We received my wife’s 401k plans statement yesterday and we felt like financial geniuses. Splashed on the first page of the statement was our mutual fund performances, up 28.14% in the quarter and 18.43% year to date. My instant reaction was of joy, but it quickly faded as questions were bubbling in my head. Did the performance numbers always showed up in huge font on the first page? Am I supposed to be happy even though our 401k balances are still down from year ago levels?
As I snapped back into reality, I remembered that all companies offering 401k plans are just sales organizations. When times are good, they emphasis how great your investments are. When times are bad, they hide their tracks by telling you how others are doing just as bad.
In addition, 401k plans:
- Offer funds that almost always have higher fees – Look in your fund selection and chances are good that your average expense ratio is more than 1%. That’s 1% in fees taken off every single year, whether your fund increases in value or not.
- Always seem to have great performing funds even if they underperform – The 401k plan companies call it “monitoring to give you the best funds” when it’s actually their tactic to always keep more “advertisable” funds in front of customers. How could your money grow if they always make you switch to a better performing fund based on past history (buy high), and take the underperforming fund off the selection list (sell low)?
- Have Very Limited Selection – I was actually told that having a limited selection is a good thing because it’s confusing to have too many choices. I agree completely, but it makes no sense to have choices that just suck.
Why have your funds in there unless you have to? Every time you have a chance to roll over your 401k balances into a IRA (for example, a job change), do so. Don’t ever roll them over to your new company’s 401k. It may seem like an easier way to go, but trust me, you are really losing out because of the high fees.
401k Plans Aren’t All Bad
With that said, you may wonder why we even contribute to a company sponsored 401k plan. Don’t worry, we aren’t crazy. We do it because my wife’s company offer a match, and we never say no to free money. Having money taken out of our paycheck before we ever get to see it also has an amazing (almost magical) effect. Without ever having access to it, we don’t seem to need it and after a while, money seems to accumulate without effort.
My Thoughts on How to Deal with 401k Plans
How much to contribute is a question I get asked constantly, and here’s what I usually recommend.
- Contribute your 401k to Get the Maximum Benefit of the Employer Match
- Then, Max Out Your Roth IRA (pre-tax and post-tax debate aside, it’s better than your 401k as long as you pick a broker that gives you maximum investment flexibility)
- Finally, the rest can go in your savings/taxable investments
If you are a high wage earner, you should contribute a bit more to your 401k plan in order to beef up your retirement savings percentage. Also, some of you may go over the limit that excludes you from taking advantage of the Roth IRA. Hence, more 401k contributions needed.
Many of you may feel that you are giving away too much taxes to Uncle Sam with my approach, but by having more money in your savings and taxable investments, you can actually use it to meet your short to medium term goals. Some of them include:
- Saving for Your Home
- Having a Rainy Day Fund
- Paying Cash for a Car
- Buying the Little Budget Travel Book so You can Go on Vacation For Less (Seriously, how can buying my book not be your short term goal?..?)
- Saving for a Big Occasion Like a Baby, Wedding, Etc
Not putting away as much as you can in your retirement accounts may defy conventional wisdom, but whether it’s now or in your retirement, you need to live a little too.
Editor's Note: I've begun tracking my assets through Personal Capital. I'm only using the free service so far and I no longer have to log into all the different accounts just to pull the numbers. And with a single screen showing all my assets, it's much easier to figure out when I need to rebalance or where I stand on the path to financial independence. They developed this pretty nifty 401K Fee Analyzer that will show you whether you are paying too much in fees, as well as an Investment Checkup tool to help determine whether your asset allocation fits your risk profile. The platform literally takes a few minutes to sign up and it's free to use by following this link here. For those trying to build wealth, Personal Capital is worth a look.
- E*TRADE IRA - Official Site