I like James Altucher. He's a sharp writer and a smart thinker. It's just those kinds of people -- people who know what they're talking about -- who deserve to be called out when they say something silly.
Altucher did a video with Business Insider this week pleading with young workers not to save in a 401(k).
It is -- and I'm being gracious here -- one of the most misguided attempts at financial advice I've ever witnessed. It deserves a rebuttal.
Altucher begins the video:
"I'm going to be totally blunt. Are you guys in 401(k)s? OK, you're in 401(k)s. I honestly think you should take your money out of 401(k)s."
Why? His rant begins:
"This is what is actually happening in a 401(k): You have no idea what's happening to your money."
Everyone who has a 401(k) can see exactly what's happening with their money. You can see exactly what funds you're investing in, and what individual securities those funds invest in. These disclosure requirements are legal obligations of the fund sponsor and the managers investing the money.
You might choose not to look, but the information is there. An investor's ignorance shouldn't be confused with an advisor's scam.
Altucher lobs another complaint:
"And, by the way, if you want that money back before age 65, which is 45 years from now, you have to pay a huge penalty."
You can take money out of a 401(k) without penalty starting at age 59-and-a-half. You can also roll 401(k) money into an IRA and use it for a down payment on a first home or for tuition without penalty.
A lot of companies also offer Roth 401(k) options, where you may be able to withdraw principal at any time without taxes or penalty.
According to the Census Bureau, 91.2% of Americans currently of working-age will turn 65 in less than 45 years.
"They're doing whatever they want with your money. They're investing wherever they want."
There are no 401(k)s where someone does "whatever they want with your money."
All 401(k)s are heavily regulated by the Department of Labor and have to abide by strict investment standards under the Employee Retirement Income Security Act of 1974.
Part of those rules require that you, the worker, have control over how your money is invested. Here's how the Department of Labor puts it (emphasis mine):
There must be at least three different investment options so that employees can diversify investments within an investment category, such as through a mutual fund, and diversify among the investment alternatives offered. In addition, participants must be given sufficient information to make informed decisions about the options offered under the plan. Participants also must be allowed to give investment instructions at least once a quarter, and perhaps more often if the investment option is volatile.
A lot of companies still offer subpar investment choices, but check out this article on how to lobby your employer for a better 401(k). Someone at your company has a legal duty to provide choices that are in your best interest.
"They're paying themselves salaries."
It's true: Mutual fund managers earn a salary.
You know who else takes a salary from the stuff you buy?
Plumbers, accountants, electricians, doctors, nurses, construction workers, shoe salesman, car mechanics, pilots, dentists, receptionists, gas station attendants, TV anchors, the guy behind the counter at the coffee shop, the lady who scans your groceries, me, and -- at some point in his life -- probably James Altucher.
Look, a lot of fund managers are overpaid. It's an injustice. But skipping a 401(k), the employer match, and decades of tax-deferred returns because they draw a salary is madness. The employer match, in many cases, offers a risk-free and immediate 100% return on any money contributed to a 401(k). A mutual fund manager's salary likely eats up a fraction of 1% annually.
Plus, fees have come way down in recent years. Here's a report by the Investment Company Institute:
The expense ratios that 401(k) plan participants incur for investing in mutual funds have declined substantially since 2000. In 2000, 401(k) plan participants incurred an average expense ratio of 0.77 percent for investing in equity funds. By 2013, that figure had fallen to 0.58 percent, a 25 percent decline.
What does Altucher say to do with your money instead of saving in a 401(k)?
"Hold on to your money. Put your money in your bank account."
Haha, OK. I shouldn't invest in a 401(k) because mutual fund managers take a salary. I'm sure the bankers where I have my checking account work for free?
His biggest beef is that people just don't make money in 401(k)s:
"The average 401(k) -- they won't really tell you this -- probably returns, like, one-half percent per year."
There's a reason they "won't really tell you" that: It's nonsense.
According to a study of 401(k) investors by Vanguard, "Five-year [2008-2013] participant total returns averaged 12.7% per year."
The average return from 2002 to 2007 was 9.5% per year.
Even from 2004 to 2009, which is one of the worst five-year periods the market has ever produced, the average 401(k) investor in Vanguard's study earned 2.8% annually.
This is Vanguard, the low-cost provider. But even if you subtract another percentage point from these returns to account for higher-fee providers, you won't get anywhere close to half a percent per year.
There's actually a good reason to think investors will do better in a 401(k) than in other investments.
The rules designed to make it difficult for people to take money out of a 401(k) until they're retired create good behavior, where investors leave their investments alone without jumping in and out of the market at the worst possible times. Automatic payroll deductions also help keep long-term investing on track.
Take this stat from Vanguard:
Despite the ongoing market volatility of 2009, only 13% of participants made one or more portfolio trades or exchanges during the year, down from 16% in 2008. As in prior years, most participants did not trade.
The majority of 401(k) investors dollar-cost average every month and never touch their investments again. That is fantastic. If you could recreate this behavior across the entire investment world, everyone would be rich.
Altucher has another problem with tax deferment:
"You don't really make money in a 401(k). It's just tax-deferred. When you're in your 20s, what does tax-deferred really mean?"
What does it really mean? About a million freakin' dollars.
Save $10,000 a year in a 401(k) -- half from you and half from your employer -- and in 45 years (Altucher's preferred timeframe, here), the difference between taxable and tax-deferred at an 8% annual return is massive:
You can play around with the assumptions as you'd like with this calculator.
Here's his final takeaway:
"What you should do in your 20s and 30s is invest in yourself. Building out multiple sources of income, investing in getting greater skills, and so on."
Great advice! But you can do all of that and still invest in a 401(k). And virtually everyone should.
** James, are you reading this? Let's do a video together and duke this out in person! My email is firstname.lastname@example.org **
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