50% Returns, No Risk?

The catalyst for this post is an article from the WSJ yesterday about 401ks. No shock, many people are down a lot of money in their 401ks. Being down a lot can cause disillusionment, again no shock.

It has been a while since I have had a 401k (1099 means picking some sort of self-employed retirement vehicle) but from what I read, employers still match a portion of what employees contribute (save for a couple of companies that are not matching for 2008).

This might whip a few people up but I am pretty sure I have mentioned this idea before.

If you get a 50% match on your first, say, $8000 or $10,000 or whatever, then why put that $8000 or $10,000 or whatever into anything but the money market choice? You are already getting 50%, why mess with that? There is even an argument for getting a 50% match on the first $8000 but putting in more than the amount needed to max out the match and still just putting it into the money market. If you put in $12,000 into a 401k and get $4000 from your employer then you have a 33% return with no investment risk.

If you have a career of normal duration getting 50% a year on your 401K in the manner described above you’d probably be in good shape when retirement comes.

Investing in riskier assets then would come into play with excess savings (maybe not the best term) beyond where you get the maximum benefit from your employer match. If you put $8000 into the 401k (get a $4000 match) and can squeeze out another $8000 into something (max out an IRA of some sort that would be compatible, or even a taxable account if that is the only choice that can work for you) with more choice than a 401k and average 8% per year there over the long term you’d be in even better shape.

At the very least this might get you think before you go hog wild with risk in the 401k. Let me say I do not think it will take anywhere close to ten years for the US stock market to get back to the 2007 high but if that is wrong then people who are 55 today, down a lot and hoping to retire at 65 may have a big problem. If you are younger than 55 you may confront a similar problem when your time does come. If you can get a 50% return (via the match) on a big chunk of your savings for another 20 years how much risk do you need to take?

Comments

[adAstra:]

Interesting perspective. In that situation, I'd probably be willing to put it in a stable value fund. Unfortunately, my current company only matches a fraction on the first 4k invested so it's a tiny consideration in my portfolio.

On a conceptual level, it's probably a much better idea to invest in an index fund for the next few years instead of a money market due to valuations. And once we're officially in a bull market, it would be a decent time to switch back to cash.

Jan 09 04:23 PM

[BxCapricorn:]

Most companies are giving up on their 401K matching fund programs as part of their "belt tightening". That brings us to the "why bother" segment of our program. If tax rates will be higher going forward, might as well get it and spend it now, while tax rates are lower.

Jan 09 04:42 PM

[AlexS:]

It's just not a good idea to put all your eggs in the stock market basket, that's for sure. I'm also sure that there are some government/academic types just slathering over the money we common people have in 401(k)s and asking how they can get their grimy hands on it. That seems to be the real purpose behind many of those "401(k)'s have failed" articles. If the government was so worried about how the market has hurt our 401(k)s, how about a proposal to exempt a certain portion of withdrawls from the federal income tax? Haven't heard that idea mentioned a whole lot.

Jan 09 04:42 PM

[timhope:]

Correct me if I'm wrong, but you're completely missing the concept of compounding interest. If you contribute $10,000 and the company matches an additional $5,000, then yes, at the end of year one you have $15,000 and a 50% return on your money. If you do that again in year two, you'd end up with $30,000 on a $20,000 contribution - still 50% more than you put in but spread out over two years. Doing this for thirty years, you'd end up contributing $300,000 with a total match of $150,000 for a grand total of $450k. Not a very good return over a 30 year period. This simple example assumes no interest on you money market account. But even if you earned 2% a year - this would still only come to $621k in 30 years. I hope you do not actually advise this strategy to your clients.

Jan 09 04:59 PM

[Thinkr:]

The first thing I thought was "what about compounding?" I don't imagine you took time to think this through or you wouldn't have penned this article. As Time Hope noted, I hope you're not advocating this strategy to your clients. If you had my money and I saw this post, my confidence in your financial accumen would be completely obliterated.

Jan 09 07:11 PM

[The Tall Guy:]

The match only comes in the first month!
What about the next 5, 10, 20+ years? Still money market accounts? That's fairly ridiculous. Also, why treat an asset that your received a great initial return on any differently than any other assets? Shouldn't your long-term allocation be determined by things like your time horizon, risk tolerance and (most importantly) the returns you need to reach your goals - rather than the return you received in the first month?

Jan 09 07:42 PM

[bigmoney:]

the no-thinking approach might be 1/2 cash, 1/2 investments, where the latter is stocks & bonds. That fence-sits both inflation and deflation.

I work for a mega corp, and our 401k choices leave alot to be desired. They are proprietary black-boxes, with high fees. There is one S&P500 index, and a global bond index (whatever that is) with low fees, and everything else is 1%+. And if you crack open the Statement of Offerings, the funds typically have the disclaimer "may use derivatives". Even Conservative Fixed Income says something about derivatives.

Jan 09 09:04 PM

[justcurious:]

Derivatives are not necessarily a problem. Even a plain vanilla currency forward or stock future is considered a derivative. These could just be used for reasons related to liquidity, or just to hedge the FX risk.


On Jan 09 09:04 PM bigmoney wrote:

> the no-thinking approach might be 1/2 cash, 1/2 investments, where
> the latter is stocks & bonds. That fence-sits both inflation
> and deflation.
>
> I work for a mega corp, and our 401k choices leave alot to be desired.
> They are proprietary black-boxes, with high fees. There is one
> S&P500 index, and a global bond index (whatever that is) with
> low fees, and everything else is 1%+. And if you crack open the
> Statement of Offerings, the funds typically have the disclaimer "may
> use derivatives". Even Conservative Fixed Income says something
> about derivatives.

Jan 09 09:36 PM

[Research123:]

Roger, that is the most idotic article I have ever read by someone who claims to be a financial advisor. You clearly called that one in from the golf course. I hope you spend more time and thought when you work with your paying clients.

Jan 09 11:40 PM

[John Lounsbury:]

Roger - - -

You sucked me in to read the article with the title. Now that I've read it and looked through the comment stream, you've sucked me in to write a comment.

I understand where the critics are coming from and you didn't give all the detail you should have, but when I read the article (before seeing the comments), I was thinking the 401(k) plan would have a "Fixed Value" or "Stable Value" option, which are usually comprised of 30-day or less insurance contracts and other short-term debt. In 401(k) plans that my clients have, these have been yielding between 4% and 5% through most of 2008, but some are now under 4%. These accounts have recently been paying up to 2x the money market options (sometimes more).

So what I was thinking as I read your article was that some part of the additions to the employee's account would go into a "Stable Value" account and some portion into other options, like TIPS (if available) or equity (like S&P 500 index fund).

The next step went back to the no risk part of your title. That would imply investing in something with little chance pf losing principal. So you could have suggested putting all (employee and employer contributions) into the "Stable Value" fund.

What I expected you to introduce by the end was a suggestion that the Stable Value account is where you could put the employee contribution and the employer contribution could be dollar cost averaged (DCA) into the S&P 500 fund. This is almost no risk for the employee's contribution and the employer's contribution could be invested with lower risk by DCA.

You didn't carry the article to a conclusion that would have made more sense so I understand why the critics wrote you up.

Jan 10 12:48 AM

[donzelion:]

A straight to cash strategy would seriously underperform over the long run, as would a lowest risk strategy. The big risk for 401(k)s seems to be either taking on too much risk or too little risk. Seems to me the best strategy though, if one has time and control, would be to put half a 401(k) in cash and half into bonds - then move a portion of that cash into an index fund every time the market drops a certain percentage.

Much more work than the average worker is willing to put into retirement - but in the future, we'll have to work harder (and smarter).

Jan 10 12:53 AM

[Kunst:]

It really doesn't matter whether my employer put in part of what's in my 401k. A 50% employer match is nice, but it's already happened. It's there now, and I have to decide what to do with it for the future.

Jan 10 02:33 AM

[boisterousbob:]

This is a particularly stupid analysis. Might as well say "I have my salary, why invest it".

A Matching program is just more money given to you by your employer. Who cares it is a match. Call it bob if you like. Or for that matter, call it salary and pretend it came in your pay check and went into your 401(k). So what?

There is only one question here. If I keep adding to my retirement account via contribution and growth at this rate, will I be able to retire.

If not, putting it into an investment vehicle you believe will grow more quickly is an option, totally irrespective of where the money came from and regardless of whether you ever called it Bob.

Jan 10 03:54 AM

[boisterousbob:]

I am so flabbergasted by the blatant sillyness of this article that I am penning my first ever response to, well, anything.

OK you seem to have forgotten about compound interest, and be throwing aside the age old tradition of choosing investments based upon timeframe, appetite for risk and all that other old clot. Good for you!

Perhaps silly illustration will help you understand just how silly you are being.

Bob has two job offers, 30 years to save for retirement with nothing yet saved.

Job A's salary would allow him to invest $1000/month in a 401(k) but no match.

Job B's salary is lower and would only let him put $500/month in a 401(k) , BUT it does come with a $500 match.

Are you really suggesting he invest differently based upon which job he takes?

That $1000 is not, after all, $1000?

I had to check it wasn't April 1st (I really did).

Jan 10 04:23 AM

[User 273178:]

A huge point being missed here is the benefit of dollar cost averaging, one of the reasons why 401 (k) investing is a good idea. During a bear market, the same amount of money per month buys more shares, so when the market rebounds, you've bought more shares low, fewer high. If one had invested a lump sum at the top in 1929, it would have taken many years (I think 17?) to break even, even with dividends. But if one had invested the same time every month, they would have broken even in 7 years. Someone at age 55 still has a life expectancy over 80, which is still a very long time. While I understand the point, this is not the best advice IMHO, that one could get, and I would have gone with the DCA angle.

Here are some DCA numbers:

If one invests 100/mo at 10 per share, they buy 10 shares. If it drops to 5 per share, they buy 20 shares. Let's suppose it drops $1 per month to reach 5, then rises $1 per month back to $10 per share.
month 1. 10 shares
month 2. 11.111 shares
month 3. 12.125 shares
month 4. 14.286 shares
month 5 16.667 shares
month 6. 20 shares.

After 6 months, one would have 84.189 shares, with $600 invested. Average cost is $7.13. So, if it rebounded at the same rate it fell (and even stopped contributing), anything past month 8 (approx) would see that old money AVERAGE a profit. If one just stopped investing at month 6, it is easy to see that by month 12, one would have $841.89, or a gain of 241.89 (a gain of 40%) over their original investment. Now that is in a market that went nowhere according to my example, from month 1 to month 12.

Jan 10 06:32 AM

[tedster98:]

that's assuming you have an employer that has a 401k.

a waste of an article for me.

Jan 10 08:44 AM

[Ela:]

How about the old fashioned vehicles: i.e. I Bonds - buy /sell them in the bank [or internet Treasurydirect], compounded interest, rates adjusted every 6 months, current rate 5.64%. Yes, it is not perfect and sexy investment but it provides some security in addition to real estate, stocks and falling 401K.

Jan 10 09:17 AM

[Archman Inv...:]

That article in the WSJ made me sick.

Reading about these cry babies who lost money in a market was comical.

Why you ask?

I think Americans need to revisit what I consider to be the "basic" rules of investing:

1. Investing involves risk.

2. Investing should be done as a business.

3. There IS a difference between investing and speculating.

4. Investing is NOT an entitlement system.

5. Know your risk tolerance.

6. If you do not understand something, stay away from it.

7. The financial services firms, mutual funds, and the media are all in collusion to separate you from your money.

On and on. I am sure there are some very smart people who can keep adding to this list. I did not want to bore anyone with more.
I am the worlds worst trader and would never claim to be otherwise.
I consider myself an investor and am no smarter than anyone who posts on SeekingAlpha. I am a simply self employed family man, same as any other person.

Yet I have to ask myself:

Why is it that since 1996, I have only had two down years managing my portfolio (-7% in 2002, and -20% in 2008), thus putting my portfolio back at 2006 levels, while the average American's portfolio is back at 1998 levels?

I hope all of you have met with success as well, but is apparent that most Americans still have no clue as to what they are doing. They have fallen prey to that three ring circus called the financial media, and the lies they put forth each and every day.

Jan 10 10:37 AM

[constantnormal:]

So .... if your 401-K is with Bernie Madoff, and your employer matches 50%, then you have 50% risk-free? Is THAT what you're saying?

And by the way, in my experience, most matching 401-K plans (and only a portion of them match anything AT ALL) match at much lower levels than 50%. My last employer matched up to 6% on the first 10% of the employee's salary, but they only allowed that match to be paid in company stock (which no sane person would have invested in). My son's last two employers have paid no match whatsoever on their 401-Ks.

You may as well have used a hypothetical 100% match in your fairy-tale example, to draw in a few more suckers. I presume that the more hits a Seeking Alpha page gets, the better the return to the author (certainly the better the return to Seeking Alpha). So start posting those 100% RETURNS WITH ZERO RISK headlines.

Jan 10 11:18 AM

[david roper:]

and I am retired. So how does this dumb article help me get 50% risk free, huh?

Jan 10 12:35 PM

[Bruman:]

OK, I'll defend Roger here, and just add that he should have mentioned some other stuff to avoid all the flak he got here.

Roger makes a very valid point about something that a lot of people don't necessarily think about. They see their portfolios down and think "The market is tanking, finances are tight, I might be laid off; maybe I'll not contribute to my 401(k) this year."

Roger's point is that's crazy. You can put the money into a money market/cash, and the match will mean that you're up 50% on day one (or whatever the match value is). This happens whether the market goes up or down. If you think we've returned to a growth trend, then put it in the market; but if you think we're in for more rough waters, keep the 50% and put it in cash for now.

The two things Roger should have added:

1) Don't leave it in cash forever. At some point, if it's going to serve for retirement, you're going to need that money to grow (unless we have very long term deflation, which is a whole other issue), so you'll eventually want it invested somewhere else... but lock in that 50% gain right now.

2) That 50% gain isn't going to compound at 50% every year. You'll get one shot of 50% returns, and then it will return whatever your investment plan justifies... but don't use a down market as an excuse to forget about grabbing that 50% right now.

Jan 10 12:39 PM

[Did U Think...:]

I hate to burst everyone's bubble, but if something sounds too good to be true then you can believe it is exactly that. After the recent credit bubble bust one would think you would be figuring this out by now. Since it seems you have learned nothing from the stock market Ponzi scheme, here are the facts:

We have this thing called a military industrial complex which is in close cahoots with the gov't. In other words, corporations, gov'ts and military are all really 3 branches of the same top level organization which runs the country and owns the sheeple. Yes, owns. Sorry if you don't like those words but they are technically accurate. People who disagree with this probably think they own their own home but the truth is that we are all renters. If you stop paying the bank, the home is no longer yours. House already paid for? Fine, stop paying the taxes and see how long you continue to "own" your home. Forget the marketing package that our society is wrapped in for a second - try to look past it to the truth.

Now, the owners of livestock like to care for the livestock so that productivity is increased so that the owners can enjoy a better living from the fleecing of the herd, but only a stupid sheeple believes the gov't and corporations and the military are really looking out for the sheeple. They are all looking out for themselves. So when your corporation "gives" you a 50% return on your savings you are an IDIOT not to question why.

And now I will tell it. Both the gov't and the corporations kick something into this system for a reason and it is not because it will lead to a better life for you. The tax deferred status and the employer match are bait for the trap used to keep your wealth in their fiat currency system. Without this, you might do something that frees you from the system such as buying gold and silver.

Storing wealth in honest money like gold and silver frees you in 2 ways:
First, as the gov't inflates the fiat currency, the honest money is not affected. In fact, by racking up a lot of fiat currency based debt and then storing your wealth in honest money you win in 2 ways: a) your debt is inflated away over time relative to your salary which is rising due to inflation. b) your honest money appreciates relative to the fiat currency so that you will be able to pay off your debt using a lot less of your honest money based savings than you would otherwise have been able to do.
Second: Honest money is private. It exists outside of the currency tracking system of banks. Thus, it is untraceable when you sell it thus making cap gains tax payments unlikely. Go to Ebay and Craig's list and look at all the gold and silver for sale. Do you really think these people are paying caps gains taxes? Note: In reality they should not have to pay any taxes because any "gains" on the conversion of honest money into fiat currency is simply inflation, but the gov't wants a piece of that inflation.

But with all your money tied up beyond your reach in their system, they have all the power and I am talking about a lot more than the power to tax your inflation gains (which is what share price gains will be for a long time going forward). Start thinking about what hedge funds are doing to their participants: halting redemptions. The US gov't is nothing but one big leveraged hedge fund.

At some point, the USA will be declared insolvent or will be sliding down the slope of insolvency with sovereign credit downgrades (unless you think we can just rack up debt forever in which case you are a lost cause). As we head down that slope, the gov't will be desperate and desperate gov'ts have ALWAYS done desperate things throughout history.

Do you know that Argentina recently nationalized the 401k programs of its citizens? Of course, the official story is that it was all done for the safety and benefit of the sheeple, blah blah blah, but the truth is that it was the gov't mechanism for restricting redemptions. With all that sheeple wealth tied up in the system, the gov't can inflate the currency (legalized counterfeiting) without the effects being felt as quickly in consumer prices, which of course is the canary in the coal mine for hyperinflation.

In short, the 401k is a trap. If you have any sense you will store your retirement wealth in physical gold and silver in your own physical posession not trusting any Madoff wannabes in the military industrial complex to take care of it for you.

Suspend disbelief. This sort of thing has happened the world over and throughout history. No, the USA is not any different this time.

Jan 10 03:53 PM

[bobbobwhite:]

What I would like to see is an alternate, parallel stock market that would emphasize stability with no shorting and no options and a minimum holding period. Any public company and investor could participate that would abide by the set principles, but the company could not then participate in the NYSE, etc.

Time to get a new vehicle for real investors tired of the Big Rich Crooked Guys Casino called Wall Street today. It could be done.

Jan 12 02:34 PM

[dustbusterz:]

the 401 K is a sham. They charge a fee(which in many cases is way past 1%)this fee eats away at your savings just as inflation does. Now, to make matters worse. ask your employer how much the fees are. I bet 100.00 he won't be able to tell you , cause he chose this company that holds your money for 1 or 2 reasons. First, he gets discounts on banking and tax services from the company holding your money. second, he just might be getting a kick back from those fees the company is charging you for investing(recklessly investing) your money.
And ask yourself this. Why would you pay a fee to someone to invest your money, when its a proven fact, that you can do as well, if not better at investing than the best investment firm out there.Its been proven time and time again, they do not get better returns than the average investor(thats you ) .who will watch your money better than you? you think these guys are gonna care if your money goes up in value when they get their fees win or lose? 401 K's again, are a scam .better to invest it yourself,pay the taxes, and keep your gains to yourself instead of paying out these hefty fees for under performance.

Jan 13 11:52 PM