The 401(k) is often considered the no-brainer, gold standard of retirement plans. But far from being a bedrock retirement plan, the 401(k) started as an experiment in 1981 and still has to prove itself.
Those who decided to be a 401(k) lab rat in the first test group are just starting to get back their results. After 30-plus years of faithfully funding their new retirement plan, it’s time to retire. As you’ll see, the last 15 years have not been kind to them, but that should have been no surprise. The supposedly dependable 401(k) is not your best choice for retirement. Not by a long shot.
I’ve worked with hundreds of professionals. Most of them diligently saved in a 401(k), but once I explain the risks, they’re eager for alternatives. Here are 13 dangers of a 401(k) for you to consider.
1. You can be wiped out overnight.
A report on CBS’s 60 Minutes TV show asked of 401(k)s, “What kind of retirement plan allows millions of people to lose 30-50 percent of their life savings just as they near retirement?”
Unlike other investments that are protected from losses, your 401(k) rises and falls with the stock market where you have absolutely no control. Retirement planners will tell you the market averages 8-11 percent returns per year. That may have been true last century, but this century has seen that turned into a fiction. From 2000 to 2015, the market was up just 8.4 percent total when adjusted for inflation, or 0.56 percent per year, and that was after a substantial market rally.
Do you want to live your ideal life only if the market cooperates?
2. Administrative fees and the tyranny of compounding costs.
The toll taken by 401(k) and associated mutual fund fees is staggering, and can eat up more than half your gains. With 401(k)s, there are usually more than a dozen undisclosed fees: legal fees, trustee fees, transaction fees, stewardship fees, bookkeeping fees, finder fees and more.
But that’s just the beginning. The mutual funds inside 401(k)s often take a 2 percent fee off the top. If a fund is up 7 percent for the year, they take 2 percent and you get 5 percent. It sounds like you’re getting more, right? At first, yes, but in the end the mutual fund wins.
As Jack Bogle, the founder of Vanguard explains it, “What happens in the fund business is the magic of compound returns is overwhelmed by the tyranny of compound costs.”
If you contribute $5,000 per year, from 25 years old to 65, and the fund goes up 7 percent every year, your money would turn into around $1,143,000. Yet, you’d only get to keep $669,400, or less than 60 percent. That’s because 7 percent compounding returns hundreds of thousands more than a 5 percent compounding return, and none of it goes to you. The 2 percent fee cuts the return exponentially. In the example above, by the time you turn 75 the mutual fund may have taken two-thirds of your gains.
Bogle puts it like this, “Do you really want to invest in a system where you put up 100 percent of the capital, you take 100 percent of the risk, and you get 30 percent of the return?”
Credits: Garrett Gunderson