Your 401k and the New Year

We’re in the season now, aren’t we?  The season of telling your employer your benefit choices for next year.

In belated celebration of Ted Benna Day let’s think through the 401k.  The 401k is kind of like the Social Security system except that:

• Contributions are voluntary
• Returns tend to be much better
• The system is solvent
• The money is always yours

Unless you’re sure that the in-the-red Social Security system is going to become much more generous than it is right now, you should use your 401k  to maximize your chances for a good financial future.

The biggest problems with trying to invest in the stock market are:

1. Fear of Loss – since bonds are more predictable than stocks, surely bonds are safer?
2. Overconfidence – we believe we can pick stocks or funds well, even though the experts have a poor track record
3. Underconfidence – we correctly realize we aren’t experts, so we incorrectly avoid the stock market
4. Bad memory – we overremember our losses and our successes.
5. Impatience – we want to achieve our goals more quickly than is possible.
6. Lack of Discipline – we can’t muster the willpower to consistently invest
7. Confusion – when given too many choices, we freeze and do nothing

Interestingly, the 401k helps you overcome all of these.

1. Low Risk – While individual stocks are risky, virtually every 401k offers a low cost S&P500 index equivalent, hugely reducing risk.
2. Low Expense – Instead of  following “experts” who routinely underperform the market, invest in low cost index funds or target date funds.
3. Less Error – When you use a 401k, you’re out of the day to day decisionmaking, so you have fewer opportunities to mess things up.
4. Less Panic – Don’t check your 401k much and just let it work.
5. Long Term View – If you use a 401k as a long term effort you won’t misuse the stock market as a casino (hint:  the casino always wins).
6. Gradual improvement – At the start of each year raise your 401k contribution till you hit your max.  You don’t need discipline when you never see the money till you retire.
7. Good Options – Ignore any options other than low cost index funds and a target date fund.  If you still can’t decide, pick one of those at random.  If you can’t tell which is best–they’re all good.