In September and October, Houston-based financial advisor Mike Robertson was getting 60 calls a day from panicked clients. On Long Island, New York, about 5 percent of Mark Snyder's clients hit the phones.
“They're saying, ‘What's happening?’” says Snyder, president of Mark J. Snyder Financial Services, a financial advisory firm that manages about $140 million. “It's scary out there.”
As the federal government starts to dole out its $700 billion bailout and worldwide markets collapse, financial advisors across the country like Robertson and Snyder are trying to figure out what to say to customers frantic about their plunging retirement accounts. The standard recommendation — stick with your asset allocation — doesn't always cut it.
Clients want to know how soon the advisors think conditions will start to improve. Will their money be safe if their employer or mutual fund company goes bankrupt? If they really need cash, would it be better to tap into their 401(k) or individual retirement account, or max out their credit cards? Is this financial meltdown something far beyond the bounds of what their advisor has ever seen or planned for? “What they're really calling for is reassurance,” says Cleves Delp, president of the Delp Company in Maumee, Ohio, which manages $1.5 billion.
And it's no wonder: The head of the Congressional Budget Office in early October estimated that Americans' retirements accounts — including traditional pension plans as well as 401(k)s and IRAs — had lost as much as $2 trillion, or 20 percent of their value, in the prior 15 months — and that was before both the Dow Jones Industrial Average and the S&P 500 suffered their worst weeks on record (both fell by 18 percent in the week ended October 10).
“It is probably the worst week I ever remember,” says Robert Liberto, of benefits consulting firm The Segal Company, about that stretch in early October, and he's been in the business for 30 years. Advisors have been forced to take action, and fast. Delp headed off panicky phone calls during the days Washington cobbled together the bailout by “proactively calling clients and sending video emails.” Similarly, Kelly Campbell, founder and CEO of Campbell Wealth Management in Fairfax, Virginia, thinks he deflected a rash of calls because he held four town hall meetings within three months, called all of his 180 clients during the week that Congress was debating the bailout, and shot out e-mails after every sharp downturn or other major financial news broadcast, “explaining how they should react to it.” As Delp says, “In times like this, you've got to communicate, communicate, communicate.”
Unprecedented Or A Rerun?
But just what message should financial advisors be communicating? Undoubtedly, the main question on clients' minds is whether they should adjust their asset allocation for the volatile new financial world. In the past, the answer has been: Stick to your plan. Presumably you, as a financial advisor, have established a sensible, long-term investment strategy based on the client's age, retirement objectives and risk tolerance, so there's no need to change it just because of short-term market blips.
Today, however, the answer depends on how pessimistic the advisor is about the economy — and how close retirement is on a client's horizon.
Delp, for one, is an unabashed optimist. The current turmoil, he says, “is just a new chapter in the book of finance. We know how the story ends over a long holding period.” Not only does Delp counsel clients to hold to their strategy, he even urges them to use this as a buying opportunity for beaten-down asset classes. How does he handle scared callers? “It's a matter of the number of phone calls you need to make,” he says. “As the market moves, the effort to keep them from making a bad decision mounts.” Campbell, too, is telling his clients to hold firm. “Right now, I'm saying, ‘Try not to let the media scare you too much,’” he says.
But other financial advisors argue that these unusual times call for unusual action. “The whole idea of asset allocation is, if you can stomach X amount of risk over the long term, you're better off staying invested,” says Mark Lookabill, chief strategist for Carson Wealth Management Group in Omaha, which runs just over $2 billion.
Lookabill's firm shifted its typical client asset allocation from around 80 percent in equities to “closer to 50-50” in August of last year — and that, he says, is precisely what has prevented him from being deluged by calls from frantic clients. “Eighteen months ago we saw slower growth. We have been recommending to clients that they become much more defensive.”
As always, the advice depends partly on the client's age. “If they're 60, they're probably going to be in retirement and withdrawing before life gets better. They may have to make changes,” such as putting a chunk of stock into money market funds, says Mike Robertson, the founder of Robertson & Associates, which manages over $1 billion.
And some investors just can't be reassured. “Sometimes with clients, you have to make a change in the portfolio just because their temperament has changed so much that you're no longer dealing with the same person,” Robertson says. Even the optimistic Delp admits that he couldn't talk one customer out of panic selling.
As a compromise, “One of the things you can tell them is maybe, temporarily, they can put their current contributions into a stable value or fixed income fund until this gets better,” without moving the assets already in their portfolio, suggests Liberto. “That's not a lot of money.” Of course, he admits, that tactic may not help much if the insurance companies that back the stable value funds also sink, as happened last month.
Clients who work for a company that goes bankrupt, or whose IRA or 401(k) is managed by a Wall Street brokerage that disappears in a last-ditch acquisition, may be especially concerned that their money will go down with the ship. In a similar vein, a benefits official at Washington Mutual was flooded with anxious inquiries from employees after that bank was acquired by JPMorgan Chase.
Advisors can point out to these clients that their accounts are no worse off than anyone else's. (Okay, that may not sound very encouraging.) That's because, of course, IRA and 401(k) assets are legally separate from the assets of the brokerage or plan sponsor, and creditors can't touch them. That sounds nice until you realize how important company stock is to defined contribution plans. About 23 percent of employers make their matching contributions solely in company stock, according to the benefits consulting firm Hewitt Associates. Also, if the asset management firm has been taken over by another, the previous benefits phone number may be out of service. “There could be challenges in finding someone to talk to while some of these details are worked through,” Lookabill warns. That may scare clients.
But out-of-service phone numbers and tumbling returns may actually be the least of a client's problems. In this turmoil, day-to-day expenses come first. What if the client feels too pinched to keep contributing to the retirement account — or, even more drastically, wants to siphon out money just to live on?
In fact, that's exactly what's been happening. When AARP surveyed 1,600 people age 45 and older in September, 20 percent said they had stopped contributing to their retirement accounts during the past year, and 13 percent said they “prematurely withdrew funds” from their retirement and other accounts.
Financial advisors may disagree on investment strategy, but they agree almost unanimously on this issue: Depleting a retirement savings account is absolutely the wrong route to take. You better make sure that your clients realize these accounts give investors a tax break, compound accumulation (at least, in theory), and, often in a 401(k), deliver “free” money in the form of the employer's matching contribution. Why abandon all those perks? “More often than not,” Lookabill says, “if people reduce or stop making contributions, it's less likely they turn around and start them back up” when conditions improve.
Still, if they want to keep their money-pinched clients on the retirement-savings track, advisors are going to have to come up with alternative sources of cash.
The best choice, virtually all advisors tell their clients, is to lessen the need for tapping their accounts at all. “Take a look at your spending,” Robertson says. “Most people can slice off 50 to 100 bucks a month in their extraordinary expenditures.”
Investors know the drill. Eat out less frequently. Keep your old car another year. Postpone your dream vacation. And, gulp, postpone retirement. (In the AARP report, 65 percent of the respondents said they are considering working longer.) If high medical bills are the problem, try to negotiate with the doctor or hospital. Robertson's next piece of advice might make some people squirm, however: Ask relatives to help out.
If those steps don't suffice, many advisors say their clients should go for a home equity loan because the interest payments are generally tax-deductible. This tactic presents several problems: The client would have had to establish the equity line of credit before the credit crunch, because it will be a lot harder to get now. And home values have dropped so badly that the line of credit may be pretty short.
Only after the client has tried all those other routes would most advisors recommend hitting the 401(k), which about half of employers allow, according to the Employee Benefit Research Institute, a Washington D.C.-based research organization. (IRAs don't offer loans.) The advantage is that because clients are actually borrowing from themselves, they will eventually get their own money back — including interest. Also, no penalty is levied. And Liberto notes that, “at the most, you pay 1 or 2 percent over prime, which is a relatively small amount right now.” In fact, he says that some of the companies he works with have now started allowing employees to take loans because of the financial crisis.
Still, Liberto recommends reminding clients that such loans take a double tax bite. The investor presumably is using taxable salary to pay back the principal and interest; then, the investor will pay tax again on any money withdrawn from the 401(k) in the normal course of retirement. (By contrast, standard contributions to the 401(k) aren't taxed.)
Almost the last choice among advisors is an outright withdrawal from a 401(k) or IRA. That's worse than a loan because investors who are under age 59 ½ will probably have to pay a 10 percent penalty, depending on the type of account and the reason for withdrawal, in addition to income tax.
What could be worse? Maxing out credit card limits and racking up debt at 17 percent annual interest. “The last place I would go would be putting things on a credit card,” Lookabill says.
If all this advice sounds painful — eliminate the family vacation, live on macaroni-and-cheese and peanut butter-and-jelly sandwiches — financial advisors caution their clients not to overreact. “For the most part, people still have their jobs,” Campbell says. “Maybe the value of your house has gone down, but unless you're planning on selling your house, it doesn't matter at this point. Your cash situation hasn't changed.” He adds, “One thing I'm saying to clients is to put on the seatbelt. It's a wild ride so far, but we are going to come to the end of the ride at some point.”
Fran Hawthorne is the author of Pension Dumping: The Reasons, the Wreckage, the Stakes for Wall Street, published by Bloomberg Press.
How badly will today's markets hurt retirement savings?
As we all know, Americans have become more and more dependent on 401(k)s, which put the market risk right on their shoulders rather than traditional pensions, in which the employer bears all the risk.
Total number of traditional pension plans:
1985: 112,208 2006: 28,784
People in a traditional pension plan as a percentage of the private-sector work force:
1985: 30.5% 2006: 18%
Percentage of companies where a 401(k) is the primary retirement vehicle:
1985: 35% 2006: 65%
Within those 401(k) plans, the single biggest asset class is stocks.
Average plan asset allocation, 2006:
Equity funds: 49%
Balanced funds (stocks and bonds): 13%
Company stock: 11%
Three factors in particular could hurt savers:
Will they reduce the amount of their contributions?
The average contribution rate has held steady since 2003 at around 6.9 percent of salary.
Will they borrow money from their own accounts?
In 2006, 18 percent of those eligible took a loan from their 401(k)s, and the average size was 12 percent of the account balance.
But things may be getting worse. In September 2008 alone, 13 percent of people surveyed by AARP said they “prematurely withdrew funds” from their 401(k), IRA, or other investments.
Will their employer go bankrupt? If so, they could be hurt by their holding in company stock. But the good news is that they have learned from failures like Enron:
Percentage of the average 401(k) held in company stock:
1996: 19% 2006: 11%
Source: Pension Benefit Guaranty Corp., Hewitt Associates, Employee Benefit Research Institute, AARP.