The reason I created this site is not only to help teach you
about accounting, but to also help you learn and master how to manage your
money and investments. I want you to realize your dreams or retire
comfortably, whatever it is that your eventual goal is.
As part of this service to you, I must warn against certain
mainstream thought about money and finances that can harm you or at the very
least, not make you as successful as you may want to be.
One of the largest of these schools of thought is the 401k plans.
I recently came across two articles on infolific.com that were
talking about 401k plans and the history of them as well as how they
worked. The title of the articles were “401k
Guide & Some History to Boot” and “How
to Deal with a 401(k) Plan That Sucks.”
The history of the 401k plan written in the first article
was more or less accurate in terms of the time frame given as well as part of
the reasoning behind the move. However
there were some serious facts left out as well as faulty thinking sprinkled
throughout these articles.
The sad thing is some people will use this as investment
advice. You however will not be one of
them.
The 401k was implemented in order to give employees “control”
over their retirement planning and management of their money. However that is not what transpired. Prior to the 401k, companies heavily
utilized pension plans for their employees.
Now pension plans are true retirement
plans because an employee would work
for so many years and the length of time that the employee worked determined
the percentage of their salary that they received every year in retirement until they died. These are also known as a
defined benefit plan (accounting talk). For example, suppose Megan works at ABC Inc.
for 30 years and this length of time gets him a payment of 75% of his
salary. Then once Megan retires, she will
receive 75% of his salary every year until she dies.
Now the 401k does not pay you a set amount every year in
retirement. Instead, you save money
throughout your career and get matched by your employer (hopefully) and when
you retire you have a lump sum of money in your account that you can then live
on. However, the 401k money does not regenerate every year and eventually you
could run out of money in your 401k where with the pension plan, you could
not run out.
This next part is key to understand how to effectively use
the 401k. You place money in a 401k
and continue to add money to it and hopefully it generates gains and dividends
off of the stocks or indexes you have invested in.
This sounds an awful like a savings account where you put
money in and get interest for keeping it in there and that is exactly what a
401k plan is: a savings plan. Knowing that the 401k is a savings plan and not a retirement plan will change your
mind on how you look at and utilize the 401k in your investment
life. The common thought in these
articles listed above talks about the 401k plan as an investment vehicle but
then makes it sound as a replacement to a retirement plan. It is not a replacement! The 401k did not take the place of pension
plans. Instead the 401k was packaged
as a retirement plan and companies switched over to it because in the long run
it is cheaper. Think about it, would a payment of an employee’s salary every
year in retirement be more expensive than paying a matching contribution of
3-5% of an employee’s yearly salary? Of
course it is!
Knowing the purpose of the 401k will assist us in later posts
as I go through strategies and utilization of the 401k plan but thinking that
the 401k plan is a retirement plan is just one of the faulty investment advice
tips circulating today. Others that I
noted in these articles are listed below.
How to Recognize Faulty Common
Investing Thought
The rest of these articles contained some serious fallacies
in investing thought and I will break them apart in the following ways:
- Investment Advice Should be Challenged by You
- Controlling Your Investments is Done by You
- Look at Other People to Know if you are on the Right Track
1. Investment Advice Should be Challenged by You
While reading these two articles on infolific.com, I noticed many inconsistencies or ideas that are prevalent in today’s mainstream
investment world. As a result I looked
to see who the author of these articles were.
Not surprising, I found that the author of these articles was a project
manager and then became an SEO professional.
While I have nothing against these two stellar careers, this should not
be the author of articles on investing or 401k plans!
This is a great example of looking to see what the source
of your advice is from when it comes to money and your management of money. You will be surprised when testing the school
of thought from “financial advisors” that you may know as much as they do about
money and investing. Many companies
employ fantastic sales people for their investments. After all, aren’t you going to buy their
investments? If they sell to you don’t
their “advisors” get commissions?
I do not wish to leave you with the opinion that all
financial advisors are like this, they are not. However, money and finances are something
that is not taught in most schools and so ignorance in this scenario can be
costly in the long run. Especially since
your money was earned by hard work done by you – think twice and challenge
investment advice.
2. Controlling Your Investments is Done by You
This is one that really hits me hard when I hear investment
advice that constitutes putting your money in a 401k plan or other investment
vehicle that constitutes locking your money in funds or indexes and hoping that
the market goes up. In the 401k Guide
article on infolific.com the author was stating about how historically the
average market return has been 10%. I do
not doubt this statistic but this is looking at a broad period of time and if
we look at the early 2000s as well as 2008, we will find that the return was
exponentially different. In both of
these cases the returns for both of these years was deeply negative.
If you had
begun investing in 1999 with your 401k plan and bought the indexes, you would
have gone through two massive drops in the market in less than 10 years. This would have destroyed your capital and do
you think it would help listening to a guy talk about the average returns of
the market being 10%? This definitely
does not sound like you have control in your investment using this strategy.
Instead, I use the definition of control that we utilize
every day. If you can affect the returns
of your portfolio, then you have true control.
While I recognize that some investment vehicles are impossible to have
true control, there are other ways to mitigate your risk and take back some
control. First, look to see what kind of
options you have for investing in your 401k plan with your employer. Are there only 2-3 funds to choose from? Or are you blessed with an assortment of
options? At least by pairing up your
money in different types of investments (precious metals, stocks, bonds) you
will have less risk in putting all of your money in one index.
For those of you who may not have an employer match at your
company for your 401k plan, then a self-directed 401k plan might be a
better choice that gives you more control.
A self-directed 401k plan is one that can be opened at many online
brokerage accounts that allow you to choose exactly what investments you want
in your plan. As long as you report your contributions to
your 401k plan on your tax forms then you will be able to receive the tax
benefits of a 401k plan
You can also investment in more items than just stocks in a
self-directed 401k plan however this is more advanced and requires research
of the tax code to see what ramifications this can potentially bring.
3. Look at Other People to Know if you are on the Right Track
Lastly, there are items in these articles that boil my
blood because it confuses those of you who wish to truly learn about investing
and finances yet would get confused because it appears that everyone is saying
something different or there are fully of contradictory tips. In the first article of the 401k Guide
article the author states that your best shot of getting wealthy is to get a
401k plan. The author also states that
you can definitely retire wealthy using a 401k. Definitely sounds like a guarantee and this
might be true if your last 10 years of investing in a 401k via an index as
from 1990-1999.
The best part is that in the second article, the same
author states that if the 401k plan at your company “sucks” then you should
invest in a Roth IRA and he says, “I believe most people will be paying more
taxes in the future, so a Roth is usually the best solution.” Wait, what happened to getting rich using the
401k plan? As I mentioned previously,
the market has taken huge dips periodically and saying that your best shot of
getting wealthy is using a 401k is misleading (these “truth nuggets” are what
first alerted me to the fact that this was not written by anyone who
understands investing).
I am sure the author of these articles has not gotten
wealthy investing in his 401k plan. He
may have gotten wealthy with all of the website hits and advertisements he has
on his site since his forte is Search Engine Optimization (SEO). I also find it
ironic that he states becoming wealthy in the 401k plan is based on proper
education and you should start with his article despite it being full of
fallacies.
I like to look at others when I want to know ways of getting
rich. Donald Trump earned his money
through real estate development and building businesses. Bill Gates became what he is through building
of a business. Warren Buffett made his
fortune through buying businesses and investing in the greatest
businesses. None of them had a 401k
plan. Even if you do not wish to become
a business mogul, then you should still observe and look at options outside of
the 401k plan to increase your wealth and create a secure retirement for you
and your family.
Conclusion
401k plans are a savings plan, similar to a bank account. Companies no longer offer retirement plans in
the form of pension plans. This means
that instead of receiving a paycheck in every year of your retirement, you will
have to save and ensure that your money lasts you throughout your retirement.
There are multiple benefits of utilizing a
401k plan which we will cover in later articles but this by no means will be
the best investment path for all. There are plenty of people out there offering
faulty investing advice which requires you to learn about investing so you can
challenge the common thought.
The 401k
plan does have ways you can minimize your risk by learning about investing and
then taking control over your 401k through a self-directed 401k plan. The self-directed plan makes more sense if
your employer does not offer a 401k matching contribution. Look at examples of those who have succeeded
in money and finances in order to see if you are on the right track.
To see my other articles on
401k investing click the 401k link to the left in the idea cloud. This will filter the site for articles on
this subject.
To Your Success,
