The Three Buckets Principle

Whenever new technology enters the world there are two inevitable emotions: excitement and fear. The thrill of new possibilities tempered by fears of new tech failing to live up to the hype. Take, for example: Robo-advisors. A great example of the complexities surrounding emerging tech, Robo-advisors provide automated digital financial advice based upon algorithms and/or mathematical rules.

When Robo-advisors launched in 2008 they were heralded as the dawn of a new era in financial planning. Some experts even believed this advancement signaled the end of financial planning (and real, human financial planners) as we know it. Not so. Over a decade later Robo-advisors are still around; however, they have failed to take over the financial planning world as predicted and in fact many are shuttering their doors or seriously scaling back on size.

So what happened? Why did Robo-advisors fail to eliminate the role of humans in the financial planning process? At the end of the day, it comes down to human connection. While an algorithm can crunch numbers, make predictions, and even offer investment advice, it cannot form impactful and lasting relationships like a real human. Investment selection and management is a part of what financial planners do – but that is only the tip of the iceberg. Real, effective financial planners are there to prepare you for and coach you through life’s unexpected inevitables. What happens when some life event inevitably occurs or you have a pressing question about your financial plan and when you try to get an answer you reach an automated phone tree that leads nowhere? Unlike a Robo-advisor, a financial planner is a real human available to provide advice and support when you need it. Think of them like a coach for your finances!

True, a human financial planner may cost more than a Robo-advisor. But in return they provide much more value. A study conducted by Vanguard found that working with a financial planner can add about 3% to client returns with 1.50% of that coming from behavioral coaching (that’s half the value coming from coaching alone!). When you start working with a planner you are not simply hiring an investment manager. Instead, you are partnering with someone who will work with you as life evolves to achieve your unique priorities. As you progress along your financial journey you form a trusting relationship with your advisor, so whenever you have questions or concerns you know there is a real human you trust who will answer the phone and provide clarity for you.

Let’s talk about employer loyalty. For much of the 20th century, Americans (by and large) followed a standard script: enter the workforce and work for a single company for decades, then throw a retirement party at 65 and cash in a pension – a reward for years of company loyalty. This pension provided retirement income; usually, a percentage of the yearly salary the employee earned while working. American Express established the first corporate pension plan in the US in 1875. By 1960, about half of the private sector employees had a pension. Of course, in 1960 the average life expectancy was 67, meaning that if you retired at 65 (standard at the time), the average pension only had to provide income for two years.

Since 1960 there have been many advances in modern medicine raising average life expectancy to 79. Suddenly, plans designed to cover a few years of post-retirement income were expected to cover retirees well into their 80s and 90s. Companies offering pensions began to realize that their retirement plans were becoming increasingly – sometimes prohibitively – expensive to fund. As pension expenses continued to rise towards the end of the 20th century, many companies were forced to design new systems to ensure their employees were financially secure come retirement.

The 401(k) plan hit the streets in 1980. The employer-sponsored retirement plan was rolled out as a replacement to traditional pensions and has since become the most common retirement savings mechanism in America. In essence, the 401(k) provides a tax-deferred way for employees to set aside wages for retirement. Employees elect to divert a certain percentage of their income each year to a 401(k) account. The diverted funds grow tax-free in that account until the employee retires.

In addition to providing the account, most companies offer a savings-match system. For instance, in a 3% match system, the company would match up to 3% of an employee’s elective contributions to their 401(k) account. The employer match provides a strong incentive for employees to start planning for retirement. If an employee doesn’t divert AT LEAST the match threshold into a 401(k) they miss out on the employer match – in other words, they lose out on free money from their employer.

Let’s talk about the benefits. Funds in a 401(k) account are able to grow tax-free. Because growth is not disturbed by capital gains taxes, accounts are able to grow faster than a standard individual account. Of course, there’s always a catch: money in employer-sponsored plans – like a 401(k) – cannot be withdrawn prior to age 59 ½ without paying penalties. Most plans offer options for the participants to increase their contribution rate on an annual basis, and small increases in contribution rate (even as small as 1%) year over year can make a huge difference by the time you retire.

Contributing to employer-sponsored retirement plans such as a 401(k) or 403(b) – the non-profit version of a 401(k) – is a vital part of preparing for retirement. The money is automatically deducted before your paycheck is cut, making it easy to budget and painlessly save for retirement at the same time.

Contributing to employer-sponsored retirement plans is an essential step towards retirement planning – but it is only the first step.

Please contact me at zach.swaffer@trilogyfs.com if you are interested in discussing the next steps you can take to ensure retirement security.