OK, the 401(k) retirement system didn’t work. What’s next?

For years the conventional wisdom has been to plow money into 401(k) plans for retirement. Anyone who didn’t was considered a financial dunce. Well, so much for conventional wisdom. The 401(k) system has “serious shortcomings,” says The Wall Street Journal (“Big slide in 401(k)s spurs calls for change,” 8 January 2009). Employees have seen their retirement accounts drop, 20%, 30%, 44% in the economic downturn.

“This is the biggest test that the 401(k) plan has seen to date, and it has failed,” says Robyn Credico, head of defined-contribution consulting at Watson Wyatt Worldwide, noting that many baby boomers are ready to retire. “We’ve put people close to retirement in a very challenging position.”

The timing couldn’t have been worse.

[E]ven when workers make good choices, a market meltdown near the end of their working careers can still blow their savings to smithereens.

“That seems like such a fundamental flaw,” says Alicia Munnell, director of Boston College’s Center for Retirement Research. “It’s so crazy to have a system where people can lose half their assets right before they retire.”

The U.S. Congress is beginning to take a look at retirement and 401(k) policy, starting with an October 2008 committee hearing with a variety of witnesses.

Some proposed setting up “universal” retirement accounts, which would cover all workers. One such plan called for establishing accounts that would receive annual contributions from the federal government, and would offer a guaranteed, but relatively low, rate of return. Another proposed automatically investing contributions in an index fund that holds stocks and bonds, with the mix getting more conservative as workers approach retirement.

U.S. Rep. George Miller (D-Calif.), the chairman of the House Education and Labor Committee, recently issued the following principles for future 401(k) reform:

  • Expose excess fees that Wall Street middlemen take from workers accounts.
  • Bring young and low-wage workers into the system at a higher rate through automatic enrollment for employers already offering 401(k)s.
  • Ensure that retirement accounts have diversified investment options with low fees, including low-cost index funds.
  • Ensure workers have access to reliable independent investment advice.
  • Reduce vesting periods and improve portability of 401(k) accounts.

But is this just minor tinkering with a system still dependent upon the wildly fluctuating stock market (not much different from gambling)? Do we need more radical reform that provides a solid financial foundation for retirement?

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Top concerns of CFOs, 2008

The top external concerns of U.S. CFOs:

  1. Consumer demand
  2. Credit markets & interest rates
  3. Housing-market fallout
  4. Cost of fuel
  5. Cost of nonfuel commodities

Top internal, company-specific concerns:

  1. Cost & availability of labor [nonfinance]
  2. Ability to forecast results
  3. Cost of health care
  4. Supply-chain risk
  5. Data security

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Source: Duke University/CFO magazine survey of 475 U.S. CFOs, May 2008

Related:
June 2007 (previous post) What CFOs worry about
Most companies fail at forecasting earnings
CFOs predict: The top business risks through 2009

Maybe what we need is a Financial Services Corps

Melissa Koide, an analyst at the New America Foundation, has an interesting idea for helping low- and middle-income American households make more-informed financial decisions. The idea is to create a Financial Services Corps of financial advisors to counsel households on today’s rather complex financial landscape.

The policy proposal has four key elements:

  1. Enlisting financial experts and advisors to deliver personalized financial counseling and planning to low- and middle-income households;
  2. Providing the tools, resources, support to local, regional, and workplace-based initiatives to ensure these families are effectively reached;
  3. Collecting & analyzing data to understand the short-, medium- and long-term financial education, counseling and planning needs of these households; and
  4. Exploring new strategies and approaches to financial education & advice — through an innovations fund.

I have a few concerns, such how to make sure the financial advisors provide unbiased advice, i.e., not biased towards certain investment strategies where the advisor has a conflict of interest (e.g., gets a commission). I also wonder whether this will be a magnet for lawsuits, filed by families upset that the well-meaning advice ended up losing them money.

But I applaud the fresh thinking that went into this. It’s an improvement over the Bush administration’s volunteer initiative for financial literacy.

Continue reading “Maybe what we need is a Financial Services Corps”

In praise of organic growth vs. financial engineering

Research shows that mergers & acquisitions don’t produce the expected financial bonanza. But “organic growth” does.

The Batten Institute, part of the University of Virginia’s Darden School of Business, has released the latest results of a decade-long study of corporate earnings, establishing a correlation between organic growth and outperforming stocks. Using an Organic Growth Index (OGI), Darden professor Ed Hess compiled a list of “Organic Growth All-Stars” for the period 2003-2006. The conclusions:

In addition to consistent growth in underlying earnings, as measured by the OGI, the all-star companies’ share prices have outperformed the S&P 500 by a factor of 10 over the past 10 years.

Actual 10-year returns (1996-2006) for the OGI All-Stars were over 1,368% vs. approximately 130% for the S&P 500 Index and 144% for the Dow Jones Industrial Average.

“These companies have shown that they can grow in good times and bad. It’s not about the economic cycle. It’s about the business model,” Hess says. “Organic growth is growth the old-fashioned way: more customers, more products, better operating efficiencies,” he says. Not financial engineering or manipulation.

Hess identifies four key attributes of strong organic-growth companies:

  • Simple, focused business strategies, implemented by managers who are are “execution champions”;
  • Top management is home-grown and made up of “humble, passionate operators”;
  • A highly-engaged workforce characterized by a strong degree of loyalty and productivity; and
  • A “seamless, self-reinforcing internal growth system”

The study — and the list of 27 All-Stars — is available at this link. For some reason, the all-star list includes a couple of “dollar stores,” a couple of casual restaurant chains, a couple of big-box retailers, and the maker of Spam.