Russell Bailyn's Financial Planning Blog

I’m in my 20’s, but I spend much of my time with people in their 50’s and 60’s. These clients are nearing retirement- the point in life where one would like to either cease working, or dedicate substantially less time to work-related activities. The challenge is sustaining an income stream which is sufficient to lead the same lifestyle established during prime working years. I have many answers to how workers nearing retirement can supplement their savings or find insurance-related products which can mitigate the risk of outliving one’s assets. What I’d like to focus more on is why 99% of the questions I get related to retirement and creating long-term income streams stem from people in their 50’s and 60’s- just the demographic which should have already planned for these issues. The people who should concern themselves with retirement planning are those in their 40’s, 30’s, or younger.

One of the looming issues facing the younger generation is the social security system. This is one of those taxes which you can’t write off, negotiate, or choose not to pay. It often shows up on a pay stub as FICA tax. FICA stands for the “Federal Insurance Contribution Act.” The government has made the decision that as a resident of the United States, 12.4% of your gross income (capped at $87,900 worth of earnings) will be paid into the Social Security Trust Fund. The logic here is that, as a nation, we’re a bit too irresponsible to properly plan for our retirements. The government will tax us during prime earnings years and then provide us with some guaranteed benefit when we’re old enough to qualify for it. From a glance, it seems like a forced savings plan, not a bad idea assuming all the money we pay in comes back to us in later years. Let’s take a look at how the system holds up to its theoretical purpose.

The Social Security Act was passed in 1935 by Franklin Delano Roosevelt as a reaction to the Great Depression. Following the crash of 1929, the United States grappled with a 25% unemployment rate and a 70% drop in stock prices. The Social Security Act was quickly passed with 16 people contributing for every 1 person receiving benefits. The system was very liquid and the government invested all the proceeds in safe Treasury paper to ensure that the funds would be available for later generations. Gradually, the population both increased in size and aged. By the 1980’s there were about half as many workers contributing to the Social Security system for each person receiving benefits. A lot of this had to do with the heavy Baby Boomer popular moving through the workforce at the same time. The result is that now there are about 3 contributors for every 1 person receiving benefits. If the system remains the same, a 27% decrease in benefits will be necessary to maintain liquidity by 2042. Those over age 40 probably don’t have much to worry about in terms of decreased benefits, but workers in their 20’s and 30’s will, without question, be affected by these demographic changes.

The solution to the Social Security problem is complicated by a number of factors, the greatest being that we truly cannot predict with the degree of accuracy we need the demographic statistics which would allow us to pinpoint a solution. How can we anticipate a world war or a depression? We can’t, so we do our best job to set up a flexible system that will evolve with the population. Some people have suggested raising Social Security taxes above 12.4% to create liquidity for the system. Other have suggested raising the maximum level of earnings which social security tax can be applied to. Currently, the 12.4% only applies to your first $87,900 worth of income. Increasing that number to $160,000 would create hundreds of millions of dollars for the system. It would also be a direct tax on the upper-middle class, presumably people who are employers and an integral part of keeping the economy floating. We have to carefully consider the ways we raise taxes so that the impact doesn’t trickle down to other areas of the economy. The one solution which is easy to understand but extremely complicated at the same time is privatizing the social security system so that the money we contribute each year is earmarked for us. Why should all the Social Security money go into a collective account controlled by the Federal Government? Are they really more fiscally responsible than us as individuals? Think about the size of the budget deficit in the United States when pondering that question. Granted, if individuals were in charge of managing their own Social Security funds we’d likely have a problem on our hands. What if John Doe decided to invest his savings all in shares of Google stock? Well, that could be a good or a bad decision, but certainly too risky for an account labeled “social security.” Perhaps the investment choices could be simplified as conservative, moderate, and aggressive. This way, there wouldn’t be too many investment choices, but still an opportunity to participate in the markets over the long term. This would have proved a very positive decision if the baby boomers were investing in the markets since the 1960’s. All of these ideas are currently being thrown around in Congress and debated by opposite ends of the political spectrum. We’ll likely see the issue heat up as the next presidential election approaches.

The logical extension of a discussion on decreased government benefits and the needs for us to take on more personal responsibility in planning for our retirement is how we can save more through qualified retirement plans which are available to us. The most common qualified retirement plans which are available to individuals are 401(k) plans, 403(b) plans, and IRA’s. When I refer to a “qualified retirement plan,” that includes any savings vehicle in which we can save money on a pre-tax basis (not getting taxed on those contributions) and the money continues to grow tax-deferred until withdrawals are taken. Generally we can’t take withdrawals from qualified plans prior to age 59 ½ without getting hit with a penalty. The reason for that is the government understands certain people will pull the money out when they don’t absolutely need it unless a penalty is put into place. The government offers these incentive savings plans in the first place to encourage people, through tax benefits, to participate in individual and corporate savings plans. In fact, the government estimates that for a person currently 40 years old, Social Security, combined with qualified retirement plans such as 401k’s and IRA’s will still only account for 60% of the income needed for a comfortable retirement. The extra money is usually found through personal savings, part-time employment during retirement, or a more substantial decrease in lifestyle during eldest years. Obviously each person has their own situation with factors specific to just them.

To return to my original point, the planning aspect of retirement is easiest for those in their 20’s and 30’s. The process becomes increasingly difficult and involves more sacrifice as we approach our 50’s and 60’s. The power of compounded savings (reinvesting interest rather than spending it) has a tremendous benefit to those who can afford to do so. And the truth is most of us can’t afford not to. If you treat saving like a bill and never miss a month, you will reach your savings targets earlier than you ever thought possible. This applies to both retirement savings and other long-term spending goals. Thanks for reading and feel free to contact me with any further questions about this article or any aspect of the financial planning process.

Russell Bailyn
rbailyn@gmail.com

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What method would you use if you owned an investment company that offered a retirement plan and wanted to get some new money invested in your plan? Maybe you’d send a letter to the human resources director of some businesses in your city and ask for a meeting. If you get the meeting, you can explain why your retirement plan is beneficial for the participants and explain why they should go with you over a different company. Maybe your fees are lower, or you have a customer service department. This is not the method major investment companies take.

ING, an insurance and investment company that manages hundreds of billions of dollars has taken a different approach. They decided to contact New York State United Teachers (NYSUT), an extremely powerful teacher’s union in New York that oversees benefits for over 500,000 teachers and ask for their endorsement. There is no beating around the bush here- they wanted the opportunity to have over 500,000 employees of school districts invest with them. Well, they got the endorsement. What was their method? Rather than explaining why their plan was in the best interests of the union members, they decided to offer a little “incentive.” ING makes an annual payment of $3 million, yes $3 million dollars, to “support” the union. Wow! That’s very nice of ING to generously support New York State United Teachers. I wonder if the staff of ING does it because of their recognition that teachers are the backbone of a strong, academic nation. ING should really be rewarded for their generosity and support. So, why is Eliot Spitzer investigating the relationship between ING and the teachers union? Spitzer, smart man that he is, has been alerted to the fact that ING is not in the best interests of the union members. In fact, as an insurance company that offers investments, ING is among the more expensive providers of retirement plans around. Combine that with the fact that teachers are not historically the most knowledgeable investors- understandable considering they work in schools, not on Wall Street- and you have a situation where hundreds of thousands of people are not properly preparing for their retirements.

The noise really started when Eliot Spitzer decided not to attend an endorsement dinner in Rochester which NYSUT was having in honor of his run for governor in 2006. The only reason a potential governor would not accept such an important endorsement is if he truly recognized that a conflict of interest was at hand. Spitzer can’t accept an endorsement from a union that’s accepting bribes- that makes him look bad. He sent David Paterson, the Senate Minority Leader instead.

In all fairness, I should explain that ING has a defense. They published a response to the various criticisms published about them on their website. The reason why they have the nerve to respond (rather than apologize) is their frustration that all this “generosity” has started to blow up in their face. The $3 million payments were not made to executives at NYSUT- that would make both of them potential criminals. The payments were made to NYSUT’s Member Benefits Trust, which is actually a not-for-profit organization. This makes the payments legal, and allows ING to create an argument that they are helping rather than bribing the organization. ING says that the stories published against them are “disparaging” and they are dedicated to helping teachers across the United States prepare for retirement. This is a load of bs when you are out in the field and see what happens in practice.

Well, I’m an independent financial advisor who works with a lot of teachers in New York State. One of those teachers is my mother, who had an account with ING’s Opportunity Plus program until I transferred her account into something with lower fees and no withdrawal penalties. In the transfer process, my mom had to pay $800 in penalties to ING for doing the transfer. Was losing $800 in her best interest? I think not, and I stand tall against ING. Her performance is up over 20% since she left them and started working with a reasonable team of low-cost advisors.

Before any of this discussion about the $3 million dollar annual payments, I was trying to get into various schools on Long Island with my firms preferred 403b product which is very low cost to the employees. All the schools told me they don’t endorse fund companies or financial planning firms because in a 403b plan (unlike a 401k plan), the employer doesn’t make any contributions on behalf of the employee. I still observed that ING was all over New York State. The schools aren’t endorsing them, but NYSUT is making the overall recommendation that the schools use them and allow their representatives to linger around the teacher’s lounge and quietly rip off teachers who don’t know any better by purchasing food for them and acting friendly. I can only imagine the commissions of the ING representatives who cover the Long Island and New York City districts I’ve come across. They have thousands of accounts.

Bottom Line- The 403b system in New York needs serious reform. In California the states have already put many rules into place to protect the teachers from situations like this. The schools should have a fiduciary responsibility to ensure that employees understand the choices available to them when investing in a 403b plan. It’s their money which they worked hard for, why should they share it with investment representatives who are doing nothing to earn it?

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Mad Money starring Jim Cramer is hitting Columbia University on May 16th. Cramer is former co-host of Kudlow & Cramer, and owner of thestreet.com. I wrote in to CNBC back in March about getting a seat in the studio audience. I got selected along with 3 friends to come to the taping and even give picks for the lightning round. For those who don’t watch, the lightning round is the portion of the show where people from the audience come up and ask Jim about a stock of their choice. So yes, I will be on TV!

The “back to school” broadcast started back in February at Harvard University where Jim Cramer went to law school. The second show taped at University of Michigan, and now the show is coming to New York. The Cramer show gets mixed reviews from financial professionals because of the unusual trading patterns caused by his stock picks. When Jim spends time pushing a certain company or sector, the volume generally increases the next trading day and throws the stock into a frenzy.

The show airs at 6 PM on Tuesday, May 16th on CNBC.

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I wrote an article in March outlining the macroeconomic case for investing in water. The PowerShares Water Portfolio (PHO) has moved up 5% since then, and I still believe it plays a crucial role in most portfolios. Let’s review factors in favor of water investment:

Opportunity for growth: The Water industry is quickly evolving. As global demand increases for potable water, the companies which collect, purify, and monitor water become more valuable. The water industry receives heavy investment from both the public and private sectors. Furthermore, the structured-equity approach used by PowerShares generally favors small and mid-cap stocks. These sectors have outperformed the large-cap indexes consistently over the past five years.

Preservation of Capital: PHO has an excellent risk-adjusted return. It’s heavily resilient to economic cycles and inflation. At what point in time has the demand for clean water decreased? Common sense would suggest water is the commodity in highest demand on earth. This is a great dual play on natural resources and utilities.

Portfolio Diversification: PHO is comprised of small, mid, and large cap stocks mostly in the industrial and utilities sectors. However, it also has exposure to health care and information technology stocks. As mentioned above, water companies have shown strong risk-adjusted returns in the past five years.

Tax-efficiency: Prior to the creation of this ETF, mutual funds were the best way to gain exposure to water utilities. But even the best utility funds don’t have the tax-efficient structure or total return of PHO.

Expenses: PHO costs you 60 basis points and consistently outperforms the broader markets. You can’t ask for much more than that from an ETF. The other utility ETF which you might use for this sort of portfolio exposure which is cheaper than 60 basis points is IDU, the utility iShare. Owning IDU for the past 5 months would have you underperforming PHO by 20%.

What further pushes me towards water as a valuable natural resource is recent press linking tap water to bladder cancer in men. The New York Post ran an article on Saturday summarizing the results of six completed studies in which all six men who consumed tap water based drinks were linked to a higher risk of bladder cancer. Note that PHO is careful to correlate to the increasing demand for bottled water. Bottled water prices have outpaced inflation, on average, by 20% annually.

I also believe investing in water is a side play on the current craze for alternative energy stocks. As the world becomes more polluted, water purification and filtration systems increase in price and demand. An article from Summit Global Management Inc states that improving water infrastructure systems will be a top priority for governments in the next ten years.

So I repeat, in your quest for alpha, consider adding PHO to your portfolio.

Russell Bailyn
rbailyn@gmail.com

Please note: this weblog is for informational purposes only and is not a solicitation to buy or sell any particular security. Past performance does not guarantee future results. There are certain risks inherent when investing and you should speak to a financial professional prior to getting started.

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