Recently I wrote a post that challenged the ‘Set It And Forget It 401k Brigade’ to at least rethink their strategy instead of just automatically maxing out their 401k …
… in doing so, I mentioned that there was a ‘hidden risk’ in your 401k.
Whilst the 401k proponents put forth all the wonderful, low risk arguments in favor of 401k’s (quoting long-term market averages of 12%+) they conveniently forget:
1. Fees: Figure around 0.5% – 1.5% in fees set by the funds that your 401k invests in and the fees associated with managing the 401k and the underlying funds (but, only the ones that your employer doesn’t pay). Most of these are conveniently hidden in your returns.
2. Market Dips: Did you know that while the ‘market’ averages 12%+returns, you can only count on 8% as your 30 year return, 4% as your 20 year return, and 0% as your 10 year return from the market. My rule of thumb is: when planning your retirement, count on less … enjoy the possible upside when you are wrong!
3. Inflation: It takes time to get to the nest-egg that your 401k will give you … 20 – 40 years when you are starting out … so $1 Million just ain’t all that much money (now, let alone 20 – 40 years time!).
But, that’s not the hidden risk that I was talking about … it’s much, much more dangerous than those …
… the hidden risk of your 401k is that you may not get enough out of it to retire well.
Almost as bad, you may not care enough now to plan for what may happen then; after all, for you ‘retirement’ may be still 10 – 20 – 40 years away! Although, it need not be …
So, what do I mean?
As I said yesterday, the arguments that the 401k proponents put forth center around: it’s ‘forced savings’; it’s pre-tax savings; and, the possibility that you get free money from your employer!
All good things to have in an investment. But, not the only things …
… in fact, there’s only ONE THING that I want from an investment: that it gives me a return that supports My Life.
Not, the life that the investment is capable of supporting … not the life that I have … not even the life that I want … but, nothing less than the life that I need.
Just remember this: there’s nothing holy about a 401k.
The purpose of your 401k investment is NOT to get a tax break, not to put aside 15% of your gross salary a month, and not to get any employer match … they are just (important) features …
Just like any other investment, your 401k’s purpose is to help you get you to Your Number so that you can live Your Dream!
Anything less is just settling for less. So, let’s consider the binary options here:
1. Your 401k will get you to your Number
You know your Number, right? And, you know when you need it?
If not, either read this and do this … or, you’ve just wasted a valuable 3.5 minutes beer drinking, relaxing time that would have had a far more beneficial effect on your life than what you have just read … or, will ever read … on this blog!
And, you know what your 401k can deliver by then, right? Not when your employer says that you retire, but by when you need The Number!
If you haven’t done the calculation yet, ask a Financial Adviser to help you (or follow along with our 7 Millionaires … In Training! at http://7m7y.com starting with this article) …
… you think knowing this might be just a tad important?
Now compare what your 401k is likely to be able to produce (now, I would not be using ‘average returns from the stock market’ for this life-critical calculation … I’d want a buffer … but, that’s really up to you and your bean-counter) with Your Number …
… if they are much the same, stick with your 401k (after all, it is ‘set it and forget it simple’). Then concentrate on keeping your job and, getting bigger and bigger pay-rises, because you’ll need ’em!
2. Your 401k will NOT get you to your Number
If your 401k will not get you to your Number, what choice do you have but to at least consider alternates, be they instead of – or in addition to – your 401k savings plan …
… be they real-estate, stocks, 2nd/3rd/4th jobs, marrying into money, winning the lottery, businesses …
…. be they whatever …?
Of course, you could just give up and settle for your lot in life; who am to tell you not to give up on your dreams?
I’ll leave that little job up to Frankie 😉
They might not be too exciting, but regular, disciplined, and long term investments in a tax deferred account are a great way for anyone to put a substantial nest egg away for retirement.
A fundamental problem is that too many people fail to get an education about what to do with that money. The US Federal Government’s Thrift Savings Plan, for example, defaults to the Government security insured income fund if the member fails to select another option. How does 6.42% average return sound since April 1987? Compare that to 11.82% since January 1988. That’s the difference between retiring at 60 or retiring at 70+.
The market will fluctuate. As you get closer to retiring you’ll have to adjust your retirement game plan to minimize those fluctuations for your cash flow, but by that time you should have accumulated a serious pile of cash!
The real tragedy would be to put off planning for retirement. Whether you start your own business, or devote your life to service, start planning for your future as early as possible. And remember, always have a plan-B! Things don’t always end up going the way you’d planned.
All the best!
Lee
(Canopybowstars on NetworthIQ)
@ Lee – who wants to retire at 60 when you can ‘retire’ at 50, or 40, or 30, or … ?!
Very interesting. Goes against the grain of all of the personal finance blogs I frequent. I do have to agree with Lee, though, that at the very least it gets people saving. I know way too many 40 year olds who haven’t even started and are too strapped for cash living their keeping-up-with-the-joneses lifestyle.
@ Heidiroo – The 80% who don’t save don’t read the PF blogs; the 19% who do won’t get rich just by saving. Now, what do the ‘missing’ 1% do? I’m hoping that some of them are here right now …
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