other Medicare expenses such as
deductibles and coinsurance.
If you have worked and paid into Social Security long
enough, you also may be eligible for Social Security benefits
while you are receiving SSI.

Why a mutual fund is better than its equivalent EFT

The famous financial advisor Allan Roth commented on ETF.com and used Vanguard Total Stock Market (/VTI) as an example to illustrate why a mutual fund is better than its identical twin in ETF format.(http://www.etf.com/sections/index-investor-corner/vanguard%E2%80%99s-mutual-funds-better-its-etfs)

An ETF from Vanguard and its mutual fund are merely different share classes of the same fund. ETFs generally have low expense ratios and the same expense ratios are for every investor no matter
how many shares she or he owns. And those expense ratios are cheaper than most comparable mutual funds.

But the lowest­ cost class of mutual funds at Vanguard, the so­ called Admiral share class, have the
same annual expense ratios as any corresponding ETFs. The only catch is that an investor needs to be investing at least $10,000.

Given your brokerage firm charges no commissions on buying and selling either mutual funds or ETFs, there are 6 reasons Allan has to choose the mutual funds over the ETFs:

1. No bid/ask spread – Mutual funds trade at net asset value (NAV), while ETFs have bid/ask spreads. For example, Vanguard bid/ask spreads for the first two months of 2015 averaged 0.06 percent. While lower than the 0.32 percent spread from non­-Vanguard ETFs, buying the mutual fund eliminates this cost all together. To put it in perspective, a 0.06 percent spread represents about 1.2 years of the expense ratio of the Vanguard Total Stock Market ETF (VTI)

2. No premium or discount – You may get lucky or unlucky here, trading ETFs, but you can eliminate the risk altogether by buying the mutual fund at NAV.

3. Purchase of fractional mutual fund shares – ETFs are a bit more difficult to deal with. If, for example, you have $50,000 in cash and wanted to purchase the Vanguard Total Stock Market ETF (VTI) , you must
look up the current price, calculate the whole number of shares, and then deduct a few shares before pushing “execute,” as the price may have increased and you don’t want a negative cash position. On the other hand, with the mutual fund, the Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX), you just put in a buy order for the entire $50,000, and will end up investing the entire amount by owning a fractional share.

4. Automated dollar cost averaging – For clients wanting to use dollar cost averaging, mutual funds are far superior. That’s because they can be set up on an automated basis. For example, you can have Vanguard purchase $10,000 a month of VTSAX for the next 18 months, and it will happen unless you
intervene. With ETFs, you must go in monthly to make such purchases. I’ve found that either life gets in the way, or we listen to too much financial media, and don’t typically follow through on manual dollar cost averaging.

5. Less cash drag from faster dividend reinvestment – Most brokerage firms allow you to reinvest ETF dividends (where you will end up with fractional shares), but your dividend sits in cash a bit longer since the fund pays the brokerage company, which then reinvests in those shares. With the mutual fund, the fund buys more shares directly. Elisabeth Kashner refers to the ETF delay as “drip drag,” which can
take at least four business days.

6. Tax ­free exchanges of mutual funds but not ETFs – Though investors can make tax­ free exchanges to different share classes within mutual funds, or even to ETFs, they can’t make them from ETFs to mutual funds. With $5 million, investors can generally buy institutional share classes that have lower fees than the Admiral share classes. So one could convert the Admiral share class to institutional, but not the ETF share class. Allan does have clients in this predicament, with ETF positions of more than $5 million yet with tax consequences too harsh to warrant selling to buy the lower­ cost institutional share classes.

One argument on the superiority of ETFs is that they don’t have the 60­day rule that Vanguard imposes on mutual funds. This means Vanguard will generally not allow you to buy a mutual fund that you have sold in the past 60 days. While I’m not a fan of frequent trading, there can be legitimate instances where one would need to do this.

Still, one is no worse off by starting with the mutual fund, since, in either case, one could just buy the ETF. For the most part, these six reasons are fairly minor, and investors can build a broad, low­ cost and tax­ efficient portfolio using either of these share classes.

However, making the assumption that ETFs are always better than mutual funds is flawed.