Vanguard’s Target Date Funds have some new competition

Target Date (or Life Cycle)  funds have become increasingly popular by investors looking for a hands-off investment vehicle, particularly inside 401k or other tax-advantaged accounts. While they may be appropriate for investors who truly don’t want to be involved in the investment process, I believe many people could do better by either investing in the underlying holdings and rebalancing as necessary to their desired asset allocation, or selecting one of Vanguard’s newly updated LifeStrategy funds.

The reason is Target Date funds make broad assumptions for the general investing public, but these assumptions may not fit an individual’s risk tolerance or personal investing beliefs. For instance, TDF’s have been marketed as using one’s retirement date range to select the appropriate fund. Using this methodology, I would be in the 2055 fund, comprised of 90% equity and 10% fixed-income. For me, the downside potential of a 90% stock position is more risk than I’m willing to take, so this fund is inappropriate for my risk tolerance. If I were instead to move into a less risky fund, such as the 2020 fund (currently 65%/35%), the asset allocation would shift to (45%/55%) in ten years.  This seems too conservative to me, so I’d consider it inappropriate as a long term holding.

However, Vanguard announced yesterday that they are in the process of removing the active management holdings inside the LifeStrategy funds (Asset Allocation and Short-Term Investment Grade), and instead will hold static allocations of Total Stock Market, Total International Stock Market and Total Bond Market; all low cost, low turnover index funds. This is fantastic news for investors who have Vanguard as a 401k custodian or use them for an IRA, as these updated funds will offer consistent asset allocations at low cost (below is a chart from the Vanguard article above with change in expense ratios for each LifeStrategy fund).

Current and proposed expense ratios*
Fund	Current	Projected
LifeStrategy Growth	0.20%	0.18%
LifeStrategy Moderate Growth	0.19%	0.17%
LifeStrategy Conservative Growth	0.19%	0.15%
LifeStrategy Income	0.18%	0.14%

These LifeStrategy funds now share almost identical holdings with their Vanguard Target Date Fund counterparts, with the exception being that four of the twelve Vanguard TDF’s also have a TIPS component on the fixed-income side. However, for investors who are uncomfortable with their asset allocation shifting at a certain rate over time, these LifeStrategy funds are definitely worth a look.

Investors with portfolios of at least $30K could still do slightly better on the expense side by purchasing Admiral shares ($10K minimum per fund) of each of the underlying holdings and rebalancing to their desired asset allocation, but the new LifeStrategy funds are now an attractive option for the hands-off investor.

Roth IRA for young investors?

Among priorities with shorter timelines (car repairs, paying down debt, etc.), one of the first responsibilities recent college graduates have upon landing a job is to begin setting aside a little money for retirement. If one notion has become apparent over the past few years, it’s that Gen Y will not be receiving anywhere near the social security, defined benefit contributions or retiree healthcare many of our grandparents have access to. Not only will we be shouldering an increased tax burden to help current and near retirees, but we’re going to be responsible for providing a higher percentage of our retirement dollars.

In my view, the smart way to do this is not through increased risk on the investment side, but rather through using the effect of compound interest and creating a diversified, buy-and-hold investment strategy. In terms of diversification, most college grads with a corporate job will have a 401k plan, presumably with some level of company match. In almost all cases, the first order of business should be to contribute enough to receive the maximum company match.

Personally, I’m in the camp of maxing out a Roth IRA after meeting these guidelines for several reasons. Since Roth contributions are made with after tax dollars, your money grows tax free. If a Gen Y employee were to contribute $5K (roughly $400 per month) every month to a Roth IRA from age 25-65, that would grow to over $1 million tax-free dollars (assuming a 7% return) at the end of forty years. Pretty cool! Secondly, unlike most 401k’s, Roth’s can easily be invested in a variety of investments. While some people will not care about this and use a Target Date fund, those who want to slice-and-dice their portfolios among a variety of asset classes will most likely be disappointed in their ability to do this cost effectively within a 401k.

Thirdly, since Roth money is contributed with after tax dollars, it can be accessed without a penalty such is the case in most instances with a 401k. For younger employees with fewer assets, that’s definitely a nice to have from a comfort level perspective. Lastly, employees who invest in both a traditional 401k and Roth IRA receive tax diversification. If for instance, an employee were to have a $2 million portfolio at retirement ($1 million in 401k and $1 million in a Roth IRA ), half of that money would be taxable and half would be not. Also, this employee would not have to take RMD (Required Minimum Distribution) on the Roth dollars, which can be a significant benefit depending on one’s circumstances.

For Gen Y (or Gen X, Baby Boomer) employees who are able to contribute more to their retirement than a minimum 401k contribution, a Roth IRA is a great way to receive tax diversification and help save for retirement.

Gen Y: A tough market for disability carriers

While much has been written on attracting, retaining and managing Gen  Y employees, less frequently discussed is the sizable and potentially lucrative opportunities within the income protection market. Gen Y is typically characterized as a tough consumer segment for marketers to attract due to the strong influence of friends and family when making purchase decisions, the ease with which they are able to research information and their perceived immunity from the effects of traditional advertising. The need for this age group (roughly defined as those born between 1977-1994) to purchase disability and life insurance is growing however, and their sheer size (about 25% of the U.S. population according to a 2009 Metlife MMI report) is reason for ancillary carriers to take notice.

Gen Y is in serious need of income protection as they face challenges with debt, income and job security. A recent Wall Street Journal blog states that 2011 graduates are the most indebted ever, to the tune of nearly $18,000 (parents average an additional $5K), with average starting salaries down 23% against 2009 ($37,800 to $46,500). To further complicate matters, average credit card debt of college graduates has grown to more than $3,000 and an alarming number of Gen Y’ers are moving back home with their parents. According to Metlife’s 2011 Employee Benefit’s Study, 43% of Gen Y live paycheck to paycheck, 49% worry about having enough money to make ends meet and 52% are very concerned about job security.

With what could only be classified as alarming financial obligations (and stress) so early in life, one might assume this generation would protect their income the most, however, that has not proven to be the case. While a 2010 Unum survey showed an uptick in their perceived insurance knowledge between 2008 and 2010, this doesn’t necessarily translate into actual sales. According to a recent LIMRA survey, fifty-percent of Gen Y households do not have life insurance, and a recent Guardian survey found that only 28% believe disability insurance is extremely important.

As ancillary benefits continue to move towards Voluntary, shifting more costs onto employees, Gen Y is going to need to find a balance between paying bills, paying down debt, funding retirement and deciding which insurance products are the most essential. Furthermore, the insurance industry needs to do a better job educating consumers and positioning the concept of why life and disability insurance have a place among the priorities mentioned above. According to a recent Prudential study, many Gen Y members believe life insurance is only a necessity for people who have high risk occupations or are ill or elderly and fail to understand the complexities of underwriting, pricing and product types.

The good news is, Gen Y appears to recognize the role voluntary benefits play and their importance. According to Metlife’s 2011 Study of Benefit Trends, 57% and 58% of Gen Y employees believe it’s important to have disability and life insurance respectively offered in the workplace, even if they have to pay 100% of the cost. Generationally, they placed second in the study in each product line, behind only Gen X, perhaps indicating a realization by younger employees that they are likely to face increasing financial responsibility for their own coverage.

If carriers can improve education and price products reasonably, the potential market opportunity is impressive, especially as the economy stabilizes and employers become more open to making Voluntary products available to their employees.

Why understanding the “big picture” is so difficult

One of the most challenging aspects of entering the workforce for a young person is rarely discussed. While most people talk about culture, building/maintaining effective relationships, understanding the inner-workings of corporate America, etc., rarely mentioned is how important a thorough understanding of the “big picture” is to one’s future success. While  learning the ins and outs of one’s job and the above topics are of utmost importance,  developing a thorough understanding of the business and its key drivers, the competitive environment and financial literacy (understanding balance sheets, income statements, statements of cash flows, as well as important valuation metrics such as earnings per share, operating margin, debt-to-captial, etc.) is of equal importance.

Why? Firstly, young people should feel exceptionally fortunate if they have the opportunity to meet with and learn from senior management. If this opportunity presents itself, however, what are you going to talk about? Nobody in an organization has a better understanding of the competitive environment, factors which influence stock price and the KPI’s of an industry better than the senior management team. Knowing enough to ask the right questions is the best way to rapidly improve your own knowledge and learn some of the important intangible information that an income statement can’t tell you.

Secondly, this knowledge provides a completely new lens from which to view your current job. One of my primary goals is to develop and use this knowledge to improve business decisions and be able to make recommendations which drive the business instead of simply interpreting data.

I’ll be the first to admit, however, learning all of this information is as challenging as it is time consuming. Essentially, each piece (understanding the business, competitive environment and financials) starts out as a separate entity until one’s knowledge base is enough to begin connecting the dots. Indeed, if I could redo my undergraduate degree, it would undoubtedly include more finance courses, but that’s a story for another day. Furthermore, most young people’s roles within an organization are so granular it’s difficult to see the value of investing time in learning the high-level, especially since there really isn’t any short-term incentive to do so. Lastly, so much information and data is available, deciding where to begin can be the most significant challenge.

Working through this process myself, I’m learning many things along the way. Firstly, I’ve learned that absorbing this information is a long-term process and you don’t need to learn it all at once. My goal is to have a very solid understanding of all these areas within five years, which is a far cry from studying for a couple of months like was expected in college. Secondly, asking questions is absolutely the best thing you can do. I’m fortunate to have an extremely bright and knowledgable boss who enjoys teaching, and I try to take every advantage to ask her questions, especially on the competitive environment. She has proved an invaluable resource, and has without question greatly improved my understanding and helped to connect the dots.

Thirdly, I think developing an understanding of financial statements is extremely important because it provides an easy way to compare companies in a tangible way. I thought my understanding of financial statements was relatively solid until I started reading annual reports and realized I didn’t have a clue as to what most of the metrics and ratios really meant to an organization or shareholders. Lastly, you need to do it for yourself. While I don’t see any way that understanding these concepts won’t help your career in the long-term, it’s a significant amount of time and energy to invest if you’re not interested in learning it.

While I’ve learned quite a bit since embarking on this journey a few months ago, there’s no question I have years more worth of learning to do. As English poet Richard Monckton Milnes famously said, “the virtue lies in the struggle, not the prize.”

Why Morningstar’s premium membership is worth the investment

Morningstar.com is an investment website which provides independent research on areas ranging from mutual funds, ETF’s, stocks, bonds and personal finance. While a great deal of the data is free, people who manage their own portfolios or want a deeper understanding of their current (or future) holdings will likely find value in a premium membership. Below are three of the premium offerings I find most useful (mutual funds are used to depict examples).

Analyst Reports:

I’ve found Morningstar’s analyst reports to generally be helpful, particularly when trying to decide between two mutual funds in the same asset class. The reports cover high-level differences between the fund and its category average, and usually include an explanation of current results and how the fund’s strategy could affect performance moving forward. While the insight is typically worthwhile, it’s not detailed enough to replace investor research. It is however, a valuable resource to determine whether a fund fits your investment style.

Portfolio X-Ray:

The Portfolio X-Ray tool is far and away the best premium feature, allowing the user to understand how the pieces of his/her portfolio truly fit together. For instance, say you want to examine your portfolio, which contains 401k and IRA investments. By inputting the total percentage of each holding, one can see a detailed breakdown of the asset allocation, sector, stock type, top 10 holdings, foreign investment exposure and much more. Furthermore, the stock intersection tool allows the user to see how much exposure their portfolio has to individual companies. If your portfolio contains a large cap growth fund and a large cap blend, both may hold a significant stake in a company such as Coca-Cola, which can increase the portfolio’s overall exposure and volatility to individual companies (or sectors).

Similar Funds Tool:

The similar funds tool is useful for investors trying to decide between funds within a particular asset class. For example, if one wanted to invest in Vanguard International Explorer ($25K minimum) for an IRA, that particular fund would be out of the question due to its $25K fund minimum. However, one could use the criteria they like about that fund to find another with similar characteristics. This is also useful to learn about “competitive” funds within the same asset class to understand how their strategies differ from your fund’s.

While there are more tools premium members can use, such as fund analyst picks, trade analyzer and premium stock picker, I’ve found the three listed above to be the most useful for mutual fund investors. Morningstar allows new users a two-week premium membership free trial and then offers a variety of membership plans, making it easy to find an affordable option. The only complaint I have with the process is that one must call to cancel a membership, which is kind of annoying. Other than that, I think Morningstar’s premium membership is a worthwhile investment, particularly for those who don’t have a financial advisor or institution managing their assets.

Assessing risk tolerance as an investor

Being brand new to the investing world, I often wonder the impact risk tolerance will have on my long-term investing discipline and asset allocation strategy. One challenge I think most investors wrestle with is balancing portfolio return potential with risk, and many probably don’t truly understand the potential volatility associated with their asset allocations. Paul Merriman of Merriman, Inc., has an interesting article which depicts how various asset allocations have done over the past 30 years and it’s definitely an eye-opener!

Due to my age and time horizon, it makes theoretical sense to hold a high equity position (somewhere between 80%-100%), and many financial advisors would probably advise such an allocation because there is plenty of time to ride out “bumps” in the market. Additionally, seeking higher returns at a young age makes it easier to transition to a more conservative allocation and not “need” to take on as additional risk as retirement approaches. The problem with this, is according to Merriman’s chart, a person holding an 80% equity postion (20% fixed income) would have faced a worst 12-month performance of -42.8% and a worst five year performance of -15.5%! Move to a 90% equity holding and these numbers change to -47.1% and -19.7%, while a 100% equity allocation would have produced -43.3% and -29.1% respectively.

While buying low and selling high is conceptually simple to understand, keeping emotions in check and continuing to dollar-cost average while potentially losing half of one’s portfolio in a year is a tough pill to swallow, and I wonder how easy that would be to handle in reality.

The primary issue is one of trade-offs. If my goal  is to have $2 million by age 65 (assuming 40 years of investing), a return of 8% would require $570 per month. However, at a 9% return (just 1% more), it would require roughly $425 per month, a monthly difference of $145 !  Is the potential for slightly less volatility worth having to save an additional $145 per month?

While risk aversion is an issue, another part of me wonders if it really matters whether my portfolio loses 42% or 48% of its value (if I stick with it at 42%, will I not at 48%)?

I think most of us believe that we are rational investors and are disciplined enough to stay the course during tough times. While the best investors have a tendency to buy what is unattractive, I know (judging from the amount of outflows during the market crashes of the past decade) many investors are unable to do this. Understanding the temptation to sell at the worst possible time will undoubtedly cross my mind, forming a relationship with an independent financial planner is at the top of my to-do list!

7 lessons to learn from millionaires

Many people envision becoming rich one day and having their money work harder than they do. Sadly, most who are capable of achieving this goal never do . The Millionaire Next Door is an older book (published in 1996), but is worth a read by anyone interested in finding out more about wealth accumulation and preservation. I found a few things in this book particularly interesting, and have provided brief descriptions below.

1. Millionaires pay themselves first. While many financial advisors tell clients to aim for saving 10% of their pre-tax income (some include company 401K match in this number), this may not enough, and is almost guaranteed to not be enough for those not investing from an early age. Indeed, the WSJ recently had an article on how  many Boomers’ 401k accounts don’t have nearly enough to fund their retirements. Money experts, such as Dave Ramsey, says that one of the key to becoming rich is investing 15% of pre-tax income (not including any matches) every month.

2. Millionaires don’t invest large amounts of money on assets which decline in value. Cars are a topic covered extensively in this book, as many millionaires drive 2-year old (or older) cars, and many drive American makes! Also, most millionaires don’t finance or lease their cars because it doesn’t make financial sense to do so.

3. Millionaires understand the power of compound interest, and as a result don’t carry debt (possible exception of a mortgage payment).

4. Millionaires understand that accumulating wealth is not a race. According to author Tom Stanley, most first-generation millionaires don’t actually become millionaires until they are in their fifties. This indicates to me that millionaires probably have a thorough understanding of minimizing portfolio risk, keeping their expenses low and trade infrequently.

5. Many people might consider millionaires to be “cheap” when it comes to discretionary items such as clothes or automobiles, but one area they pay a premium for is financial advice. Why? Quality financial advice can lead to higher returns over a lifetime.

6. Millionaires know how much they spend every year on food, clothing, vacations, etc. and many operate on an annual budget. One of my favorite quotes in the book is “Only those who have considerable wealth want to know exactly how much they spend…”

7. Finally, millionaires derive satisfaction from financial independence instead of “keeping up with the Jonses”.

The Millionaire Next Door is truly an eye-opener and I’d highly recommend it to anyone who is serious about accumulating wealth.

Retirement saving potentially troubling for Gen Y

What do Dave Ramsey and Paul Merriman have in common? They both stress the importance of investing early and consistently as the best way to increase the probability of having enough income in retirement. In fact, just about every financial planner or investment advisor pushes this idea due to the power of compound interest. However, the significance of this advice is magnified many times over for members of Gen Y because the likelihood of people in their early twenties receiving fixed-income from Social Security and/or pension funds at retirement is unlikely.

Unfortunately, if the short history of Americans’ saving patterns is any indication, Gen Y needs a dramatic change to achieve this goal. According to US News, only 39% of Americans invest enough in their 401K to receive a full company match. That’s double dumb since 401k contributions are tax deferred and you receive a 100% return on your investment if the market stays flat! Employees under 30 are even worse, with 53% of workers not contributing enough to earn a company match. IRA numbers are equally disturbing, with only 45% of households owning any type of IRA in 2004.

What’s equally troubling  is young people are incurring so much debt from school costs early in life, they are sabotaging their ability to benefit from compound interest. In fact, the only compound interest many students will experience for at least a decade is from the wrong side. For example, a student graduating with $19,000 in undergraduate debt (about average, although private schools can be considerably higher)  at a modest 6.8% would have to pay $218 per month for 10 years, accumulating around $7200 in interest payments. Keep in mind, this doesn’t include credit card debt, which the average undergraduate has over $3,000 of upon graduation. Since most people earn the lowest salaries during their twenties, it stands to reason the majority of money not tied up in living expenses would be funding these loans.

This estimate also doesn’t include graduate school, which I’ll cover in more detail in a later post. My point here though, is to poise the idea that if Gen Y will (at least potentially) be 100% responsible for providing their own retirement dollars, many are handcuffing themselves between college debt and saving habits inconsistent with wealth accumulation. I hope we smarten up as both a society and generation, or we are headed for serious trouble down the road.

Price Impression is today’s brown cow

Seth Godin’s book, Purple Cow, provides terrific insight into why companies tend not to be remarkable. Godin refers to most companies as brown cows; unremarkable, indistinctive companies churning out incremental change. The coveted purple cows are those companies whose product offerings, culture, or business strategies are different enough to break through the clutter. Seth wrote this book back in 2003, but it’s relevance today is alive and well (in my humble opinion) in companies’ efforts to drive price impression.

Look at Wal Mart, Kohls, Home Depot, and most other retailers, and the primary message is price. Is price impression effective? Certainly it is for Wal Mart, but Wal Mart is remarkable to consumers because of their pricing. Let’s face it, there is nothing exciting about shopping at Wal Mart besides the potential of saving money. Most companies, however, rely on price impression because they are not remarkable, (is it just me, or are Home Depot and Lowe’s essentially the same company)?

Am I the only one tired of hearing the incessant ring of price messaging, whether shopping for a razor or a car? Fully appreciating the severity of the economic downturn (how would you like to graduate into this economy?), I believe companies have to build more than price into their products!

A few examples of purple cows would be Hannaford’s Guiding Stars system, which launched in 2006. Hannaford realized the intricacy and time associated with making healthy choices in the grocery aisle, and created a very easy to use and understand star rated system from which customers could quickly and easily make healthier shopping choices. Although this program is “old” now, I think it’s a terrific example of a company in a commodity driven industry designing and executing a purple cow idea. Today, many supermarket chains have attempted to copy this idea, but have created mostly convoluted and ineffective systems.

Another (more recent) example would be Apple, who recently overtook Microsoft in market capitalization. Despite charging twice as much for many of their products as competitors, Apple has experienced undeniable success over the past several years in terms of market capitalization and market share with many of their product lines.

In each of these examples, what makes these companies successful? First and foremost, each brand is providing solutions to real problems customers face. Hannaford recogized there was a (large and growing) segment of consumers who wanted to make healthier choices, but simply had too many options. Apple (computers) realized a certain segment of consumers were tired of hassling with Microsoft/PC products with short life cycles that were not designed to support creative jobs.

In both of these cases, the brands were not focused on everyone, but a particular customer segment, and the marketing was built into the product(s) itself. Seth’s book is as relevant today as it was seven years ago, and is worth a read by any marketer. Highly recommended!

360-degree customer views will come from Social CRM

Financial institutions, retailers and the hospitality industry need not worry much longer about how to measure the value of social conversations. According to a study released by Altimeter Group earlier this month, Social CRM will soon become a 360-degree CRM program designed to create engagement before, during and after the shopping experience. The goal of Social CRM is not to take the place of traditional CRM systems, but rather to augment the effectiveness of current systems by using five basic processes called the “5 M’s”. These stand for Monitoring, Mapping, Management, Middleware and Measurement. The concept is integration, both between current CRM systems and internal structure because social conversations require near real-time responses. To effectively keep up with these conversations, streamlined processes and an internal structure based on collaboration instead of siloed work flows are a necessity. Below, I have depicted these five processes based on the descriptions provided in said study.

Monitoring- Companies can use brand monitoring software solutions to receive an aggregate of relative brand information across online, print and broadcast sources. The value is not only having all of this (previously) unstructured information at your fingertips without having to search for it, but allowing a company to quickly grasp the important, relevant and timely perceptions and changes in their markets. Vendors such as Biz360 use natural language processing, point-of-view sentiment (measures tone of conversations), impact metrics and more to provide a level of insight never before seen by most organizations.

Mapping- Conceptually, Mapping is about tying customers’ social profiles (Facebook, Twitter, etc.) back into their unique traditional CRM profiles, in order to provide 360-degree insight into their consumer background. Essentially, this equates to combining their real-time social conversations and transactional purchase history to allow higher degrees of marketability. From an execution perspective, vendors such as Spredfast acquire customers onto the company’s social media sites (such as Twitter), allowing said company to incentivize these new acquisitions to sign up for their loyalty program; successfully integrating the two parts.

Management- Proper CRM management is crucial to prioritize the flow of information to the correct internal departments. The idea is to use real-time, actionable data from social conversations to create real-time responses. Since most companies have traditionally been built around the company instead of the customer, effective CRM Management is a seismic shift in both business process and thinking. Indeed, successful CRM Management integrates with the other four “M’s” to deliver a real-time, un-fragmented response to the consumer. It also ties in most closely with Middleware.

Middleware- While CRM Management revolves around directing information to the correct departments, Middleware focuses on effectively and efficiently sharing data between those departments to create an un-fragmented experience for the consumer. For retailers, this means much higher levels of collaboration between internal corporate departments as well as between retail and corporate. Think for a minute about the hundreds of in-store encounters retail associates deal with every day regarding customer complaints that never make it to a call center to be recorded. If systems are in place to record these and look at them from an aggregate perspective, that will provide much more insight into consumer opinion.

Measurement- While the other four “M’s” should all have measurement components attached to them individually, there should also be benchmarks set for Social CRM results as an enterprise, based on the strategy and goals of the organization. Business solutions such as the SAS Institute allow companies to become more cohesive while bringing the results into an actionable state.

To find out more, check out the study.