Your employer may be stealing from you!

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“Oh, little 401k, how I hate thee … let me count the ways” (2008, Anon.)

I don’t know who first uttered these words ūüėČ but, they strike a chord with me; here are some (admittedly, slightly cynical) reasons NOT to like the humble 401k:

1. Little or no choice of investments

2. Have to wait to traditional retirement age to receive the benefits

3. Stuck with low-returning investment choices

4. Little or no opportunity to ‘gear’ (I guess the employer match and tax benefits counts as a kind of gearing)

5. Fees

6. Your employer may be ‘stealing’ from you

Stealing?!

Yeah, in a way … but, first let’s take another quick look at fees [AJC: Inspired by a comment left on a post by Dustbusterz … thanks ‘Dusty’!]; in 1998 (!) the Department of Labor received and published an independent Study of 401(k) Plan Fees and Expenses.

It found the following average fees being charged by the larger 401k funds:

Total Annual Plan Fees

Lowest       0.57%
Mean         1.32%
Median      1.28%
Highest     2.14%

(Source: Butler, Pension Dynamics Corporation, in Wang, Money, April 1997)

Now, this goes back to 1997, but I just covered some very recent work by Scott Burns, noted financial columnist, and published in his new book, Spend ’til the End, which points to the fees continuing to trend up, citing average (mean? median?) fees of 1.88% now.

Remember that, according to Scott, even a “1% increase in a fund’s annual expenses can reduce an investor’s ending account balance in that fund by 18% after twenty years”!

I calculate that a 1.88% fee reduces your returns after 20 years by a whopping 38%

But, do you know how your employer actually chooses your funds / 401k provider? On the basis of better returns to you? Given the possible 38% ‘hit’, you would assume at least on the basis of lowest fees for you?

Right?!

Nope … not a chance. In fact, the study quoted an earlier report that found that “78% of plan sponsors [employers] did not know their plan costs” (Benjamin) …

… Great! You are putting your financial future into the hands of your employer, 3/4’s of whom don’t even know what the plans that they are choosing will cost you!

So how do they choose the plan that’s right for you [AJC: ironic snicker]?

The study found, one of two ways:

1. In my opinion, an unethical way: The Study of 401(k) Fees and Expenses quoted a prior report that found employers most often choose “the institutions that furnish the firm other financial services – banking, insurance, defined benefit plan management – to provide their 401(k) plan services and may not make an independent search for the lowest cost provider.”

Your employer feathers the bed of their own business relationships with your retirement money. Nice!

2. In my opinion, a criminal way: That would have been enough for me, if I hadn’t accidentally come across what is regarded as the Retirement Industry’s ‘Big Secret’ … it’s a doozy: it’s where the 401k provider shares some of the fees that you pay them with your boss!

Think about it; your employer provides you with a match to encourage you to remain employed then gets back some of that in fees, rebates, ‘free’ services, or just good old ‘relationship building’ at your expense, literally!

How do the funds and your bosses get away with this? Simple, nobody’s looking: “Revenue sharing is a poorly disclosed and relatively unregulated practice, which falls into the gap between Department of Labor and SEC oversight.”

OK, so does this mean that you shouldn’t participate in your employer’s 401K?

Not at all … it just means that you should do the following:

1. Decide if the 401k is going to do the job for you … will it get you to your Number? At a maximum ‘investment’ of $15,500 per year and a compound annual growth rate of 8% – 12% less fees, this is highly unlikely … you run the numbers then make your choice!

2. If not, is it still wise to continue your 401k (consider it a backup plan) as well as more aggressively investing elsewhere?

3. If you can’t do both, you have no choice but to decide which investing strategy is going to have to give way to the other?

4. If you do decide to continue with the 401k, choose any ultra-low-cost Index Fund option that may be on offer over any other selection; if not available, choose a ‘no load’ fund (be careful … some ‘no loads’ are actually just ‘lower load’). And, do your own homework on fees, because you just know your employer ain’t doing it!

5. Lobby your employer to pass back any revenue-sharing back to the employees

6. Insist that your employer choose funds that work best for you over the funds that work best for them.

What you do with this information is entirely up to you; I don’t need a damn 401k … never have and never will ūüėČ

A different way to diversify …

Despite my apparent posts to the contrary, I think it is OK to diversify, but only when you have reached your financial goals (i.e. Your Number) – or, are damn sure that lower/diversified returns are going to get you there – and are transitioning to Making Money 301, when you are trying to protect your assets.

Even then my perspective of what constitutes ‘diversification’ is probably very different to what common wisdom would suggest. However, today, I want to look at a different kind of diversification …

Let’s start by looking Bill’s comment:

I guess you are trying to espouse that one must FOCUS on ONE thing which creates the abundance of ACTIVE income and then leverage further to create PASSIVE incomes via real estates…

Focus is indeed a great way to build wealth … you pick something that will give you the best return (at least, one that you believe in your heart-of-hearts) and ride that sucker until it proves otherwise!

You don’t need to diversify your wealth-building activities: it can halve the outcome – or worse, you actually double your chances of a (partial) failure!

But, when it comes to passively investing the proceeds diversify away!

Don’t leave all of your profits in the investment that is generating the wealth – here’s just one example:

You have a business operating out of a shop, warehouse, or office: a simple way to diversify is to use the income from the business to buy the premises.

If you ‘go under’ you can simply re-rent the premises to somebody else (if you buy well, and hold a cash buffer against such a disaster). And, if you sell the business, you have tenants – with a business that you could always take over again, if they bust!

Similarly, if you have any kind of business (or job, for that matter … which is simply a business where you are selling your time on a pre-determined contract on a semi-exclusive basis) you invest some of your income.

But, this is an example that is NOT diversifying: you have a business operating in one geographic area and you reinvest the proceeds of your business into opening up new locations. You will find that your empire can unravel due to some unforeseen circumstance as quickly as it was created … then, where is your backup.

I started real-estate investing, using the income from my businesses before I started expanding my businesses internationally. I already all-but-completed my 7 million dollar journey before I even had a business that was able to be sold (eventually) … and, I did it all on the same income that any reasonably-well-paid professional can claim.

The advantage of this kind of diversification is that I had built a backstop for my business, in case my expansion plans backfired.

No the diversification that I am talking about is to:

1. Focus on one area in which to create income, and

2. Focus on one other area in which to build (passive) wealth.

I would be happy with just one business and one – bloody big – office building. To me, that’s diversification enough!