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March 01, 2012


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Free Money I am an advocate of saving and shunning debt but I can't agree that the 401-k millionaires are the winners! Here's why, I recently worked with a friend of mine who retired early at 48; with a million in his 401-k. He had other savings outside his 401-k but not nearly enough to cover day to day expenses etc. So, he ended up dipping into his 401-k-taxed at normal rates with a penalty.

Upon reflection he wishes he had spent more efforts building a million dollar cash portfolio which threw off a lot of income. For those really serious about retiring in their 40's and 50's start thinking about what my friend came up against and maybe structure your portfolios differently.

There's a disconnect here...perhaps just between the title of the post and the content. The advice to save more for longer has nothing to do with getting great investment RETURNS. Naturally those who save the most for the longest are likely to have more in their 401k. That doesn't mean it's the best way to accumulate great returns. If 401ks were the key to getting rich, then the percentage of people with $1m+ in their 401k would be MUCH higher than 0.2%, since the actual numbers of non-401k millionaires (even just considering those who got there by saving and investing) is far higher than 0.2%.

The advice to save and invest early and often is good, but there are ways to get much higher returns than a 401k (such as real estate).

I have maxed out my 401-k every year for the last 22 years - the total time I have worked for my current company. I have also benefited from profit-sharing and matching paid into the same account.

For the first part of my career, we had no investment choice and everything was in a balance of bonds, stocks and cash. Later we had choices and I put everything into the available stock index funds. The only reallocations I ever did were to go more international when those options were made available.

Yet I am still only at $660,000. It seems that my overall rate of return is pretty low, and I can see why only 0.2% have balances over $1 million!

Mark, do you ever wish you had put less in a 401k and invested more in other accounts or investments? My wife has a mutual fund account that was funded nearly 10 years ago. The balance is pretty much the same as what she put in. The company once sent us a summary of returns over those years and said, "look how great we've done! In this year and this year and this year it returned 12%, 18%, and 32%!" and totally ignored the fact that in many of the other years there were major losses, and the much more important fact that the balance hadn't grown at all. My point here is that, had we put that same money ($25k or so) into a rental house like the ones we buy now, we'd have made some $40k in cash flow AND have another $40k or so in equity over those 10 years.

Steve --

That's a GREAT comment! I need to write a post on that issue!

My eldest daughter, now 53, has a very unique IRA story.

After leaving high school I encouraged her to go to our nearby state university and become a nurse, she soon found that she wasn't cut out to be a nurse and left for Texas to become a flight attendant for several years travelling the world. After the airline went belly up she came back home and went to dental school to become a dental assistant. This lasted about 3 years, by then her younger sister had married a wealthy attorney. She then quit dentistry and went to work in the attorney's office, working her way up to becoming his office manager. This attorney was very generous and put each of his salaried employees into his SEP-IRA plan and made all their annual contributions for them.
In 1992 she asked me to manage her SEP-IRA for her, it then had a value of $64,427 when I took it over on 5/11/92. In 2003 she decided the job was too stressful so she quit full time work, moved to Lake Tahoe but continued to do all the office billing by tele-communication at a much reduced salary. About a year ago she decided that she couldn't handle the Tahoe winters any more, especially after she and her 3rd. husband adopted two baby girls, so the family sold their home and moved to Maui, but she still takes care of her two little girls in addition to tele-commuting to Silicon Valley to do all of the office billing.

As of 2/29/12, without ever contributing a penny herself, her SEP-IRA has a value of $1,607,542. The attorney's 2011 IRA contribution for her part time work was $4,290.

The husband is a builder and for the last 6 months has been busy remodelling a beautiful oceanfront home at Kihei, that they will soon be moving into.

Thanks Free Money! I'm not really a fan of conspiracy theories but the best thing that ever happened to tax collections in the United States was the invention of the 401-k.
The government has impeccable records on where every penny of your savings are located and when they come out ;)

While I have not maxed out my 401k saving - I have contributed regularly for many years, and supplemented it with monthly contributions to Roth IRA's my wife and I have. It's amazing to look back at where we were just a few years ago, and see how much all of these accounts have grown through committed regular investing!

My oldest son just recently turned 17 - and has also within the last year gotten his first regular part-time job. Just last week, we opened a Roth IRA for him, and he is making regular monthly contributions to that. While the amount is pretty small that he's investing now - he can always change that later - and he has time on his side in a very big way.

With a little bit of planning and commitment - this IS achievable!

interesting Lance
so what sort of income would children need in order for them to benefit from the Roth? any downside?

Jonathan --

Your post is classic example of hindsight bias. It's very easy to look at past spans of time and claim that there was a better answer. I wish I had dumped my life savings into Apple 10 years ago but that doesn't mean it's necessarily good investing advice today.

My take on things is to just make sure you're diversified. Both my wife and I have healthy 401Ks/SEPs but we also maintain a well-diversified taxable portfolio of stocks & bonds, a Roth IRA, a 529 plan for our kids, and even some real estate.

MonkeyMonk, there is definitely a trace of that in my comment. What I was really trying (and basically failing) to articulate is that I don't think saving huge amounts of money in a 401k is the best way to wealth, for two reasons. The first, which I alluded to, is you're generally locked into the financial markets (and a small subset of the available securities in many cases). The second reason is that your money is essentially locked away until you reach a certain age. There is no chance it's earning you income during your working years, there are penalties for withdrawing the money for emergencies, and you're restricted as to when you can withdraw for retirement purposes (i.e. age restrictions).

Lynda -
I'm not seeing a downside at all to starting a Roth IRA for my son. In addition to saving for his (long term) future, it also essentially "hides" some money for when we begin planning for college (and completing the government FAFSA form) since retirement money (as I understand it) does not count as assets when determining college financial need.

We're starting out by investing $1000 of his money to start with, and then a small monthly automatic deposit into the Roth going forward.

I believe it's also teaching him about the power of saving over the long-term - and hopefully building money habits that will last a lifetime.

I am maxing out my 401k, but is just one leg of my retirement. I am fortunate to have a generous pension plan that is projected to cover 120% of my projected retirement expenses. I am also building a sizable after- tax investment account that is now larger than my 401k. In my retirement, I will have most of the after-tax investments in municipals and dividend stocks (depending on market conditions and tax issues). Like FMF, I don't count on social security. Each of these three legs could support me in retirement. By having the three sources, I reduce my risk in the event of market changes, higher than expected expenses, etc.

This is great but I'd rather have $100 million in my IRA like Mitt Romney

I Agree with Jonathan, though I take it a step further.

For the average person, a 401(k) is a fine option because that is all they have, or realistically can do.

So if you are average, 401(k) on.

But then if you are average then you likely won't retire with $1M since only 0.2% do.

HMMMM? Kinda creates a problem there. Add to the fact, as Jonathan illustrates, that 401(k) and many other specific retirement account force assets into a specific, and many times corrupt asset class with high maintenence fees and taxes, along with limits on when they can be accessed penalty free.

And why the need for a million. The point isn't the assets, it's the cash flow the asset provides.

Stable cash flow is what everyone is after. So why not invest in that.

401(k)'s get way too much attention.

Wealth can be acquired through a variety of methods. It doesn't matter which method you use. What matters is the method that works best for you and with which you are the most comfortable.

I have known several contemporaries that went the "Real Estate" route and ended up with a number of rentals that was in 2 digits when I last saw them.

My best friend and colleague at work who was also the most brilliant guy in our department unexpectedly turned in his notice one day to start his own company which has done extremely well, and now the Big 3 automakers are on the list of companies that are licensed to use his software.

I chose to actively trade mutual funds using fund selection and market timing to increase my portfolio by a factor of 10 in 7 years after retiring and a factor of 20 in 18 years after retiring.

What suits me personally about my choice is that I don't have to deal with tenants, customers, employees, or property managers, I do it all on my own just sitting at my computer. I first started using computers in 1956 when they used vacuum tubes and ended up in 1992 using the most powerful computer in the world at the time, the Cray XMP4, now I use a Dell laptop.

401k has been a saving grace for me. This June I will be retiring with my beautiful wife to our cabin far away from all people just like I have planed. Thanks to our savings we can chase each other around the woods naked for the rest of our life without a care in the world!

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