401k investing. Do those even go together? Is it the best vehicle to use when saving for retirement? Or will it set up people for a financial slaughtering just when it is most needed?
In this page we'll go over the actual creation of this concept of 401k investing. We'll take it from the original idea behind the legislation all the way through the pros and potential cons of the idea. We'll draw from an empowering book that offers a scenario that is now coming full circle, even though the book was written in 2002.
For many people, this might be the best retirement planning option. This page is really about providing more information so you will have viable, informed options.
The 401k investing plan came into existence in 1974 as part of the ERISA legislation. It was designed to protect employees from pension fund mismanagement and outright plundering. The very official sounding title is "Employee Retirement Income Security Act."
The need arose in response to numerous instances of employers under-funding of employee pension plans and from corporate takeovers that occurred not so much because of the track record of business success, nor even to eliminate competition.
In some cases the large pile of cash in a pension fund was the driving force behind a hostile takeover. The opportunity to siphon off these assets was a buying incentive of the worst kind.
So the ERISA legislation sought to offer employees some protection from this danger to their future retirement funds. And 401k investing was born. This new idea would also be a financial windfall for many business entities.
The first challenge with this new idea was that it didn't come with a packaged education program to teach employees how best to use it. Employers had no choice. They had to seek the answers because the bills were due to the tax man whether they took the time to learn the rules or not.
ERISA took workers away from the defined benefit plan and moved them into a defined contribution process. The old idea of working for the same company for many years and then retiring to a designed pension fund is an example of defined benefit. Social Security is an example of defined benefit. You get it until you die.
In a defined contribution plan, you get it until it runs out. That is of course assuming an employee actually puts money into the account. And puts enough into it each year to reach the "number" needed to really retire. And never borrows against the account until they retire.
Every year reports indicate that most people are far short of what is needed to ever retire. Many don't even contribute to an available plan. So while the defined contribution plan was designed to benefit the employee, if that worker contributes nothing, it is a huge cash saver for his or her boss.
Before the idea of 401k investing came around, employers who carried a pension plan had to put money in every month for every employee. All the employee had to do was show up for work. ERISA changed all that. Learning something new would now be required for every worker who didn't want to just do nothing and hope it all worked out.
I recognize the the good ideas concerning the 401k concept.
* Employers matching the funds an employee puts into that account. Who doesn't like free money?
* Tax deferred status on any growth in the fund balance.
But there are potential pitfalls. Personal willingness to learn new things, levels of commitment and risk tolerance are the measuring sticks on whether a 401k is your best choice or not.
Lack of financial literacy is the first major flaw in this way of saving for retirement. People are now forced to become investors. Most with no educational background in this subject
This led to a large new industry. Financial planning. They were on every corner. Some skilled and possessing good intentions. Many others just repeating the sales pitch of the company that paid their salary.
Which leads to problem number two. Limited investment options. Many 401k plans offer groups of stocks or bonds. If a new "investor" doesn't know what to do next, they fall back on the famous,"invest for the long term in a diversified portfolio of stocks and bonds" Most of these plans carry fees associated with the transactions.
And then we get to the biggest flaws in this type of retirement option.
* Who will be the buyers when you are a seller?
* Corporate mismanagement
With the federal reserve printing presses running unabated, inflation is a distinct possibility. In fact most governments depend on some inflation to make things look better than they are and they always have the option of using inflation to eliminate debt balances by debasing their own currency. I worry about the person who thought he planned wisely. He diligently put his money into his 401k and his individual retirement account to the point where the balances seem about right to retire "comfortably".
But if indications and history are even close to correct, that balance may lose all of its purchasing power. It isn't fair, but it may be so. Please check out our page about the Reichsmark era to gain a historical perspective of what happens when governments lose control of the velocity of money at a time corresponding with major market shifts.
Near the bottom of the resource library page, you'll find 6 "must see" videos from Mike Maloney that provide a fantastic, free course in understanding inflation, deflation and how money really works.
In "Rich Dad's Prophesy", author Robert Kiyosaki gives an excellent explanation of this 401k investing conundrum. His books are very easy to read and this edition follows the trends set in his other books. His advice is accurate, although controversial.
He also provides an interesting assessment written back in 2002 that points to events that could occur in the future. But even better than pointing out pitfalls, he offers some great alternatives.
The oldest members of the baby boomer era have begun to make those required withdrawals. If the stock market is good and people are buying stocks, that isn't a problem.
But the market has booms and busts. Timing could be critical for many people seeking to maximize the value on these 401k accounts. What if there are more sellers than buyers?
When the massive number of baby boomers begin to make the required withdrawals, who will be the buyers? Stocks are only worth what someone will pay for them. If you have a group of sellers much larger than the group of available buyers, what will the price be like? What will your fund balance be then? Will it change your retirement options? Will you have a retirement option?
Did you catch that part about required withdrawal? At around age 70, you have to begin to take it out. Taking it out means selling it off. This is the exit strategy in 401k investing.
A downward trending stock market coupled with far fewer buyers further driving down value will spell disaster for many people. Again, knowledge is power.
And what about that third flaw. Corporate mismanagement? Wasn't ERISA put in place to protect employees from this problem?
In"Rich Dad's Prophecy", the author tells of a picture in USA Today from November of 2001. He writes that there was "a large color photograph of a fifty-eight year old man. His hair is gray, his arms crossed, he is intelligent and distinguished-looking.
Although he could pass as the CEO of a large corporation, he isn't. Instead he is a loyal employee of Enron, a company where the CEO and other top executives may have personally made millions of dollars but the company is now bankrupt."
This man made the cover because he did what the mainstream planners told him to do. He dutifully put money into his 401k investing plan. But a market crash, a downward economy and corporate corruption and incompetence devastated his retirement account.
At age 58, he had also lost his most important asset. He lost time. He doesn't have nearly enough available working years to make up for these losses. For those too young to remember the Enron travesty, please click here to see another example of wiped out retirement assets.
Failure to plan is planning to fail. You don't have to be in that group. Even if you don't see yourself doing anything else but following a path of 401k investing, your time will be well spent reading this book. The message is as relevant now as when it was written.
And as our children's most important teachers, it falls to us to guide them toward new knowledge. They won't learn it in schools. And the pain from learning it from life is much worse and far more expensive.
Booms and busts, economic and world events and even bad timing can all effect retirement accounts. But armed with better financial literacy, you can overcome these obstacles.