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The 401(k) is a Beautiful Thing So Stop Bashing It

by Darwin on September 17, 2012

After the so-called “lost decade” and the Financial crash of 2008-2009, many people derided the 401(k) as a scammy money-grubbing employer tool that leaves employees ill-prepared for retirement. A “201(k)” became the running joke due to the losses we saw a few years back (which have since been regained and then some). Over the years, we’ve seen criticism of everything from fee disclosure to high fee structurs to lack of choice to the volatility of the underlying investments. The constant bashing from the media and bloggers alike would make one wonder whether the 401(k) is even a good idea at all. Of course it is! And it’s about to get even better. Here are some common complaints and reasons why this is a bunch of BS:

  • Returns: So, we had a lost decade. This should not come as a surprise at all in retrospect as we’ve been living for a few decades now in a period of false prosperity bought with our kids’ money (borrowed at a rate of $1 Trillion per year) with no intent of ever paying it back. If you don’t believe Federal deficits are tied to stock market returns and the goods and services our government provides you with every year then you need to read up on it (alas, with our burn rate of $1 Trillion a year in deficits, we’ve still conditioned our citizens into the Welfare Nation we are now). It’s all tied together and we were due for a crash. Fortunately for people disciplined enough to maintain their long-term investment strategy, they’ve regained all those losses and made some really incredible gains for funds invested along the way. From the pivot bottom in March 2009, the S&P500 returned about 120% with dividends. That’s not too shabby at all, especially compared to hiding cash under the mattress. I’m not making predictions about where the S&P500 will close in a year or two, but I am willing to wager (and I’m doing it in my plan) my entire retirement that in 20-30 years, equities will provide favorable returns.

  • Fees and Disclosure: Granted, going back years, the fees on funds in 401(k) plans have not been nearly as efficient as individually going over to Vanguard (no relation, but I always recommend based on the highest ethics and lowest fees in the industry) and picking the lowest fee index funds yourself.  However, this year, new rules took effect mandating that companies clearly deliver fee disclosure to their participants.  This is one favorable piece of legislation by the Labor Department that was pleased to see.  So, with this new legislation in place, fees should come down and participants should be able to choose the most efficient options.
  • Choices: People complain about not having a lot of choices, but in general, all you need if you’re young is a broad-based equity fund.  And if you’re older, a bond fund.  Virtually all plans at least have that.  Sure, maybe it’s not the lowest fee or “market-beating” actively managed fund, but there are Roth IRA Strategies to beat the market to round out any missing options in your plan if you qualify and trying to invest in gold, time the market with money market funds or trading in and out of sector funds is not a good approach for the long-term investment horizon of the 401(k).
  • Volatility: Can’t handle the volatility of stocks?  Well, you need to.  That’s stocks.  If you have a 15+ year time horizon and want to have a decent real return (net of REAL inflation), you’re going to need to invest in equities, especially considering that bond yields cannot go to negative infinity.  I work with many 20 and 30-somethings that went to 0% equities and totally into money market and bond funds in 2009 at the worst possible time.  This is when the greatest market rally of the past decade and a half began!  They earned probably 20-30% over that period while I earned 120%+.  If you take one thing from this article, concede that you cannot and will not time the market any better than random chance.  You need to have a strategy based on your time horizon and some other factors like assets outside the plan, spousal finances, and such.
  • What About Your Heirs? I know, these days, many people are just looking out for themselves (notice the heads in the sand on the mounting deficits that our children will be burdened with someday). But if you contrast a traditional pension/social security type retirement plan vs. an asset-based plan, there’s a huge difference. I can work my butt off to hit that FICA Cap each year to get the maximum Social Security benefit only to die as soon as I hit retirement age. My kids will never see a dime of that money I (and my employer) plowed into the plan. However, with a 401(k), those assets are kept in the family, after the government gets their pound of flesh of course.
  • Government Pension Plans Do It Better: Many in Congress (shocker) and the left (double shocker) are calling for government-run plans to replace the traditional 401(k) arrangement.  It’s basically another Social Security with some variations.  The purported benefits are that it would be employee funded but guarantee a real return.  However, the returns would be much lower than investing in equities over long periods, so I’ll take control of my finances, thanks.  Then, let’s chalk one up for the law of unintended consequences.  Who would have thought decades back that the Social Security fund would be going insolvent and that an inept Congress would plunder it (sorry, “borrow”).  What do you think would prevent a future Congress from doing the same?  If there is money to be had, the money-grab will transpire.  This is the leadership of our country past, present and future.
  • Who Would Complain About Free Money? Last but not least, who the heck would complain about free money?  Virtually all plans offer some sort of company match.  Let’s say they’re just matching the first 3% of your annual investment.  Well, that’s a 100% return on the first 3 % invested.  Even if you were paying a 2% expense ratio in a fund that broke even for a decade, you got a 100% return (98% net of fees) each year on that money.  This is money the company is giving away for free – who the heck would complain about that?  Better yet, some companies still offer both a pension AND a 401(k), yet employees still complain that their retirement plans are set up for failure.  Is it the plan or the participant?  After all, 90% of Americans Can’t Answer These Basic Finance Questions.
Overall, I’m pretty pleased with my company’s 401(k) plan since they offer a match and some broad-based index-type funds, but I’m happiest of all that I’ve stayed the course during thick and thin.  At my age, there’s no reason to be shifting money into low-return safe investments.

Are You Pleased with Your 401(k) Plan?

{ 20 comments… read them below or add one }

Roger @ The Chicago Financial Planner September 17, 2012 at 9:38 pm

Great post and I’m glad to hear someone say that 401(k) plans don’t suck. I agree that they are a great retirement accumulation tool. In fact I have a number of clients who have or in the process of accumulating very solid retirement nest eggs via their 401(k) plan. Clearly there are some lousy, high cost plans out there. However, I think the issue is often that investors either don’t save as much as they can afford and/or they make poor investment choices. The “Lost Decade” is a bunch of garbage in my mind. Diversified portfolios did reasonably well over that time frame, but this type of reality doesn’t create sexy, ad selling copy.

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Darwin September 18, 2012 at 5:38 pm

It’s become pretty cliche to knock the 401(k) but it’s a freebie the company doesn’t even have to offer! People that just left their money alone actually made out quite well over the past few years!

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W at Off-Road Finance September 18, 2012 at 9:57 am

I’ve never found company run 401Ks to be particularly attractive except for the match. The available funds are usually abject garbage. If there’s a big match obviously that’s good. Self directed 401Ks are better in terms of products available. But they’re still can’t be a margin account, which is a big downside.

I’ve mostly avoided 401K contributions and gotten good results by doing so.

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Darwin September 18, 2012 at 5:39 pm

My company offers a match and the tax deduction is a fringe benefit, so I guess it depends on what’s available to you.

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Roger @ The Chicago Financial Planner September 18, 2012 at 7:35 pm

Sadly many 401(k) plans offer lousy high cost investment menus. I’m always glad when I land one of those plans as a client so that I can revamp the menu to make it more attractive for the plan participants. Its just as easy for an employer to offer a top-notch plan as it is to offer a lousy one. In one case we took a large local employer’s plan, cut the number of choices offered from over 80 to 16 (plus the target funds). Better funds, institutional shares in many cases, a good selection of index choices, much more participant friendly.

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Money Beagle September 18, 2012 at 11:09 am

I’m all for the 401(k) option but I do see where people get jaded. Used to be in generations past that your retirement was pretty well fully funded except for what you had to contribute to the Social Security fund. Now, you still have that contribution but your employer basically has no input on anything, unless they happen to contribute to your 401(k) via a match, which I can tell you there are many employers who do not.

I think also many people did the right thing. They saved. They contributed. And they watched their retirement savings get cut in half anyways. For people in their 50′s and 60′s, that’s bound to leave a bitter taste, don’t you think? I’m in my 30′s so I am hopeful to recover that, but for people who were counting on retiring in the next few years, a lot of those dreams were dashed. I don’t think their criticism is unwarranted.

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Darwin September 18, 2012 at 5:41 pm

I think people that “lost” money in their 401(k)s have themselves to blame. They were in 1 of 2 camps. Either close to retirement with too much in stocks, so they were greedy. Or 2, they couldn’t stay the course and sold all their stock portion at the worst possible time in 2008-9. Anyone that left the money in the existing allocations through the crash and recovery is sitting pretty. Who actually “lost” money over the past decade? I haven’t, even excluding the match.

SPY over prior 10 year period is up over 60% excluding dividends (so, really like 75% or more)

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Joe @ Retire By 40 September 18, 2012 at 8:34 pm

I think proper asset allocation is the problem too. People who are close to retirement really need to have less allocation in stocks. My 401k did pretty well over the last 10 years because I kept contributing every month. That’s the easiest way to do it and and it has been effective for me.

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PK September 18, 2012 at 11:46 am

Yep – and if you didn’t cash it at the nadir (or convert it to cash/safe investments) you aren’t looking at a lost decade. In fact, you’re looking at an 80.7% return August 02 – 12, or 6.1% a year.

I’m still on team 401(k)!

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Darwin September 18, 2012 at 5:42 pm

Oh, I just happened to run that on my last comment and estimated 75% – pretty close! So, yes, anyone that wasn’t either fearful or greedy (but basically did what they were supposed to) realized a decent real return.

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Lance@MoneyLife&More September 18, 2012 at 1:37 pm

I like my company’s 401k as well. I get a match, they have a Roth option and low fees. That is a benefit of working for a large company!

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Darwin September 18, 2012 at 5:37 pm

Yes, large companies do tend to offer more generous benefits; glad to hear yours is working out!

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Investor Junkie September 18, 2012 at 3:05 pm

401(k)s are far from perfect and some companies have been 401(k) plans and better matching. So in most cases you should be using it to your advantage. If there’s no matching and only high fee actively managed funds you might be best to put your money elsewhere.

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Darwin September 18, 2012 at 5:36 pm

Sure, if no matching and fees are high, I’d use a Roth IRA if possible. Tax deduction on front end vs back-end is roughly a wash

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Investor Junkie September 18, 2012 at 5:38 pm

In my case I’ve also opened up a SEP IRA for the reason for differing income.

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Self Made Retirement September 18, 2012 at 7:56 pm

I agree, how can you give up free money if your company matches, and how can you turn down a tax benefit. It’s a win win…..I’ve made alot of money over the last few years because I ended up buying when funds were low…However, I have to admit, I have moved about 60% to stable funds because of November 2012…..Should I move it back?

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JoeTaxpayer September 24, 2012 at 12:48 pm

When I read about the lost decade, I assume we’re talking the ten years from Jan ’01 – Dec 10, right? The S&P returned 1.36% CAGR over that time for about a 14% total return including dividends. What I wonder, though, is how the effect of dollar cost averaging impacted the returns of the typical 401(k) investor. Did this factor help or was it completely wiped out by the masses who bailed instead of just staying the course?
I’m far better off after the decade than before, both for not exiting at the low, as well as from simply budgeting and saving a high percent of our income.

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Investor Junkie September 24, 2012 at 12:51 pm

Hi Joe,

Money Mag did research on this exact thing (DCA) in a recent magazine. If I find the article I’ll post it. You came out ahead by DCA, with ok returns.

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Investor Junkie September 24, 2012 at 12:53 pm
Eddie September 27, 2012 at 10:33 pm

No one denies that there are individuals doing better with 401k’s then they would with potential alternatives. I don’t think many deny that almost anyone -could- do better, if they chose.
The problem with 401′s is instead, that in practice most people have done utterly terrible with them, and it seems likely they will continue to. That don’t save enough, and don’t invest what they do put in well.
Whatever the source of source of the fault- system or user error- it exists, and alternatives need to be created.

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