401k plans seemed like a good idea at the time. Individualized retirement plans. Personalized portfolios to replace the stogy old pension. Real growth for young, aggressive investors; safety for senior employees facing retirement.
Many years ago, there was no 401k-it simply didn’t exist. Companies had pensions-giant pools of money conservatively invested to provide employees with lifetime incomes after they retired. It was a wonderful system if for no other reason than accountability.
Yikes-accountability in the investment world? You bet. The brokerage houses that ran the pensions had to have good money managers. Pensions required solid returns and the law required that pensions could only buy good, safe, reliable investments. If the brokerage house couldn’t perform, they’d lose the multi-million (or billion) dollar account.
Why Should Wall Street Be Accountable For Investments?
Then, the 401k plan was born. Now, I won’t go into the full history but I’ll sum it up like this: How does it make sense to take retirement money away from professional money managers who are accountable for their performance, and put it into the hands of the employees-people who don’t love investing, don’t have the time to do it properly, and don’t necessarily want to spend the time to learn it?
So, on top of all the work, family, social, and other obligations you have, you are solely responsible for managing what may end up to be your most important retirement account. Of course, most people are busy, don’t understand it, and get no support from the brokerage firm providing the 401k; so, it is no wonder that, while the S&P 500 earning some 12.2% a year, the average 401k investor had an average annual return of just 2.6% from 1984-2002 according to this study by Dalbar (no longer online).
Why The Shift From Pensions To 401k Plans?
Let’s go full circle-accountability. Wall Street was accountable for the performance of the pensions. But many of the Wall Street brokerages are not in the business of providing investment advice and portfolio management for growth-they’re in the business of selling investments for a profit. Any advice they provide is generally incidental to their investment sales business.
Here’s the problem: At any given time, there are only a few great investments worthy of your retirement (or pension) money. Wall Street will buy/sell those-but no firm could survive on making only a few sales a year. Once the great investments are gone, they have to buy and sell mediocre investments.
But, Wall Street firms have to make more money next year than they did last year-so they have to start buying and selling bad investments too.
Here’s The Rub
Picture it: All the Wall Street suits drooling over hundreds of millions of dollars in pension money-money they can’t invest but in blue chip stocks and AAA rated bonds. All those commissions being wasted. All those investment banking deals being passed on. All those profits.
Hmmm. They can’t sell us bad investments directly. What to do? What to do? I got it!
The Profit Plan
Let’s take all of that pension money, roll it into 401k plans, jam them full of our mutual funds. Then, we’ll buy and sell great, mediocre, and bad investments in the mutual funds! Investors won’t know the difference because we don’t need to tell them about the tens of thousands of mutual funds out there or that index funds would beat our pants off. We’ll just throw them a bone: 10 or 12 of our funds-funds that pay us commissions ever three months, buy our investments, and pay some of our expenses.
Out Goes Accountability
The end result? Wall Street is no longer accountable for your retirement-you are. But hey-they don’t want you to hurt yourself, so they’ll give you a list of mutual funds-some good, some horrible-so you don’t get confused.
Oh, and if you don’t reach your goals? You should have saved more, spent less, been more aggressive, been less aggressive, diversified more, or diversified less. In any event, don’t blame the people managing the mutual funds or providing the advice to the plan. They’re just there to get paid.
I’m Too Angry To Go On
Actually, I’m just getting a bit long winded. I’ll continue the 401k rant tomorrow. If you can feel my seething anger towards this ridiculous now-standard retirement plan, I apologize. My anger stems from seeing (and having seen) too many people in their late 50s with little more than two- or three hundred thousand dollars in their 401k plans. Their dreams of retiring with their near $60k income are out the window as they struggle to figure out if (not when) they can retire.
They thought they were doing well. But that’s only because no one told them differently. And with their 401k, they have no options.
Filed under: Thanks Wall Street
Joe,
I recently started reading your blog from page 1, much like a book and love it! Here I am about half way through @ page 48 and this topic has sparked a question.
If I have a 401K plan where the company matches dollar for dollar up to 6% of your salary, should I participate to take advantage of the free money and before tax contribution, while risking it with a potentially crappy mutual fund tieing it up behind a penalty for the next 35-40yrs ? (Im 26)
Or would I be better off not participating, getting a bigger paycheck and allocating after tax dollars to a savings account and eventually an awesome business(stock) that I will find within the next 7 yrs that will earn 15%?
Do you have an example of how these two options would play out if carried on for 30 yrs with a 45K salary with 6% contribution to either my plan, or through the company’s 401K.
Summary: Is it worth the risk to get the company match and tax benifits?
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Allen and Ryan are dead on. Find out your options. You may be able to open a separate account and buy whatever you want. Or, you can try to petition for it.
Otherwise, it generally makes sense (though this isn’t a recommendation) to get the full match and dump it all into an index fund. That way, you get the immediate 100% gain (for your $1 for $1) and then put your money into a fund that more than 80% of active managers can’t beat.
If your index fund earns 11% for ten years, your $1,000 contribution plus your employer’s $1,000 would grow to roughly $5,679 – a 19% average annual return on your contribution. If you took the $1,000, paid $300 in taxes, and invested the $700, you’d have to earn 23% for ten years to match that $5,679 end result. Possible, but then you also run into the problem of not saving.
I know – you’ll save every penny. But like me, you’ll have the occasional wedding gift, dinner out, new car, or other expense, and you’ll easily not save for one or two months every year. That would put you even further behind.
But first and foremost, see if you can get a separate account. Then, you’ll know which way to go.
Hope that helps!
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Joe and all,
I assume you mean a brokeridge account when you say a seperate account ??!! I do have this type account on my Fidelity 401k plan … I am able to buy and sell several hundred different funds … the problem is, I’m not a financial ‘wizard’ and research each fund to the best of my ability and choose many world funds that are averaging a 40% return if not higher, YTD, 1,3,5,10 and life of fund …
I guess my question is this, should I pay a financial consultant to help manage this 401k or continue managing this on my own ??? I have the V.P. and others following my lead since it got leaked out how my 401k returns have been doing … for instance LATX has been doing great overall and all indications tell me that it will continue to do well … TCWCX is another fund I’m going to buy into as soon as possible …
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Lawrence,
If everyone is upset about the 401(k) plan, it might be worthwhile to bring it to an independent company that has the freedom to choose any mutual fund, stock, bond, etc. Companies like Fidelity give you some freedom, but are mostly proprietary.
I have never used this forum as a place to sell my company or services; still, if you need to make some changes, consider an independent firm with independent thinking and investments.
If you can’t make a change to the plan, you may want to consider a separate account (it acts like a brokerage account) where you can buy and sell whatever you want. Just make sure the fees to do so don’t kill your returns.
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I agree with you.
I also think the 401K is a scam because you’re not allowed to invest in the stocks you choose but only the 5-10 mutual funds available. How’s that fair? Who picks the mutual funds that are allowed to be in the list? I’m sure mutual fund companies scramble to be put on that small list of those to choose from. Then there’s the problem that if you actually know what you’re doing and what to invest it yourself you can’t without withdrawing the money which comes with a huge penalty.
Total garbage.
And for the record I participate in the company’s 401K i’m with but I’m not happy about.
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