Despite all the shade thrown on 401k plans in the press this year, I would gladly take a 401k over other retirement account alternatives. The individual choices and flexibility of 401ks can be outstanding for those who know how to use it, but not so good for those who don’t. I personally have benefited tremendously from my 401ks over the years – much more than I ever would have from any traditional pension, and certainly much more than I ever will from social security. That said, not all 401k plans are created equal. I currently work for a small Silicon Valley tech company with some pretty f-ugly 401k investment options. What should you do if your 401k plan sucks?
It’s really up to each company to design a plan that is best for its employees, and not all companies do. Let’s take a look at my company’s plan:
My Company’s 401k Investment Options
There’s really only two things that matter when choosing a 401k investment option: the fees and the asset type. Here’s what my company’s plan has (There’s over 25 options. Scroll through if you like):
|Fund Name||Asset Class||Total Expense Ratio|
|Amer Fds New Economy R6||US Stock||0.71%|
|Vanguard 500 Index Adml||US Stock||0.25%|
|DFA US Small Cap Value I||US Stock||0.77%|
|TRP Diversified Sm Cap Grth||US Stock||0.92%|
|Vanguard Mid Cap Index Adml||US Stock||0.33%|
|Vanguard Small Cap Idx Adm||US Stock||0.33%|
|JHancock Disciplined Value R6||US Stock||0.95%|
|MFS Mid Cap Growth||US Stock||1.14%|
|MFS Mid Cap Value||US Stock||1.02%|
|T. Rowe Price Growth Stock||US Stock||0.73%|
|BlackRock Hi Yield Bond Instl||US Bond||0.85%|
|Oppen Senior Floating Rate I||US Bond||0.95%|
|Fidelity Government Income||US Bond||0.70%|
|DoubleLine Total Return Bond I||US Bond||0.72%|
|T. Rowe Price Retirement 2020||Target Retirement||1.07%|
|T. Rowe Price Retirement 2030||Target Retirement||0.91%|
|T. Rowe Price Retirement 2040||Target Retirement||0.97%|
|T. Rowe Price Retirement 2050||Target Retirement||1.01%|
|Fidelity Advisor Real Estate I||REIT||1.09%|
|Amer Fds EuroPacific Growth R6||International Stock||0.75%|
|Franklin Mutual Glbl Disc R6||International Stock||1.09%|
|Amer Fds SMALLCAP World R6||International Stock||0.96%|
|Vanguard Ttl Intl Stk Idx Adm||International Stock||0.37%|
|Vanguard Emerg Mkt Stk Idx Adm||International Stock||0.35%|
|Templeton Global Ttl Return R6||International Bond||1.01%|
|Oppenheimer Int'l Growth I||International Bond||0.91%|
|T. Rowe Price Prime Reserve||Cash||0.92%|
Why My 401k Plan Sucks.
My main beef is that the fees are outrageous on all but a few options. The investment adviser tacks on 0.25% to all funds for their outstanding management and “advice”. So, for example, if an underlying fund is charging 0.5%, our 401k administrators add on another 0.25% to bring it up to a total fee of 0.75%. I cringe whenever I have to pay anything more than 0.25% fees on a mutual fund, so this extra fee makes me want to cry a little bit inside.
If not for the Vanguard options in my 401k plan, I would perhaps even consider not participating at all. Vanguard, as always, comes through like a champ, with several investment options around 0.1% (that’s 0.35% total after adding the 0.25% administrator fee). Wouldn’t you know it, all of my money is in the Vanguard funds.
The 1 Percenters Are Not Welcome
If you pay 1% fees on a mutual fund, you’re being absolutely defiled. It is highway robbery. Think it’s not a big deal? Let’s say you invest $10,000 per year in Mutual Fund A with a 1% annual fee, and $10,000 in Mutual Fund B with a 0.1% Annual Fee (like so many choices at Vanguard). Assuming they both earn 7% returns per year, here’s what that means over time:
Performance of Two Funds: 1% vs 0.1% Annual Fee
|Time Invested||Mutual Fund A With|
1% Annual Fees
|Mutual Fund B With|
0.1% Annual Fees
Over time, this really adds up to big bucks. In a mutual fund with 1% annual fees, you will pay over $30,000 in fees over 20 years. Plus, you will miss out on another $16,000 of growth of what you’ve paid out in fees. Together, this adds up to over $46,000 that you’re missing out on over 20 years. If you are paying 1% annual fees in your 401k, someone’s retirement plan is being blessed, and it sure isn’t yours.
Even Our Target Retirement Funds Suck
I normally like target retirement funds because they have automatic diversification and built-in re-balancing. Both of these are great features, and can goose your returns over time, while reducing risk. Plus, they are hands-off, which is great. It’s usually the best choice for someone who doesn’t what to take the time or effort to manage things themselves. But, the ones in my 401k plan are horrible – all around 1% total annual fees. No thank you.
This is the part where I put on my complainy-pants about not getting any free money. Company matching contributions to 401k plans are just that: free money. It’s a wonderful thing, and I’ve probably made over a hundred thousand dollars from matching contributions over my career. Whatever you do, you should always contribute at least as much to your 401k to get all of your company’s matching – even if it means investing in bad funds with high fees.
Life Pro Tip: Don’t pass up free money.
But, my company’s 401k plan has no company matching at all. According to Wikipedia (which never lies), about 2/3 of companies with 401ks offer some sort of matching. So, this definitely puts my plan near the bottom of the scale.
Too Many Choices
Too many investment choices, especially when they are bad choices, can be confusing and can lead to bad decisions if you don’t know what you are doing. My 401k plan definitely falls short here too. There are way too many choices. Our well-paid investment advisers would tell you that’s what they are getting paid the big bucks for: to help us make good choices. I’d rather keep my money, thank you.
My company is full of engineers – analytical men who like to do things themselves, and prefer not to ask for directions. Many of them who really don’t know much about money or investing, and many don’t know how to make good investment decisions. Some are too busy / proud / egotistical to seek help. But seeing the mutual fund choices we have in our plan, I have to question whether they would even get good advice if they did seek it.
So What’s An Early Retirement Dreamer To Do With A Bad 401k Plan?
You should max out your 401k, that’s what. Despite all of my complaining, my 401k plan is still one of the best places I can put money. Even though my plan sucks, I’m all-in for the maximum contribution of $18,000 in 2017 for several reasons:
- Taxes: The tax benefits easily outweigh any fees you have to pay. What’s your marginal tax rate? 15%? 25%? 28%? Would you rather pay that, or pay 1% in annual fees? Unless you’re going to continue paying the high fees by staying with your company for decades, it makes no financial sense to pass up the immediate tax benefits. Remember, you can always get money out of retirement plans tax-free, with a little foresight and planning under a Roth Conversion Ladder.
- Portability: once you leave the company, you can roll it over to a much better plan. I won’t be out the door for more than about 15 minutes before I move my 401k funds over to an IRA at Vanguard, where I will reduce my annual fees to well below 0.25%. Even if you don’t have an immediate Escape Plan from your current job, you’re most likely not going to stay more than several years. The average tenure at a job is now only 4.2 years, and declining according to the Department of Labor.
- While I wish I could have free money too, the lack of matching is not a reason to avoid your 401k Several co-workers told me they aren’t participating in our 401k plan because there is no matching. They claim to have better places to put their money. Of course, if they have another investment option that does include free money and awesome tax benefits, then more power to them, but I don’t think that was the case.
Better Than A Pension For Achieving Financial Independence
For sure, some 401k plans are worse than others, and mine is one of them. But, if you know what you’re doing, you can still reap tremendous benefits. The key is to educate yourself, and to pay attention to the details of your plan. I thank my lucky stars that I’m not tied to a traditional pension scheme. Pensions are usually not good tools for early retirement and financial freedom. With a pension, I would probably be facing decades more of cubicles and office politics.