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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Manage Your Money Don’t Let it Manage You

 
So I haven’t written anything in a very long time and I’ll get around to some reasons in future posts but yesterday I saw a sudden rush (which for me means three or four people) reading some posts I wrote a while back, they even tweeted links to their followers (thanks!). That inspired me to make an effort to write some more so I’ll start again with a favorite topic of mine, finances.

Percentage_IncreaseI keep very detailed stats on my money, what’s coming in and what’s going out, my investments, how they’re performing, and my plans for the future. One thing I do every year is a cash flow analysis (because I’m that exciting). Because I track everything I spend I can make informed decisions rather than just guessing. Of course I’m not going to share actual numbers – you know my name after all, but I will share percentages.

All of my income is 100% but what is the total from? Well my salary represents 35.92% and my wife’s salary represents 41.91%. Yes she makes more than me and I’m not only ok with it, I love it because it shows that smarter people are rewarded more. So our salaries represent 77.20% of our income where does the rest come from? The next largest chunk comes from investments in the form of dividends and interest at 14.75%. This might sound high and it is (and will be the subject of a future post) but is key to building wealth. I wrote about our two rental properties in What Next and they represent 6.11% of our income. After that comes our 401k match which represents 1.87% of our income and that is free money, money that we’re not taxed on but that grows and grows until we retire (and beyond). The importance of the match can’t be overstated.

Now comes the importance of tracking your spending because I can list, in broad categories, where every penny of my money went.

Mortgage: 12.67%  Loans: 2.22%  Insurance: 1.78%  Taxes: 19.59%  Commuting: 1.59%  Household: 1.57%  Vehicles: 4.19%  Eating Out: 2.67%  Groceries: 0.80%  Entertainment: 2.01%  Utilities: 1.79%  Travel: 0.72%  Medical: 0.38%  Pets: 0.49%  Rental Properties: 9.09%  New Business: 17.57%  Misc: 2.64%.

Since the numbers above don’t equal 100% where did the rest go? Savings! Last year we saved 18.23% and that’s from gross income while in the midst of opening a new business.

Some observations:

While my rental properties contribute 6.11% of my income it takes 9.09% in expenses. In other words “passive” income like this isn’t easy money and often the return isn’t evident until the property is sold.

Even though a large amount of money is generated by dividends and interest (this year, 2013, was unique because of how much stocks were up) most of that money is inaccessable because it’s in retirement accounts such as a 401k.

We spend very little on groceries for two reasons: we eat out a lot and we buy in bulk at Costco which if done carefully can save us a lot.

 


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