[continued from yesterday]
Now, I’m not particularly proud of this … but, it is true … I have no idea how much is in my retirement accounts; and, I didn’t even bother opening my own 401k account as CEO of my last company!
Why?
Yesterday, I wrote about the costs that can build up in the ‘food chain’ of the investing world, showing that merely accounting for the cost-differential between a typical mutual fund and a typical low-cost index fund can account for 20% of the performance of your entire investment portfolio after just 10 years.
I also, mentioned that I don’t like any of these products (even low-cost index funds, even though I will recommend them to lay-investors), primarily because of lack of control and too much diversification (who ever got rich from diversifying?!) …
So, the second part of this post will, hopefully, tell you why I don’t worry about 401k’s and Roth IRA’s as well as address a question that I recently received from a reader who asked:
Any suggestions on a strategy to use for retirement accounts if you earn beyond the limit for a 401k and Roth Ira? I have no company match for a 401k … get hit hard in taxes and have discovered that there is an income limit to a 401k and Roth IRA. Any suggestions?
Well my simple suggestion is: don’t …
The only time that I invest in a retirement account is when my accountant says:
“AJC, you have too much income flowing in, we had better plonk some into your [401k; Roth IRA, Superannuation Plan, whatever]”.
Yet, using a tax shelter is saving money, and as yesterday’s post showed, even a small difference in cost can add to a big difference in outcome … so, what do I really recommend and why?
If you still have plenty of working years left, I don’t recommend that anybody invests inside their company 401k except to get the ‘company match’ (who can argue with ‘free money’… yee hah!)
I also don’t recommend that anybody – who still has 10+ years of working/investing ‘life’ left – invests inside any tax-vehicles (such as a Roth IRA) etc. UNLESS they can:
(a) Choose their investments, and
(b) leverage those investments.
By choosing, I mean the whole gamut of what we want to be investing in: e.g. businesses, stocks, real-estate, and ???.
Now, in practice, these 401k/IRA’s are limited, so if you don’t intend to invest in some/all of these classes of investment or you have so little money to invest that you can ‘fit’ the whole or part of your intended, say, stock purchase strategy into one of these vehicles then, absolutely … knock yourself out!
Therefore, for most people, it’s still possible that a 401k or Roth IRA can provide an important place in their investing strategy … simply because the amount that they have to invest is so small …
… even so, they should go ahead only if it doesn’t limit the scope of their overall investing strategy, hence returns!
And, we should all know by now that primary importance of your investing strategy should be set on maximizing growth unless:
i) You are within a few years of retirement, when you no longer have time to take risks and recover from mistakes), or
ii) Have such a long-term, low-value outlook that simply saving in a 401k will do the trick (in which case, invest to the max.).
Just remember, this blog and my advice isn’t for everyone … it’s only for those who need to become rich …
… which usually means getting into investments that:
1. You understand and love, and
2. You can grow over time, and
3. You can leverage through borrowings.
If it doesn’t meet all three of these criteria, I simply don’t invest!
Direct investments in businesses and real-estate are the investment choices of the rich because of these three criteria… stocks to a lesser degree (you can only ‘margin borrow’ up to 100% of these, so the amount of ‘leverage’ that you can apply is lower than for, say, real-estate) … and, Managed Funds even less so (you can margin-borrow only on some of these, and only from limited sources).
For me, the limits that tax-effective vehicles place on me, and the maximums that I am allowed to invest in them, automatically reduce these typical ‘tax shelters’ to a very minor position in my portfolio … so minor, that I allow my accountant to manage them for me, totally.
Remember, though, that they only became a minor portion of my portfolio because I followed the advice that I am giving you here when I was still early into my working/investing career!
Now, I hope that (eventually) you, too, will have so much money OUTSIDE your 401K that whatever is INSIDE will be insignificant for you … in the meantime, at least invest for the full company match.
Pretty controversial? Let me know what you think?
Most PF bloggers are too much into putting money into retirement accounts. The key problem for me is the money is locked up for a long time. In the US penalties apply for taking it out early, in Australia it is pretty much impossible till age 55 and basically you need to wait till 60. The advantage of Roth IRAs are that contributions come out again with no penalty and there are some nice homebuying features. It makes sense of course to meet any match. It also can make sense to add a lot more as you near age 60. In Australia you can get a lot in in your 50s and then have low to zero taxes on it going forward. But I really don’t understand people in their 20s stuffing all their savings in there just to get a “tax break”. People do lots of irrational things for tax breaks.
@ Moom – Thanks! Of course, in Australia you have no choice, and the employer is LEGALLY BOUND to put something approaching 15% of your GROSS into your version of a 401k (called Superannuation) with absolutely NO contribution required from YOU, the employee …
… that’s a pretty good return. I would just be dubious about adding to it, unless, as you suggest you are getting close to retirement age.
Although, I know that the Aussie Government recently reversed a previous ruling: now you CAN borrow inside your Superannuation Account to buy, say, real-estate. So, as an investment vehicle, the Aussie system is improving …
I do the 401K for the match since it’s an instant (aka vested) 75% return. I have also set up a Roth IRA with Scottrade which is where I purchase individual stocks. I dig the Roth since the income/dividends aren’t taxed and I can pull out my contributions at anytime if something more lucrative comes up.
That’s the extent of my retirement account usage. Real estate and other things are much more interesting than plowing more into a tax deferred long-term savings/investment plan.
@ Fiscal – spot on … thanks for the real-life example!
This strikes me, in a good way. I am about to be eligible for the 401k at my company. I was almost eligible for the enrollment period at the beginning this year but I was a few days short. This coming June I’ll be able to open up my first(!) 401k. I’m also thinking about the Roth-IRA as well and not too long ago, before I knew I would be hit hard by the tax bill, I was so contemplating on starting the Roth-IRA.
You are right, AJC, to state that
“Just remember, this blog and my advice isn’t for everyone … it’s only for those who need to become rich …”
Normal people who cannot think of anything else better (and safer) than sticking their money in the funds. But to give some credits, it actually requires a level of financial competency and some work/research to be able to do that. Most people are afraid of learning how money works and how to achieve different goals through different investment instruments. If it requires too much work then far fewer people would even start thinking about investing.
Personally, after reading your advices, I would sit down and re-evaluate my strategy: where I should allocate my money to be both safe and aggressive at the same time. By safe, I mean a strategy which guarantees the retirement money when I am 65 (don’t want to get there, but life will always be too fast). With the aggressive investment, my goal is to increase the passive income significantly. I think your advices are really geared towards “be smart and handle your investments”.
Correct me if I’m wrong, what you are really saying is: instead of saving diligently and sticking $30,000 into a fund, maybe that same $30,000 can be used as a down payment for a rental property that will both appreciate and generate cash flow. This scenario will work or not depending on the evaluation of the situation, but ultimately: the goal is to maximize the return of investments. The safe way of 401k will not always be the wisest choice when I am young and can tolerate more risks. And since I can tolerate more risks, I can also use leverage to boost the return rate (e.g. getting equity out of the house and go for the 2nd one, etc.)
For sure I’ll have a different mentality when it comes this June for the company 401k.
@ Alex – it’s common-sense (not financial advice) to join the 401k UP TO the full company match … whatever they give you is like a ‘free’ 1st year ‘boost’ to your return. What people don’t tend to factor in, is that you then have to average that over the life of the 401k; over the long run the ‘return’ may tend to cr*p, compared to what you can get elsewhere.
I think I need to analyse your “that same $30,000 can be used as a down payment for a rental property that will both appreciate and generate cash flow” suggestion and post on this.
controversial? This article was absolutely controversial and thats why I come here.
if you want extradinary results you need to make controversial moves, a.k.a “taking risk”.
@ Josh – Thanks for that ‘vote of confidence’ … marching to the beat of my own drum is one thing … but, when I write, it’s obvious that I’m sometimes swimming with – but usually swimming against – the Personal Finance ‘stream’. We’re all salmon here!
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