Take the Money and Run

By Wayne F. Currie

Some of you may have seen the above-entitled NBC-TV special "Dateline" recently. Tom Brokaw jumped hard on some corporate executives ? Global Crossing's CEO Gary Winnick in particular ? and generally accused everyone in the financial advice business of being self-serving and biased.

It was a pretty persuasive piece of TV journalism. It surely caused many of those watching, perhaps even you, to run out and redeem their mutual funds and fire their brokers.

However, when you consider that there are 10,000 or more public stocks out there, it seems a little irrelevant to general investing to concentrate on exposing a few bad apples when most of the barrel is fine. And it's such a complicated issue for the average investor, what is legal and what is not, that it's somewhat useless information.

Brokaw did not resolve the major problems: What should you do with your savings? What should a masonry business owner do in light of all this?

One tends to get defensive in a climate like this. Many of our parents were bank account, savings account, and money market investors. This is a serious challenge at the moment. For example, one of the major banks in my area sent out an interest offer on money market and savings accounts last week, offering between 0.8 and 1.2 percent per annum. A high yield for a Certificate of Deposit, nationwide, for a three to five year period, might be 2.5 to 3.0 percent per year, payable at the end of the period with penalty for early withdrawal.

This is not attractive to most people at all. Even the low inflation rates we have had over the past couple of years are equal to this kind of inflation rate structure, meaning that postponing purchases equals zero or less net return. Still, it may be better from some people's viewpoint than seeing their fund investments go down in value every month. The current market situation leaves most people with a 401(k) or an IRA wondering what they should do with their monthly contributions.

There was a significant amount of investor redemption activity in mutual funds in May and June. They call this capitulation. What it really means is that that many investors simply gave up. This forces mutual fund managers to sell stocks that have already declined 50 percent or more, to pay out cash to investors, further pushing the market down. Now the market, the New York Stock Exchange and NASDAQ should be near the bottom.

What I want to do in this article is to identify what masonry executives and employees can do with their savings safely right now. Where can you re-deploy your much reduced portfolio assets to best take advantage of the likely recovery, and how can you go about doing so?

First, the important thing for most of us is that Congress has set up the right for businesses to establish deferred profit-sharing plans and pension plans of different types for their employees. Investing pre-tax dollars is the key to success, if at all possible.

This can be done as a Simplified Employee Pension Plan (SEP) for smaller employers and self-employed individuals (usually with no more than 25 employees). This plan allows participating employees to deposit up to 15 percent of their pay or a maximum of $24,500 in 2002 as a payroll deduction, without having any matching funds from the company. This maximum figure will increase slowly until it returns to the 2001 level of $30,000 in 2008.

Companies can contribute to this on a matching basis, up to 15 percent of gross payroll level, if they so agree. Company contributions will depend on profits and the amount contributed by employees. Total contributions for both employee and employer cannot exceed $24,500 in 2002.

The costs of such plans, with brokerage firms such as Incentive Capital, are usually minimal, generally $35 per year. Each participant selects their investments and employees will generally be asked questions to categorize their risk profile and long-term objectives.

Over a 10-to 20-year period, with no attributed growth on assets, you may find certain employees can set aside, on a tax-deferred basis, a maximum of $480,000, "maxing" out contributions for management or key professional employees. Important is the tax-deductible nature of the contributions which continue to accrue free of tax inside the plan until withdrawn.

The IRS has also set limits on the total amount that may be contributed to your 401(k) account from all sources combined, including any employer matching or profit-sharing contribution, and any employee after-tax contributions. For 2001, the maximum was the lesser of $35,000 or 25 percent of your total compensation. For 2002 the maximum is 100 percent of compensation or $40,000, whichever is less. The $40,000 limit will increase in $1,000 increments based on cost of living adjustments.

Depending on plan rules, you may become eligible to make salary deferral, pre-tax, catch-up contributions beginning January 1st of the year you turn age 50. These contributions are in addition to your regular deferral contributions. Catch-up contributions start at $1,000 for 2002, and increase by $1,000 a year until they reach $5,000 in 2006. Thereafter, the maximum amount will be indexed in $500 increments.

To make sure that an employer's 401(k) plan does not unfairly favor its higher-paid workers, there are also rules governing highly compensated employees, or HCEs. The term "highly compensated employee" may include a person who was a five percent owner at any time during the current or prior year or an employee who earned more than $85,000 in 2001. An employee whose salary ranked in the top 20 percent of the company's payroll for the prior year might also be considered an HCE.

Generally, to make sure a 401(k) plan is compliant, each year the plan must pass a non-discrimination test. (Note that some plans are designed so that they do not need to pass these tests each year.) These tests generally compare the amounts contributed by and on behalf of highly compensated employees to those contributed by and on behalf of the non-highly compensated employees. As long as the difference between the percentages of these two groups is within the Internal Revenue Service's Codes guidelines, the plan retains its tax-qualified status. If the plan does not pass the tests, the plan must take corrective action or lose its tax-favored status.

Similarly there are some benefits regarding access to the money and additional contributions to setting up a small company "Defined Contribution" 401(k) plan. The contributions, up to 15 percent of gross compensation with a maximum of $30,000 per year, are tax deductible to employees on a salary reduction plan, and the participating contributions by the employer may not be necessary, depending on choices in the plan document.

Generally, the "boiler plate" documents most investment companies already have to help you set these up ? usually available for under $200 ? will contain borrowing privileges that most employees will find attractive as they invest over time. This benefit allows participants to take out a loan from their accumulated contributions to help with house buying or educational challenges. They can simply pay these loans back later with interest, which of course is going to their own investment account. Each member of the plan has a segregated investment account from which you can direct where you want your contributions invested.

In summary, the real opportunity here is to use the pre-tax dollar to build a significant equity position over a long period of time. If we assume that anyone who is able to contribute a maximum amount is paying tax at the 35 percent rate and possibly a state income tax on top of that, we might be deferring tax of 40 percent on each dollar contributed today to be taxed later, say in 20 or 30 years.

This is an important point because your normal taxed dollars are representative of 60 percent of funds invested. The tax department is, in essence, giving us the 40 percent to invest until later, when we start to draw it out as a pension or a lump sum distribution after age 59.

Thus, if you had a 50 percent drop in your 100 percent contribution, 40 percent of which were deferred tax dollars, you have only lost 10 percent on your own money. Investing outside pension plans or IRA's is a lot more expensive in a down market, even though the future growth on pensions and IRAs will be taxed.

Looking then at what the average person should do with the funds they do save, you should anticipate that a diverse selection of beaten down mutual funds we referred to above, will be the best choices for most now!

Large fund groups, such as Berger, State Street Research, Eaton Vance, Nuveen and Franklin Templeton are examples of fund families with many alternative fund groups that have had quality records in past markets. And, believe it or not, there are phenomenal opportunities for you to reposition into some of these fund groups now. But you do want to look at all the funds in each family. Once you are in, you may need the flexibility to move from one fund to another inside the fund group, usually a free transfer.

Those who are familiar with the Internet can gather information from Morningstar.com on different fund groups. The key thing is to be buying into funds that have consistent long-term performance over a 10-to 20-year period, perhaps 12 to 15 percent, year after year except for exceptional years. In addition, it is important that these fund groups have a couple of dozen choices in different investment sectors, so that when a bad year comes along you can move your investment sideways within the fund group with no penalty.

Now mutual funds offer A, B, C, D and E shares. Generally the "C" shares get you 100 percent of your dollar invested today and don't charge any fee at all except for a 12(b)1 fee unless you sell out of the fund in the first seven years or so.

While there are some funds that only offer A and B shares, which will charge an upfront sales fee, studies have shown little correlation between non-sales charge and upfront sales charge funds. Therefore, making a decision on something because it has a sales charge or not is probably not valid.

Key indicators of success are a long-term management team and consistent year in, year out returns that are beating the sector indexes in the target sector. We need to be looking at positioning a portfolio right now, into the following areas: Large Cap Growth, Large Cap Value, Mid Cap Value, Balanced Growth and Income, High Yield Bond and Small Cap. The percentage of your money you want to put into any one sector will to some extent depend on your own perception of what will happen next in the economy, the political landscape and company earnings.

Consider this: 2002 is the first year in a very long time that the economy has had very low interest rates (1.75 point Federal Funds Rate), a tax cut (did you get a check?), and increased government spending (returning to deficit again). The dollar, due to our low interest rates and the market crash, has been declining against foreign currencies, making it more attractive to sell things made in the USA to foreign countries. According to Treasury Department statistics, the economy actually grew by four percent during the first six months of 2002. In short we are already technically in recovery.

In short, my advice is: If you have put your money in a money market or savings account for shelter while the market went down, get back in now! Choose from the selected mutual fund groups above or call a financial planner to assist you. This may be the best single buying opportunity to get into selected sectors in the past 20 years. Among funds I have been suggesting ? State Street Research Aurora, Berger Small Cap, Eaton Vance Worldwide Health Sciences, Davis Financial and others ? may be consistent opportunities for positive growth.

My overall reaction to Tom Brokaw's "Take the Money and Run" is that you may want to take it as far away from Brokaw as possible and run back into the market, carefully, in order to participate in the next big bull market.

Some people believe that Allen Greenspan will retire in 2004 and is going to hold down interest rates to make sure the economy is booming as his legacy to the future. Using "60 percent dollars" to buy in now, you should have 200 percent of your investment in your retirement accounts by 2004 ? if the impact of fundamental economics maintains the usual result 24 to 36 months after government action of this type.

This figure is derived in the following way: Your investment ? in other words 100 percent of dollars invested ? should double by 2004-05 (i.e., a 100 percent return based on market recovery). The actual cost in savings by investors of this 200 percent is 60 percent (the out of pocket amount invested) the rest of the money is tax dollars saved by the deduction itself. So the real return on savings while tax sheltered is 333 percent of cost (if achieved at that level). Now you can see why most people need the services of a professional planner! This can be confusing.

For those of you who are business owners and employers, setting up tax deferred retirement plans is an attractive way to keep employees in a competitive marketplace. Doing it now if you haven't yet would be a timely step toward your own better financial future.