With pension plans becoming extinct, more and more corporate Americans are using 401(k)s as their primary retirement savings vehicle. But the rapid decline in value of these accounts is raising questions about the viability of this system. But is the 401(k) really to blame for this mess or is it the custodians that set them up and manage them?
The 401(k) is rightfully expected to go under the microscope with the new administration and overwhelming popular sentiment that retiring at 65 for most Americans is a pipe dream.
But don't blame the 401(k). The 401(k) is a well structured retirement vehicle that encourages employees to save with tax deferred contributions. It also allows the corporation or small business to contribute to the employee's account and earn tax savings of their own. Someone under 49 years of age can contribute up to $15,500 a year tax free. If you're 50 or older, the maximum is raised to $20,500. When you add whatever corporate match your company provides, these numbers are significant when done over the course of a career. Your 401(k) can provide a significant amount of retirement savings if the contributions are invested wisely. So what's the problem?
The problem is that most 401(k)s are managed by banks and Wall Street custodians that only allow investments from their portfolio of products. Want to own a duplex that produces monthly cash flow and long-term appreciation? Too bad. How about a parcel of land in the path of development? No way. Your neighbor's ice cream shop that has an exciting new business plan? Forget about it. Since the custodian doesn't profit from these types of transactions, they aren't allowed. But are they legal? Absolutely. Do these types of investments allow a better diversification of your retirement account and help protect your nest egg when the stock market declines? Without a doubt. Then why don't more corporations allow them?
When the 401(k) and IRA were first created in 1974, the law required a 3rd party custodian to manage the accounts. Wall Street quickly seized this role and made stock market investments the centerpiece for growing wealth. To date, nearly 85% of all assets owned in 401(k)s and IRAs are invested in stocks and mutual funds according to the Investment Company Institute. And for the first 30 years the stock market produced unusually high gains so no one questioned this model.
In 1974, the Dow Jones closed around 1,000. In 2000, the Dow closed at 11,000. That produced almost a 10% compounded annual growth rate. For the century, the Dow produced a 5.3% growth rate. So for the first 25 years that the 401(k) was in effect, the market was delivering a return that was TWICE it's normal rate. Everyone was making money, so no one questioned the system. Since 2000, the Dow has been losing money at -3.6% every year. Naturally, questions are arising and Wall Street is digging in its heels.
I argue that it's not the 401(k) that needs to be fixed but the current system that perpetuates this over-investment in the stock-market. We need to wrestle away the control of our retirement accounts and start exploring a greater range of investment options. If you're not sure what to invest in, get professional guidance through a FEE-based certified financial planner that makes their living on growing your account, not by selling you a specific set of investments products. And being a real estate guy, I encourage you to explore real estate. Eight out of ten millionaires made their fortunes through real estate. It's a proven long term asset that when invested properly can substantially grow your retirement account.
Should more Americans save more money? Absolutely. And maybe if more investment options beyond the stock market were available, they would.
