How 401(k) Plans Are Losing and Will Lose Your Money by Investing in Mutual Funds
When it comes to retirement planning, the humble 401(k) is the king of them all.
It’s the most frequently used vehicle, due to its widespread implementation by employers, as well as the number of employers now matching employee contributions dollar for dollar up to a certain percentage of their income.
Putting money into a 401(k) seems like a “no brainer”, but is it, really?
Truly, yours may actually be losing you money by investing in mutual funds.
Investing in Mutual Funds Is the Key to 401(k) Performance
You might be surprised to learn that the key tool to wealth building within just about any 401(k) is mutual funds.
He writes, that “these funds have ballooned to hold more than $16 trillion. But these funds pose dangers to our savings in three ways: through structural vulnerabilities that give money managers the incentive to focus on marketing over investing; through the very human challenges of managing our savings decades into the future; and through the peril of financial professionals behaving badly, to our economic harm.”
It’s not just the running of these funds that should irk you. It’s also the extreme costs involved here. The fees you’ll pay within your 401(k) can be exorbitant, which is one reason that so many lawsuits have been filed regarding them.
Birdthistle goes on to say, “More and more studies have shown irrefutable evidence that in the experiment of putting all this money into the hands of individual investors, the results just aren’t there. One-third of Americans have no retirement savings and, of the cohort about to go into retirement, they have $111,000 on average, which works out to about $7,000 per year.”
Obviously, that’s no way to fund any type of retirement. In fact, it’s barely enough to pay for the medical expenses you’ll incur that are not covered by Medicare.
Another pundit has further thoughts on why investing in mutual funds through a 401(k) is such a bad idea.
Brad Katsuyama says that, “the problem is that high-speed traders are speeding past portfolio managers to execute trades, driving up the prices at which mutual fund managers can buy shares and reducing the prices at which they can sell their shares. Over time, this takes money out of the pockets of individuals who hold mutual funds in their retirement accounts.”
Why Your Expectations Are Hurting Your Investments
One factor that should wake up Americans hoping to plan for their retirement by putting their money into a 401(k) is the fact that you don’t always get what you pay for.
In everyday life, paying more for a higher-quality lunch is usually a good thing. The same principle applies to electronics – a higher-end, a higher-quality tablet will cost you more than a bargain-basement option that will only last for a few months before it goes belly up.
Investors bring that common sense approach with them to their 401(k) investing. They assume that higher costs here equate to higher-quality investments.
Sadly, that’s not the truth. In the area of mutual funds, price and performance correlate differently. Paying more for a particular mutual fund does not guarantee you higher performance.
In fact, the fees you incur actually hurt performance, costing you money and reducing your retirement nest egg proportional to the fees you pay.
Your Money Isn’t Going That Far
A recent study found that rather than spreading the wealth around, most employer-managed 401(k) programs actually favor their own funds.
While that’s not inherently bad, it can be for those who want to diversify their holdings and who don’t want to rely on the performance of their employer for the bulk of their retirement savings.
While it might seem like a common sense approach from the employer’s perspective, it’s bad news for employees.
The Danger of Bond ETFs
Yet another reason that investing in mutual funds through a 401(k) might be ruining your financial future is the fact that your money may end up in a bond ETF (or more than one). Exchange-traded bond funds (bond ETFs) are risky and should be left alone by the average investor just hoping to secure a comfortable retirement.
How to Avoid Investing in Mutual Funds and All the Headaches
So, what is an investor to do? Should you avoid 401(k) plans altogether?
No, they can be highly beneficial when managed correctly. And, you can’t avoid investing in mutual funds in your 401k plans, because there are no other options.
However, if you change jobs you can simply rollover 401k plans from your previous employer to an IRA.
An IRA will allow you to invest in plain securities without any intermediate risk and higher cost.
As you already know, bonds should be part of every investment portfolio.
However, income from bond interest is taxed as ordinary income, compared to the only 15% tax on long-term capital gain. Therefore, it is tax efficient to invest in bonds from your IRA accounts, while investing in stocks from your traditional investment accounts or from your existing 401(k).
However, you also need to make sure that you’re investing in high-quality, individual corporate bonds. These are time-targeted, so you know exactly what you’ll earn and when that return will be available.
With a little time and planning, you can actually create a bond ladder that consists of bonds with different maturity dates to help ensure that you have a constant stream of income throughout your retirement years.
This is actually an invaluable financial tool for anyone, whether you’re planning to help your kids through college, want to ensure you’re comfortable in your “golden year” or just want to build your wealth.
When everything is said and done, remember that investing is complicated, more so than you likely realize. Even something as seemingly straightforward as using the 401(k) provided by your employer could actually put your financial well-being at risk.
It is absolutely crucial that you have sound advice and guidance to navigate these troubled waters, and that you see through the smokescreen that allows mutual fund managers to make a killing while putting their investors’ money in danger.