Briefly Noted

    How Professionals Tamed the Bear: Back to Basics

    A recent study conducted by the employee-benefit consulting firm of Watson Wyatt Worldwide, found that traditional employer-funded pension plans outperformed worker-funded 401(k) plans during the 2000–2002 bear market.

    The study found that while both types of plans lost money during the three-year bear market, 401(k) plans fared worse by an average of 3.9% annually compared with professionally managed pension plans. Although 401(k) plans outperformed pension plans during the three years preceding the bear market, pension plans still averaged better returns than 401(k) accounts over a 12-year period ending in 2002, according to the study.

    What lessons should 401(k) investors learn from the study findings? Stick to the basics, including the following:

    Rebalance your portfolio. Most workers failed to rebalance their 401(k) accounts, according to the study. Pension plans, however, following a disciplined investment plan, regularly rebalance their assets to reduce risk and maintain their various asset categories. Failure to rebalance actually helped workers in the boom markets—the stock portion of their portfolios grew disproportionably large, and by 1999, stocks comprised 72% of 401(k) account values, compared to only 59% in defined-benefit pension plans. However, when the stock market tumbled in 2000–2002, stock-heavy 401(k) accounts suffered steeper losses.

    Diversify. The Watson Wyatt study found that large-company 401(k) plans performed better than plans run by small companies. The study attributed the difference to the fact that plans of larger employers typically offer more investment options, thus allowing for greater diversification.

    Go easy on company stock. The study noted that the average 401(k) participant who held employer stock devoted 42% of his or her account to that stock—despite recommendations from many financial planners to limit company stock to no more than 10% or 15% of the portfolio’s value.

    Contribute and make the match. The bear market scared many workers from even making contributions to their 401(k) plan. Yet 401(k) plans will be the main source of income for many retirees. Contribute at least enough to maximize any company contribution matches and, ideally, increase contribution amounts every year. You can always shift account assets into less-risky investment options in the plan.

    From The Financial Planning Association, the membership organization for the financial planning community, based in Denver, Colorado;

    Where the Money Goes...

    Bonds Dominate Global Capital Markets
    2003 Global Financial Assets: $123.8 Trillion

    Source: International Monetary Fund.

    Despite the dominance of the stock market in the popular press, the bond market is actually significantly larger both in the United States and globally. In fact, the value of all publicly and privately traded bonds worldwide totaled $52 trillion in 2003, compared with a stock market capitalization of $31 trillion. In the United States, the bond market is roughly 50% larger than the stock market!

    From the Payden & Rygel Quarterly Review, January 2005. Payden & Rygel is an investment advisory firm based in Los Angeles, California;

    S-T-R-E-T-C-H Your IRA

    If you won’t be using all of your IRA assets for retirement, what’s the most efficient way of leaving the money to your heirs?

    For many individuals, transferring wealth with a “stretch” IRA may be a useful solution.

    A stretch IRA is not a specialized product, but rather a traditional IRA or Roth IRA that has language written into its documentation allowing for continued tax-deferred growth and distribution of IRA assets to primary and perhaps even secondary beneficiaries over a longer period of time. Without the presence of “stretch” language, assets remaining in an IRA may have to be distributed on a more aggressive basis upon the death of the IRA owner. The stretch IRA concept can be especially valuable to non-spousal beneficiaries who do not have the same ownership rights to IRA assets as do spousal beneficiaries.

    Although the phrase “stretch IRA” has caught on, financial institutions offer IRAs with similar provisions under a variety of names including legacy IRAs, multigenerational IRAs, and perpetual IRAs. Keep in mind that even when different financial institutions use the same terminology, they can mean slightly different things, so you need to look closely at the fine print.

    Using a stretch IRA strategy has no effect on the account owner’s minimum distribution requirements, which continue to be based on his or her life expectancy. Once the account owner dies, however, the primary non-spousal beneficiary—for instance, a child or grandchild—may begin taking required minimum distributions based on his or her own life expectancy. The ability of beneficiaries to extend the life of the IRA in this fashion means that the money you accumulate in your IRA and leave to heirs has the potential to last longer and produce more wealth for younger generations.

    Wealth Management News Service. Written by Marc S. Freedman, Freedman Financial Associates, a Peabody, Mass., financial planning firm.


    Update: Model Shadow Stock Portfolio

    Because we didn’t have the year-end data for the Shadow Stock Portfolio last month, it is presented here. You can see that 2004 was a very rewarding year.