Why I don’t invest in my 401K (or other retirement accounts)

Aside from the fact that my employer requires for me to be 21 years old to open a 401(k) (I know, ridiculous huh?) I really find no need or reason to invest in one. 

What did this PF blogger just say?

A PF BLOGGER WHO ISNT CAPPING THEIR 401K OR ANY OTHER RETIREMENT ACCOUNT AND FEELS NO NEED TO!? Yup… here’s why. Granted, I am playing devils advocate in this post, I still find a 401(k) account to make a great investment vehicle for retirement. There are plenty of benefits as well to having a company sponsored 401(k) account. It's just not for me. 

Fees

Christ, I feel like a broken record talking about fees on this site, I always come back to fees to justify any shitty argument I might have. 401(k) fees and other fees will eat you alive (well, not you specifically, but your overall net worth in your retirement account) over time. I'll explain in just a bit, but for now some stats I found from numerous sources. 80% of people who own a 401(k) (and I presume that the stat is that high with other investment vehicles) aren’t aware of the fees enclosed in their retirement account or the mutual funds they are invested in. Companies many moons ago who provided 401(k) plans weren’t required to disclose any fees, that was until the previous administration placed a stop to it, and forced the companies, by law, to disclose fees, even still, we tend to ignore how they eat up our returns over time. Financial firms now write up REALLY long fee disclosures and no one wants to take the time to read it, just shut the hell up and tell me the percentage you’re going to take out of my investments over time rather than killing trees by giving me 30 – 70-page long documents.

 Actual 401(k) document

Actual 401(k) document

We’re given some paperwork when we first start working, asked to fill it out, pick out an investment vehicle, which is most likely a mutual fund created by the company, and hope for the best. Let’s take a closer look at the fees and the impact behind them over time.

The fees 

The mutual fund you chose, likely has a fee for your money being managed, transactions, advisory fees, and marketing for the fund, anywhere between 1% - 2%. They are usually disclosed under "expense ratio"

The company that provides your employer the 401(k) plan has a fee for providing you, well, the plans they offer. On another note, if you withdraw the cash before 59 ½ years of age, you pay a hefty 10% penalty on the cash that you withdraw, more on that in a bit, but let's focus on the fees you pay while you're investing in your 401(k). Let’s say you’re disciplined and wait until the age of 59 ½ to withdraw your cash, you no longer pay the penalty, but it’s still tax-deferred money, so, therefore, depending on your current tax bracket, you’ll have to pay a tax on the money you withdraw, on top of whatever it was they took over time. While the percentages seem harmless and small for the most part don’t be entirely fooled, the more your cash compounds, the more fees compound as well, even if they remain under the same percentage. 

Joe's retirement account

Let’s say that Joe here contributes $7,500 a year into his 401(k), gets a modest 7% average market return, and cashes out in 40 years. His balance ends up being 1.65 million, congratulations Joe for amassing this much wealth and on being a millionaire.

 Joe's last decade of returns

Joe's last decade of returns

But wait :( we haven’t taken fees into consideration. The mutual fund and the 401k provider all amass to a 2% fee, in an extreme case, cutting Joe’s 7% return into 5%. Joe is now left with $957,000, overtime, Joe hypothetically lost $695,000 that went towards fees. Still a hefty amount, $957,000 can get you far, especially if you're frugal with your cash. Lastly, we still haven’t taken into consideration the taxes he’ll have to pay up AFTER he withdraws, which all varies by the current tax bracket he finds himself in. 

 Joe's returns after fees

Joe's returns after fees

Okay, what if Joe pays up 1% in fees and still gets a 7% average return? 

 Joe's returns with a 1% fee

Joe's returns with a 1% fee

Not entirely bad and this is before taxes. The national average cost for a 401(k) is about 1.37% according to Captain401.com and according to Motley it's around 1%. The 1% is as realistic this scenario gets.

Lack of liquidity

They don’t provide the same liquidity as other assets do, I mean, they’re still liquid/paper assets, yeah, but there are other hurdles you have to mantle over before getting your hands on any profit. I mentioned above how you’re hit with a 10% penalty if you withdraw your cash before age 59 ½ and to me, that is ridiculous for having to pay a penalty for withdrawing MY MONEY before a certain age. SURE, I understand taxes, I also understand mutual fund fees, I understand paying a commission, and management fees, and fee fees (I mean, might as well have a fee called “the fee fee” since there are so many damn fees) but to withdraw my cash and get slapped with a 10% penalty since I haven't reached a certain age, oh hell no. I prefer paying a commission on my online brokerage for selling my assets, pay capital gains tax come tax season, and use my money for something else. Rather than, paying a 10% penalty, then pay taxes on top of that, and any commission I might have to cough up for having my assets sold.

It’s justifiable for you to pull cash out of your 401(k) like in an emergency or a down payment on a home for first time home buyers, you then have the ability to have the penalty waived, but, can only take out a certain amount before the penalty is reinstated. I always suggest consulting with a tax professional before withdrawing any cash from any retirement account. Meanwhile, with your personal brokerage account, you simply pay the commission for selling out of your position, anywhere between $5 - $10 and pay taxes depending on how long you held the asset for, usually at income tax rate if you sold your stock under 365 days and about 20% if you held it for more than 365 days. 

You’re capped on your contributions

As of 2017, the maximum contribution you can place into your 401k is $18,000 a year and $24,000 if you’re older than 50. A ROTH IRA is $5,500 and $6,500 once you’re over 50. A solo 401k and SEP IRA can place $53,000. Granted, the contribution limit will grow over time to keep up with inflation, but no, what if I want to place $18,000.01 in my 401k or maybe $5,001 in my ROTH. It’s not as lenient as having your own individual brokerage account where you can contribute HOWEVER MUCH YOU FUCKING WANT and cash out whenever you’d like. Why must I wait until I’m older than 50 to contribute an extra $6,000 on my 401(k)? The point of compound interest is for it to compound from an early age, not last minute when you're about to retire. It can potentially make your journey to financial freedom MUCH faster since your contributions to the markets can be higher than $18,000. 

Your higher contributions can mean a higher return

Since your contribution to the market can be greater than the capped contribution on your retirement account, your returns can be larger, and if you sell (hopefully during prosperous market conditions) you'll have a lot more cash. Just by adding an extra $2,000 to your brokerage account you end up with $4.4 million after 40 years with a 7% return. In comparison to your capped $18,000, after 40 years with the same 7% return, you end up with $3.96 million. 

 Capping at just $18,000

Capping at just $18,000

 Contribution of $20,000

Contribution of $20,000

You’re better off owning an S&P 500 index fund

So, if you can’t invest in your 401(k) than where can you place your money? I, as well as the Oracle of Omaha Warren Buffett, recommend for you to place your money in an S&P 500 index fund or a low-cost mutual fund with a positive 30 year track record. An account from Vanguard is the way to go. 

 Vanguards low-cost mutual funds

Vanguards low-cost mutual funds

Conclusion

Will I invest in my 401(k) after I turn 21?

It's hard to say since I will be most likely leaving my company fairly soon before I reach the age of 21. In the meantime, I place the cash I would have invested in the 401(k) if I weren't so young into the portfolio I showcase in the stocks I'm buying series just to see if I beat or underperform the S&P on a yearly basis. 

A 401(k) is still a great investment vehicle

While I did bash on the 401(k) and other retirement accounts, I still think they are good investment vehicles. For those that don't want to put in any research time in finding a fund or individual stock, and would like to just set it and forget it. You just need to be aware how much your employer’s plans fees are, so you can either make up the lost money in another investment vehicle or create another stream of income. The other huge benefit, your employer might match your contributions to your 401(k), say you placed 3% of your check every month, depending on the amount of money you placed, let’s say $600 to keep figures simple, your employer might match 1 – 4% of your contribution or another $24. So rather than having $7,200 by the end of the year, you’ll have $7,488 working hard for you. While it might not seem a lot, it still gives you a significant push in your net worth over time. 

Fees aren't permanent

In your lifetime, you will most likely switch to a different job, this is especially true for millennials. Your 401(k) plan will most likely improve the moment you work for a different employer, and hopefully, the plan will improve for the better as you roll over your previous 401(k) account into the new one.