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Why a 401k Plan is Not Worth It When It Comes to Retirement

Why financial education takes you beyond the 401k plan

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Most people don't have a financial education. So, when it comes to investing and building a solid retirement, they blindly turn their money over to people they believe are financial experts: people such as bankers, financial planners, and stockbrokers—usually through a financial vehicle for retirement such as the 401k in the US.

Most of these so-called experts are not really investors in the true sense of the word—the big I quadrant in the CASHFLOW Quadrant. Most are instead in the E quadrant, working for a paycheck, or self-employed financial advisors in the S quadrant working for fees and commissions. Most "experts" can't afford to stop working simply because they don't have investments working for them.

Not just the poor fall for 401k plans

To be clear, this is not a poor person or a rich person problem. Both the rich and the poor give their money to these "experts." This is because having a lot of money doesn't make you financially intelligent. There are many high-paid employees who have no idea how to manage their money, and many who lose a lot of money because of it. That's why Warren Buffett said, "Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway."

If people don't have a sound financial education, they can't tell if a financial advisor is a salesperson or a con artist, a fool or a genius. There is nothing wrong with being a salesperson. We all have something to sell. Yet, to quote Buffett again, "Never ask an insurance salesman if you need insurance." When it comes to money, there are many people desperate enough to tell and sell you anything, just to get your money.

401k plans and retirement

Interestingly, the vast majority of investors never meet the person taking their money. In most of the Western world, employees simply have their money automatically deducted from their paycheck into retirement plans like a 401k, the same way the tax departments collect taxes.

Retirement plans like the 401k go by different names in different countries. For instance, in Australia, they are called superannuation plans, and in Canada, they are known as RRSPs. But they all share one thing in common, your employer takes money out of your paycheck and hands it over to a broker you've most likely never met to manage one of the most important things for your future—your retirement.

And they're all possibly the worst way to invest.

Why 401k plans are the worst investments for retirement

I say the 401k is possibly the worst way to invest for retirement for the following reasons:

  1. Taxes work against you with a 401k plan: Long-term capital gains are taxed at a lower rate of around 15%. But the 401k gains are taxed at the ordinary earned income tax rate, which is much higher and the highest taxation rate of the three types of income: Ordinary earned, portfolio, and passive.

  2. 401k and the early withdrawal penalty: If you want to take money out of your 401k early, you'll have to pay a 10% penalty. That’s right. The government doesn’t trust 401k investors enough to even let them manage their own money how they want. Once it’s in, it stays in...or it will cost you.

  3. You have no insurance if there is a stock-market crash: To drive a car, I must have insurance in case there is a crash. When I invest in real estate, I have insurance in case of a fire or other losses. Yet the 401k investor has no insurance to prevent losses from market crashes.

  4. The 401k is for people who are planning to be poor when they retire: That is why financial planners often say, "When you retire, you'll be taxed at a lower tax rate." They assume you'll make less money when you retire and thus be in a lower tax bracket.

Many experts agree that the 401k plan is a horrible retirement vehicle

TIME Magazine

TIME magazine is on my side. TIME has run a number of articles over the years questioning the wisdom of putting so many people's retirement at risk through 401k’s, such as “Why It’s Time to Retire the 401(k)”. They've been predicting that millions won't have enough money to retire after a lifetime of handing money over to strangers.

John Bogle, founder of Vanguard

John Bogle is an entrepreneur, true capitalist, and the founder of one of the world’s largest mutual fund companies—Vanguard.

In his book, The Battle for the Soul of Capitalism, Bogle expressed concerns about the retirement system as a whole. He takes aim at CEOs of investment firms and believes retirement is going to be the next big financial crisis in this country. That’s a big deal, especially with so many people relying on distant retirement accounts to provide for their future security.

Bogle, an insider in the mutual fund industry, is disturbed by the greed he sees in his industry. He says:

When I came into this business there were relatively small, privately held companies, and these companies were run 
by investment professionals.

Today, that has changed in every single respect. These are giant companies. They are not privately held anymore. They are owned by giant financial conglomerates, whether it’s Deutsche Bank, Marsh & McLennan, or Sun Life of Canada. Basically, the largest portion of mutual fund assets are run by financial conglomerates, and they are in the business to earn a return on their capital in the business—and not a return on your capital.

Bogle points out that in mutual funds, you, as the investor, put up 100% of the money and take 100% of the risk. The mutual fund company puts up no money, takes no risk, and yet keeps 80% of the returns. The investor gets back 20% of the gains (if there are even gains).

Warren Buffet

Warren Buffett is regarded as one of the greatest investors of our time. He is a capitalist. He is an entrepreneur. He is not a managerial capitalist. (Managerial capitalists are not entrepreneurs. They did not start the business. They do not own the business. As managerial capitalists, they have responsibilities, but take no personal financial risks).

This is what Warren Buffett has to say about these corporate money managers, managerial capitalists, most of whom are “A“ students from great schools.

He says: “Full-time professionals in other fields, let’s say dentists, bring a lot to the layman. But in the aggregate, people get nothing for their money from professional money managers.”

If this is true, it might be stated another way: Those who choose not to become financially educated or play an active role in their investments and, instead, turn their money over to professional money managers, are abdicating responsibility for their financial future—and, if Buffett is on target, getting little value for it. How great is the risk of turning your money over to a “professional” who brings little value to the undertaking of making your money work for you?

So why are 401k plans so popular?

So, why are 401(k)s so popular? They're easy, for one. But the main reason is that those who run these plans make a lot of money off your money. Those who run these plans don't get paid by how much money they make you. They get paid by how much money you turn over to them in the long run. Thus the old line, "Invest for the long-term in a well-diversified portfolio of stocks, bonds, and mutual funds."

The reality is that real investors do not park their money. They move their money. It is a strategy known as the velocity of money. A true investor's money is always moving, acquiring new assets, and then moving on to acquire even more assets. Only amateurs park their money.

There are much better ways to invest for your retirement, but they require financial education. I encourage you to start building your financial education and learning about better, more sophisticated ways to prepare for retirement.

Original publish date: August 27, 2013

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