A 401(k) is meant to help you invest for retirement, but how much do you keep?
Here at The Rich Dad Company we spend a lot of time bashing the idea of a 401(k) and its international counterparts. We also tell people that in order to find financial success they need to learn the difference between an asset and a liability.
An asset puts money into your pocket (cash flow), while a liability takes money out of your pocket. Buy assets, not liabilities and you will be successful. Right?
Well… maybe we’ve gone too simple.
We’ve received questions such as: Doesn’t a 401(k) make money and put it into your pocket? Isn’t a 401(k) an asset? All we have to do is buy assets that put money in our pocket so why the hate?
To answer those questions, let’s ask ourselves if a 401(k) puts money into our pockets. A typical 401(k) plan takes 80 percent of the profits. The investor may receive 20 percent of the profits, if they are lucky. Don’t believe us? Ask John Bogle. Yes. John Bogle, Founder of Vanguard Investments.
The investor puts up 100 percent of the money and takes 100 percent of the risk. The 401(k) plan puts up zero percent of the money and takes zero percent of the risk. The fund makes money through fees, even if you lose money.
Generally speaking in a bull market, a 401(k) does put money in your pocket – but only 20%. So if you had $10,000 in your 401(k) and it made 5%, then your 401(k) made a profit of $500 - you only get $100 (before taxes).
Now we have to understand that taxes work against you with a 401(k). Long-term capital gains are taxed at a lower rate of around 15%. Great! The only problem is the 401(k) treats any gains as ordinary income. Ordinary income is taxed at the highest rate, sometimes as high as 35%. And if you want to take the money out early, you’ll have to pay an additional 10% penalty tax.
In real investment assets, tax law is written to your advantage, not taxing you at every turn.
It gets worse. It turns out that when it's calculated correctly, without government creativity, inflation increases faster than any 401(k). That means money is leaving your pocket!
It’s difficult to really call a 401(k) an asset, even by the financial industry’s definition. If you look at a 401(k) using Rich Dad’s definition of an asset - something that continually puts money in your pocket whether you work or not – then it’s downright laughable. That’s not even factoring you can’t touch that money until you’re 59 ½-years-old without an additional 10% penalty.
The mutual fund industry has done a masterful job making it nearly impossible to determine whether or not your 401(k) is an asset. But it doesn’t really matter. We’ve seen that even if it is making you some money, it’s not enough to justify the risk.
Risks? Oh… you did not know?
With a 401(k), you have no insurance if there is a stock-market crash. To drive a car, you must have insurance in case there is a crash. When one invests in real estate, one has insurance in case of fire or other losses. Yet with a 401(k), you have no insurance to prevent losses from market crashes.
So, let’s ask the question again, “Is your 401(k) an asset?”