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Questions! Questions! Questions! There Are So Many Questions On Why Your 401k Is A Retirement Income Loser!

by Jeff Brown on August 26, 2014 · 34 comments

  

In last week’s post I spoke about why your employer sponsored 401k is a loser.

Since its inception over 30 years ago, it simply hasn’t produced the promised results. The only real empirically demonstrable fact you need to know about ‘em is that the average American turning 65 has $100,000 or less in their 401k account. Not quite the retirement bonanza anticipated by far too many. In fact, it’s a major reason why so many of us remain in full time jobs into our 70s.

I offered an alternative. Some readers had questions, most of ‘em striking to the heart of my approach. So this week, let’s just pose the questions, I’ll answer ‘em as specifically as I can, and we’ll get down to brass tacks. I’ll be paraphrasing the questions.

Question:

Though you spoke of risk aversion both nearing and in retirement, it seems your approach didn’t move away from risk. Would you address that?

Answer:

Short version — Yeah, it’s riskier. However, that assumes the investor is a member of the ever increasing tribe known as DIYers, those who insist they can become experts cuz they will it so. I know that sounds a tad harsh. But I’ve spent much time in my career cleaning  up DIY spills on ‘aisle 5′.  Without exception, every single note I’ve bought or brokered was found on ‘the street’.

Today’s market makes that unnecessary. There are relatively large note ‘funds’ now, and many are governed closely and strictly by the Securities and Excahange Commission. (SEC) Much of the due diligence most newbie note investors wouldn’t even know to do has been done by highly seasoned pros, who’ve literally done thousands of ‘em. Furthermore, some of the funds, not most, offer both preferred returns to their accredited investor/members, AND warranties on notes. Huh? What? Note warranties?

Why don’t you tell me about the warranty those super safe, risk averse stocks offered to ya as you saw your hard earned investment capital circling the drain back in 2008? What?! They didn’t offer one? I’m both shocked and chagrined. Speakin’ only for my own fund, specializing in first position notes secured by real estate, there’s more risk reducing reality than a warranty. When stocks, or for that matter, real estate goes south in a hurry, and we all know they both can and do, what happens when the value falls below the purchase price? Worse, what happens when the real estate value drops below the loan balance? Oops. What happens is you have a couple choices. You either bite the bullet and take the loss, or you sit it out ’til the market comes back. That could take a year, or a whole buncha years. We never know, right?

Yet, that homeowner who lost their home, lost it to the owner of the note on which he defaulted. So, the note owner did NOT lose everything. They simply moved from lender to homeowner. They have a whole lot more than a big bag of nothin’, which is exactly how the home owner ended up. Furthermore, that note owner will rent the home out and earn net income. Will it equal his old note payment? Not likely in my experience. But the market will recover. Values will return to the norm — most of the time — and the note owner will remain whole, instead of watching their investment capital disappear like steam in the wind.

The note investor ends up with security backing their investment, the real estate. They get a warranty. They make a far better cash on cash and overall yield than those remaining on Wall Street while retired. One last note, pun intended. Let’s say you follow the advisor at work who tells you your yield nearing and in retirement will be around 4%, and also assume you ended up with $1 million bucks in your 401k. That’s a whoppin’ $40,000 a year — BEFORE taxes. Heck, you can do that with just half as much without ever buyin’ one single note in a fund with an 8% preferred return. Thing is, if you followed my advice from last week, that $40,000 is TAX FREE. The ‘other’ approach wins again. It’s at this point I can’t help myself, and must ask the question beggin’ to be asked.

How many of you know ANYONE who’s retired on even $50,000 a year, before tax, via their work related 401k? There’re more of them than unicorns, but it’s close. ;)

Question:

You assume the 12-15% cash on cash yield from discounted notes will always be in place. What happens when another recession hits and there’s very high inflation, the double digit variety? What if you were in, gulp, California and that happened?

Oh my Lord! Did BawldMom use an alias then ask that question? :) Talk about teein’ it up.

The first note in which I ever invested, was acquired in what later turned out to be the highest inflationary period for America since the end of WWII. I made roughly 13.8% cash on cash, and almost 20% overall. Just a few short years later inflation had risen from just under 10% to 14%. Prime rate was 20%. Oh, and those notes that might suffer during inflation and recession? They rose in yield and dropped in price. Since those buyin’ ‘em for income didn’t much care about future note value, they just kept acquiring as many as they could prudently afford. The value of a home securing a particular note bought in 1982, a horrifically bad recession year, was worth FAR more just seven years later in 1989. In other words, the note became way more secure. Maybe the collateral investors get in the stock market would do the same? What?! There IS not collateral in the stock market? Who knew?

For the Record:

In my 38 years of note brokering/investing I’ve yet to see a note sold at discount generating a yield less than double digits. Could it happen? Oh, you bet it could. But it’d be the first time I’ve ever seen it, including my two note mentors, both passed, who began as note investors just a few years after the end of the Korean war. They likely wouldn’t understand the question. ;)

Related: Retirement Security: Invest In Texas NOT California

Now, about California’s perceived higher risk. Well, let’s all say it in unison, shall we? A big Captain Obvious, DUH!! ;) For Heaven’s sake, why do ya think I abandoned California over 11 years ago? Think it might’ve been cuz I no longer had confidence in that region’s market? Ya think? Or, do ya think I was bored, and thought, “Hey, I could turn my life upside down, and leave a two generation business behind? Yeah, let’s do that!” 

Question:

What happens when one of your 12% notes gets paid off and there’s only 8% notes available? Could that happen?

Answer: It could happen in a heartbeat, and don’t let anyone tell ya it couldn’t. If we’ve all learned anything about the economy in the last half century, it’s been that anything can happen. Still, my family’s been in the business since Eisenhower was in office, owning our own brokerages beginning in 1964, and we haven’t seen it yet. But for the sake of this post and the question, let’s assume it happens next year.

So Freakin’ What?

Do you think stock dividends, treasury notes and the like would, in that scenario, be higher? Cuz if you do, I know a bridge in Brooklyn I can sell ya, cheap. The next time I see the discounted real estate backed discounted note market produce yields the same or lower than Wall Street will be the first. What goes unsaid is that no down economy in America ever really recovers ’til the common perception is that real estate has also recovered, nationwide. Ask regular folk what they think of our current ‘recovery’, and most of their answers couldn’t be published here. Ask note investors how they did in 2008, and do it right after you asked others in the same room how their 401k plans fared. Here’s what will most surely happen next. The note investors will all be taken out to lunch by those who got slaughtered by the downturn. ;) In fact, let’s pile on for a second here. My clients with EIULs made 2% in 2008, when their neighbors were wondering IF they’d even be able to retire.

Question:

What is the minimum required distribution from a retirement account for a 71 year old? Is that distribution really all that bad, especially since the return for all those years was only 4%?

Related: How Has Your Retirement Plan Been Workin’ Out For You Lately?

Answer:

Let’s take ‘em in order, shall we? The phrase ‘minimum required distribution’ is not something to merely pass over. It’s the government FORCING you to take and pay taxes on income against your will, and for many when they don’t even want or need it. Embedded in that question is that since they only made 4%, that shouldn’t be something about which to worry. Are you freakin’ kiddin’ me?! Where are they handing out these white flags? After all, we got you this far into retirement paradise, surely you believe that 4% is reasonable, and that you should learn to live on it, right? People, in my view it’s horrific as soon as the government tells us how we’re gonna spend our retirement income, and IF we wish to cannabalize our very retirement net worth.

Since when does a married couple who’ve made six figures the last 20 years of their working life, look at $40,000 a year before tax in retirement income as paradise? 

Folks can frame it any way they wish, but once we’re forced to begin eating into our own principal in retirement to live on, we’re inarguably in the race between when we run outa money and when we die. Yeah! Right on, man! Where do I sign up to guarantee THAT happens to me?!!

Am I on candid camera? :)

Are we gonna take seriously those who defend 4% yields? Then, in the next breath they say it’s really not so bad that you’ll hafta hope ‘n pray you don’t outlive your lifetime of savings and investments capital? What’s really happening when you read/hear folks doing those things, is they’re tellin’ us to watch their right hand, as their left hand isn’t doing anything. Remember this if nothing else: Everyone you know who’s nearing retirement or retired, had an employer match of some sort. How’s it workin’ out for ‘em now?

We’re not finished by any stretch. There are many more questions to address, and some very solid observations to acknowledge. Next week we’ll continue with this. Thanks so much to the commenters’ questions. Every single question was spot on topic, making solid points.

And thanks so much in advance for allowing my smarty pants side to make an appearance. ;)

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{ 34 comments… read them below or add one }

Nick August 26, 2014 at 1:20 pm

Jeff,

Warranty is only as good as the company behind it. What happens to the warranty if something happens to the company? To make it worthwhile the warranty has to be backed by a big insurance company. Otherwise it’s just a marketing gimmick.
As for 12-15%, I see 15% on 2nds with no equity and scary borrower’s history. Can you show a real example of the 1st with equity and at least 12% yield? Something that is listed on FCIExchange, for example, so I could buy it.

Thanks
Nick

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Victor Brak August 27, 2014 at 4:25 am

Nick, he goes on to state that the note is backed by the real estate itself. So even if the warranty is, as you stated, a ‘gimmick’ the real estate is the asset taken into ownership by the owner of the note should a default occur.

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Nick August 27, 2014 at 8:22 am

Victor, the note is backed by real estate, you are correct. However, it all depends on your LTV and borrower’s equity. For example, if the property can be sold for $200K and you bought a note for $150K, you have $50K safety cushion. The unpaid balance of the note may be $190K which means the borrower only has $10K equity. If the value of the property declines to $150K your cushion is gone and the borrower is upside-down. He may then decide to walk away from the property and you may end up with the property or with auction sales proceeds that would be less than $150K (quick sale, attorney fees, repair expenses).
If you had a warranty, you’d simply had your money back less payments already received. However, if many warranted notes follow that scenario a warranty issuer may become insolvent. So, essentially, a warranty may protect you against a particular bad event with a note but against a systemic macro-economic crisis such as happened in 2008.

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Victor Brak August 27, 2014 at 10:31 am

Thank you for the explanation!

Paul August 26, 2014 at 2:20 pm

I’ve always been a big proponent of putting money in my 401k. The question I ask myself is… Would I rather take the tax hit now or take it later and allow the money to grow tax deferred? Because I’m in a fairly high tax bracket now, my guess is that when I’m 71 my tax bracket will be lower. So when the gov’t forces me to withdraw 3.9% my tax hit will be much less than it is today. If I were to convert my traditional IRA to a ROTH it would half the value due to the taxes. When you’re 70, would you rather have 1 million in a ROTH or 2 Million in a traditional IRA? Personally I’d rather have 2 million in a traditional IRA.

The S&P 500 (with Dividends reinvested) have retuned over 11% in the last 30years which isn’t too bad and is much better than the 4% the “advisor” is recommending. Will 11% gains continue for the next 30 years? Heck if I know

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Jeff Brown August 28, 2014 at 12:03 pm

Hey Paul — thanks for you input. My only question: Given enough time, the majority of Americans are not producing anything close to what you are. They’re ending with with $100k or less in their 401k plans. Nobody, especially those poor folks, care a whit about how they got there, they’re just ‘there’. Dalbar Corp. has shown repeatedly that the average work sponsored 401k has a rolling 20 year average yield of, give or take, 3.5% a year. Virtually all of ‘em have employer matches, yet they still end up with a whole lotta not much.

It’s a hurtful joke to the vast majority of Americans with these plans to even suggest they have a butterfly’s chance in a force 5 tornado of even seeing 25% of that figure. You’re the exception that proves the rule.

But my question remains: If you’d paid the tax hit decades ago, would the formula you’ve employed have produced different results via yield/growth? Of course not. They’d have grown just as tax free as the 401k. The difference being they’d come out tax free. But, different strokes, etc. If the 401k had worked they way it’s been advertised we wouldn’t be having this conversation. Seriously though, Paul, you are the exception and to be admired for the results you’ve produced.

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Joe August 26, 2014 at 3:18 pm

Jeff,
I have been reading your blogs for a year now, I’ve been putting away my 401K money like a good boy should, enjoying a company matching 5% as well. But I’m getting very tempted with the concepts of SEC monitored funds, and warrantied notes…
So much so that I called my local credit union to see if they were interested in off loading a “one-off”…they weren’t.

Now i’m curious as to where I find these collective funds you mentioned. There was a point in time a year or two ago that a SEC oversight REIT (NASDAQ: AGNC) was producing an almost 20% annual dividend, then it was 15%, now it is barley 10%, and under the tax laws these dividends are always taxed at short term cap gains (at least this is what I am told, not CPA vetted).
Would this be an example of what you are reffering to as a “fund”? Could you link or refer an example of this elusive “fund” if I’m completely off track?

I’m sure the higher up on the investor food chain you go, the more options open up…what I need to find is the $2-10K option(s) that a “non-accredited” investor can get in the door for ~12% cash on cash returns. And, risking upseting my entire family which are long term care planners as well, I understand the fee structure and how much comes out of the stock market to those who sell the products…its a lot more then most think, if you can own a note yourself with little to no “management fees” creating “trail fees” and everything else, a 12% note would absolutely have better returns than most brokerage diversified products.

I see the vision, and most importantly the reward…but, how do I get there?

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Jeff Brown August 28, 2014 at 12:22 pm

Hey Joe — You ask very good questions.

These funds aren’t like REITs, which I’ve personally never favored. That’s not to say many of ‘em haven’t produced big time results for investors, cuz they have. My note fund pools money to by notes from lenders that aren’t performing. The fund manager then ‘rehabs’ the note with the homeowner such that it returns to ‘re-performing’ status. At that point the note buyers can then buy the notes for either their own account or their IRA/401k.

Make sense?

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russ August 26, 2014 at 6:25 pm

This article made me intrested in “notes”. What is the best way to learn about investing in these “notes” and how do you find these notes to invest?

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Jeff Brown August 28, 2014 at 12:24 pm

Russ — You can go to bawldguy.com, subscribe, then hit the ‘opportunity’ button. That will take you to info about notes and note buying. Also, I’d recommend you visit Dave Van Horn’s site. They offer various classes about discounted notes that have been pretty well received.

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Craig August 26, 2014 at 7:01 pm

Have a feeling that notes have their own risks (along with their rewards). I would not poo-poo the stock market too much, espeically if you’ve not done well in it in the past. Others, like me, have. Point is, that we all can benefit from diversification across stocks, bonds, and RE. Real Estate is not the perfect investment, nor should it be the only thing you invest it. Anyone who says differently is selling something.

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Jeff Brown August 28, 2014 at 12:26 pm

Hey Craig — Let me pose a question, based upon your comment.

If the stock market is so good in producing both capital growth and retirement income for investors, why are average Americans ending up with such pitiful balances and income at 65? Nobody seems to wanna address that question.

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Jason R August 28, 2014 at 5:46 pm

I will address it.

1) Most people do not contribute much to the plan. (Think $10-20 per week.)
2) Returns are generally lower than “stock market returns.” This might be because of fees or investments choices, regardless it is real.
3) Most people withdraw the money the first time they get into a tight spot. I’ve been the 401k administrator at my employer. I’ve seen it first hand, MANY, MANY times. I have on more than one occasion seen people empty their whole account to buy a new truck because they “deserved it.” People withdraw to get braces for their kids, to post bail for a family member, pay the attorney in their child custody case, etc. Their “reasons” are never ending so their account balances will be perpetually small.

I am very intrigued with note buying, Jeff. (I am also intrigued by the concept of income and cash flow in retirement even though I am far away from it.) Please keep explaining the concepts and addressing the questions. It is appreciated!

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Frankie Woods August 27, 2014 at 12:44 am

I think Craig hit it on the head. Generally, managing risk is all about diversification. I too have done relatively well in my 401k and have been investing in one since ~2004. Even with the 2008 market crash, I have still managed to acquire over 200k @ 33 years old in the 401k, not accouting for my IRA, taxable accounts, and real estate. Not too shabby if you ask me, and much better than the “100k” the average 65 yr old has apparently has netted. If this figure is true (lying with numbers continues to be a growing trend), I think the figure is a result of poor investing strategies (e.g., letting emotions drive investing decisions/buying high and selling low) and low savings habitats more than anything else. I really do like your strategy about adding notes to your overall investment makeup, but I do not think it’s the be all/end all. As always, I still enjoyed the read :)

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Jeff Brown August 28, 2014 at 12:30 pm

Thanks so much, Frankie. As always it’s different comfort zones for different folks, right?

I didn’t make up those numbers. Unless you’re wantin’ me to accuse Forbes of that, those same numbers, give or take, have been reported by completely unrelated, independent sources for decades. It’s not a secret, and nobody’s makin’ them up as they go.

All I care about is results. Results show the 401k is a dismal, often times tragic failure for most Americans. If the average American had been retiring well with their work related 401k would we even be having this chat today? Um, no.

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David Shafer September 2, 2014 at 10:51 am

Frankie, congratulations on doing well in your 401K. Let someone that has 35 years of investing experience add some thoughts. We are 5 years into a major bull stock market. Just last year most mutual funds went up over 30%. I remember back in 1999, on the then new yahoo stock web site many were describing their amazing results [some actually thought they would average over 25% a year for the next couple decades!]. Everyone was a stock market genius. Making fun of Warren Buffett was a popular sport because he refused to invest in those internet companies with no profits.

The market will turn. How nasty will it be? Don’t know but when it turns it does it very quickly. Then people start to need the money, maybe lose a job, etc. Then the sales start happening. Dalbar, Inc. has been recording this behavior for 20 years now. The mutual fund companies also do, but you would never hear them say it. The government tracks retirement accounts and every 5 years issues a report. All the data we have states that people, for the most part have very small 401K retirement accounts.

A few people are lucky or have the correct personality to withstand the downdrafts. But, you better hope there is no major bear market near your retirement time or even a great saver is in trouble [its called sequence of return risk]. The issue is really you are investing for retirement income by using vehicles more appropriate for speculation that are driven by emotion. Not your emotion, but the emotion of the market.

Take it from someone that has and still does play in that sandbox, anyone depending on their 401K to retire on is a fool. They are a fool for thinking they are better than everyone else who got that 3.5% returns from their mutual funds that all the studies indicate. Better to find a way to invest that has historically demonstrated better results in obtaining retirement INCOME than in investing in a strategy that has failed the vast majority of people. There are many ways to do this, RE notes being one.

Ask yourself this? Why can I invest in such limited strategies [usually limited to a small group of mutual funds] in my 401K if it is such a great tool? Who set it up like that? Hint: look to New York and Washington DC. Have those folks in those cities ever done something that is best for the middle class?

Good Luck in your future endeavors.
Yours in investing success,

David Shafer

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Michelle August 27, 2014 at 4:08 am

I would like to learn more about investing in notes. Where do I begin?
I am comfortable with real estate having owned rental properties for over 20 years and have flipped houses, but have no experience with providing financing to buyers.

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Loren Whitney August 27, 2014 at 9:46 am

Hey Jeff,

What’s your opinion on IRA/401k withdrawals vs Roth conversions? Why would someone withdraw the money and pay taxes when they can do the same thing and derive tax-free growth, tax-free distributions, and avoid RMDs. Thoughts?

Keep writing, we love it!

Loren

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Sharon Tzib August 27, 2014 at 1:08 pm

Read last week’s post, which he linked to at the beginning of this post. He explains it there.

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Sharon Tzib August 27, 2014 at 1:07 pm

Well I love your smarty pants side – really enjoyed this article. Following along for your comments :)

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Nathaniel Dockstader August 27, 2014 at 11:26 pm

Would the shares of businesses you buy when investing in the stock market not be considered collateral? I’m still lost and feeling like most of the answers lacked detail and hard evidence to back them up. All of the answers seem completely anecdotal and didn’t answer the questions sufficiently.

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James Evertson August 31, 2014 at 6:40 am

I’ll field this one for you. Should a company selling common shares become insolvent or bankrupt and you own said shares you get in line with the rest of the folks collecting their money from the selloff of the company and/or its assets. You get in line behind senior bondholders, junior bondholders, and preferred stockholders. Should there be any scraps leftover at that point you may recover a portion of your money but it isn’t likely.

Don’t freak out; this is an extreme scenario that doesn’t happen often when investing in large companies (think S&P 500 or Fortune 500). But it is something to be knowledgeable about and may encourage further diversification unless your name is Warren Buffett.

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Dave August 28, 2014 at 6:11 am

Love you Jeff…..but, seriously, you are better than this. You are taking this too far too an extreme.

Of course a 401k plan in which an employer matches your contributions is a good decision. Now, should you max out your 401K plan and thus have no money too invest elsewhere, of course not.

Invest some in rentals, some in notes and always have some cash lying around. You should also do your own research on stocks and buy strong, dividend paying companies when the price is right.

Stocks can be a tax shelter too…..WATCH this:

I put $40,000 in SBUX at $20 a share back in 2006-2007. I did my research and I viewed SBUX as a big long-term winner. That money is now worth $156,000. I have NOT paid a share of tax because I have NOT sold it. I collect $2,340 a year in dividends (which will increase over time), which is a 6% return on my initial investment alone. Also, I took out a “Portfolio Line of Credit” against this stock for 50% of the value at Wells Fargo (at the time the stock was worth $130,000 so I have a “Portfolio line of credit” for $75,000 with an interest rate of Prime). I invest that money in Notes making 15-16%.

So, don’t be fooled. Stocks can be a great, great investment. If you have a diverse portfolio you can leverage stocks and by NOT selling great companies and holding for the very long term, you are growing your money tax-free for many many years. A 401K can be a great starting point. But, don’t max it out because you want cash for other type of investments too.

An investor should always be looking at the best place to park their money. Some times that is stocks, some times that is rentals, some times that is notes, etc.

Diversify, keep your options open, and always have some cash in reserve. That is the best approach for growing your money and retiring properly.

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David Shafer September 2, 2014 at 10:57 am

Dave, multiple streams of income….great advice
Dividend growth stocks…..great advice
Taking the company match…..ok advice as long as you don’t think you are going to retire on the proceeds

And that is the rub…..most people have been told they can simply put money into their 401K/take the match and will retire fruitfully. Hasn’t happened yet, most likely won’t ever happen. We are left alone to invest for retirement and most people will fail at this. Especially if they listen to Wall Street.

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Scott August 28, 2014 at 12:09 pm

Jeff- Seems like your answers to questions add more questions! Craig’s comment above touches on the risks. Can you address the risks and how your fund addresses this? What is the average LTV? How does the fund handle repossession? What accounting controls are in place and what documentation is provided to investors? Dave makes a great point that notes can be a part of the portfolio, but probably not a great single solution. I look forward to hearing more!

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Shaun September 2, 2014 at 8:24 am

So I always agree with the people that say you generally don’t want to contribute past the match amount in your 401K as there can be better investments out there.

However this is an issue I have had in the past with some of your articles on “gutting” an account and not contributing to it at all.
Why does the “free money” have no value to you?
For example say your company did some unamazing match of of like 50% of the first 5% you put in. You only put in that 5% and are crazy risk averse so put it all in the Money Market fund to preserve capital.
Let’s say you make $100K a year. So you put in $5K and at the end of the year you have $7.5K. Let me bust out the financial calculator… Looks like you have a basically riskless 50% CoC and will each and every year.
Also with that salary taking that $5K as income will easily result in $2-2.5K+ in federal, state and local taxes. Let’s go low and say $2K. So in this case you only reduce your “pocket money” by $3K but end up with $7.5K in your account with the investing equivalent of stuffing cash in your mattress.
So that after tax $3K would produce a completely riskless $7.5K if put in the 401K account or a… (hold on financial calculator…) 150% return.

So that is a 150% CoC with the assumptions of:
– Fairly lousy match, if you have a better one then the return will be much better.
– Taking pretty much the minimum Tax hit so if the take home is more like $2,500 the return will be much better.
– Getting 0% growth on the money. Put it in one of those awesome 4% mutual funds and you will blow this away with years of compounding.

The absolute dollars are not that impressive but the returns are phenomenal.

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David Shafer September 2, 2014 at 11:02 am

My problem with the whole 401K issue is that money is dead money to you. Try to get ahold of it from most companies you work for and you will find huge roadblocks even it you want to pay the penalty. Just strikes me the wrong way to invest and have little control over it, pay penalties to access it, be extremely limited in how and what you an invest in, etc.

For many I guess that doesn’t bother them, but for me that really does. So the company match is a forced invest account that actual data demonstrates fails most people. Free money is not really free at all. And lets not get into the tax implications of it. DC loves 401Ks!

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Dave Ackerman September 2, 2014 at 11:26 am

I hear you David. You make some good points about the 401k. But, I think its important that most people are NOT disciplined enough to be long term investors. They buy bull market markets and then sell in the panic of the bear market. So, from that standpoint, there is something to be said in a positive light about the 401k NOT allowing you to pull money out without a steep penalty. For the average person, that would be a benefit.

Now, here’s what I think the average person should do with their 401k:
1)Only invest what the company matches. If your company doesn’t match then don’t do it.
2)Make sure the 401k plan offers a low cost index fund (less then .3% fees) that tracks the S&P 500. If you company doesn’t offer that, then I would NOT invest. I would call up the person in charge and demand that they offer a low cost index fund for the benefit of the their employees.

If you did this on a monthly basis for 20-25 years, and never touched it, I’m pretty sure you would be happy with your return on that part of your money over that time frame.

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David Shafer September 2, 2014 at 1:58 pm

I like your rules! But still doesn’t take care of the sequence of return issue. Ask anyone who retired from 2000 to 2010 what a stock market bear does to your portfolio. Fortunately for those folks most had a defined benefit pension unlike the following generations.

Bottom line for me is that you are speculating in the stock market [investing is a very different thing to me] and hoping for a positive outcome that defies our current experience.
I have a hard time recognizing that diversification of stocks [like in an index fund] to the point of not knowing anything about the companies you are investing in is a smart investing style although I did it for close to 20 years.

So it is not the 401K part that bothers me nearly as much as the mutual fund part.

David Shafer September 2, 2014 at 2:07 pm

One final comment I wrote a while ago on my blog:

I got an investment for you.
First you are going to invest in a strategy that has failed for 2 generations.
That strategy will have you investing in things you don’t have the time to possibly understand the details of.
You are going to be locked out of getting your money from that investment for as long as you work at your job or perhaps they will let you get at it and only charge you 10%.
You will defer taxes, but if you have any success at all with this investment you will end up paying more taxes than you deferred.

So are you ready to sign up?
You probably already are; its your 401K at work!

Dave Ackerman September 2, 2014 at 2:43 pm

David….A 401k is certainly NOT ideal. The best way to make money in the stock market is to buy incredible businesses at decent prices and hold for a very, very long time. Look at Warren buffet’s portfolio….it’s top 5 holdings make up a huge % of his portfolio. But, how many people are gonna really think about companies and do the necessary research? VERY FEW.

Thus, an index fund with a low cost is ideal for the average person. Many people are paying 1-2% in fees too advisors, or mutual funds, or 401k adminstrators. That’s absurd. If you are only making 7% per year, and paying 1-2% in fees, then that is a huge loss over 20-25 years.

It’s heartbreaking that people will do more research on buying a $20,000 car then they will in how or where they invest their money. Just heartbreaking!

Nick September 2, 2014 at 2:29 pm

I disagree on taxes. It all depends on your income level vs. consumption level.
Say, you were making $100K/yr but lived on $50K and want to continue the same lifestyle in retirement. Do you need to withdraw $100K from your 410K or IRA or only $50K? $50K as you are not saving anymore. Taxes will be lower on $50K vs. $100K

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Nick September 2, 2014 at 8:37 am

Shaun,

I like your math and I’ve done it many times to dispel a myth of “401k being a lousy investment”. It is a tool and you need to know how it works and what limitations it has and use it accordingly.
Ignoring company match is plain stupid and I don’t know why people do that.
My only complain about 410k match is that it is not compoundable and there is a limit to it.
Another great investment vehicle that many people don’t understand and/or use is ESPP.

Nick

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Dave September 2, 2014 at 8:56 am

Well done Shaun. You clearly explained the value of using the company match for a 401K and why it is a good plan.

The job of an investor is too look at all investing options (stocks, bonds, notes, real estate, 401k’s, etc.) and create a diverse mix of all based on which offer the best values at any given time.

Too just blindly put all your money in a 401k in which a company only matches 2% of it would be stupid. Too put all your eggs in just notes would be stupid also. But, too utilize all of these tools is the key to growing money and retiring unlike most people.

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