A couple of weeks ago, I wrote that investors should expect the market to rally going into the last month of the year. For several days after my forecast appeared way off base as the major indices dropped. Now the market has rallied for three straight days and the major indices are higher than when I made that forecast. But the amount of weakness shown by stocks in the past couple of weeks makes me nervous.

I still think it is likely that this rally will continue and the highest market levels of the year will probably be seen in December. But I also think investors and traders are very nervous and there is likely to be serious downward volatility on days when economic news is bad. I also would not be surprised to see a significant sell off in January.

For now I would continue to hold onto long positions, but caution is warranted. If major indices struggle in the early part of December, the best course might be to start taking defensive positions.

Understanding your self-directed retirement plan

Prior to the Employee Retirement Income Security Act of 1974 (ERISA), companies that offered pensions to their employees were usually in charge of how those pension assets were invested.  That didn’t always turn out well. Corruption and defaults prompted Congress to make some changes. The result included several types of defined contribution plans where the employer, employee or both contribute to an employee’s individual retirement account. These plans include 401Ks, Simple IRAs, SEP IRAs, profit sharing plans, and more. 

At first, most companies that offered these plans still made the decisions about how they would be invested. The assumption was that employees weren’t smart enough to make sound investment decisions. As things turned out, many of the people overseeing the plans did not make great decisions, either. As a result, today most companies have adopted defined contribution plans that allow the employees to choose how their plan assets will be invested. 

If you work full time, chances are you are participating in some type of defined contribution plan or at least have the choice to participate. From plan to plan there is a wide variation in the types of investment options available to plan participants. Obviously, this will have a direct impact in how the plan assets perform over time.

For example, my wife is an educator. In addition to her state sponsored retirement, the school district she works for offers her the opportunity to contribute to a 401K plan. The district contributes an amount equal to .25% of her salary each year. That doesn’t amount to much, but anything is better than nothing. My wife also makes a tax-deferred contribution to this account each month. That means the money comes out of her check before taxes are withheld.

Her 401K plan is totally self directed. In other words, she decides where the money will be invested and how it will be allocated. She is restricted, however, to the investment selection offered by the plan. In this case, she has about 20 investment options. She is allowed to change her allocation once per month.

You might be wondering where the plan comes from and who decides what investment choices will be included. In this case, the plan itself is actually a variable annuity created and offered by an insurance company. The investment offerings are determined by the insurance company and are variable annuity sub-accounts. The best way to describe a sub-account is that it is essentially a clone of a mutual fund offered through the insurance company.

To obtain these sub-accounts, the insurance company contracts with a mutual fund company to create clones of some of its existing funds. The sub-account might even have the same name as the fund it is replicating. But because it is a duplicate and not the original, there will be differences in performance. Even though it is the same manager, execution times might be slightly different, the amount of money the manager has to work with will be different, and there could be differences in trading restrictions. So when someone owns Fund A in his 401K account and he checks the year-to-date performance on Yahoo!, it is likely to be different that what is reflected on his account statement.

In contrast, the defined contribution plan offered by my employer is a Simple IRA. In this case, instead of coming from an insurance company, my plan is set up through Fidelity, a brokerage firm. I can choose virtually any investment option available through Fidelity for my plan. I can purchase stocks, Exchange-Traded Funds (ETFs), regular mutual funds, and more. In this case, the mutual funds I buy are the real funds, not clones. I can change allocations any time I want, but I am subject to fees and penalties imposed by the investment vehicles and by Fidelity.

Most defined contribution plans are going to fall between these extremes when it comes to the number of investment choices that are offered.

The real challenge is deciding where to allocate the assets that are in the account and how often to change those allocations. I’ll provide some advice on that subject in next week’s blog. 
F.S.

If you would like an investment strategy that attempts to minimize risk but still provides the opportunity for solid growth, check out the Foundation Strategy from Strategis Financial Group.  This actively managed strategy is designed to take advantage of the experience and expertise of some of the nation’s best mutual fund managers. To learn more, call me, Flint, at 800-279-3377.

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