What if 401K Plans Were Not the Best Place for Investing?
When it comes to saving and investing for retirement, the first step to take is enrolling in a 401K plan. The concept of the 401K plan is presented as the golden ticket to retirement. If you max this plan out year after year, you should have a great retirement.
Let me stop there for a minute. If only it were that simple... As a side note, there is way more to having a successful retirement plan than just maximizing a 401K plan for a number of years.
If you look closely at your 401K plan, you might discover the unexpected.
“Not all 401 K plans are necessarily the best place for your retirement money.”
I know that is almost considered blasphemy in some pop culture finance circles. However, hear me out!
When you contribute to a 401K plan, and the employer matches your contribution, you are getting free money. Thus, you never want to not participate and miss out on free money. I would always encourage anyone to invest up and to the point where you get 100% of the free employer money offered.
The Inability to Diversify
True diversification is a process of dividing up your money into different investments that allow you to protect against risk. It has nothing to do with the number of investments you use. It has everything to do with splitting your money up between investments that don’t go all of the same way. For instance, if you invested your money between 10 stock funds, you could argue that you were diversified because you spread your money out over ten stock funds. In reality, you probably have 0% diversification because if the stock market went down, all of your ten stock funds would probably go the same direction – down.
True diversification occurs when your money is divided among different types of investments that don’t necessarily all go the same way. Unfortunately, you will find a good percentage of 401K plans unequipped for true diversification. Should you still invest your retirement money in a 401K plan that doesn’t allow you to practice true diversification?
So, how do you know if you should invest in the 401 K plan versus some other type of plan?
Here is the litmus test –
Does the 401K plan have a match? If yes, I would invest up to the percentage of contribution that allows you to get 100% of that employer match. If not, I would consider alternatives for my retirement.
Can you practice true diversification?
If you and your financial advisor cannot develop a well-rounded plan that allows you to protect yourself from excessive risk and there is no employer match, I would strongly consider going another route.
To be a prudent steward of money, we have to question what we are doing with money and evaluate if it makes good sense. Unfortunately, the recommendation of investing in your 401K plan is not always the best avenue for building toward your retirement.
Bob Brooks is the host of the Prudent Money Radio Show, heard every weekday from 3:00 PM - 3:30 PM on FM Radio 91.3 KDKR