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The 401(k) – Have We Been Played?

by Shawanda Greene

Wall Street Street SignI’m pretty confident I’ll be able to provide for myself in retirement. I’m frugal, self sufficient, and personally responsible. Additionally, a decent income certainly doesn’t detract from my ability to accumulate financial wealth.

Although I believe the government has its place in our lives, I’ve never seen it as my provider. Not only is government woefully incompetent and wasteful at times, but it’s also bought and paid for by folks with way more money than I’ll ever have.

I often engage in frequent, heated discussions about everything from health care reform to Social Security with Sally Socialist, a close friend of mine. In summary, she believes the American people were taken for a long, rough ride by Wall Street.

According to Sally, 30 years from now, we’re going to look up and realize that the best thing corporations could’ve done for the American worker was continue to fund pension plans. The defined contribution plan, i.e., 401(k), is a joke. Gen X’ers, Gen Y’ers, you’ve been duped!

Sally tells me we won’t be able to care for ourselves because not only will we have no pension, but Social Security will have dried up. (Last I heard, Social Security is set to run out of money by 2037.) Stock market returns won’t be enough to sustain us in our old age.

Well, I don’t believe Sally. The stock market goes up. The stock market goes down. That’s the way it works. Just because it hasn’t done well for the last ten years doesn’t mean it’s in a permanent state of stagnation.

Buuuuuut, I can’t help but wonder whether Sally’s arguments are valid. Anything is possible, right? What if it is impractical to invest enough money over your working life to replace your income in retirement?

First, I don’t think Social Security is going anywhere. Members of congress don’t have the collective cojones to make any significant cuts to that program.

  • Do I think we should increase the full retirement age above 67?
  • Should we remove the cap on wages that are subject to Social Security taxes?
  • Should there be means testing?
  • Should benefits be cut?
  • Should all who are able contribute to a personal retirement account?

Wanna know what I say to those questions? Yes, yes, yes, yes, yes. I don’t think Social Security should be eliminated, but I also don’t think government should shoulder the responsibility as sole funder of your retirement for a quarter of your life. That’s where 401(k)s, IRAs, paid for primary residences, full and part-time jobs come in. Can your kids pitch in to help with your living expenses? Social Security should be S.U.P.P.L.E.M.E.N.T.A.L.

Sally calls me a conservative. I can see how someone would think that. I tell ya. You ask the Heritage Foundation for one free pocket constitution, and you somehow end up on Sean Hannity’s mailing list. Ick!

Neither Sally or I know what will be 30 or 40 years from now, but we both plan. My retirement plan consists primarily of investing in stocks and bonds while maintaining a debt free life. Sally’s plan is a bit different, but worth noting.

As I indicated earlier, Sally hates Wall Street and loves pensions. Unfortunately, she doesn’t have a pension. Since she doesn’t trust the financial markets, she doesn’t invest in them. Part of Sally’s retirement plan consists of continuing to live in her 4-bedroom house while renting the basement as a one-bedroom apartment. Renting 3 bedrooms in the main house would allow Sally to have the entire mortgage and all utilities covered by her tenants. She’d even have money left over to use at her discretion.

Of course I still think I’m right. However, I don’t think Sally is wrong. Even though Sally and I don’t always see eye to eye, I fully support her on this one. If Sally doesn’t accept conventional retirement wisdom, then she shouldn’t base her investment decisions on it.

What do you think? How are you preparing for your retirement?

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{ 8 comments… read them below or add one }

tmgbooks.com February 7, 2011 at 7:23 PM

I linked over from Pfblogs. Interesting topic and I agree that you sort of pick your poison on this one. I played the middle: Saved a bunch, have rental real estate, and earned a substantial deb pension with health insurance for life for me and my wife.

Here is the problem, as I see it, with the stock market—the actual return is much lower than the touted market average. That number does not reflect human nature which is to sell low and buy high. In other words, people panic and sell too late in bear markets and buy at too high a price during bull markets. And jumping in and out like that incurs extraordinary costs related to the total cost of total transactions.

Those actions on the part of the small investor will drive their actual realized return down, way down—as low as 1.3% according to an article at MSN Money. (I have the link if you want it.)

You might know better, have a stronger stomach as loses mount, but, then, that would mean you are extra-ordinary; most of us aren't!

Reply

Shawanda February 7, 2011 at 9:19 PM

Thanks for engaging me, TMG Books! You actually inspired me to get off my rump and write a blog post.

1.3%? That's pretty pathetic. I took comfort in knowing that retirement was over 30 years away during the last market downturn. Since I'd committed to a strategy of "buy and hold," I knew I couldn't abandon it when everything seemed to be falling apart. Otherwise, the strategy would work against me – big time.

I think it helps to have liquid cash – lots of it – when you see your portfolio decline 40% in one year. Cash gives you the flexibility to wait out the storm without selling off wounded assets.

Over the years I've grown to believe that the most important factor to retiring comfortably is a big income during your working life. Which means you pretty much have to invest in increasing your income. I’d better keep working it.

Reply

tmgbooks.com February 7, 2011 at 10:48 PM

You're welcome and the pleasure is all mine!

I wrote in the comment that I have a "deb" pension when what I meant to write is db — as in, defined benefit.

Just a tip to build your net worth and manage your spending so that it becomes a smaller and smaller percentage of your income throughout your working life:

Save one-half of every pay raise. It is as simple as that but a truly powerful strategy — alchemy almost!

For example, let's say that at present you are saving 10% of your gross income and spending the rest. Now let's say you receive a 4% raise for whatever reason and following the Save-Half Plan you save 2%.

If we assume a $40,000 annual income, you will be saving $4,000 and spending $36,000 before the 4% raise and saving $4,800 and spending $36,800 after the raise.

But look at what happened to the percentages:

Saving before: 10%

Saving after: 10.9%

And what that means is that your spending as a percentage of gross income has dropped from 90 to 89%. Follow this strategy for another five years and assuming the same 4% annual raise the numbers will look like this:

Saving 15% and Spending 85%.

Five years later? Saving 20% and spending 80%.

And the progression is painless — you never need to cut your spending or spend any less than you are spending today! You can be more aggressive, of course — save the entire raise some years, for example.

Just imagine what the percentages will look like after twenty years, how much you will be savings every year, and how much savings you will have!

Having a plan to steadily increase your savings like that, is also a plan to reduce your spending! And it is runaway spending that gets most people into financial trouble: Runaway spending is not possible when you follow the Save Half Strategy!

R/

Reply

Shawanda February 7, 2011 at 11:19 PM

Now that is a fantastic idea! It's so easy to let your spending grow to the size of your income.

Reply

Tia February 9, 2011 at 6:53 AM

Welcome Back Shawanda!!! 401k -maxing for employer contribution. paying down debt, and treating my son nice so that he will take care of me when I am old.

Reply

tmgbooks.com February 10, 2011 at 9:57 AM

Hey, Tia, the last part of your comment about your son taking care of you later in life…I have family in Mexico and that's how they do it. Very common there for the oldest son to take in the last surviving parent and all the kids pitch in to keep the parents in their own home as long as they are both alive (the parents, I mean).

There is no money there for nursing homes but they make due. There is still some of that on this side of the border but not as common as there. The problem here is that, many times, the kids aren't doing as well as the parents and can't afford another mouth to feed or to have someone stay home to provide the necessary care.

Reply

Shawanda February 10, 2011 at 11:39 AM

@Tia and @tmgbooks – I think my income and my assets are part of my mama's financial plan. Seems like I need to get serious about getting rich. Well at least rich enough to take care of my mother. Or perhaps it's just cheaper to read the book Boundaries.

Reply

@financialsamura November 24, 2011 at 10:29 AM

I am very trouble we can only contribute $17,000 in 2012 pre-tax to our 401K. People are dreaming if they think they can retire off 30 years at $17,000 a year.

401K really is only supplemental income until we can raise the pre-tax contribution to $50,000 or more.

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