You Should NOT Bank on Your 401k For Retirement. Here’s the Superior Alternative.

In This Article

Put nine investors in a room, and you’ll generate 10 opinions on the most reliable investment strategy as it relates to creating wealth and/or retirement income. Let’s begin with the strategy providing the most heartache for Americans — the employer sponsored 401k. There are different reactions when I make that statement during speaking engagements. Some roll their eyes back, some nod their heads in agreement, but most haven’t heard that statement before. Also, most are somewhat skeptical of my belief concerning the employer sponsored 401k as such a spectacular loser.

I then ask the audience some questions.

1. How many of you know someone personally who has retired with more than $10/hr worth of 401k retirement income? That’s $20,000 based upon a 2,000 hour work year. Usually a very few scattered hands go up.
2. How many of you know of anyone who retired with a balance of $1,000,000 or more in their work related 401k? I’ve asked dozens of audiences this question, and to date, roughly 4-6 hands have gone up.
3. How’d your 401k fare in the 2000 NASDAQ and 2008 DOW “corrections”? Crickets.

How 401k Plans Have Performed

Boomers were the first generation to get a lifetime to test 401k plans, as they became available during the Carter administration. At nearly 40 years old, it’s more than fair to say we’ve had a long enough test to draw some credible conclusions as to their ultimate efficacy as vehicles designed to create retirement income. Wouldn’t you agree?

Today, as happens every day since 1/1/2010, continuing ’til 12/31/2030, 10,000 Boomers are “celebrating” their 65th birthdays. Though professional analysts’ opinions vary, the most generous analytical conclusions say the average Boomer blows out the candles on that cake with less than a $100,000 balance in their 401k at work.

Woohoo!! Let’s party!! NOT.

Real estate investors seem to be a somewhat different breed of cat in that they appear to pay more attention to what’s what with their 401k. My clients, for example, whose demographic profile is all over the map (pun intended, I think), have more in their 401ks at work by 45 than the average American does at 65. ‘Course, all that usually means is they can become susceptible to feeling OK about how things are rollin’ out. When you’re 50 with $250,000 in your account, do you really think you’ll reach a million bucks in the next 15 years or so?

Related: How Much Do I Need to Retire?

Those who say they will can make a credible case, though they require a relatively dubious assumption to be in place. They’ll point out that at an annual contribution level of $18,000 for 15 more years, they’ll build that $250,000 to a million bucks with a mere 5.84% annual yield. Add to that any employer match, and the needed yield goes down even further. So, let’s visit the implausible assumption:

They would never have a losing year.

Furthermore, if they had a low yield year, say 2%, the next years would necessarily have to make up for it with yields above 5.84%. In the last 15 years we’ve had two rather onerous downward corrections, both of which did major portfolio damage to most Americans’ 401k. It took most investors multiple years to merely get back to “go,” much less make up for lost yield. Meanwhile, those pesky birthdays kept showin’ up year in and year out.

The Takeaway

If you were 50 in 2000, you’ve seen a couple stock market crashes of significance. One of the most compelling factors leading to low average yields for Americans in their work-related 401k accounts is their own behavior. They tend to allow the alternating emotions of fear and greed rule their investment decisions. Dalbar Corp. has shown that the average annual return in the employer sponsored 401k has been well under 4%/yr the last 20 years! It coulda been higher, but when folks sell stocks/mutual funds as they’re goin’ down and buy them back again on the upswing, they tend to sabotage themselves. Know what I mean, Verne?

So, what’s a superior alternative?

First off, let’s agree on a couple of known facts we can all empirically document.

1. The 401k menu from which you choose in what you’d prefer to invest is made up of what the Wall Street firm your company hired to run it has on their shelves to sell you. If they can’t make money selling it, it won’t be on your menu. No real estate. No notes.
2. As mentioned earlier, all those Boomers are hittin’ their 65th birthday with an average of under six figures in their 401k accounts. VIRTUALLY ALL OF ‘EM HAD MATCHES. Matches are akin to the worm we put on the hook when fishing. The problem is that in this instance, we’re the trout. In other words, if it wasn’t for employer matches, the numbers would be even more embarrassingly pathetic.
3. The least one can do to help themselves outta this potential retirement nightmare is to stop contributing good money after bad. Sure, that’s merely my own professional opinion. But I ask you again: Whom do you know who retired with more than $2,000/mo. from their work related 401k?

Real Estate and Notes and . . . ?

News bulletin: Real estate goes down in value, too. However, it separates itself from the pack when it still delivers cash flow after losing 10-40% of its value. When the stocks in your 401k got kneecapped in 2000 and 2008, did the “handsome” dividends keep on truckin’? The same with notes. Values are sensitive to both supply ‘n demand and market yield. If you paid $40,000 for a note giving you $400/mo and the market yield goes up, your note will tend to lose some of its value. Yet your $400/mo keeps on keepin’ on. ‘Course, that begs the question that you bought the dang thing at a discount in the first place, right? 🙂

Real estate and note investing have been creating impressive retirement income and wealth for the “common folk” since the beginning of the 20th century. I know, I know, long before that. But I’m talkin’ about regular folk, like you ‘n me. The grand experiment with the employer sponsored 401k is an abject failure. Almost 40 years, and it’s considered a success if it ends up providing more retirement income than Social Insecurity.

Furthermore, in retirement the typical American finds themselves in a situation for which they didn’t bargain. Even if they created a somewhat relatively impressive income from their work related account, it’s 100% taxable. But wait, it gets worse. They’re also virtually naked tax-wise every April 15th. Their home is generally paid off, so no interest deduction. Their kids are gone, too. Pretty much every buck that comes in is naked to both state and federal income taxes. But wait, it again gets worse. Once they reach 70.5, the government looks at their handy dandy actuarial tables to find out your life expectancy. At that point, you’ll be introduced to the concept of RMDs — Required Minimum Distribution.

Related: Case Study: How to Create $350k+ in Annual Retirement Income Through Real Estate

All that means is that you’ll likely be forced to take out more each year than you planned or need. All of it, of course, taxable. You will then be in a race: Do you run outta money first, or die first? Welcome to your relaxing, carefree retirement, sponsored by your friendly work-related 401k. 🙂

Conclusion

Does this mean all 401k/IRA accounts are bad? Not even. Does it mean that real estate and note investing is all good? That’s a bad joke. What it means, when all the smoke clears, is that the vast majority of Americans are being hosed when it comes to their ultimate retirement lifestyle and income. We’re akin to farm trout being trained to bite at the nearest worm. In the end, that’s not funny at all. Just ask the 50-something man or woman who just realized having a couple hundred grand in their 401k isn’t gonna get ’em even close to what they’ll need in a precious few years.

Take a step or two back to reassess your strategies for creating retirement income. The key to your success will be finding the answers to the questions you haven’t known to ask.

Investors: Weigh in! Are you happy with your 401k’s performance? Do you think real estate investments win, hands down?

Let me know with a comment, and let’s discuss!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.