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STICK TO YOUR GUNS, PEOPLE!

By JLP | January 8, 2009

From the front page in today’s Wall Street Journal comes, Big Slide in 401(k)s Spurs Calls for Change. Here’s a quotes (WARNING: some of this might make you mad):

The stock-market rout has ignited a crisis of confidence for millions of Americans who manage their own retirement savings through 401(k) plans.

After watching her account drop 44% last year, Kristine Gardner, a 35-year-old information-technology project manager in Longview, Wash., feels no sense of security. “There’s just no guarantee that when you’re ready to retire you’re going to have the money,” she says. “You either put it in a money market which pays 1%, which isn’t enough to retire, or you expose yourself to huge market risk and you can lose half your retirement in one year.”

First off: SHE’S 35-YEARS OLD! Why is a 35-year old worried about retirement? People need to understand that the market goes up and DOWN! Simple concept but it is very hard for people to comprehend.

Unfortunately, this woman’s example is leading our idiots in Washington to propose changes (emphasis mine):

Congress has begun looking at ways to overhaul the 401(k) system. At hearings in October, the House Education and Labor Committee heard from a variety of witnesses. Some proposed setting up “universal” retirement accounts, which would cover all workers. One such plan called for establishing accounts that would receive annual contributions from the federal government, and would offer a guaranteed, but relatively low, rate of return. Another proposed automatically investing contributions in an index fund that holds stocks and bonds, with the mix getting more conservative as workers approach retirement. Other witnesses proposed less drastic changes, such as providing better education.

I don’t know about you but I really do not like the first two ideas. The word “universal” scares the living daylights out of me and I can’t imagine the government doing a better job at managing people’s money.

As far as that “guarantee” goes…guarantees come with a price. Let’s look at the math.

Let’s look at two hypothetical examples. The first one is a traditional 401(k) plan in which the participant contributes $10,000 per year for 30 years and gets the LONG-TERM average rate of return of 10%. The other is a guaranteed plan, also with annual contributions of $10,000 for 30 years and with a 5% “guaranteed” rate of return.

Now, say the market crashes and the Traditional 401(k) account’s value drops 40%, while the “guaranteed” account remains unchanged (this would be highly unlikely). Even with a 40% loss, the Traditional 401(k)’s balance after the crash is still $322,000 HIGHER than the guaranteed account. And, that’s assuming that the guaranteed account didn’t drop in value.

Not only that, but people who are at retirement age STILL HAVE A LONG-TERM HORIZON! If you’re planning on being retired for 30+ years, you are a long-term investor. Therefore, you should be investing as such. So what if your account value is down. Just live on a smaller income while your account value builds back up. It most likely isn’t the end of the world.

So, I’m going to say that it’s people’s lack of self-discipline, saving money, and poor choices that are the real cause of their problems and NOT the market’s performance. For example:

Peg Kelley, a 58-year-old small-business consultant in Watertown, Mass., didn’t contribute anything to her 401(k) last year. Instead, she’s been focused on paying down credit-card debt and building up an emergency fund in case the bad economic times turn worse. She’s also still paying off an $8,000 loan she took from her 401(k) plan four years ago to buy a new car.

Afraid of reliving the dot-com market meltdown, which knocked $100,000 off her retirement savings, she moved her entire 401(k) from diversified stock and bond holdings into cash-like investments early last year.

“I’m not going to get rich on my 401(k),” she says, “but also don’t want to get poor because of it.” She had hoped to retire early, but now she figures she won’t quit work before age 65.

She borrowed $8,000 from her 401(k) to BUY A NEW CAR!!!!!!!!

I’m stunned…

Topics: 401(k), Investing, Retirement Planning | 13 Comments »


13 Responses to “STICK TO YOUR GUNS, PEOPLE!”

  1. sam Says:
    January 8th, 2009 at 12:18 pm

    I hear you JLP. But at the same time, I think these people’s reactions to the losses in their 401k accounts is one reason why abolishing Social Security, or cutting it back in favor of private accounts will never happen. Too many people are unable or unwilling to handle the risk and responsibility that is needed to invest for their own retirement. They want and need the security blanket that Social Security provides. I have argued this point in the past on this blog and have gotten slapped down in the comments, but to me this article is just another confirmation of my point.

    Personally, many of the ideas being floated in the article make me grit my teeth. But then again, the folks that frequent this blog are not the average Joe and Jane in the workforce. We may relish the opportunity to invest and grow our wealth, but for many others they worry about pushing a shopping cart down the street and collecting aluminum cans from dumpsters in their golden years.

    Anyway, thanks for the post.

  2. Jim B Says:
    January 8th, 2009 at 12:33 pm

    JLP,

    I understand the premise of your piece, but the whole system is stacked against the typical investor. The Federal government had to provide backing for money market mutual funds or the entire system would have collapsed. Even if the sample investor retires at 65, she could have a retirement period of 25 years or more, meaning she’d need a large equity exposure to battle inflation. The rules changed. Traditional investments still make sense, but only as a portion of the pie. I’m talking about other viable sources of semi-passive income like SSI, your blog, real estate, and the like. Heck, even my Dad watched congress pass a retroactive change which reduced his federal pension a few years after he retired, dropping his monthly benefit by 40%. It was eventually restored but it was tight. Investors must be cynical, defensive, and proactive.

    Best regards,
    Jim

  3. David C Says:
    January 8th, 2009 at 1:09 pm

    Long time reader and first time poster here.

    Methinks Larry Winget is onto something… (People Are Idiots and I Can Prove It!)

    For myself, I am sticking with my 401k at this time. In looking at a 20 year time horizon, a lot of things can change between now and then. I just need to be more agressive and active in the managment of all of my money. Laissez-Faire is not gonna cut it anymore.

  4. Mike P Says:
    January 8th, 2009 at 2:32 pm

    The less of my money that the government (federal or otherwise) manages, the better.

    While free market systems are far from perfect, history certainly indicates that they’re more successful than government-controlled economies. And taking away retirement accounts is a BIG step in the wrong direction.

  5. Adam Says:
    January 8th, 2009 at 2:34 pm

    I love this one!

    “Another proposed automatically investing contributions in an index fund that holds stocks and bonds, with the mix getting more conservative as workers approach retirement”.

    Now that would not have helped “poor” Kristine Gardner because she is 35 years old. She would have had the majority of her money in equities.

    I think that education is the key here. People are so brainwashed now my the media! You have no idea how many Google hits I get on my site for “heading for a depression”. That is ridiculous!

  6. David B. Says:
    January 8th, 2009 at 2:45 pm

    My preference is for the individual to retain complete control over their 401(k). This includes, but is not limited to, investment allocation, risk, contributions, and account fiduciary responsibility. To the extent people can not deal with the swings in the market may I respectfully suggest they place their money in an FDIC-insured CD or government treasuries.

    What is lacking is not oversight, but education.

    Also, JLP, I suggest you read up on the flaw of averages. Depending on assumptions of future growth and expectations of market returns, your example may breakdown, videlicet percentage return, when accounting for the up-and-downs of the market and not taking the average return.

  7. Lord Says:
    January 8th, 2009 at 4:25 pm

    What? Don’t think the government could come out ahead investing it and providing the guarantee? You have already shown how profitable it can be. Imagine the government earning money instead of spending it. Just so long as it is voluntary. One might say it would be government taking advantage of people, but they already do that with the lottery.

  8. John Says:
    January 8th, 2009 at 8:46 pm

    I agree with Sam. This is further proof that converting Social Security into “private accounts” would be a disater. The only people who would make money are the investment firms who would manage the money.

    When 401(k)’s were established by Congress, they were supposed to be a supplement to defined benefit pension plans, not a replacement. The corporations realized they could greatly reduce their retirement costs by eliminating pensions and giving workers 401(k)s. They promised them matching contributions, which many companies are now eliminating.

  9. thomas Says:
    January 8th, 2009 at 10:17 pm

    I can understand losing a job or your spouse and being forced to not contribute as much, but for those examples being so young and pulling out is down right stupid. Great example of long term investing.

  10. Ian Says:
    January 9th, 2009 at 12:47 am

    JLP –
    I agree with your view that individuals should remain in control of their own retirement futures. However, you might want to rethink your shock over this conversation in Congress. Even intelligent, hard-working members of our society are often clueless and intimidated when it comes to managing their money, and that’s a failure of our education system to bridge a sea change in how retirement preparations are made… not a failure of the individuals. Should we presume that Peg Kelly is lacking self-discipline when she’s clearly been trying to save for retirement? Or is it more likely that her understanding of her 401k came from woefully inadequate sources?

  11. Traciatim Says:
    January 9th, 2009 at 6:22 am

    Hey JLP, I used FireCalc to run a scenario. I assumed that the person was putting 10% of their salary away (10K of 100K) and would spend 60K per year in retirement (60% of pre-retirement, in today dollars). FireCalc adjusts for inflation each year. I left the default investment mix (75% equities).

    Here are the details:

    Because you indicated a future retirement date (2039), the withdrawals won’t start until that year. Your contributions will continue until then. The tested period is 30 years of preretirement plus 20 years of retirement, or 50 years.

    FIRECalc looked at the 87 possible 50 year periods in the available data, starting with a portfolio of $0 and spending your specified amounts each year thereafter.

    Here is how your portfolio would have fared in each of the 87 cycles. The lowest and highest portfolio balance throughout your retirement was $-1,654,611 to $835,909, with an average of $-286,448. (Note: values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

    For our purposes, failure means the portfolio was depleted before the end of the 50 years. FIRECalc found that 63 cycles failed, for a success rate of 27.6%.
    __________________________________________________

    That Guaranteed account is looking a little better now, don’t you think?

  12. BankerBryan Says:
    January 11th, 2009 at 12:47 am

    Maybe we should filter our news by age groups. Only people within 5 years of retirement get to hear about the performance of their 401(k) plans. This way, we don’t have government changes sparked by the temper tantrums of 35-year olds.

    I hate to sound mean, these aren’t stupid people, they are just uneducated. A 58-year old shouldn’t be allowed to make such a stupid decision as to buy a car with 401(k) money, a 35-year old shouldn’t be freaked out about her portfolio performance and our government shouldn’t have the same types of people controlling our future finances.

    Let’s get some people in there that actually know what they are talking about!

  13. CMD Says:
    January 13th, 2009 at 2:13 pm

    We all know that it is a good idea to stay put and ride this wave out. Sometimes that is easier said than done. I’m young…only 28…started my 457(b) 3 years ago. I got a pretty slow start but am now up to 15%. I’m not that worried yet but my account is down 30% in the last year…doesn’t make things easy.

    I’m ok with it because I know the basics and that I have a long time left but it’s easy to understand why others aren’t so sure.

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