The Magic of Your 401(k)
Would we really be better off letting the government manage our money?
Just a few years ago, it was a popular idea to make 401(k)s an opt-out proposition, where you would be signed up for 401(k)s rather than having to opt in. Now, the talk is of eliminating 401(k)s, because they are thought to be too volatile a vehicle for retirement. One proposal would require everyone to invest 5% of their income in government bonds with a guaranteed 3% rate of return adjusted for inflation. But is this truly what’s best for workers? Would we really be better off digging a hole and sticking our money in the ground or letting the government manage it?
Let’s take the case of one worker: me. I began putting money into my 401(k) in 2005. The market decline has seen my 401(k) take a beating. It lost nearly half its value between November 2007 and the end of business on March 31, 2009. Would I have been better putting my money under a mattress? Not at all. Even with steep losses over the past 17 months, I have 35% more in my 401(k) than I’ve put into it over the past four years.
I wish I could say this was because I am brilliant investor, but the secret of my gain is far simpler. First, the funds and stocks I invested in went up and they paid dividends. Also, I received an employer match. On top of the gain within the 401(k), I’ve received tax deductions for my 401(k) contributions, as well as the saver’s tax credit instituted by President George W. Bush to help middle and lower-middle class folks save for retirement. And while there have been significant losses in retirement accounts over the last year and a half, the media’s focus on this has left out several key facts.
The first question is whether people would have been worse off had they not invested in retirement savings. Secondly, will most people be better off if they don’t invest? In most cases, the answer to both questions is no. In general, those who have lost money wouldn’t be in nearly as good shape if they hadn’t invested in the first place. And if workers in their 30s and 40s panic and pull everything out of the market, they’ll miss the next big increase.
Most importantly, these losses have not been realized. The value of the stock or mutual fund may have plummeted, but until you actually sell what you have, nothing is permanent. If the stock or fund goes back up before being sold, the loss may be reduced or even turned into a gain. Or if consumers transfer money from a security that’s not going to make money to one that will, they could make their losses back.
Yet, as usual, media reporting and politicians make matters worse by not putting what’s happened into proper perspective. There’s the hyper-panic attitude when it comes to the billions lost in 401(k)s that assumes declines in stocks have never happened without wiping out everybody invested in them. Also, the coverage is one-sided. How many stories did you see between 2002 and 2008 about the hundreds of billions people made in their 401(k)s and IRAs?
Media coverage may have let you know the Dow hit 13,000, but it didn’t tell you that meant people all across the country with retirement accounts were earning huge gains. Even your Pizza Hut delivery driver could be raking in some serious percentage gains. The media will tell you the story of the lady who is forced back to work because her stocks lost money. Yet the media won’t highlight the successes of the guy who — thanks to smart financial decisions – retired as a millionaire at 52 despite never earning more than $60,000 a year. The media would only report this story if the guy made a poor move, put all his money in AIG stock, and lost it. The media doesn’t want to show a positive focus on investing; it would rather focus on economic behaviors it finds worth encouraging — like buying lottery tickets.
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Adam Graham is a contributor at Race42012.com and host of the Truth and Hope Report podcast. His personal site is Adam's Blog.
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22 Comments
1. retrophoebia:One addition to this post–
I’ve heard that the Left claims that individual accounts, 401ks, etc, are too volatile for the average citizen. Yet we also hear that they don’t earn enough. Which is it? Surely something cannot be volatile downwards only. Additionally, something that gets absolutely 0 media exposure is that Social Security provides, for most taxpayers, negative return on the pay-in. That is, for most earners (everybody above female payers in the lowest tax brackets), real returns on SS range from -5% to about -30% if not a little more.
Detailing this: http://www.heritage.org/research/socialsecurity/CDA98-08.cfm
It’s not the original set of numbers that I recalled above, as I couldn’t find my original reference; but compare it to a hypothetical average of 6% RoR over time to individual stock-holding accounts.
Point being– Government managed retirement accounts are a bad idea. Power to the people!
Apr 13, 2009 - 3:09 am 2. BillB:Union membership is declining in the private sector ONLY! Government is awash in union membership, where there is an endless supply of funding for lucrative early retirement.
Apr 13, 2009 - 4:57 am 3. venividivici:401(k)s need the following tweaks to be the perfect vehicle for any worker:
1. A “target-date” fund that meets strict asset allocation guidelines based on empirical market returns data as the default option, into which everyone is autoenrolled with autoescalation of contributions
2. A guaranteed income annuity option which can be purchased over time at different points in the interest rate cycle. This annuity can be either a straight fixed annuity or a variable annuity with a range of relatively limited investment choices based on risk tolerance.
3. Better and more transparent fee disclosure that enables true apples-to-apples comparisons of fees versus value-add by administrators.
4. Ability of plan sponsors to provide objective advice via automated means such as software packages that are not compromised by conflicts of interest. Financial Engines is a good example of the type of software I mean, but if I recall correctly, they were under scrutiny for conflicts of interest with investment managers, which undercuts the value of the advice.
After 30+ years of 401(k) plans being in existence, I’d say those are the key limitations that have emerged. All that noise about putting retirement planning in the hands of the government is just stupid.
Apr 13, 2009 - 5:24 am 4. Harry Schell:Gee, I dunno…they can’t seem to manage anything else…so why not give them the chance. What could go wrong?
The arguement that 401k’s have failed is tied to the crash in the stock market which is tied to the crash in the credit markets which is tied to…the Community Reinvestment Act and Fannie/Freddie buying subprime loans to promote their issuance…which came at the insistence of Congress…which now proposes to manage your retirement money for you due to the loss in value of 401k accounts.
So we are supposed to hire the people who denuded our retirement accounts to “fix” them?
Why not just get one bullet, a Smith + Wesson and do the “honorable” thing?
A triumph of hope over reality. Or delusion.
Apr 13, 2009 - 6:48 am 5. ajacksonian:Government has proven unable to ‘invest’, seeing any funds under government control as ’sources of revenue’ for it. If an act of congress can make it, so can one take it later on. Just look at how cities, counties, municipalities and States raided pension funds… or how the government through FICA funds effectively into general revenues and not a ‘lock box’. If there was a ‘lock box’ Congress holds the keys so it isn’t a ‘lock box’ for you, it is a future goodies fund for Congress.
About 5% of my retirement account went into government bonds in my working years, and the increase on them has not been great just ‘ok’ compared to everything else. Even after the massive problems, my other investment in retirement accounts have *still* earned more than the government bond portion… and I have a restricted set of funds for that working time and they are still pretty decent investments. Basically I’m back to where I was in 2005… so long as the government doesn’t CF the economy, which is now becoming the question, my investments will recover. And if the economy collapses due to government ‘help’, then there is very little in the way of a safe haven from it. Which is why I prefer to let the American people screw up as they tend to have cumulative sense… Congress has a cumulative echo chamber that makes them senseless.
Apr 13, 2009 - 6:59 am 6. tommyd:It never ceases to amaze me how so many can be duped into believing that the only people that can save us from ourselves are the very power grabbing MORONS that screwed us in the first place.
Apr 13, 2009 - 7:10 am 7. MarkD:If you don’t know who I am talking about then that ought to tell you something in itself.
I’ve “invested” over $200,000 in Social Security over my lifetime, and the system is almost insolvent. If it were anyone but the government running it, it would be illegal and they would be in prison.
I put far less into my 401K over a shorter period, and it is worth more, even after the recent beating I took. Why? Because I diversified.
Letting the government have more of my money is the worst idea I have ever heard in my life. When they balance their budget and pay off their debts, come back and talk to me.
Apr 13, 2009 - 7:45 am 8. rocketeer:I’ll trust the government with my investments when they show me that they’re able to manage them (which will be never). In the meantime, we can keep reading about the bankrupt social security, bankrupt medicare, and all the other failed bankrupt government programs. If our government was a private business, they would have been put out of business decades ago.
Keep the government out of my money and out of my life. I don’t want another government program. I want the government to guard the border and maybe build freeways (and I’m negotiable on this).
Apr 13, 2009 - 8:38 am 9. Good Mutual Funds:Hearing stories like this makes me crazy. It is a terrible thing to lose your retirement in this fashion. Especially when it can be avoided so easily. Every investor MUST learn to identify uptrends and downtrends and move to cash when the latter appears. There are a million ways to do it, pick one and stick to it for the rest of your life. I suggest using something based simply on price such as a long term moving average. Just take a look at a chart of the Dow Jones and plot a 200-day moving average. Buy when price is 1% above it, sell when 1% below. Look how you could have avoided getting killed in 2008. Now follow this system for the rest of your life and you are set. You never have to worry again!!
Apr 13, 2009 - 9:17 am 10. WJ:You write “As it is, 7.65% of a worker’s income is eaten by Social Security and Medicare payroll taxes.” The correct number is a 15% cost to the employee. Language matters.
The reason for this is the amount the employer “pays” is really the employee paying. The taxes that the employer “pays” is considered compensation by the employer.
The employer looks at the total cost of employing a person and just divides it into two categories, wages and fringe. The total of those two is called the compensation that needs to be paid.
You can call the individual categories taxes, fess, or grasshoppers, if the employer has to pay it it is considered compensation.
To test what I am writing, do you think that anyone’s take home pay would increase if the 7.65% being paid by the employee was all of a sudden paid by the employer?? Or do you think that the employer would just as quickly reduce all of their employees pay by 7.65%?
Apr 13, 2009 - 10:33 am 11. wayne:Next to Global Warming, this Government takeover of 401k’s is the biggest act of piracy ever conceived.
What is really going on is the scum in DC figured out that they are losing out on about $88 billion they could be spending on things like new “urine crucifixes as art” for their favorite museums, building monuments to themselves, and paying off the friends and family. Not to mention putting money into their solar-panel-and-windmill slush fund as a trade for the carbon they are emitting by having their entourage ride around in Gulfstream G-5’s and a parade of Escalades.
In addition where do you REALLY think they are planning on getting the money to pay for all this damn stimulus? There is around $5 trillion in the 401k system and if it was funneled back into Social Security it could be IOU’d out just life the rest of the money they robbed from the fund to pay for BS.
Apr 13, 2009 - 1:54 pm 12. myth buster:WJ, take home pay would increase temporarily if they did that, because contracts would prevent people’s pay from being cut, but soon inflation will eat up your pay while your wages don’t keep pace.
Apr 13, 2009 - 2:48 pm 13. Marc Boyd:One problem that I have seen with how people invest in their Company sponsored Thrift plans and 401(k)s is that they think that they are too busy to monitor the investment selections they have made.
I started in 1980 with CONOCO who offered both a stock investment plan and a Thrift plan. I maxed out the matching funds every year. I pretty much ignored the investments for years. I had everything in Magellan in the Thrift plan and made a ton of money until the 1987 mini crash. That was a wakeup for me. It quickly bounced back. I started monitoring my investments on a daily basis after that.
Now the internet lets anyone monitor their investments in near real time. If you have a Charles Schwab account you can get real time pricing on demand. For charting, BigCharts is tops:
http://bigcharts.marketwatch.com/markets/indexes.asp
You don’t need to log on or pay for the basic service. They also offer Options chains, for those who know how. I have used Options for years to capture a Buy/Sell price.
If you are going to invest in any stock or ETF, you really need to learn simple charting signs and have a strategy to enter and exit the market. I use EMA and Bollinger bands to visualize the trends.
Use the 6 Mo time frame for the general trend and the 5 or 10 day for entry timing.
I am now a half or 3/4 millionaire at 65. I got out of stocks when the market got iffy and into the gold ETF (GLD) when gold was $350/oz. I cashed out at over $900. Use the charts, or learn to use them.
Hope this helps someone.
Marc
Apr 13, 2009 - 4:12 pm 14. Marc Boyd:My add on comment to the above.
I suffered no losses in the ongoing market mayhem because I was listening to the market, Investment commenters, and the charts. In other words I was paying attention. I also got out of Magellan when Peter Lynch got out. Seems it made good sense. It got way too big.
Marc
Apr 13, 2009 - 4:50 pm 15. therealist:Good article. The liberal vision is that you give 15% of your salary to the government as a pension contribution and then hope that they will treat you fairly when you’re 65 years old and completely helpless. Yet, the social security fund is empty and has been for years, despite the promises of a “lockbox” and an expected future obligation in the tens of trillions of dollars. It’s shaping up to be the greatest moral failing the world has ever seen, and if you’re in the generation behind the boomers then you’ve been thrown to the wolves. In fact, Obama has greatly accelerated the social security crisis by busting the budget while throwing the brakes on future economic growth, so maybe the younger boomers will be living in the Obamavilles too.
Apr 13, 2009 - 8:26 pm 16. Paul -Indiana:As long as the government is handing out bailouts, why don’t they return to Social Security, the money they took from the ‘lockbox’?
Apr 14, 2009 - 5:10 am 17. Delia:We spent our 401k already [dental work]. The hubby and I figured we might as well spend it now before it’s gone on things we’ve put off.
Apr 14, 2009 - 6:22 am 18. Mr Lucky:I think Mr. Graham got the 401k end of it correct, but he did not include in the equation the debt that many have incurred during this the march to 14,000. If you factor in the interest paid on credit cards, car loans and home loans the 401k plan may not look as attractive as diverting (in the least) some of the 401k contributions for paying down your debt, or staying out of debt.
Many just pay the minimum. When money becomes short, you have the distinct possibility of losing much of your non-401k investments (car, house, furniture, wife/husband/children etc.) investment because you cannot maintain the debt.
A 401k strategy is just part of the picture.
You never really own what you have until that last payment is made. Better yet, pay cash when possible.
Apr 14, 2009 - 8:01 am 19. The Historian:EURO SOCIALIST STATISM DESERVES A TEA PARTY
Tax and spend never fixed a strained economy. Prosperity lies in the opposite direction.
http://greensrealworld.blogspot.com/2009/04/obvious-path-back-to-prosperity.html
Apr 14, 2009 - 9:37 am 20. weirdone:Would we really be better off letting the government manage our money?
Is there any entity in the world further in debt than the U.S. Government? Enough said.
Apr 14, 2009 - 7:49 pm 21. John Moore:There is one gotcha about 401k’s…
When you take the money out, it is taxed as ordinary income, even if it grew as capital gains.
Since taxes may go up substantially in the future, IRA’s and 401k’s can be a tax trap. This is especially true if you plan to retire at a comfortable income, in the not to far distant future.
Apr 14, 2009 - 9:18 pm 22. RF:Very encouraging. Thank you writing this.
Apr 15, 2009 - 12:19 am