The Worst Way to Invest Your Retirement Money image

The Worst Way to Invest Your Retirement Money

Why financial education takes you beyond the 401(k)

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.

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.

Money doesn't mean financial intelligence

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.

Deductive reasoning

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 401(k), the same way the tax departments collect taxes.

Retirement plans like the 401(k) 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 401(k)s are the worst investments

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

  1. Taxes work against you with a 401(k): Long-term capital gains are taxed at a lower rate of around 15%. But the 401(k) 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. And, if you want to take money out of your 401(k) early, you'll have to pay a 10% penalty too.
  2. 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 loses. Yet the 401(k) investor has no insurance to prevent losses from market crashes.
  3. The 401(k) 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.

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 401(k)s. They've been predicting that millions won't have enough money to retire after a lifetime of handing money over to strangers. A typical 401(k) plan takes 80 percent of the profits. The investor may receive only 20 percent, if they're lucky. The investor puts up 100 percent of the risk and the money. The 401(k) company puts up no money but gets the majority of profits.

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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