401K - The Lie

Monday, January 09, 2006
There is so much crap spewed about the 401K plan it drives me nuts. This was painfully evident to me when we last had our 401K meeting. I for one do invest a great deal of money into my 401K but I do it full well knowing how it fits into my overall financial strategy. (I am however about to drop my contribution to 0% for the next few months) Many people do not.

1. 401K plans make less sense for high-income individuals - How can this be? I mean don't the rich save more in taxes? It depends. If you remain a high income individual retirement, which is likely, than you will pay taxes at your personal income level. However, if you were to invest in the stock market instead, you would only have to pay the capital gains tax instead. This stands at 15% rather than the 35% you would otherwise get taxed.

2. You may end up paying more in taxes later - The US has historically low tax rates now. If you believe, like me, that the budget deficit, the trade deficit, aging baby boomer population are areas of major concern, than you probably believe that at some point, the U.S. will raise taxes again to cover the shortfall. That being the case, it is better to pay taxes NOW rather than pay higher taxes later. Also, in all likelihood, you will have less deductiosn than you do now. You will most likely have your mortage paid off, no child deduction, have less business expenses, etc.

3. Diversification - Most people just don't understand what diversication really is. It's kind of frightening really. They think diversification is just picking lots of the different funds in a 401K plan and that will handle diversification. This concept is just flat out wrong! In fact, people may be exposing themselves to much more risk than they expect when they follow such a strategy.

4. People who are investors who shouldn't be - Could you imagine if the government mandated everyone had to drive their own car to work but nobody had to take a driving test? There are enough crazy people on the road as it is, can you imagine if there were even more people who had no idea what they were doing. That is essentially what they did when they started 401K plans. Millions of people started investing in it but have no idea what they are really doing.

5. Your money is not liquid - Most people vastly underestimate the need for liquidity but it can be very important in times of financial crisis. The problem is that you are not able to withdraw funds in a 401K plan until you reach 59 1/2 without paying some significant penalties. If you were to take the money and invest it yourself instead, in the exact same financial products, you would be able to pull out your money at any time without penalty.

6. You have much more limited choices - You are at the mercy of your 401K plan in terms of what you can invest in. If you have your own IRA or just money in a taxable account, you have a lot more options in terms of what you can invest in. Maybe all the funds and investment choices in your 401K plan just suck, and you would be better off diverting your money into different vehicles.

Again, my advice is not to not invest in your company's 401K plan, my advice is to really Think About It. Don't just do it blindly because you think you should. However if the alternative is to save in the 401K plan or not save at all, then, of course, save in your company's 401K plan.


Anonymous said...

I agree from experience and as a seasoned investor buying stocks directly.
I'm 54 now, was laid off at 51, am job temping, and must deplete the 401k to
survive in "amreeka". Illegal immigrants have more security than I do.

The only way a 401k works is if ALL the following are true:
1. The company plan has the highest quality and variety of fund selections.
2. Company has matching stock contributions of at least 50%.
3. Company stock has continual growth and allows profitable dispersion into funds.
4. The stock market averages 10% annual growth up to, including, and after retirement.
5. The employee is guaranteed 30 years employment with the same company.
6. Income level provides enough disposable income for max annual contribution.
7. The 401k has a cash fund which automatically captures profit taking within the shelter.

For me, only 1, 2, 6, 7 were true for 10 years.
However, that's more than most companies offer and I was employed by one of the largest
corporations in the world! In some companies, 30 years of full contribution investing will
leave you with a maximum of only $30,000 for retirement!

It's a nefarious lie that sacrifices millions of hard-working amerikans to darwinian market forces every year.
FDR established Social Security for one purpose: GUARANTEED SECURITY FOR THE AVERAGE CITIZEN.
My late father lived through the depression and experienced loss of everything.
He said "FDR was elected 4 times for good reasons".

Your point about investment knowledge is valid, but even the smartest investors have been fooled
because investment dynamics changed with globalization and continue to change--I witnessed it from 1988-to the present.
In effect, there are no more rules: I cannot navigate by the fundamentals anymore, because there are none!

We are helpless regardless of who is in whatever political office.

The wolves are devouring the hens and the hen-house be damned!