Friday, November 03, 2006

Jumping into assett allocation and the trouble with employer retirement accounts

Last night I talked with a good friend of mine. Another friend and I had bought him Bernstein's Four Pillars as a gift. We had also bought him the Intelligent Asset Allocator.

After only a few days our friend had finished the Four Pillars - amazing what one can do when you don't have three pairs of little feet running around!

He immediately worked up an asset allocation model and was strategizing on how to fit it into his varied collection of retirement and personal accounts. I was so pleased to see that he enjoyed the book and also pleased that he had gotten so much out of reading it.

Like myself, though, I feared, he was jumping into the asset allocation planning process a bit too early.

Only 1/2 way through the Four Pillars, I had created an asset allocation plan last February, which I implemented. By the time I finished the book I had wished I had done it differently. It wasn't a bad plan - you can see what I selected in my monthly post of my trading account results, however, it wasn't the right long term plan. It's very important that an asset allocation plan be slowly and carefully thought through such that it's the right long term plan. Frequent revisions to the asset allocation model negate the benefit of regular rebalancing.

My biggest mistakes in my first asset allocation plan were:
  1. Little distinction between value and market/growth investments (I ignored one of the best long term asset classes available)
  2. Too much attention to mid-caps - I'm not sure they have enough discorrelation
  3. Overall, not enough international
  4. Too much emphasis on large cap and not enough on small cap

My friend, too, put everything into blended accounts, however, he probably did so correctly - his plans do not offer passively managed value based indexes. Also, I didn't notice any emerging markets investments - then again - they may not have been available. Otherwise, he did a great job!

I encouraged him to read Rick Ferri's All About Asset Allocation and visit Index Universe before jumping into the details of his plan. I also recommended visiting Bernstein's The Efficient Frontier as well as the Altruist website. Both have excellent articles. The Altruist site does a very nice job of discussing preferred investments for each asset class. Ferri's company also has a website, Portfolio Solutions. Rick posts a number of interesting things there, including his regular projection of asset class performance over the next 30 years. One thing to keep in mind is that the various investment advisors previously mentioned share quite a few basic principles in common, but they also have very different philosophies on the details. Consider that carefully if you plan to mix and match ideas from different advisors - make sure the ideas work well together.

Unlike my situation, where job changes have allowed us to rollover much of our money into retirement plans at Schwab or Vanguard, my friend has most of his investments stuck in employer retirement accounts: 401as, 403bs, etc.... Unfortunately these accounts have a fairly limited selection of low expense index funds. And certainly not the variety of some of the more unique asset classes: such as foreign developed value, etc.... Despite desiring to implement a low cost index based approach, his employer was conspiring against him.

He's currently researching the issue. The only thought I have is for him to try to make a trustee to trustee asset transfer out of his employer plan and into a plan at a low cost brokerage like Vanguard, Fidelity or Schwab. Barry Barnitz has written about using this technique in his blog, Asset Allocation. He is rolling money out of an overpriced employer sponsored plan into a personally owned retirement account at a brokerage.

My wife is in a similar situaiton. Her employer's plan is sponsored by a bank who charges a ridiculous administration fee of 0.5% on top of the expense ratios of the mutual funds within the plan. The bank claims this represents payment for the due dilligence work they do. Over the last year I have not seen a single example of due dilligence work - perhaps they charge 0.5% of asssets under management for filing annual reports. A third party TPA will charge $1200 to do all the paperwork for the entire year. Much less tha 0.5% of a very large retirement plan. As we're moving, it's not worth fighting the battle, but I will give the employer information on cutting their expenses when we leave.

Barry, if you're reading this, would you illuminate on your technique for transfering assets from a retirement plan with a few comments? I'm most concerned about transferring assets out while keeping the origination plan open.

Is anyone else in a similar situation?


1 comment:

Anonymous said...


As far as I can determine, only two types of employer provided plans allow in service transfers to a fiduciary of one's owm choosing, namely, a SIMPLE IRA and a 403(b) plan.

In the case of my employer plan, a SIMPLE IRA, I transfer assets annually (one could transfer assets more frequently, but once a year reduces the paperwork hassles and also reduces the risk of transfer errors.)

Because of penalty tax differentials during the first two years of a SIMPLE (25% percent penalty as opposed to the 10% Traditional IRA penalty) one can only execute trustee to trustee transfers between SIMPLE IRA's during the initial two year holding period. After two years, one can execute a trustee to trustee transfer to a Traditional IRA.

I execute these transfers to my Vanguard Traditiona IRA. The process is quite easy. I fill out a Vanguard Ira transfer request, noting in the margin that I am transferring a SIMPLE IRA. The transfer request allows me to direct the transfer to my chosen investment fund in my Traditional IRA. I also include a copy of my last quarterly statement from my employer plan. Upon receipt of my completed transfer request, Vanguard implements the transfer. One important reminder. Always select a no-load, no redemption fee fund within the employer plan; this reduces transaction costs.

A 403-b transfer is similar. Technically it is known as a 90-24 transfer. I helped a friend of mine transfer his 403b from a Variable Annuity account over to a Vanguard 403-b(7) last year. My friend, a school teacher, had finally, after nine years, reached the end of his insurance surrender fee period. We were thus in position to transfer virtually his entire balance (we left 500 dollars in the Annuity plan so that we could maintain our tenure and insure no surrender fees for subsequent annual trustee to trustee transfers). The transfer was similar to the SIMPLE transfer discussed above, except for the fact that we had to also fill out a form with the insurance annuity firm.

One should keep in mind that the IRS proposed regulations governing 403-b plans is scheduled to be implemented in 2008, and that the 90-24 transfer allowance is going to be disallowed under the revised regulations. So 403-b investors have only 2006 and 2007 to continue with transfer programs.

As for the common 401-k plan; in service transfers are not allowed; one can execute an iRA rollover only upon severence of employment with the employer.