The WORST Investment In America, Part 1
For a lot of working Americans, the 401(k) as an investment vehicle is all they know about retirement planning.
Since they were very young, they’ve been told to sock money away into a 401(k) and when they are ready to retire, they will magically have enough money to live on.
Of course, retirement wasn’t always this way. My dad and many other people of his generation enjoyed a pension plan. Work your entire life as a good employee for a company and they’ll take care of you when you retire.
Yet, fast-forward 40 plus years later, and pensions are rare and 401(k)s are everywhere. It’s estimated that 56% of Americans are in this investment…at least for wealthier workers. Poor workers, well, they have nothing.
Even the earliest proponents of the 401(k) regret their support.
In the words of Herbert Whitehouse, a former human resources executive at Johnson & Johnson, and one of the first to usher in the 401(k),”We weren’t social visionaries.”
Gerald Facciani, the former head of the American Society of Pension Actuaries, says, “It was oversold.”
Gerald actually helped defeat an effort by the Reagan administration to kill the 401(k) in 1986.
Some say 401(k) plans weren’t designed to be a primary retirement tool, and it’s also been acknowledged that forecasts used to sell the plan in its early days were too optimistic.
Others say the proliferation of 401(k) plans has exposed workers to big drops in the stock market and high fees from Wall Street money managers while making it easier for companies to shed guaranteed retiree payouts.
The History of the 401(k)
In 1974, ERISA (Employee Retirement Income Security Act) was passed. ERISA led to the DC (Defined Contribution) pensions, like the 401(k) in America.
Shortly after, the Fed and Wall Street became a den of thieves, preying on the innocent and uninformed.
My rich dad was very concerned about the 1974 law.
“At the time of its passage, most people were not even aware of ERISA. Even today, many people have never even heard of this act passed by Congress and signed into law by President Ford. The full impact of this law change will not be felt for 25 to 50 years, long after I am gone. I wish I could tell them to prepare now, but how do I tell them about the future?”
One of the intended results of ERISA was to encourage individuals to save for their own retirement. This would encourage a three-pronged approach to retirement funding:
- Social Security
- A worker’s own savings
- A company pension plan paid out of money the company set aside for a defined-benefit pension plan for its employees.
So as a result of ERISA, people suddenly became responsible for their own retirement planning, transferring the responsibility from the employer to the employee—without the financial education needed to help the employee plan successfully.
Suddenly there were thousands of quickly trained financial planners educating millions of people to “invest for the long term, buy and hold, and diversify.”
Many of these employees still do not realize that their income during retirement will be totally dependent on their ability to invest wisely now.
Why the 401(k) is A Horrible Retirement Plan
Millions of Americans rely on employer-sponsored retirement plans, but they have no idea what they’re paying for or where their money is going.
They sign away control of their retirement and don’t think about trying to get it back until it’s too late.
The 401(k) has become less of a retirement “plan” and more of a retirement “cross your fingers” recipe, with lots of unhealthy ingredients thrown in.
With a lack of financial understanding and some strong misunderstandings about where their money is going, Americans have relinquished control over their future, leaving them with an absolute mess.
Which leads me to my question:
Do you know what’s really in your 401(k) “plan”?
Here’s the truth about what you can expect to find:
1) Hidden Fees
The first thing you should know is that your 401(k) is sprinkled with hidden fees that are buried in pages of legal paperwork. Legal fees, transaction fees, bookkeeping fees, and more. Plus, the mutual funds in the 401(k) often take 2% right off the top.
These fees may not seem like a lot when you sign on the dotted line, but over time, the compounding effects cut down your returns substantially.
Jack Bogle, the Founder of Vanguard, 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?”
The worst part? Most Americans are completely unaware that there are any fees on their 401(k)!
These hidden fees water down the returns, destroying all your well-intentioned saving and investing. If you don’t know about these fees, you’re putting your money (not to mention your future) on the line.
2) No Control
The worst part of the 401(k) recipe is that you aren’t even the chef in this game. Instead, you’re sidelined, watching other people prepare your retirement buffet for you.
As an employee, you have absolutely no control over your investment. If you were to take your money and invest in the same mutual funds and stocks as the 401(k), but on your own terms, you would already have 100% more control over your money than an employee who goes with the employer-sponsored program.
That’s because most employees don’t get to opt-out of the 401(k). And when they invest, they have no voice in which mutual funds they put their money into.
Would you ever make a purchase where you don’t know everything you’re paying for? When you buy a house, a car, even a shirt at the mall, do you just blindly hand your money over, hoping for the best? Of course not! But that’s what happens with a 401(k) plan.
This is the same as gambling for me. When you put your money in a 401(k) you rely on other people to conduct due diligence and invest in quality funds that uphold your philosophies and produce a return.
But you will never meet the people investing your money. You’ll never have a conversation about your financial goals or your retirement plans. You’ll never look them in the eye. Instead, you’ll just hand over your money and hope for the best.
That’s not a retirement plan. That’s jumping off a cliff without a parachute.
3) External Factors
When you cook a recipe, there are lots of things that can go wrong. Your oven could overheat or your ingredients could be out of season. In the same way, the 401(k) relies on and is governed by multiple external factors, reducing your control over your investment even more.
For example, the 401(k) depends on the stock market. Whether the market rises or falls, your money pays the price.
You could lose half of what you’ve put away overnight if the markets fail. Your retirement hangs in the balance and you have absolutely no control.
In addition, the 401(k) is subject to government control, and as we all know, Washington can change its mind pretty quickly. The rules and regulations governing your 401(k) could be altered, new laws can be passed, and you could be dealt a very poor hand.
The One “Good” Thing?
With all these things stacked against a 401(k), why in the world would anyone want one, and why are they still around?
To answer the latter part, no one has come up with a better idea and implemented it yet.
Not to mention, big corporations and a whole financial services industry would revolt if they were taken away.
To answer the question of why anyone would want one, the truth is, people don’t know a lot about money and investing and are often ready to believe whatever they are taught.
They also buy into the lie that they get free money when their employer matches their investment. The problem is, there’s no such thing as free money.
Here’s a story to show what I mean.
Years ago, I had a conversation with a young man about 401(k)s. “I have a question for you,” he said. “I’ve read that you say 401(k)s are the worst investments, but I don’t understand why you say that.”
“What is it that you don’t understand?” I asked.
“Well,” said the young man. “Most employers match your contribution. For instance, my employer matches up to four percent of my salary. Isn’t that a hundred percent return? Why is that a bad investment?”
“It’s a bad investment,” I said, “because it’s your money to begin with.”
He looked puzzled and perplexed.
“Listen,” I said, “If it weren’t for 401(k)s, your employer would have to pay you that money as part of your salary. As it is, they still pay it, but only if you give up four percent of your existing salary into a retirement account where you have no control. And if you don’t, well the employer comes out ahead. It’s your money, but they’re in control.”
My advice? Take back control of your money with investments that you actually have a say in.
And stay tuned for Part 2 of this issue tomorrow…
Editor, Rich Dad Poor Dad Daily