I came to the US a decade ago with nothing in my pocket, a work Visa and virtually unlimited optimism. Diligent saving and timely investments has made for a bitter-sweet ride. With this background to my story, I confess to knowing a thing or two about finances, investing and retirement.
In this article, I would like to approach 401k investing with a contrarian twist!
“401(k)” is a type of retirement savings account in the USA passed in the 1980’s and all the good stuff which you can Google or Yahoo and find out.
Why 401(k) and not traditional IRA or ROTH IRA? Very simply put, you set aside a large amount of money aside to compound tax-free, lower tax bill for today, defer taxes for tomorrow. There is no other instrument in the market which allows you to postpone taxes on earned income than the 401(k). As of 2011, the IRS set the contribution limits at 16500. For traditional IRA, it is 6000. Remember, the money is locked away for 20-30 years giving you a couple of compounding cycles. To give you an example, let us say you invested $1000, @10% which is nearly impossible for 401k funds as it stands today (my dire warning to you!), it will take 7.5 years to double. Thus, over a course of 30 years, the money will grow to $2k in 7.5 years, $4k in 15 years, $8k in 22.5 years and $16k in 30 years. However, there is at least 2 recessions once in 10 years and a total of 5-6 recessions over 30 years. This will dent your portfolio and the oft advertised, drool-producing $16k is really not available to you at the end of 30 years. The numbers presented above are mere math. Period.
To finish first, you must first finish
As the famous saying goes, “To finish first, you must first finish”. When you retire, it is imperative there is some money left in the fund which is paid out as distributions after the IRS collects the taxes due. During my employment, I have found employers to be paranoid about dishing any common-sense advice. Mind you, there are tons of CFA’s with good intentions but caught between the devil (commissions) and deep blue sea(lack of fundamental knowledge about market cycles). Caught between the government trying to protect me from me and lack of common-sense approach, I was trapped in the dragnet of the basket of funds which the company selected. Generally, there is no information on who the brains behind the selection of these funds are, what the costs to the 401(k) plan annually are and how much the company needs to fork out to maintain such a benefit to its employees. As a smart employee, it pays to ask these questions.
Borrowing a line from a Sylvester Stallone movie, “Lock-up”, follow the mantra – “D.T.A, Don’t trust Anybody” Yes, it boils down to you and an acceptance of personal responsibility and setting aside time to do the needful – not much, just a couple hours and once in a year.
At work, I constantly behoove colleagues to think differently when it comes to saving for retirement. They are simply dropping money into the slot machine known as the “401k offering” and expect to make good.
Sticking to the contrarian philosophy, as foolhardy as it sounds, the aim is to protect principal, you accept lower rate of return. In this case, money market fund or PIMCO bond funds or index funds. Caveat, individual rate of return is always skewed compared to the fund’s advertised return in the prospectus. In spite of adding the income earned from index funds, the earnings over the past decade do not measure up to recover your principal. That is how bad the performance was during 2000-2010(fund data courtesy: 500indexfund.com).
Chances are, when everybody is losing sleep over a down market, you get to sleep and feel good (like I did over the last 2 recessions). One size does not fit all -let cold hard cash dictate. In times like this, it feels awfully good to hold cash than hope on some promised multiple 10 years from now.
Investors like Warren Buffett, Peter Lynch, Seth Klarman and a whole army of investors have earned billions in the stock market over the past few decades. However, you just cannot do or achieve the same with 401k investing, inspite of the tax free nature. Go figure.
Options for the individual investor:
There are a few options – however, you will be required to take some pro-active action to ensure this happens. Respected money managers with an admirable track record run by Whitney Tilson, Mason Hawkins, and Bruce Berkowitz run publicly traded mutual funds. You may want to consider rolling money over older 401k funds (a start) to an IRA (direct rollover) with a low-cost online discounted brokerage firms like scottrade or sogotrade and invest sums in these. Joel GreenBlatt is considering starting a value weighted index fund which is exactly what I would have recommended when we cannot make investing our full time job. While you are employed, to take risk out of the picture, consider either money market or bond funds(federal law does not allow you to rollover money from current 401k to an IRA). Rolling over to IRA gives the super benefit of investing in US Savings Bonds EE/HH, treasury bills/bonds/notes further sweetening the safety and guaranteeing principal
In addition, considering investing in stocks is fair game and requires more commitment but beyond the scope of this article.
For the record, I rolled over my 401k money to a direct rollover IRA early 2008 and managed it unscathed by the 2008-09 recessions. Currently, the IRA sits in a mix of stocks & cash. For 2 years, the return including all commissions was 9%pa.
Disclaimer: This article is solely for your informational and educational purposes. This article DOES NOT constitute or provide investment advice under laws and regulations of US or any country. Neither is it a solicitation or offer to sell investment securities or investment advisory services or financial planning services. There could be errors in the information and opinions expressed. It is solely your responsibility to verify all information before investing or making any other personal financial decision