I have yet to meet anyone who is thrilled with the concept of the 401(k). Dan Solin, writing in the Huffington Post suggested: “For outright greed and deception, it’s hard to top the 401(k) system. It’s rife with conflicts of interest, exorbitant and often hidden fees, poor investment choices, little participant education and deception about the legal obligations of the brokers and insurance industry to the clueless plan sponsors who retain them.” Trouble with this knowledge going in gives us little incentive to continue with the plan and even less interest in joining.
This makes the plan an “it is what it is” option for the vast majority of us. So the question is: how do we live with the hand we have been dealt, knowing that the calls for fiduciary responsibility are going unheeded – short of regulating what should have been something our employers should have embraced.
The pension system fell to the wayside under the pressure of pricing (the employer had to pay more than it wanted to) and the portability issue. Employees wanted to change jobs when they saw fit and felt as though the loyalty implied with the pension system, one that locks the employee into years of service, was out-dated. Why couldn’t they take their money with them, they asked. The 401(k) answered that question albeit poorly.
To look back on the advent of the 401(k) is to see a loophole for the very well-to-do employee looking for some way to add even more value to their future and as a way to hide excess wealth. To believe that this sort of plan was fit to deliver to the masses, sold as control of our money and in doing so, making the direction of those investments our responsibility was convincing enough that there was barely a whimper when pensions all but disappeared.
The introduction of the 401(k) had the net effect of driving the bull market that fell between 1982 and 2000 giving those that sold the idea the proof they needed to convince everyone that they could do so much better on their own. We didn’t have to understand the plan in those days – anywhere we put our money made us all feel as though we had some sort of Midas touch. The markets went up, we prospered and the deal was sealed. Until that almost two decade move towards the top ended.
Yet we still didn’t see the plan as flawed. Instead, the market blamed us. Call it irrational exuberance if you like. But is was more akin to irrational blindness. Sure we were happy that our 401(k) balances grew, doing so with little more than participation. We cared about the cost – but not that much. We worried about the choices – but not so much that we rebelled. We simply kept channeling our hopes and dreams into a financial engine that offered us nothing other than an illusion of profit.
Now we are left with a plan that makes little sense. And this is where the confusion begins. People refused to use it, underused it or used it incorrectly. Participation never reached 100% among employers who offered it and with good reason. We claimed we didn’t know how. We complained that it cost too much.
So now we are left with a basket of investment choices that seem tailored to keep the rabble quiet. Lots of index funds to choose from, lots of target date funds to help us invest based on some far-off date in the future when we would like to hypothetically, retire, and matching contributions that may or may not exist. You asked for change and they made it worse. You asked questions and they answered with fewer choices, less viable alternatives and did it while tweaking the plan to their favor (this is done when the only match offered is one where you have to buy the company stock to receive it).
To this I offer the 6/100/100 plan of attack on your making this battered investment scheme work. It goes like this:
Invest 6% of your income in your company’s 401(k). In many situations, this will be the dollar amount that could match your employer’s contribution. It is also very close to the threshold amount that does not alter your take-home pay. By not changing what you need to live on, you can begin to make inroads to the single most important part of your retirement plan: the financial health of your household. How you arrive at retirement is more important than when.
Because your 401(k) is a pre-tax event, deferring those taxes to a distant future, using tax efficient index funds defeats the purpose. Look for a diversified actively managed portfolio for this initial 6% and let the risk do the work.
Then invest 100% of what you can in a Roth IRA. For 2010, this is $5,000 for those under 50; $6,000 per year for those over 50-years-old. This is where you put the index funds. Using them outside of your 401(k) is a bet against the future tax rate – which is unknown. But the low-cost environment of these types of funds creates the perfect solution to the unknown cost of the risk you may be taking in your 401(k).
Then, go back to your 401(k) and max it out. Few of us will be able to do step three but those of us who can, should use the rest of this contribution on conservative investments designed to protect the invested capital. This last step may not be something you are able to do until you get quite a bit older. Which is how it should be.
The 6/100/100 plan gives you control, risk, low-cost and an answer in playing the hand you have been dealt. There is no doubt that the whole system needs to be changed. But there is a way to rework so it at least accommodates us better. This doesn’t let us off the hook in terms of education (really, we don’t know where our money is going), fiduciary responsibility (no Virginia, your company doesn’t care about your retirement future), and the investment professionals (who care about making money and suggesting they want you to as well).
To read the article Dan Solin wrote in the Huffington Post, click here.
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