A Frustrated 401k Advisor

I talked with my banker today, a young guy, who used to work for a major stockbroker.  He moved into banking after the frustration of seeing people not make the most of their 401k opportunities.

I asked him what advice he’d give to a young person just starting out.  It’s pretty good advice for any of us.

A 401k expert’s advice:  what do you do?

1. Use it.
2. Get full company match – it’s free money
3. Pay off your high interest debt
4. Build an emergency fund of 3-6 months of living expenses
5. Max your 401k
6. Then max your IRA
7. Then do other investments

My analysis:  what stops us from doing these simple things?

1. We get overwhelmed by choices.  Just pick the low cost S&P 500 index fund that’s virtually certain to be there.  If you later decide to become an expert and want to do more things, great.
2. Unless you’re too rich already–take the free money!  If you can’t afford it start out at 1% of your salary, then raise it once a year.  I willingly set myself up to have to cash in other investments so I could get the free money.  I then forgot I couldn’t afford it…  We did fine.
3. The American stock market is the 8th wonder of the world.  You can’t reliably get 18% in the market.  You can get reliably get that return or better by paying off your credit cards.
4. We all pay for our emergencies.  The question is whether you want to pay ahead of time (and make a little interest) or pay suddenly and painfully.  Have compassion on your future self.  Would you rather buy cheap tires that you’ll have to replace again soon while hoping you can figure out how to pay the rent OR would you rather pay for decent tires (grousing a bit about how the old ones should have lasted longer) and then go home and sleep soundly?
5. Grow your 401k–start as high as you can, then add 1% per year.  The 401k is superior to Social Security because:
   • The government hasn’t already spent it.
   • You own the investments.  Not the government.  Not your company.  Not the 401k administrator.
   • You can invest in a low cost mutual fund for decades.  Social Security invests nothing.  You get what you get.
   • You keep the money.  Social Security depends on whether enough taxes come in from the next generation.  Current plan is to reduce benefits to 75% once the “trust fund” IOU is exhausted.
6. IRAs aren’t as flexible as 401k’s but they’re still a great option.  You still get these opportunities:
   • your money can still grow tax free
   • investing for the long term
   • low cost index funds
   • you own the money
7. Other investments are taxable but–you control them.  You want to build up additional money for a rainy day.  Your emergency fund allows you to leave it alone.

Anyway, make my banker happy.  Fund your 401k.  Better yet, do it to make your own life better.