Your Nest Egg in Volatile times

Seems like wherever we turn, we are at risk of losing our hard earned savings. Interestingly, it is just that volatility that makes them attractive. We have all heard the adage, no pain no gain.

We have spent a great deal of time lately dwelling on potential changes in Florida Retirement System benefits.  Since the legislative session is over until next winter, we can breathe easy at least until then.  In the meantime, the news is full of dire financial news and predictions.  We are in year three of a terrible recession, and the devastating crash in real estate prices has set us all back a few years.   So what is a person to do to try and protect their nest egg?

In order to discuss how to protect one’s nest egg, we should probably start with trying to figure out what risk is, and how do we deal with it.  For this discussion, let’s define risk as the possibility of losing money!  Does that sound fair?  The legislature has added risk to our pensions by threatening us with the loss of benefits we thought were secure.  The real estate market has become risky as the value of our homes has declined, and the stock market goes up and down on a regular basis.  Seems like wherever we turn, we are at risk of losing our hard earned savings.  Interestingly, it is just that volatility that makes them attractive.  We have all heard the adage, no pain no gain.  Without risk, there can really be no reward!

Over the last twenty five years, I have witnessed some seemingly cataclysmic events – all having dire consequences on savings and investments.  Remember the stock market crash of 1987?  That was probably my first real taste of risk.  I was old enough to have some assets and investments and remember being horrified that they were losing money so quickly.  When something like that happens, it is easy to err on the side of fear, and sell into the panic.  The fight or flight mechanism kicks in and since we don’t really understand what is going on, we run!  Unfortunately, as often as it happens – we know it will be a mistake.  The average investor buys when they should be selling, and sells when they should be buying.  After several hundred years of experience, we know that time will cure most of the markets ills.  The crash of 1987 was regained in a mere two years.  The fall after 9-11 took less than six months.  Even the devastation after the fall of Lehman Brothers in September of 2008 triggered the worst financial panic in our history was regained in about 18 months.  The Florida Retirement System Pension plan has rebounded to $118 billion from a low of $83 billion (Current FRS Plan Balance).  Had you sold into the panic, those losses become real, with no real way of regaining your losses.  On the contrary, had you maintained your holdings in a well diversified portfolio, you would have been made whole in relatively short order!

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Should FRS drop the D.R.O.P?

When the DROP was initiated, 6.5% was about 125% of the then 5.25% five year Treasury bond rate. With the yield on the five year T-bond down to 2.5%, the same 125% premium would put the DROP rate at 3%. If you survey other states with DROP plans, you will realize that 3% is a pretty common rate.

Since potential legislative cuts to your retirement benefits are nearly inevitable, we thought it might be educational to discuss your Florida Retirement System Options, and what changes might be made.  More importantly, we want you to understand how they might affect you!  We will begin this week with the scoop on the Deferred Retirement Option Program (DROP).   (For an overview of the DROP program, please see FRSOptions.com)

Back in 1998, when the Deferred Retirement Option Program was initiated by the Florida Retirement System, the world was a different place!  The Stock Market was on a roll; having just completed a 10 year run that averaged 19.21% per year.  The 5 year Treasury bond was paying about 5.25% and the coffers of the Florida Treasury were flush.   Skip ahead to the beginning of 2010 and the stock market has just completed its worst 10 year stint in history, and has a net minus 2% return over the last 10 years.   The 5 year treasury is only yielding 2.5%, and the Florida Treasury is facing a revenue shortfall of some $3 billion.  A shortfall that is growing, and expected to get even more dire in the foreseeable future.

The Florida Legislature is faced with the daunting task of cutting the budget to meet the shortfall in tax revenues due to the monster recession, and the Florida Retirement System is facing its first year of underfunding in over a decade.  The”Sunshine Review” of the State Budget has a succinct outline of the budget situation.  Suffice it to say the politicians see employee pension plans as a cherry ripe to be picked.  By focusing attention on the temporary underfunding of the FRS pension plan, it seems to have made your retirement benefits an easy target for spending cuts to help balance the state budget. Despite the fact that FRS is one of the most solid Pension funds in the US.  You can expect that the legislature will be looking harder and deeper next year, and will most certainly put your retirement benefits at greater risk.

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DROP Rate Dropped!

the document states the interest rate paid on DROP will be reduced from the current 6.5% to a new rate of 3% for all participants who enter the DROP on or after July 1, of 2010. W

The fears we voiced on Monday have come true on Wednesday.   In a document we secured today, which was introduced this morning at 10:00 am, titled “State Budget Conference Chairs bump issues Senate offer Conforming and Implementing Language” (click on the title to be directed to the link) has some last minute introductions that were claimed to be tabled.

Line 1 of page 7 of the document states the interest rate paid on DROP will be reduced from the current 6.5% to a new rate of 3% for all participants who enter the DROP on or after July 1, of 2010. We have further confirmed that this is already in the budget, so it appears to be a done deal.  At 3% the Deferred Retirement Option Program loses its attractiveness as a viable retirement option.  We will address this in detail in a later post.

The following lines of the document spells out that the door will be open for EMPLOYEE contributions beginning in 2011!  This would indicate that your contributions are already in process, and it is simply a matter of how much you are to contribute.

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Florida Retirement System – Should I Drop? – Civilian Participants

With the Investment Plan, employees can opt out of the pension plan at retirement, and transfer the entire value of their retirement benefit into the Investment Plan. This is known as a “lump sum rollover”.

So … Should I Drop ????? for Civilian participants.

Before we decide, let’s take a look at why we even have a decision to make. FRS added the DROP program to the Pension in 1998 as a way to induce employees to work longer. Prior to 1998, an FRS participant had no options – they retired and received a monthly pension check.  End of story!  FRS further expanded the range of retirement options in 2002 with the addition of the FRS Investment Plan. This change was significant! Now a FRS Participant has several different retirement options to choose from.  There is still the basic Pension, there is a combination Pension and the DROP (Deferred Retirement Option Program), and after 2002, a third alternative whereby you can participate in the FRS Investment Plan, and take control of how your retirement money is invested.  You also have a fourth option, which is to “roll the current value of your retirement into a self-directed IRA account at retirement.

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