The 401(k) Had Nothing To Do With Retirement
Were you fooled into believing the 401(k) was created so we could retire comfortably? Me too. We are wrong.
The 401(k) was created in 1974 for the benefit of high-earning corporate executives. They were making so much money but hated paying higher taxes. They used their connections at the IRS to pass a provision that would allow employees to defer paying taxes on cash bonuses. In other words, the 401(k) originally had nothing to do with retirement.
This is a far cry from where we are today. According to a Transamerica Center for Retirement Studies survey, 69% of respondents cited 401(k)s and 403(b)s as their primary source of retirement income. As of December 2017, there was a total of $5.3 trillion in 401(k) accounts alone.
Americans are Forced to Become Investors
How did this happen? Before retirement accounts, Americans used common sense and lived off cash savings, pensions and physical assets that they understood. A 401(k) is made up of stocks and bonds. Does the average American know anything about stocks and bonds?
The answer is… no.
And that is by design. The more that we understand our 401(k)s, the more questions we will have for our providers. Why am I paying so much in fees? Why am I not invested in international stocks? Why do I have so much in bonds?
The bottom line is we didn’t volunteer to become professional investors. We are doctors, teachers, farmers, designers, writers and parents. We are NOT investors. That said, our retirement system is such that we HAVE to be investors, whether we like it or not.
A company called Blooom created a robot to help you. The robot analyzes 401(k) accounts for free and breaks down what you are invested in, what fees you are paying and your risk levels.
Remember, if a person contributes for 30 years to a lousy 401(k) and then they are broke by the time they retire, it is no one’s fault but their own. So why would you not want a 100% free analysis?
Three People Show Us How it Works
Investor Junkie reviewed Blooom last year. The problem is the writer didn’t let the robot analyze his 401(k). I wanted to see it in action so solicited three friends to complete the analysis and share with me their results.
Saved in 401(k): $7,700
Katherine was the first friend to complete the analysis. Her account is also in the best shape out of the three. This is what Blooom had to say:
Katherine’s only paying 0.15% year. This is amazing.
Her 401(k) is 88% in stocks. According to Blooom, that is a bit too conservative for her age. 96% in stocks would be optimal.
Her account diversification is right on track. Everything from U.S. to foreign to small caps to large caps. She’s doing great.
Katherine said the analysis took her about 15 minutes. She appreciated the explanation of each point and is pleased to know her retirement account is on track. The only thing I would tell Katherine is that girlfriend needs to save more!
Location: Kansas City
Saved in 401(k): $330,000
Dave works in finance so I was nervous to ask him for this favor. Luckily he agreed and even admitted it was insightful. This is what Blooom had to say about Dave’s 401(k):
He’s paying too much in fees. Dave is paying .49% in fees when the optimal range is closer to .20%. Within the analysis, Blooom estimates that making just a few tweaks could save Dave $86,000+ in fees over his lifetime.
Blooom found that Dave only has 32% of his 401(k) invested in stocks.That’s a red flag! Given Dave is only 34 years old, less than half his 401(k) invested in stocks is way too conservative.
In the following section of the analysis, Blooom broke out the portfolio in more detail. It showed that 16% of his stocks were in US Large Cap, 6% in US Small Cap, and 10% in International. As far as the other 68%, or ~$225,000 of his 401(k)? It’s in a money market account. This is essentially a savings account. We don’t know how long it’s been sitting in a money market account but given the performance of the stock market in the last few years, it’s possible Dave has missed out on thousands and thousands of dollars. This is a screenshot from the Diversification section of analysis:
After Dave completed the analysis and sent me the screenshots, I called him right away. Was he freaking out with what the Blooom analysis revealed? Surprisingly, he wasn’t. He was impressed with how quick Blooom could uncover his holdings and make recommendations. That said, he is going to remain calm and make a few phone calls to his HR and see what he can do about it.
Saved in 401(k): $20,000
Props to Sean, right? He’s 25 and has $20k saved in his current employer’s 401(k). And get this: He has a rollover IRA from a previous employer with $15k in it. He’s killing it! That said, Blooom had a few things to say about the status of his 401(k):
Whoa. I didn’t even know fees could be this low. Sean’s 401(k) charges him only 0.04% annually. That is basically nothing.
The rule of thumb is the younger you are, the more your portfolio should have in stocks. Sean’s 401(k) has 95% in stocks, which is right on target for his age.
Red flag alert! You know how 95% of Sean’s 401(k) is in stocks? Well, 95% of those stocks are in U.S. Large Caps. Why is there no diversification?! He should have exposure to international stocks, real estate, small caps, commodities, and so much more! Below is a screenshot from this section of his analysis:
I called Sean after the analysis to see how it was. He said it was easy and interesting but that being all-in on US Large Caps was not a problem. To be clear, Sean has no background in finance so I found his reaction amusing. He was 8 in 2001 and 15 in 2008. To be 25, right?
Should You Analyze Your 401(k)?
I can’t think of any reason why not. It’s 100% free, insightful and takes less than 10 minutes of your time. What you do with the information is entirely up to you. Blooom of course has a paid service that charges $10 a month to manage your account for you. That said, you could also just take the information from the analysis and talk to your HR department or even your custodian to make the necessary changes.
The bottom line is if we are relying on our 401(k)s in retirement – shouldn’t we at least try to understand what it is?