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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James Altucher’s Terrible Advice

I’m adding James Altucher to my list of really smart, incredibly successful, fools.

I’m adding him because of this video:

Watch at your own risk because the advice is so wrong it’s sad, sad that someone so successful and so intelligent would give such bad advice. Sad, because he was allowed by Business Insider to give false information. His blanket statement is so simplistic, it’s an insult. If James gets easily verified information wrong then what does that say about his concern about truth?

In the video James Altucher says that you can’t remove money from a 401k without a huge pentalty until you’re 65. WRONG! Once you’re 59 and a half you can take money from any retirement account penalty free. And that huge penalty he talks about is really just a 10% penalty – not good but not huge either.

James also doesn’t seem to think that tax deferral means much to someone in their 20s which indicates that it probably does mean something to someone older, so what’s the cutoff, 30? 40? 50? Here’s what tax deferral has meant for me: over the years that I have invested in my 401k I have saved over $14,000 in capital gains from sales only (dividends aren’t included but are also huge) thanks to the tax deferral of my 401ks. I also don’t sell often  so that savings could have been much larger. Maybe that doesn’t mean much to someone as wealthy as James Altucher but to a regular person who has a job, that’s a big deal.

Another idiotic statement that James makes is that you have no idea what’s happening to your money in a 401k. That’s just ridiculous. You certainly know what’s happening because you can choose the investments (granted from a pre-selected group of funds) and you can buy and sell as you see fit. I suggest index funds. I have invested in a 401k since I started my current job 18 years ago and my return has been huge.

Add up all the money I’ve invested and compare that to the current value of my 401k and you get a 418% return. I understand that’s hard to believe but it’s true. Part of that is the company match which James conveniently left out of his video. How someone ignores the possibility of FREE money is baffling to me. Without giving you my specific numbers let’s break that down. The period we’re talking about is 18 years so if you invested $1,000 over 18 years you would get $4,180. Think about that – all you had to do was invest $56 a year and at the end of 18 years you’d have $4,180. Make those numbers larger and you really see the benefit: invest $5,000 a year for 18 years for a total of $90,000 and the balance would be $376,200 and you’d still have at least 10-20 years of work for that to grow.

Blanket statements might lead to clicks and bring you publicity but they are rarely correct. Blanket statements are an insult to your intelligence. Investing is somewhat complicated but I believe you’re smart enough to understand.

I’m going to give more detail into my investing and why I think a 401k is just one part of a successful investing plan tomorrow. I hope to see you back.

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