I had a listener pose a question the other day. He said, “Is the 401 K plan still a good place to invest?”
It is a question that is really never asked. Conventional wisdom has always been to start a 401 K plan and start funding as early in your career as possible. Is that still good wisdom for today?
Planning for retirement, saving for retirement as early as possible, and managing your investment dollars should always remain good sound advice. Where you save and manage your investment dollars might need to be revisited.
I can only see one good reason for investing in a 401 K plan – the employer match. The concept of free money is hard to turn down. You put money in the 401 K plan and your employer matches it. Interestingly enough, a new study by Financial Engines shows that 401 K investors aren’t even taking advantage of the one good reason.
Their study shows that Americans leave 24 billion on the table every year by not taking full advantage of the employer match. For example, let’s say an employer matches $1 for $1 up to 5% of a person’s income. The employee only invests up to 3% of their income wasting the other 2%. That is like saying to your employer “no I don’t want your free money.”
If that is the only reason you should use a 401 K plan, then what are the reasons that you might consider other accounts?
- Choice – Most 401 K plans simply don’t provide enough different types of investments for an employee to adequately diversify. For example, a 401 K plan could offer 24 stock funds and a few bond funds. That offers no diversification leaving the employee to mostly invest in stock with limited choice for diversification into bonds.
- Expenses – You know I don’t put a lot of weight on expenses. I think that companies such as Vanguard get it wrong when it comes to their explanation of expenses and investments. Expenses are ok as long as there is value added. In some 401 K plans, expenses are high and there is not much in the way of value added.
- Limited Guidance – For most people, a 401 K plan is their largest asset. Yet, they are left up to themselves to make decisions.
- Target Date Funds – 401 K providers are starting to rely heavily on target date or lifestyle funds. They market these funds as a way to just go on autopilot and easily save for retirement. You just pick the fund that corresponds with your target date for retirement and the fund will adjust the risk level as you age. Where do I start? First, you never go on autopilot when it comes to saving and investing for retirement. That is an irresponsible message from the industry. Second, age is only one factor when it comes to assessing risk.
So, it might make sense to challenge conventional wisdom and question the 401 K plan. Anything beyond an employer match might not make as much sense.