Friday, June 27, 2008

401K, IRA--or not?

1) 401K's are good, but not great. If the company matches your contribution, that's a good thing, but I would not contribute more than that.

2) The reason why a 401K is merely good is due to its deferred tax status. You get a small tax break during the contribution phase, but you get clobbered with income taxes during your harvest years.

3) Roth IRA's are better than a standard IRA, but a Roth comes with restrictions and most high-income individuals don't qualify. So it's better than good, but it is not best (the tax-free harvest makes it better than a regular IRA).

4) Indexed funds are better than MOST managed funds, but there are hidden costs when indices get re-balanced. It's still better than most managed funds due to lower fees and better performance. Better yet, there are vehicles linked to the indices, but not investments IN the indices. Hence, they also provide downside protection. This is huge. And oh, btw, they also allow tax-favored accumulation and access.

5) Perhaps small cap funds have outperformed large cap funds, but that depends on the time window, and small caps are historically more volatile. That is not a good fit for older investors. Most of my clients aren't 25, because most 25 year olds have no assets.

6) Risk is a relative value, and there are efficient ways for diversification and risk mitigation.

7) Dollar cost averaging only works if there is a general uptrend or steady state. If you had dollar cost averaged into the Great Depression, you would have had to wait until the mid 1950's to get back to even. If you had dollar cost averaged into the tech bust, you may never get back to even.

8) There are many geniuses who are financially misguided. The first thing I would ask a finance professor is how much is their net worth and how did they achieve it.

9) I advise people to contribute to a 401K only to the level the company matches, as they are basically paying for the taxes you will owe during the distribution phase (retirement). Deferring taxes only means postponing taxable events when your portfolio will be worth more--the government set it up so that they get to take a bigger slice of your accumulated values. In this scenario, a typical American worker gets a $60,000 tax break during their contribution phase, and gets taxed $800,000 during the distribution phase (retirement). And if their estate plan is poorly structured, their non-spousal heirs get taxed another 72% upon death. That is, of course, unless they die exactly in the year 2010. After 2010, the exemptions from estate taxes revert back to pre-2001 levels.

There are a select few who stack the odds in their favor, looking for high reward/risk opportunities.

The younger you are (or the more you earn), the bigger the potential mistake. Think about it--compounding is great if it works in your favor. When it works against you, it is crushing.


  1. Nice insights, Greg. Would love to see more about investing, other than 401K.

    Wendi Barlow

  2. Wendi, I will forward you a link to my website which will include a video you can watch at your leisure. It will be an eye-opener. Greg