The Good and Bad of 401ks

 
401kHighwayI believe blanket statements are too simplistic and that’s why I flipped out on James Altucher for saying that people in their 20s should not invest in 401k plans. That’s dumb advice, so here’s my reasoning why 401k plans are a good investment, but not the best, and why they should be part of your investing life but not the only part. If you’re a numbers geek then you’ll love this post.

One of the completely idiotic statements James made was that you’ll only get a 1/2 percent return on a 401k so let’s take a look at my experience. A few things: I’m a consistent investor who believes in buy and hold and favors index funds over actively managed funds. Obviously I’m not going to use my actual account balances so instead I’ll use a hypothetical based on about $1,000 invested over 18 or so years which is how long I’ve been in the 401ks I’m using for this example.

Let’s say my current 401k account balance is $4,180. There are four parts that make up this balance:

1. How much I invested over the years

2. My company matching funds – free money

3. Dividends that are reinvested

4. Growth – what James Altucher said would be about 1/2 a percent (I’m shaking my head writing that)

My investments, the money that came out of my paycheck, accounts for 23.4% of that total or $978.12.

The company match, the free money James didn’t even mention, accounts for 5.1% or $213.18.

The dividends were a big part of this and is the reason I have mutual funds that pay higher dividends in my tax deferred retirement accounts, another item James was not impressed with but can be very important. You don’t pay taxes on dividends in a tax deferred account! So the dividends were 18.6% or $777.48.

Add all that up and you only get $1,968.78 far below my balance of $4,180 so where is the rest? The rest is growth over 18 years and accounts for 52.9% of the value of my 401k balance. That’s a lot more than the 1/2 a percent James mentioned is his video. Also of note is that this includes the huge losses in 2008, losses that were quickly recovered because I didn’t panic and stuck with my plan.

But in some small way I do agree with James that 401k plans are not always the best option. I have reduced the amount I’m investing in my 401k plan for a couple of reasons. First because the money is locked up until I’m 59 and a half (not 65 as James said in his video). I want to retire early and need money available before I’m 59.5 so I’ve been investing more in my taxable accounts.

Another reason I’ve reduced my 401k investments is so that I have funds available for other investment options like a business I opened a couple of years ago. If all my money was tied up in retirement accounts I’d be investment rich but cash poor like so many people are house rich and cash poor.

One size does not fit all and blanket statements are useless. The power of compounding, as evidenced here, is incredible! So please do invest in a 401k plan as early as possible and put enough money to at least get the full match your company offers (if they offer a match). After that make decisions that work for your situation.


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