Wall Street Is Gambling with Your 401(k) [Part 1]
The fear of the 1929 stock market crash, and decades-long depression that followed, remained fresh on the WWII generation’s minds. During the 1950s and 1960s, smart investors purchased government bonds or saved money. And only gamblers invested in the stock market.
During the 50s and 60s, my poor dad and my rich dad were savers. Saving money was safer than the stock market because, after the 1944 Bretton Woods Agreement, the U.S. dollar was backed by gold. The U.S. dollar became the reserve currency of the world, or “good as gold.”
In 1971, Nixon put the ﬁnal nail in the coﬃn of the gold standard. The dollar and all government money became debt. Gamblers took over the government casino.
Debtors became winners and savers became losers.
My poor dad continued to save. He did not change. He was counting on his savings and a government pension to save him.
My rich dad, on the other hand, did change. He had to change because, as an entrepreneur, he did not have a government paycheck or pension to fall back on.
Rich dad changed his tune entirely and in 1973, after realizing what the government was up to, rich dad came up with his lesson #1, which is: “The rich do not work for money.”
He realized money was toxic, designed to steal the wealth of anyone who worked for money, saved money, or invested money in government-sponsored investments such as 401(k)s, IRAs, stocks, mutual funds, and ETFs.
The Law that Changed the World
The defined benefit pension plan (DB) was a retirement plan that defined the benefit or the dollar amount a retired person would receive. The WWII generation had a deﬁned beneﬁt (DB) pension plan—a paycheck for life. Financial education for the WWII generation was not necessary because DB plans had “professional management.”
Then DB plans ended in 1974 with the Employment Retirement Income Security Act (ERISA) which was passed in the United States that set minimum requirements for private companies to provide retirement and health plans for its employees. This lead companies to change from a pension plan (which guaranteed money to its employees) into Defined Contribution plans like the 401(k) instead.
A DC plan defines the contribution. In other words, a worker’s retirement is only as good as the contribution—if there is a contribution. A worker might retire with nothing because he or she contributed nothing. In addition, if a worker retired with $2 million in their plan and that $2 million was gone by age 85—either through distribution or by mismanagement or a market crash—then at 85, this worker would be out of retirement funds and out of luck.
Simply put, the responsibility, expense, and long-term consequences of retirement will pass from the employer to the employee. Although the difference between the letters DB to DC is small, the long-term consequences are and will continue to be, large.
As rich dad said, “It’s the World War II generation passing on the problem to the baby-boom generation, and future generations. It’s a problem my generation has benefited from.” In other words, they got the benefit, and now we get the bill. And it will be a very big bill.
Pushing the Problem Forward
Rich dad saw that the real cause for concern was that the issue of personal financial survival after retirement was being pushed forward. That is why he repeatedly said, “ERISA is the problem my generation is passing on to your generation.”
One of the more important lessons rich dad taught his son and me was the difference between a businessperson and a government bureaucrat. Rich dad said, “A business person is a person who solves financial problems. If they do not solve their financial problems, they are out of business. If a government bureaucrat cannot solve a problem, a bureaucrat can afford to push the problem forward.”
Rich dad was not being critical of the government. He was just being observant. He said, “Governments solve many problems for the good of society. It is the government that uses our tax dollars to provide military defense, fight fires, provide police protection, build roads, provide schools, and provide welfare for the needy. But there are problems that the government cannot solve and when those problems are pushed forward, they often become bigger and bigger problems. This problem of financial survival once a person’s working years are over is a monster of a problem that is growing bigger. The problem constantly grows bigger because too many people expect the government to solve what is really a personal financial problem.”
Rich dad was worried that people were never taught how to have their money work for them. Over the years, they have been taught to depend on a company and the government, rather, to provide for them. As the problem became too complex to solve, laws were passed to pass the expense of retirement on to the next generation. In other words, Social Security and ERISA pass the expense of the care of one generation on to future generations.
Then in 1996, a new DC investment plan entered the market. It is the Roth IRA, named after the senator who championed it.
The Introduction of the Roth IRA
The Roth IRA is a newer DC plan designed only for the middle class.
Soon after the Roth IRA came out, my tax advisor called me. She was very concerned about this new DC plan, which allows its owner to receive tax-free payouts after retirement for funds taxed before entering the plan. The Roth IRA was once again pushing the problem forward, again, from the baby-boom generation to future generations.
The Roth IRA was primarily created to collect more taxes. She said, “If you notice, there was a surplus of money in the budget soon after the Roth IRA was passed. I suspect the Clinton administration passed this law because they needed more taxes and wanted to create the illusion that they were doing a good job. The problem is, when the baby boomers begin to retire, it is their kids who will have to pay those taxes to make up for the future budget shortfalls.” In other words, the problem has been passed forward again.
Almost immediately, the Roth IRA was the darling of the middle class. They loved the idea of paying taxes now but being allowed to pull out the gains tax-free in the future. Because the market was going up in 1996, many people saw this Roth IRA as a gift from heaven. Money, greed, a rising market, and the new Roth IRA were all these people needed. Money began pouring into these new IRAs and directly into an already overheated stock market. The market took off like a rocket ship.
One of the ways the government made more money was that many people stopped contributing to their 401(k) DC plans and shifted money to their new Roth IRA. That meant the taxman collected more money from the middle class since only after-tax dollars are allowed to go into a Roth IRA.
The traditional 401(k) DC plan allows the employee and employer to put untaxed dollars into the plan. That means the taxman gets no revenue from those dollars. The taxman then has to wait until the employee retires before the government can begin collecting taxes.
But the Roth IRA did one more thing. It inspired many people without a retirement plan to open one. Not only were there many new people entering the market via their new Roth IRAs, money was also flowing out of savings accounts and some people were even borrowing money to invest. With so much money pouring into the market, the market continued its climb. People began to say, “This time it’s different. It’s the new economy.” By 1998 millions of non-investors who got lucky in the market the year before and who now thought they were investors suddenly began an investing frenzy just because of fear and greed.
Editor, Rich Dad Poor Dad Daily