Wednesday, 8 July 2020

7 Fact About Your 401k Investing

I royally screwed up with my 401k. I have literally lost thousands of dollars because no one told me certain things about investing. You'd think your employer or 401k servicing company would give you a little bit of education on what to do with your 401k, instead of just saying, "Oh here you go, good luck." But I guess as long as they stay out of the education business the more article that I can write. Look, I do not want to see you make the same bone-headed mistakes as me. So in this article, I will go through some things that you should know and mistakes to avoid when investing in your 401k. Some of these might be obvious to you but I guarantee there's at least a couple that you had no clue about. To be honest with you I am a little embarrassed to share some of these stories with you but I will do it anyways. Because I always have to remind myself that you don't know what you don't know, and I should not beat myself up about it. 

  • Just a disclaimer:  This article is for educational and entertainment purposes only. Nothing I say should be taken as financial advice. 

1. Avoid Investing In Your Employee's Stock

If you have a decent amount of your 401k invested in your employer stock then you might want to rethink your investing strategy. It is good that you are rooting for the company that you work for to do well, but this can turn really bad very quickly. When I think of investing for retirement, I like to be diversified. I don't want to have too many eggs in one basket because if something happens to that one basket, then you are in for a tough road going forward. Your main source of income already comes from the company you work for so your livelihood hinges on that company doing well. That's already enough risk right there. Don't mess it up by investing in their stock as well because that's just too much money riding on that one company. This is one of the main reasons I prefer to invest in low-cost total stock market index funds. I read an article in the Wall Street Journal where a guy named Gary worked at GE for 40 years. 

He retired with a pension and company stock valued at $280,000. A couple of years later the stock price tanked and that $280,000 instantly became worth $110,000. Our buddy Gary is now forced to find work in retirement and not by choice either. This is really scary to think about. Because of stories like this I've never owned and never plan to own any shares in the company that I work for, it is just not smart. 

2. Know-How Long To Be Vested 

You need to understand what it means to be vested if you have a 401k or your employer offers any sort of match. I learned this the hard way. Let's say your employer matches your 401k contributions up to 5%. All of that contribution money gets invested just like the rest of the money you invest. But it's technically not yours until you are fully invested. To be vested means you have full rights to some sort of benefit. In this case, it's your 401k contribution money. If you leave the company before the predetermined timeframe then you lost the rights to that benefit. So if you have to be vested for three years to receive all of the employer contributions and you leave the company after, we will say two years 11 months and 22 days. Then they will take back all of the money that they have been contributing to you and the gains on that money as well. So you are essentially investing that money for the employer you just left. Yeah, you've still been investing but that sucks that they are taking that money from you.

This basically happened to me years ago because I did not realize that this was even a thing. I have to be invested for three years and I left the company after about two years and nine months. When I went to my new job I started to transfer my 401k money from the old job and the numbers did not add up. I had thousands of dollars missing. I was like what the heck is going on. That's when I found out what it meant to be vested. If I knew about this then I probably would have found a way to stick it out for another couple of months to get the fully vested amount. I felt like such an idiot after learning about this. 

3. 401k And IRA Are Different 

Is that a 401k and IRA are different but kind of the same. In the past my thought process was if I have a 401k then there is no reason to invest in an IRA as well. They are both retirement accounts but a 401k is offered through your employer and an IRA is self-directed. So you have to go invest in your IRA on your own. As of right now, the maximum amount that you can contribute to your 401k starting in 2020 is $19,500 and an IRA is $6,000. You can also have a 401k and an IRA at the same time and in my opinion, you should taking advantage of both. This is one that won't make or break you but you are still going want to know about it so you are not surprised when it comes time for you to retire and you are wondering why some of your money is in this bucket. 

4. Employer Match Is Invested In Traditional 401k

The money that you receive from your employer match is always invested in a traditional 401k. Which means that this is pretext money. This also means that when you go to withdraw any of your employer's contributions when you retire, then that money will be taxed. For example, if your invest $1,800 per year into your Roth 401k and your employer matches $1,800, then that $1,800 that you invested will grow tax-free, while the $1,800 that they match and the investment gains on that money will be taxed once it's grown and you retire and you start pulling that money out of your 401k. If you leave this job and roll it over into an IRA then you have to roll it into a traditional IRA, not a Roth IRA. So if someone invests in their Roth 401k forever and they expect not to be taxed on any of the retirement money then they are wrong. Don't feel like you were getting screwed over here though because this is the case for everyone who works for a company that matches their contributions. You are not going to be able to change it. 

5. Invest Up To The Company Match

If you are not investing up to your employer's match then you are either an idiot or you are just not aware of how important it is to do so. I am guessing you are probably the ladder though because I don't think you are an idiot. The simple explanation is because it is literally free money. Think of a company match like giving you free shares of an index fund out of every single paycheck. Even if the shares of that index fund go down you still have those shares that will have the potential to grow and pay you dividends every single quarter. You also have to look at an employer match like a part of your compensation for working there, because it is. Just like your health benefits and vacation days as well. 

  • Let's go through a quick example, say your employer matches 50% of your contributions up to 6% of your annual salary. If you make $60,000 per year then you are eligible for them to match up to $1,800 for the year. Because 6% of 60,000 is $3,600 and they are going to match 50% of that which is $1,800. This means that you invest $1,800 and they will match you with $1,800. You can consider this an instant return because you are guaranteed to double your money as long as you invest up to that amount. 

I am a dummy and did not realize this when I started my first job so I did not bother investing because Dave Ramsey told me to put all of my money towards debt. Then of course I did my own research and realized he wasn't giving the best advice here. So I started contributing up to at least the match, even though I was still focusing on paying off my bad debt. Was this a bone-headed move on my part? Did I learn to not take Dave's advice at face value anymore? I sure did, but you don't know what you don't know. Don't make the same mistake as me and please invest at least up to your employer match and make sure you are fully vested before leaving the company.

6. Recognize The High Fees

You need to be aware of the fees involved with investing in your 401k. Now there are two types of fees that you need to look for.

Expense Ratio Of The Investment Offered Within Your 401k. 

This is going to be different for each investment option that you have. One thing to note do not just base your investment decisions on the one with the highest return over the past 10 years. You need to understand that what the holdings are within that particular investment, what the goal is of that fund, and how it aligns with your goals, and you need to pay attention to the cost to own that fund. I made the mistake early on in my investing career where I would just pick the one with the highest return and I did not even bother looking at the expense ratio or what was even in that fund. 

If you have got one fund that has a 10-year return of 16.5% and an expense ratio of .80% and a low-cost index fund that has a 10-year return of 16%, but an expense ratio of .03%. Then you may want to stop to think before you automatically chose the one with the highest return.

  • because you don't know the goal of that fund with the 16.5% return. 
  • you should be trying to limit your fees as much as possible. 

Just to be clear you should not only choose investment options because it has a low expense ratio. You need to understand what the goal of that fund actually is.

How Much They Are Charging You To Manage Your 401k.

I am fortunate enough to where I get charged a flat $5 fee every single quarter no matter how large my 401k balance is. But I have heard about some people's 401ks who are getting charged a lot more than that. Or even an ongoing percentage of their 401k portfolio. These expenses are the same for everyone across the company. Now you may not think that you have the power to get your company to do something about it but you probably do. If you notice that the management fees of your 401k are really high then reach out to your HR department and make them aware of what you're actually seeing. A lot of the times the higher-ups within your company are clueless. They were probably just pitched by a sales rep from one of these investment management companies and did not pay attention to how much their employees would actually be paid. If you're able to articulate how much these fees are costing all of their employees then you may be surprised at how willing they are to change companies or try to get the fees lower for you all. 

7. Increasing Contributions Regularly 

This mistake is easy to forget about. If you are not increasing your contributions on a regular basis then the future you going to want to punch you of today directly in the throat. You have done your research, you have educated yourself, you know what to invest in. So you adjust the settings in your 401k to invest 20% of your income and forget about it. The difference between increasing it by 1% every year versus only increasing it by 1% is an extra $1,700 per month you are screwing your future self out of. Yes, we are talking about a measly 1%. This is something that I do every single year no matter what. Whenever my income increases

I automatically increase my contributions by the exact same amount. I don't ever see that raise on a day to day basis, my overall wealth gets that raise. We should all be very aware of what our actions today are going to do for us in 20 or 30 years. That future person is just as if not more important than we are right now. It is our obligation to set him or her up for the future so they don't have to work until the day that they die. 

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