401Ks: not so hot

For years the financial services industry has instructed us to salt away 10% of our income and watch it grow. They send us brochures showing sweater-clad retirees hanging around a golf cart. Yes, friends, through the miracle of compounding, even a man of modest means can become a millionaire.

They don’t tell you that while your money may compound, the government is stealing your savings through the “miracle” of inflation. At best, you’ll stay even. The question is this: What will a million buy you in a few decades? It’s not the amount of money in your pocket that matters, it’s what that money can purchase. All other things being equal, a man with $1 in an economy where candy bars cost $.05 is wealthier than a man with $5 in an economy where a candy bar costs $.80.

A financial advisor may can show you that saving pre-tax money can save you a lot of money over the years. Consider their assumptions, however. First, most 401Ks have limited investment options. They are heavily geared toward investing in U.S. bonds, U.S. stocks, and the U.S. dollar. What if inflation effectively wipes out the value of the dollar? Most 401Ks allow no means of hedging in foreign currencies or hard assets such as commodities, real estate, etc. Second, you have to pay taxes on the money once you withdraw it, and when you don’t know what tax rates will be then. They could be much higher. Third, there are penalties that come from withdrawing early, which means that you have less control of your assets. (One hook financial companies give young people is this idea that if they just set up the automatic investing every paycheck, they don’t have to think about it. Well, you can do that with individual accounts. You can set up online bill pay to “pay yourself” by sending a check somewhere automatically each month. There’s nothing magical about a 401K or IRA. People still can and do withdraw money from them. It just costs a lot more.)

I think the biggest issue with 401Ks and IRAs is that they are a sitting duck for a financially-strapped government. Consider the ready-made government pitch if we have another major downturn: “Look at how your mutual funds have fallen! You trusted Wall Street (it’s their fault!) and look what happened! This is why we are graciously stepping in. Your monies will now be safe and secure, transferred to government securities with a guarantee to pay.” This will entice people who, for good reason, distrust the advice of their financial adviser and yet don’t know what else to do with their money. A lot of people are in this boat.

This is how the government works. What Gary North calls “kicking the can” i.e. pushing the day of reckoning downstream, is often accomplished by pulling panicked people out of a small pool and dumping them into a large pool with promises of government security. “Don’t worry, you won’t drown! We have lifeguards on duty.” Because the government is a studiously irresponsible, however, it just sets up the the risk of a wider-ranging disaster (witness the U.S. financial system).

If private retirement accounts are nationalized by forcing people into government securities, we’ll be witnessing Social Security redux. In effect, all of the money you save will be borrowed and spent by the government. They will leave you with an IOU. All entitlements hinge on a promise to pay. In true Ponzi fashion, the government is promising you that it will find future suckers to pay you when your time comes. Remember, it has already spent all of the money you’ve paid into FICA.

Financially, it isn’t going to work. The government will forfeit on its obligations mainly through inflation since it’s the sneakiest way to do it, but it will also use means testing (i.e. penalizing responsible savers), and raising the retirement age. This means that your effective return is going to be a lot less.

What can one say in favor of 401Ks and IRAs? Well, the government could legislate in favor of retirement plans and at the expense of individual accounts. Also, in certain legal actions, your retirement money may be exempt. In other words, it may be a form of risk mitigation to have some money in retirement vehicles. However, you have to balance that against the risk of confiscation.

When I was younger, I was suckered in by the employer matching on a 401K, but many employers are no longer matching. If I was starting out today, I wouldn’t bother with a 401K. I’d save my money on my own. You don’t need a quasi-government program like a 401K or IRA. Save it in individual stock accounts, real estate, commodities, or use it to build your ability to produce income (Gary North is big on pushing people to focus on producing income as much or more than than protecting their assets; I’m coming around to his view.) Save your money in things a desperate government will find harder to get its hands on. I’m not going to give investment advice here, except to say that Peter Schiff’s Little Book of Bull Moves in Bear Markets is a better place to start than Kiplinger or Money magazine.

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