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401(k)'s Not a Bad Idea...But

October 9th, 2007 at 06:38 pm

I think my last few blogs have probably given the impression that I think 401(k) programs and other auto savings plans are a bad idea. Of course, anything that helps people save and can be contributed to by an employee is a perk that we all ought to take advantage of (to the maximum). But I just get the distinct feeling from a lot of my friends, plus all the blogs I read here, that everyone thinks that a 401(k) or an IRA alone are going to be enough to fund retirement, and I just don't see it. For some people, maybe, but not for most.

1. You have to be lucky with the market.
2. You have to be aggressive and invest in funds that are earning 12-16% (not like most who don't have the time or resolve to deal with market ups and downs so conservatively invest and earn only about 6% or so, which doesn't keep up with inflation or debt interest).
3. You have to be in control financially so you're contributing a decent amount and not borrowing from or withdrawing from such funds to pay for overspending.

Lots of people I know put money in the bank one week and pull it out the next to pay bills...even borrowing from a 401(k) and getting penalties. It's like robbing Peter to pay Paul. I think we've been conditioned for so long to think savings and "retirement" mean 401ks or IRAs that we don't even think about other methods for funding retirement (and that don't depend on the stock market).

If you've got cash on hand, it shouldn't be entirely sitting in an IRA or a 401(k). Some yes, but not all.

Think perpetual soruces of income like rental properties, equipment rental, hard money lending. Think treasury-only checking and savings, applying savings to debt, royalties, etc.

This year is the year I buy more of the nice outdoor bistro chairs to add to my collection and start renting them for weddings. My friend did this and she makes $350 every week just on chair rentals. Last summer she made $4,200 in 12 weeks. There's no overhead and she stores them in a shed in a her backyard. I think she invested $2,000 to get all her chairs and she recouped that in the first summer she did weddings. An idea that doesn't depend on the stock market; she controls the taxes on it based on having her own business, writing off expenses on Schedule C and keeping taxes to a minimum.

My other friend put all her money in her 401(k) with Novell. It was up to $355,000 when the market took a severe downturn a few years ago. She lost all but $10,000 of it and doesn't have enough time to ever make it all back before she hits retirement age.

Just some thoughts...

11 Responses to “401(k)'s Not a Bad Idea...But”

  1. fern Says:

    I couldn't disagree with you more.

    Running a furniture rental business carries no less risk than the stock market. To make that work, you'd have to live in an urban area that would provide you with a large enough pool/demand for such things. Rental businesses around here only do moderately well, from what i can see.

    Luck doesn't have much to do with investing. What is important is being comfortable with the investments you have chosen in down markets as well as up markets, knowing that long-term, the extreme peaks and valleys will even out. If you're in it to make a quick buck or you lose sleep during volatile times, you shouldn't be in the stock market in the first place.

    To expect 12-16% returns is unrealistic, and you can meet your long-term retirement goals with returns that average about 9%.

    The one thing you said that i did agree with is that it's really a bad idea to take loans out of your 401k.

    401ks and IRAs are wonderful long-term retirement savings tools due to their tax-deferred status. They are just a piece of the puzzle, but a very important piece at that.

  2. Broken Arrow Says:

    Hi, Suzkimball. Welcome! Smile

    Those are provocative words indeed. I am a proponent of critical thinking and am always delighted when someone encourages me to think outside the box.

    That said though, I still think IRAs and 401ks is perhaps some of the best options available out there. To me, it's not a matter of dogma. If there are better options out there, I'd be happy to take a look at it. However, I think the numbers speak for themselves.

    For example, my 401k has employer contribution. When viewed from the context of return, it far out-strips just about any other margins that can be achieved elsewhere. Plus, it's done so within a tax-advantaged shelter!

    It's true that 401k is tied to the stock market, but it doesn't have to be. You can tie it all to the bond market if you want to be crazy like that. Big Grin You can also tie it into just about any asset class available to you through your employer or brokerage firm.

    It should also be diversified to balance the inherent volatility that is in the stock markets. Properly managed, and over the course of long term investing, the volatility should average out with a consistent gain. To not do so is to not have it managed properly.

    I suspect that's what happened to your other friend from Novell. It could be because her entire 401k was vested with, say, her own company stock, and when that one stock took a nose dive, it took her entire fund along with it.

    Also, you don't have to be aggressive in your investments, although if you're still fairly young, it is highly recommended. The level of aggressiveness can be fine-tuned in most any portfolios.

    Finally, leveraging against your own retirement fund is entirely a bad idea to begin with. If times are tough, perhaps it is time to adjust the contribution amount, but there's almost no reason why anyone should be pulling out their own retirement funds early or borrow a loan against it.

  3. disneysteve Says:

    Wow! You think starting a business renting chairs is a better option than investing in a 401k where most employees get an instant, automatic 50% return on their money and it grows tax-free for 30 or 40 years.

    Your friend who invested her entire nest egg with Novell made a huge mistake and paid the price. Nobody should ever put more than 10% of their portfolio with any one company.

    And forget 12-16% returns. You'll get them from time to time, but 8% is a much more realistic long-term average. But when you add to that the 50% match and no taxes, those dollars really add up.

    I do agree 100% that 401k's should not be borrowed from. You need to live below your means and save the difference for your future. Unless there is a major catastrophe and you've exhausted all other sources of money, your 401k should be off-limits.

  4. terri77 Says:

    Once again today I find myself agreeing with fern and others. That rate of return is unrealistic for the long-run. I don't think that actively managed funds or picking stocks really returns much more than picking index funds. You don't have to be lucky. You have to save and invest consistently.

  5. moi aussi Says:

    It says on your side bar that you are a personal finance instructor. I hope you are not giving these advises to your students!!
    I personally think your idea is counter productive. Most people who have 401K, their retirement fund is just adding up as you go along. With your suggestions, on top of their regular jobs, they would have to run around trying to form a side business that makes them money. Without even getting into all the technicalities of the benefits of a 401K over, lets say buying bistro chairs to rent out for weddings, your idea just seems wrong to me.

  6. Broken Arrow Says:

    I... wasn't going to say anything at first, but I have to agree with moi aussi. Bad advice can be dangerous....

  7. Caoineag Says:

    I agree that relying solely on a 401(k) or an IRA for retirement is dangerous. I have contemplated lending money (testing this one out currently), owning rental property (a ways off for now)and various other non stock market related ways of making money.

    I do think its important to take max advantage of the tax advantaged accounts and then utilizing the other options available. I already know that contributing the max to my IRA will not be enough for my retirement which is why I have looked at other things and I am only 26. (No 401(k) available to me)

    I am a little surprised at all the negative reviews here since I am pretty sure my early retirement/financial independence forums have talked about this extensively...

  8. kinchan Says:

    Retirement funds...always an emotional argument. I think most people missed the point of my last blog on the value of 401(k)s. As I said in the last post, they do have their value, but they seem to carry more weight in terms of making serious retirement money that can out-earn what people will have to pay in debt interest than they deserve. As all those who commented affirmed (myself included), most people will not make 12-16% returns and will over time make a modest 6-8% return in a 401(k). Great, but that will never keep up with interest expense over time, so if you have debt (think 30-year mortgage, credit cards), a 401(k) isn't the only or best way to fund retirement. Run a Time/Value of Money calculation and the numbers will prove that out.

    I'm not really sure how anyone got the idea that I think starting a furniture rental business is a better way to fund retirement than contributing to an employer-sponsored 401(k), but hey, it looks like some people missed that point as well. The point I was trying to make in the last blog is that 401(k)s and IRAs are not the ONLY way to fund retirement. There are lots of really great ways to put money in motion to make more money than just relying on the market and employer contributions ALONE. Yes, yes, yes, contribute to a 401(k), but open the mind to other ways of getting money to make more money for you AS WELL. That's how the wealthy get rich and stay rich. Most of them rent out their equipment, space, property, etc. They own real estate, they do hard money lending, and they are involved in angel investing and a host of other means that put them in control of their money rather than WHOLLY relying on the mercies of the market and their employer (besides, Danko proved in his book "The Millionaire Next Door" that most wealthy Americans don't have an employer anyway! They're self-employed! They have their own businesses, some even starting out perhaps with a stupid idea like lawn chair rental at weddings!) So yes starting your own business is another great way to fund retirement, even though several commented that they don't believe this will work. (If Sam Walton were alive, you could ask him if it works or you could just go down to Wal-Mart and pick up a few things you need tonight for dinner...and see how well it's working....)

    There's just so much more out there than most people realize, and yes, I do teach that in my community ed classes.

    Of course i do not advocate renting chairs in place of 401(k)s as a means to fund retirement...that would be absurd and I'm surprised that that's the only message anyone got out of the last post. Simple ideas, using resources you already have, money you already have, time you already have, etc. will end up putting more in your pocket over time than relying on employer-sponsored retirement programs alone. It's too bad that most people cannot get their minds around this.

    Also, a few people commented that 401(k)s and IRAs are tax-free. They are not tax-free, they are tax-deferred, so there will be taxes owing at some point. You have to decide if you want to pay tax on the "seed" in the beginning (such as with a Roth IRA where taxes are paid up front) or on the "crop" with a 401(k) or regular IRA. Taxes will be paid on both what you deposited and what you earned over time on these programs. The only way to decide if this is a good deal or not is to run a forecasting calculation on it, all the way through retirement (not just to age 65) and see how much it's going to cost you in taxes to keep your money in such programs.

    As for my friend who lost all her money in a 401(k) with Novell. No, she did not invest IN Novell stock, she works FOR Novell and had a diversified portfolio through the company's 401(k) employer-sponsored program. When the market took a dive (which it will at times), she lost a great deal of money on the stock she was invested in, which wasn't Novell. Nobody seems to believe this, quoting statistics about the stock market making a steady 9-10% for its investors over time if left alone. True, the market's 40-year history does show that kind of return over time, if left alone, but some companies do go under, some stocks do plunge, and not EVERYONE will make a guaranteed 9-10% return, even when they leave their money alone. The market is a risky place, plain and simple. It has it's value, but it is not a place where you really control how much money you do or do not make. There are no guaranteed returns, and everyone knows that, so why not place some of your money somewhere else, or get it to work for you even in small ways, such as through renting out lawn chairs you already have rather than letting them sit in your shed idle? If some piece of property, equipment, skill, or chunk of cash can be used over and over again to make a profit, why not use it? Yes, I have my Roth IRA, but I also have 50 bistro chairs sitting in my shed. I intend to add another 200 to them and rent them for a tidy little profit every summer. Some people don't live where that's possible, but they live where other means of making money is possible, so why not attempt it? There's nothing to lose if you already have the resource.

  9. Broken Arrow Says:

    I've responded to most of that in the next article, so I just want to focus on a couple of points I missed out.

    First, I think the stock market is indeed a risky place IF you choose to invest in a risky manner. Otherwise, there are very safe plays one can make in even stocks. Large cap dividend stocks, for example.

    The other thing that makes the stock market risky is people who go in for high-risk, high-gain, short-term speculations. But with the example of retirement funds, that is an entirely wrong mindset to have since, for many, retirement is an inherent exercise in long-term investing.

    And again, unless one is fairly young and chooses to be aggressive, one can always choose to have only a percentage of their money in stocks and put the rest on bonds or certain commodities.

    That said, I do fully agree that, sometimes, the biggest gains one can make have nothing to do with investing per se. Rather, eliminating high interest debts can get us much further in the end than many investments will.

    I myself am trying very hard to become debt-free.

  10. fern Says:

    Self-employment is a great way to amass wealth if you know what you're doing, but you seem really stuck on the idea of renting out bistro chairs. I think i counted 4 more references to that in your last post, kinchan. If i had to choose a business to start, i don't think that would be one of them. Maybe it works for you, where you live, so that's great, but it seems odd that you're pushing that specific idea so much.

  11. kinchan Says:

    Fern: Sorry that bistro chairs is all that you got out of the posts...that wasn't the intent and that isn't the point. Bistro chairs were used to try to make a larger point and paint a bigger picture. It's too bad that it couldn't be more clear.

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