In spite of what happened in 2000 and 2007, many people seem using the traditional investment vehicle, such as 401K as their primary investment vehicle (I was totally shocked to learn how many guru to be people from investment / money forum still believe 401K is path to obtain good wealth). Personally, I am not investing in dime in 401K (used to but not anymore...) simply because there is virtually no advantage for using these as good investment. Worse, these investments are worst and riskiest investments of all. In this blog, I will explain my thought of why investment like 401K is the worst investment and should never put any money into it.
Reason 1: Current economic outlook
If we take a look around the world, eurozone is verge of default and other developed countries also following the same route. There will be another Lehman moment in this year like 2008. Stock market crash that caused by euro sovereign debt crisis will wipe out many of people's life saving and investment. This is inevitable. Mass-produced financial advisor will tell average people that you need to diversified the portfolio whereby reducing the risk. This is not really diversification at all. True diversification is to diversify across all the asset classes including stock, real estate, commodities and business. What most people are doing is to buy all the fund randomly as if we are betting all the horses at horse racing without considering which one will win. Even if people well diversified their 401K portfolio, stock is still stock and these mutual funds like 401K can't prevent from these systemic stock market crash because all the stocks will fall like a rock once it happens.
Reason 2: Paying highest tax (In case of traditional 401K)
I am not talking about mutual fund here but strictly talking about traditional 401K. "Deferring the taxes so that fund will accumulate faster due to power of conpound interest!". This is mass-produced financial planners will say to the people who are lack of financial education. However, what they will not say to those people is that people investing in 401K will need to pay highest tax possible at the end. And, with this state of economy, what do you think tax will go? It will only go up in the future (Highest tax in US is 97%. Just for your information). Those people who grow money in 401K will be very disappointed how much uncle sum will take their money at the end.
Reason 3: Very illiquid
Another typical sales talk from financial planner is "Your employer will match your contribution so you should put the money more". In essense, it is true. However, once we put the money in your 401K, we can't withdraw your fund until 59 and half year old unless quitting the jobs or extremely emergency circumustances. It is big minus. According to the John Williams from Shadowstats.com, current inflation rate is 12% (Not government number, they always manipulate the number with bogus scheme). Historically, mutual fund is paying around 8%. In other words, we will be guaranteed to lose 4% every single year on average. But, can't move the money around until the certain age. We can't even use those money even if great investment opportunities come to our way.
Reason 4: Fee and expense
Fee and expense for most of the 401K and mutual fund are extremely expensive. Typical expense ratio of those funds are somewhere around 1 - 3%. So, it looks like very low cost. However, it is further from the truth. The more money and longer we hold, the more it will cost us. Expense can accumulate up to 70% of total fund value if we hold something like 40 to 45 years. Many typical financial advisors' another sales tactics is "Use your compound interest to your advantage". But what they don't tell you is that there is compound expense. The more money we hold and longer you hold, the more money will be taken out as an expense.
My biggest worry of this is not fund expense itself but opportunity cost of investing in 401K. Suppose we are not investing in 401K but instead investing in other investment opportunities that yield much higher rate of returns, how much we lose as a result of investing in 401K or other traditional investment? This can be very huge depending on the skill level of investors.
Reason 5: No control
With 401K, there is absolutely no control over the fund itself. Only thing we can do is to move from one fund to another. In deals like real estate, we can physically talk to the property manager or other vendors to improve or change the situation pretty quickly but it is impossible for us to tell fund manager what to do. Worse, what if fund manager himself does not have much knowledge about this current economy? In my opinion, most people invest in investment vehicles that absolutely no control or very little control over. Have you ever thought why banks lend money to invest in real estate and never lend money to invest in mutual fund or 401K? This is because of no control over. This is just too risky for the banks to lend the money for the project that is absolutely no control over.
Reason 6: No protection what so ever
Assets such as business and real estates can be covered by insurance that actually covers the loss when something goes wrong. However, there is no insurance of 401K. If we go to the insurance office to tell agent if there is insurance for 401K or mutual fund, they will be laugh at us and definitely say "NO". When we lose everything in 401K or mutual fund, we will lose everything we ever put up and mutual fund or 401K companies will take all the money. To me, this is very risky.
These 6 reasons confirm me that investing 401K is the riskiest thing people can do. It is absolute insanity to investing vehicle that
1. Pay highest tax - even lose only benefit of the stock investment: capital gain
2. Very illiquid - can't take out money until very late
3. Extremely high expense (accumulated expense)
4. Absolutely no control over
5. No protection
6. 100% exposure to the systemic risk
Yet, many people are believing this is the path to wealth. I feel just sad to see people lacking financial education. In this coming time, I am afraid that millions of people will lose their life saving as a result of what is about to happen. I do hope that more and more people will get financial education. so that they can invest their money much more wisely than just putting the money in riskiest asset of all. In last comment, I will conclude with Warren Buffett's quote "Wide diversification is only required when investors DO NOT UNDERSTAND what they are doing".
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Published: 07 January 2012