It’s Not The 401(k)’s Fault

USA Today published a controversial column titled “401Ks are a disaster” by Duncan Black on February 5th of this year. The article has a lot of assertions in a tiny word count, and would take a lot of time to unpack here, so I won’t address each and every one. However, I do want to talk about a couple of his central themes: that 401(k)s are insufficient to pay for the retirement of most upcoming retirees, and that young people can’t be expected to save in them because of their high student loan balances.  Therefore, 401(k)s are a disaster.

I say it’s not the 401(k)s fault.  I hate to see a decent long-term savings and investment vehicle get thrown under the bus, becasue the 401(k) is not the problem. After all, 401(k)s didn’t lose money in the market crash, the underlying investments did. If a 401(k) investor were blessed with prescience before the big recession, and put their money into a money market fund in their 401(k), they wouldn’t have lost money. It’s also not the fault of the 401(k) if your debts are so large that you have no money to invest in it.

On the other hand, the temptation, when reading this article is to jump to “personal responsibility.” I can see it now:  “If only those foolish retirees managed their investments properly,” says the uncharitable reader, “or were disciplined enough to save like me! Then they wouldn’t be in this mess. And those kids. They should’ve done the basic math and then they would’ve known they couldn’t afford that school.  I also bet they used their loan money for frivolities while they were there, too.”

Unfortunately, Mr. or Ms. Personal Responsibility is ignoring the underlying reasons 401(k)s aren’t working for most people, by blaming their suffering on their poor character. Instead of presuming a character failing for the majority of the U.S. population, I instead think the reason 401(k)s are not working well is that most people don’t understand how they need to work to replace a pension.  I think it’s simple ignorance.

401(k)s have become the de facto pension plan of the majority of the U.S. workforce.  Like any change, it comes with some positives and negatives.  On the plus side, the 401(k) allows investors to direct their own investments and to access their money (with penalties) when they need to.  On the negative side, investors direct their own investments and can access their money.  If you treat a 401(k) like a pension, your changes of a successful retirement will probably be a lot higher.  To treat your 401(k) like a pension, you would:

  • Calculate the amount of money you would need to put away to fund your retirement
  • Have a disciplined contribution plan that funds your “pension” such that it will be able to bay out “benefits” when you retire
  • Hire a competent investing professional to allocate your funds across a diversified asset mix that makes a reasonable return while controlling for risk
  • Never, ever take money out until you retire, no matter how badly you need it (just like a pension)*

Instead, people use their 401(k) like this:

  • Put in just enough to get the match, if you put in any money at all
  • Or maybe put in 10%, because you read that you should
  • Or maybe put in 15%, because a guy said you should on the radio
  • Invest the contributions in the default investment, because you don’t understand investments
  • Invest in what your colleague has down the office, because he watches CNBC and knows some money stuff
  • Take out money to pay off some debt, or pay for college, or make a down payment, or to live on when unemplyed, or settle a divorce, etc.

The 401(k) is treated as if it were a long-term savings account, where you put money in for 5 or ten years, and you take money out when you have a big expense come up. It’s not the 401(k)’s fault that it’s used this way.  People don’t know any better, and the default settings on most 401(k) plans aren’t what most participants need to meet their retirement goals.

Let’s not throw the 401(k) out with the bathwater, because it’s not the 401(k) that’s not working, it’s how it’s wrongly used.

* I’m not necessarily recommending this, because sometimes reality makes us invade a 401(k).  I’m just saying, if you’re going to use your 401(k) to replace your pension, you need to cherish and protect your 401(k) funds like Gollum cherishes and protects his “Precious.”  You don’t need to have conversations with your 401(k), though.

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