Don’t Put Money in Your 401K

by Sandy L on November 17, 2010

Today’s article is inspired by Kevin at Invest it Wisely. He wrote a great article on Challenging your Personal Beliefs.  The premise is to take a concept that you hold near and dear to your heart and think about doing the opposite to see if you can learn something from the exercise.  Some of the most effective teams I’ve been on have had left brained and right brained thinkers on it, so I’m confident that this topic is worthwhile exploring.

It reminded me of an Episode of Sienfeld where George Costanza decides his life is the complete opposite of what he expected. His remedy was to start doing the opposite of what his instincts told him to do. It’s one of my all time  favorite episodes.

Today, I thought I’d explore the following opposite mindset. I have contributed to my 401K since the day I got out  of college.  Let’s turn the clock back 15 years and pretend I never contributed to my 401K..what would be different?

  1. I would have no personal retirement fund, but I do have a company pension.
  2. I would have paid off my house 5 years ago.
  3. I would have had cash to invest in a business.
  4. I’d pay more in taxes and I’d lose my company match.

Let’s pick a business concept that is easy to grasp, real estate. If in the last 5 years, I would have taken the money I put in my 401K and used it as a 5 or 10%  down payment for a rental property,  I could have a number of rentals under my belt by now.  Yes, I would have lost some money on my purchases in 2006 and maybe 2007 BUT it would have been much less than I lost in stocks. In the meantime I still would have rental income generating positive cash flow from the investment. Rental property generally doesn’t sell for more than the income potential, so I feel confident that even at the inflated prices, I’d still be making a profit.  Plus in 2009 and 2010, I would  have snatched up some foreclosures to make up the difference in my losses from the boom time. 

I also think it’s a lot easier to calculate how many rental units you’d  need to replace your income because rents will  increase with inflation. Right now, I have no clue if my 401K balance will be enough to live off of come 2035. If I could replace my income with a  rental property today, I’d feel very confident that I could continue to rely on it as the years go by.

In a lot of ways, rental income is a much less volatile way to invest in your retirement than the stock market.  Sure, property values go up and down, but if you’re in a good neighborhood, rental income doesn’t yo-yo like my portoflio did.

The other huge benefit is that I can choose to cash out and sell a property at any time  without an early withdrawl penalty.  I can also choose to sell my home and live in one of my apartments if times got tough.  Because it’s a business, I can also write off my taxes, insurance, expenses, mileage, depreciation and repairs to these properties.  Although I’m buying with after tax dollars, I see tax benefits on the back end with all the write off options.  Once you get a handful of units under your belt, you quit your day job and become a property manager/house flipper.  You retire from the rate race 20 years before your peers. Yes, rentals can be a lot of work, but at least you work for yourself and on your own terms.

So what do you say, are you ready to ditch your 401K yet?

I personally am getting to the point where I want to take a portion of my future savings and invest it into something that’s in my control. I don’t feel like I can control the outcome of stocks as much as I can control the revenue from a  side jig.  I don’t know if I’d ever want the headaches of being a slum lord again. Someday I hope to have extra cash for something like this, but right now, reducing debt is a whole lot easier than dreaming up a business plan, so that’s what I’m doing. Once the easy stuff is done, I’ll start thinking more strategically.

Would I have been better off not contributing to my 401K? Probably not. I don’t think I could have done my day job, a side jig, started a family and moved my mother to town all in the last 5 years. It looks good on paper, but just having money taken out of my paycheck is a lot less work.

{ 25 comments… read them below or add one }

ctreit November 17, 2010 at 6:25 AM

I like this idea especially when you consider the high and often hidden fees that you pay with a 401k plan. Some of these fees are out of your control, too, since your employer negotiates them. Why did you not blog about this 15 years ago when I beefed up my 401k contributions?

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Sandy L November 17, 2010 at 7:17 AM

Well, I started my job in 1996 and back then the stock market was booming. You couldn’t lose by contributing. Here I am now with less than what I put in even after all the matches, etc.

Like I said in my post, I think it’s good to challenge some of these age old assumptions. I give credit to the financial planning industry for brainwashing most of us into thinking that 401Ks and IRAs are the only way to save for our golden years. It is not..that’s for sure.

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Nicole November 17, 2010 at 9:00 AM

Agreed on the effort. My father did a lot of real estate investing and I never ever want to deal with being a landlord if I don’t have to. Even with a housing manager.

And I like tax-advantaged investing for the long-term. We’ve only had the ability to contribute to a 403(b) for about 4 years now, and I am very glad for that ability.

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Invest It Wisely November 17, 2010 at 11:21 AM

I love the post, Sandy. My girlfriend’s parents have a rental property with a commercial unit, and while it has a decent rate of return and the commercial tenant is very lucrative, the residential tenants are a lot of work. There were more than a few days spent patching up drywall, cleaning bathrooms, changing water heaters after the tenant tried to DIY fix it and ended up breaking it, etc… there can be a pretty big time commitment. This is only with one building, so if they had several buildings like this I think they’d be forced to quit their jobs, but their income would still not be as high.

AFAIK the rules in Canada have changed so that 20% is the minimum downpayment for rental properties so less leverage is available. Still, there is something to be said for working on your own terms and answering only to yourself!

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StackingCash November 17, 2010 at 11:40 AM

I’m glad I’m not the only one who thinks the financial industries brainwashes you to think their way is the best way. Unfortunately, it takes a hard lesson to realize that investing is not a sure bet like they tell you. Read and UNDERSTAND the financial disclaimers people!

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Crystal November 17, 2010 at 1:33 PM

I like this devil’s advocate position and the fact that you can actually look back and see. I don’t think I’ll ever regret contributing the maximum that my company would match to my 401k, but I think Roth IRA’s are the way to go for young-uns like me after that. :-)

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Lindy Mint November 17, 2010 at 2:22 PM

This is a very thoughtful post. I looked into controlling my 401k after the huge crash. My father (in his 60’s) had a hunch before the October ’08 slide, and moved all of his 401k balances into the money market fund. Luckily their reserves were unscathed.

After this, I tried to research ways to track the market so I too could stash my balances when needed. I found a good tutorial on WikiHow (or whatever it’s called) that seemed reasonable, but it would require a lot of daily effort that I’m probably not qualified to do.

Conventional financial advice says to contribute and don’t pull your money out when the market falls. But do they say that just because it’s easier for the masses to do? Or is there really a better way?

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Sandy L November 17, 2010 at 8:56 PM

Nicole and Invest it – Yes. Real estate is a lot of work. Babci had a 3 family before she moved. It annoyed me that I had to nag people to pay rent every month and then they acted like they were doing me a favor by paying. I’ve had more than my fair share of trashed units. I was happy to say good riddance to that place. I was just using real estate as an example.

Stacking cash – You said it.

Lindy – I hate trying to time the market. It’s really stressful, so I’ve been trying to diversify into other things.

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Everyday Tips November 17, 2010 at 10:01 PM

Very interesting post Sandy. Have you considered contributing only as much as your company will match in your 401k and invest the rest in something else non-stock-related?

I really liked your honest assessment of what you might have if you did not invest in your 401k. It does make one think…

By the way, I am a huge Seinfeld fan. That episode “The Opposite” is one of the best.

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Sandy L November 18, 2010 at 5:25 AM

Everyday Tips – because our portfolio took such a beating, we are still playing catch up. Plus, I do want to continue to minimize my tax impact. I need to be patient and just keep doing what I’m doing. Debt and retirement first…everything else later. Oh, and I still have that pesky “save for kid’s college” to-do, that I have ignored.

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Aloysa November 22, 2010 at 10:16 PM

I agree with Everday Tips – invest upto your company’s match. The organization where I work does not match our 401K contributions. I still contribute. Not much but something… My friend, on the other hand, never had a 401K. She stashes her money into a savings account. Sometimes I think maybe it is the way to go…

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Debt Settlement November 27, 2010 at 1:22 AM

I am not reluctant to put my money in 401K, just like anyone who would like to make his safe retired life. But, I will surely respect your point of view.

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Roger December 6, 2010 at 12:52 AM

While this sounds good on paper, lets look at some of the things y0u left out. First, you said you’d have several houses under your belt… but at 5-10% down, they’d all be highly leveraged. So would you still be able to afford those when some of your renters moved out, trashed your place, and left them unrentable? (been there, done that). Would you be so far ahead if one of your renters had slipped on a wet sidewalk and sued and won a judgement against you? Or what about when the renter left a burner on and the place burned down?
It is all too easy to look at other things and think of the rosy side of things, but lets not kid ourselves. Just as there is no guarantee that you’ll always have stocks that go up, there’s no guarantee that real estate will work out, either. There is plenty of risk in either. I absolutely agree that many people don’t consider all the alternatives that they could (should) consider before committing their resources (both time and money) to a course of action. But the decision of whether you would be better in one or the other is something you should think about and decide for yourself BEFORE you do either, not something to think back on and wonder “what if”?

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Sandy L December 6, 2010 at 5:37 AM

Roger,

Thanks for stopping by. I just used renting as an example of a side business that most people could understand. I have had to manage my mother’s apartments, so I understand all the risks involved. For being sued, I’d have liability insurance on my home owner’s policy.

For horrible, unreliable, dead beat renters, I have also had people completely trash a fully renovated apartment in 6 months, then stop paying and move out. Financially, it was still a win but the emotional frustration and time spent was what was the hard part. My mom’s neighborhood got progressively worse over the years and there was definitely a correlation between finding good renters and neighborhood quality. If I were to hypothetically do it, it would only be in a nice part of town where people want to live. In bad parts of town, you only get the dregs of society.

Some people are not cut out to be landlords, but I know many who have made fortunes at it. They were in it for the long haul, focused on a geographic area they knew well, built turnover into their calculations, and worked their butts off. One of them said being a landlord is the equivalent of a high paid cleaning lady. Never in my article did I advocate that being a landlord is for everyone, but it definitely can work for some people. Thanks again for the counter argument.

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Nate December 6, 2010 at 10:51 AM

I reached the same conclusions about 401k’s and IRA’s. Too much of my savings is concentrated in these accounts. At this point I wish I had set aside more for purchasing a residence or investing in myself and my business ideas. I have stopped contributing and instead direct my after-tax savings into alternative investments.

Another disadvantage with 401k’s/IRA’s is that there are so many strings attached to the use of the money. There is even talk that the federal government might impose confiscatory policies on withdrawals to help pay for the budget deficit (as was done recently in Argentina when private pensions were seized). The point is that at any time the government can change the rules – retroactively – on any 401k contributions. You’re going to pay taxes on the withdrawals anyways – maybe more than you can imagine right now – so you might as well pay the taxes today and have the freedom to access your funds whenever you need them.

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Jennifer Barry December 11, 2010 at 5:29 PM

Hi Sandy, I’m glad you’re raising this issue. So many people dump their money into 401Ks and don’t even think about it. Due to tremendous peer pressure, I got in a fund in 1999 and got slammed soon afterward. I cashed out in 2002 and haven’t regretted it. I do own some stocks but not through a government program where the rules change regularly. I think the US stock market is a rigged game, and I prefer to invest in businesses I own or understand very well, or precious metals.

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Amelia December 29, 2010 at 12:47 PM

I am so lost on what to do with my 401K. Earlier this year I changed my allocations from 80% stock and 20% mutual funds to 80% mutual funds and 20% bonds. I am only three years invested, but I am still $2000 down from my personal contributions. At one point half of my money was gone. My company doesn’t match and the only benefit I get is a tax break. I have also lowered the percentage of income contributed from the max to 3%. My savings account has outperformed my 401K! I only get a little over 1% through ING even counting the tax dollars I saved on my salary.

These are troubled economic times and no one really knows what is going to happen to 401Ks in the next decade. Do they?!?! I am 42 and don’t want to gamble in Vegas any more. The hangover gets worse as I get older. Is there a way to rollover my 401K into a CD to lessen the penalties of withdraw? If not, should I let the 401K ride until maybe, just maybe, I can make enough through interest to pay the penalties and get my original money out.?

Thanks. Great site.

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Sandy L December 30, 2010 at 6:02 AM

Nate – for a long time, my only form of savings was 401K. I didn’t have enough cash to put it other places. Now that I’ve been working a while, I have the luxury of rethinking that approach. I still like the tax advantage portion of it but you are right, I hate the limits you have on the control of your cash and at most companies you also have limited investment options.

Jennifer – yes, I think that’s my long term goal, is to be able to invest in some kind of business that I have some say or control over (like my own). If you invest in a corporate stock, you’re trusting that the people in that company will make the right decisions or you make a prediction based on a SWAG.

Amelia – I’m not an expert, so I have no predictions. The point of the article was to remember that 401K’s aren’t the only option out there to think about when it comes to saving for the future. I’m also worried about baby boomers and their money. As they start retiring and taking money out of the market, is it going to tank again? Or are they going to keep it in? That can really sway things and I have no idea what’s going to happen. The stock market isn’t a sure thing and I also have lost a LOT of my retirement betting on it. I made a personal decision to keep investing in the market but reduce my savings and put the difference into guaranteed investments like building equity in my home by paying off my mortgage early. Thanks for stopping by. I hope to see you back.

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101 Centavos February 8, 2011 at 9:31 PM

I agree with the premise. Part of the property we just purchased was financed with a loan from our 401k. We took non-productive cash and invested in a productive homestead. Well, somewhat productive. All it we get out of it for now is 9 acres’ worth of hay bales and a few bushels of peaches.

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Sandy L February 9, 2011 at 4:47 AM

101 – you know, back in the day, most people didn’t have 401K’s and a lot never invested in the stock market. My uncle bought rental properties and the rest he kept in cash. There is something to be said about having a tangible asset. Even if the land “loses value” it still can be productive in other ways.

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Dee October 5, 2011 at 3:24 PM

I’ve always wondered after watching Suzie Orman, how 20-30 years old have 1/2 a million dollars already saved up in a 401k. You’ve just opened my eyes about retirement savings. My company does match and recently offered “free retirement management” through an investment firm. We had the webinar yesterday and someone asked the firm “Who is will oversee my account and does it matter if my balance is 1000 or 100,000″? The response was, “we dont have dedicated reps or individuals that services your accounts”. So who’s managing my funds, a computer? This scared me and I declined the services + it wasnt actually free. It was free if you managed your own account, it’s a fee if they manage. go figure

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Matt November 19, 2011 at 6:29 PM

Sure, this sounds like a good idea on paper, but…. rental properties involve work, as you pointed out. 401K contributions are automatic. A good plan, in my opinion, would be to invest in your 401k the minimum amount that will build you just enough wealth to live on by retirement age. Use the rest of the money you would have allocated for retirement savings to save for other investments, such as rental properties.

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Greg January 18, 2012 at 5:30 PM

“A good plan, in my opinion, would be to invest in your 401k the minimum amount that will build you just enough wealth to live on by retirement age.”

That is the trick. If you can save up $1 million, and then live off of a 7% return, you would have $70,000 a year. But mutual funds have a history of averaging more like 4% ($40,000), which coincidentally is what investment advisors recommend you aim to live off of. I have been saving max for 15 years, and am at about $375,000. What’s it going to take to reach this $1 million? Minimum won’t do. I need max to make it.

Some real mind challenging articles written by a guy named Jeff Brown include:
http://www.biggerpockets.com/renewsblog/2011/12/06/still-believe-your-401k-is-a-main-cog-in-your-retirement-income-plan-think-again/
http://bawldguy.com/a-challenge-for-those-who-still-cling-to-their-401ks/

Just consider that conventional property management companies charge 10% off the top of gross rent, and can handle the evictions, legal issues, and signing leases. It really makes a compelling case. That is why my wife and I are planning on making an early withdrawal to fund a new home for us to live in, so that we can turn our existing home into a rental, in order to start our business. I hope to continue my existing job so that we can pour all the rent money into the mortgage and build the equity fast. I figure I can recover the penalty of the early withdrawal in about six years.

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Matt November 19, 2011 at 6:35 PM

btw, first financial blog post I’ve seen with a Seinfeld YouTube embedded. Awesome!!

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Alpha February 10, 2012 at 2:27 AM

I agree that 401K are not the way to go, but my considerations are a bit different. Anyways, your math is very rough and that is not the way to plan. Moreover, I cannot believe that people act like they have no control over their investments. You put money in stocks and don’t tune in? I’ve done 8 trades last week that lsted less than an hour combined last week and I am up $424.24. I know this is not the norm and I could have lost that much or more, but at least I try. If you don’t have the time or desire to at least try to invest properly, may I suggest a money market fund? I mean come on. Who buys a stocks and stands by idly as they drop? Just ask people who worked for HP. Their stock was down 60% at some point. Put your 401K money in a money market fund. Then the only benefit would come from moving to a lower tax bracket if one day you withdraw less than you make now. I remember reading about S&P500 and the SPY fund saying that if you invested $10,000 in SPY about 30 years ago, you would have about $10,070 now, but you would have had a lot of excitement in the meantime :D.

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