The 401k: My Favorite Investment Vehicle

When I first began investing, I was completely lost. There were so many names, acronyms, and terms that I had never heard before.  Like so many families in America, mine didn’t talk about things like investing and money. I had no idea how to start, and as a result I made some silly mistakes. This post will be geared toward someone like myself when I was starting my career: young and naive, but willing to learn. I want to talk about my favorite investment vehicle: The 401k.

Let me kick off this post with an embarrassing story. When I turned 18 in 2007, I was stoked to start making the big bucks in the stock market. I had seen the 1987 film “Wall Street,” and I just knew that I could make it big by trading stocks. I had saved up $1,000 by working a couple of summer jobs, and I was ready to turn it into millions. So, I opened up a Scottrade account online and dumped all of my money into one stock that I knew was going to take off. After all, it had been paying dividends for decades, so what could go wrong?

That company? American International Group Inc., or AIG for short. For those of you who don’t remember what happened to AIG shortly after this purchase, let me remind you:

That’s right, the one stock that I chose to pour all of my hard-earned money into was rocked by a scandal that precipitated the financial crisis of 2008. It was literally one of the worst investments I could have ever made, and I lost everything. Thankfully, it was just a $1,000, but it taught me a hard lesson. If I was going to invest, I needed to do it in a smarter way. If you are lucky enough to have a 401k plan at your work, then this post is for you.

The Power of Automation

One of my favorite things about the modern era is that we are able to automate so many of the tedious things in life. Almost all of our recurring monthly bills are set to auto-pay, which leaves so much more time to do the things we enjoy. The same applies to retirement savings — having it automatically invested every paycheck is one less thing you have to do on a regular basis.

But automation serves another purpose. In my case, it frees me from temptation. I never see the money show up in my bank account, which means that I will never have the chance to spend it on frivolous things.  I know that I cannot trust myself to make sound financial decisions 100% of the time, so removing temptation is a powerful tool to ensure wise investing strategy.

Pre-Tax Sheltering

One of the best ways to make your investing dollar go further is to reduce your overall tax burden by investing in tax-sheltered accounts. Basically, these accounts allow you to invest money before it is taken by Uncle Sam, which in-turn reduces the amount of taxable income you have to report. This is a wonderful incentive given to us by the Internal Revenue Service that encourages financial responsibility. Of course, there are limits. Each person can invest a maximum of $18,000 per year into each pre-tax account. Still, this comes out to a lot of savings in money that would otherwise go to taxes. Our marginal tax rate is currently 28%. For every dollar that we invest in our 401k accounts, we keep 28 cents that would otherwise go to the tax man. That adds up very quickly.

Diversification

In order to avoid the financial disaster that I discussed earlier, diversification in your investments is key. Putting all your money into one investment is dangerous, and it can lead to financial ruin.

Most 401k accounts will offer up several low-cost funds that come with a passively-managed bundle of holdings. These funds look and act just like regular stocks, but they are a mix of several companies. The concept is very similar to a mutual fund, a group of stocks that is actively-managed by a fund manager. The problem with mutual funds is that they are rotten with high fees, and the returns generally do not outperform the general market.

If one of the companies in the 401k funds fails, it is highly unlikely that the whole fund will collapse. This is a great option for the new investor. It allows you to enjoy the benefit of a well-diversified portfolio without having to do all the legwork yourself. The fact that it is passively-managed means that fees are low as well, making it a very attractive option.

100% Return on Investment

And finally, my absolute favorite thing about the 401k: the employer match! Most companies that offer a 401k to their employees will offer some kind of contribution match. In my case, my employer offers an equal match for up to 5% my of income. I will make $82,147 in salary this year. 5% of that salary would be $4,107, which my company would then deposit into my account as well. I view this as an instant 100% return on investment. If you were to make a return of 8% every year on your investments, it would take 9 years before you could double your money. With the employer match, that growth becomes so much faster.

If any of you newer investors have any questions or comments, please leave them in the section below. If you are a seasoned investor, we would love to hear your advice. As always, thanks for reading!

3 Replies to “The 401k: My Favorite Investment Vehicle”

  1. MBF,

    Great take on the 401k and learning from the “punch in the face” mistakes we all seem to make when we’re young and inexperienced. My first foray into investing was 1998. I dumped every penny I could spare ($2,500) into $RAD (Rite Aid Corp). I was convinced at the time that the baby boomers would carry pharmacies for the next 30 years and $RAD at the time was expanding stores nation wide and spreading like wild fire. I paid roughly $45 per share in late 1998 and by early 2000 it had cratered to $3 per share. I finally gave up on it a year later and my $2500 investment was cashed in for a measly $272. Losing nearly 90% of my investment taught me the same valuable lesson…You must diversify!!

    I have a 403B retirement plan (which is the same as a 401k but set up for non-profit institutions. My organization will match 2 for 1 up to 10%. So I put in 5% of my income and they match 10%!! That’s a 200% return on my investment. I also max out my total contribution at $18,000 but only the first 5% enjoys the employer match. I’ve heard many complain of fees but my 403B plan is with TIAA-CREF and they have relatively low fees and have more than enough choices to allow me to diversify sufficiently.

    I also max out a Roth IRA in no load mutual funds ($5500) and fund a brokerage account in a taxable account that is also invested in no load mutual funds. I only have 2% of investable assets in individual stocks with Robinhood. This is my “mad money”, as @JimCramer calls it. I think it’s okay to go with individual stocks but only after you are very well diversified inside mutual funds or ETF’s and the money you have in individual stocks won’t break you if lose it all. I’ll likely get to a point where 10% of my assets will be in Individual stocks but not much higher.

    @millionaireby55
    MB55

    1. Sounds like we both learned a tough lesson. I am still feeling burned on individual stocks. Maybe some day I will invest in them again if I get some “mad money” 😉

      The 200% match is absolutely insane!! That means you bank $54,000 a year in the 403b? That is freaking amazing. Even with high-ish fees, i would JUMP on something like that. Maxing it out is just a smart move. Most would be able to retire in 15-20 years with that savings rate.

  2. No….Not $54,000….
    They match 10% of my income (base salary only) up to the first 5% that I put in. My base salary is $100k. So I put in $5k and they match $10k on that first $5k in my 403B RA (403B Retirement Account). I am then allowed to put an additional $13k into a 403B SRA (Supplemental Retirement Account) for a total of $18k for my personal contribution allowable by law. So in total I have $28k annually going into my 403B plan…$18k from me and $10k from my employer. Sorry for the confusion.

    —btw, since I was deep in debt up until 5 years ago, I was only able to contribute the 5% into the RA plan but did not have the free cash flow to also fund the SRA. I always took full advantage of the 2 for 1 match because there was no way I was going to turn down a 200% guaranteed return. I was also contributing what I could into an IRA but was no where near the max contribution (again due to the debt).

    When I wiped out all debt except the mortgage in 2012 I started maxing out the IRA contribution and also aggressively funding the SRA with as much as I could. After I finally got rid of the mortgage in 2015 I began maxing out the total 403b contribution at $18k as well as the IRA at $5,500. In 2 years I will turn 50 and start taking advantage of the catch up provisions on Borge the 403b ($24,000) and the Roth IRA ($6,500). Once you clear the debt it gets really easy to max out contributions to these accounts.

    @millionaireby55
    MB55

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