I was watching a video today. It wasn’t about what I’m going to write but it lead me to this conclusion once I saw the stats. The government changed 401K’s. It used to be you had to opt in to 401K’s now you have to opt out. It used to be when you opted in your money went into a money market, now it goes into a target dated fund AUTOMATICALLY. I found out 60% of 401K’s, now automatically funded, hold a single asset, a target dated fund. The amount held in this class is 2.4 trillion. You might say, well that’s good! People are being looked after! But who is really being looked after and at what cost? Fore every dollar put in a target dated 401K the government owns a percentage and that percentage has little to do with the fund. The government has effectively turned your retirement into their annuity which you will pay to them on their schedule for the rest of your life. The target fund is pretty much proprietary as well what you see is what you get. The fund gets to collect fees, forever, and even at 10 bp that’s a hell of a lot of fees on 2.4 trillion dollars. In addition your money is locked up in risky assets not of your choosing. You can’t buy gold or commodities or hedge in anyway. You can’t reallocated and put risk on or take risk off. Your money is entirely managed and not necessarily for your benefit.
If the market goes up your account grows. If the market goes down your account crashes PERIOD. If you need some money you sell some fund whether it be low or high. Your sale has no flexibility. You can’t sell bonds if they happen to be high and you need some money and not sell stocks if they are low. The same is true with purchase. You buy a share of fund automatically no matter if the market is at all time highs, all time lows or in the middle. Shares are purchased robotic-ally, essentially by government mandate. This set up makes you entirely vulnerable to SORR. The only thing you have to sell is a share no matter the price and the only thing you have to buy is a share no matter the price. Price is not part of the equation. The algorithm is dirt simple. A buy order is placed and a share is bought a sell order is placed and a share is sold. No other optimization allowed when a share is sold Uncle collects the taxes on the entire amount as ordinary income, not on just the profit. If you bought a share at $100 and sell it at $50, you get taxed on 50 even though you have a $50 loss. If inflation has eroded your purchasing power by 50% so your $100 is now worth $50, you get taxed on the $100, now worth $50 and the government pays off it’s debt with your devalued retirement money. I checked an old 401K today I haven’t looked at for a few years it used to be in JP Morgan, now it’s in a Vanguard target dated fund. It changed all by itself with no input from me.
The real trick is to stuff the rabbit back in the hat.
7 Replies to “Wanna See Me Pull a Rabbit…”
Having participated in 401Ks most of my career (I’m now 60) for companies that either didn’t have a classic pension or had a very poor one, it seems like a pretty good savings option, especially if you get a company match. Since so many Americans don’t save anything at all, a default opt in to the plan seems reasonable. I don’t think it is some government conspiracy, they are trying to encourage savings. It is always possible to opt out and it’s possible to invest in other funds than the target date funds assuming these are available in your plan, which is usually the case. That said, it does require the employee to educate themselves about how to invest wisely. The 401Ks also tend to have high fund fees (I’m in one with a 3% fee although it is graduated down over time) so the match is important. If you change jobs, you can typically roll them over into an IRA and invest it any way you want, which I did and highly recommend to have more control over your money. So I guess I’m saying, they are far from perfect, but a good option for anyone willing to learn something about investing, by reading blogs like yours, Big ERNs, and a few others. But, honestly, there is so much vacuous information out there nowadays, that I’m not sure the average person has a chance. A target date fund is one of the safer, but far from optimal solutions.
Spoken like a true accumulator! I don’t mean that in any pejorative way. The problem with 401K’s is the risk you don’t know you own. In a market, I may have some money and you may have some AAPL. I may decide I think AAPL is worth $300 and you decide you need to sell and are willing to sell and do sell at $100. What is AAPL worth? It is worth $100. Another example I have some AMZN which I paid $2000 for and I need to pay my taxes. AMZN is selling for $1500. How much is AMZN worth? $1500. I may decide to sell IBM which has a small profit to pay my taxes or I man decide I paid too much for AMZN sell it and cut my loss. I may know AMZN has a new cloud computing platform on the horizon and think $2000 is cheap and for sure $1500 is cheap and back up the truck and get a truck load of AMZN. You have a house. You paid $250K plus $125k interest and $45K in property taxes over 20 years for your house and you just retired and you want to move to FL. The housing market says your property is worth $380K and will probably sell easily at $360K, you have $420K total in the house. Is $360K enough? Do you think your house will ever be worth $420K? Is that $420K in todays dollars or $420K in inflation adjusted dollars which will purchase less than today’s $420K, maybe more like today’s $360K. You see finance is complicated especially when you are retired and no longer making money. You also see prices are set by markets not by what you think.
Let’s say you have a 401K and you put in 7% and your company puts in 3% but the expense is 3%. So your real savings is 7%. The money is in some crappy target fund that indexes stocks and bonds according to some formula and the funds suck an additional 50bp off the top beside the 3% so you actually save 6.5%. You never bothered to analyze this but you think you’re doing it right and “doing it better than most the other people!” Let’s say the “fund” is not efficient as in efficient frontier efficient and has too much risk for it expected return. So in essence you are paying too much for what you get but you have no control over that. Your buying algorithm is buy x dollars in shares every month, and the money trickles in every month but the markets are doing well, the returns are above the long term average, in fact they are 100% over the long term average. You do not own any stocks by the way. You do not own any bonds buy the way. What you own are fund shares and you have bought your shares on the way up so if the market drops in half, depending on what the fund owns your shares may drop by half. If you decide to sell. You sell for what a share is worth on the day you sell. You must accept the aggregate price. It’s a very simple algorithm. If everyone in your fund sells at once the aggregate price is forced lower than the market price. You can’t get out in the morning on the day the Dow crashes 1000 points. You can only get out at the end of the after it’s down another 2000 points BUT you may be down even further because the algorithm sold when the market was down 5000 points in the middle of the day. The algorithm doesn’t care it sells when told to sell regardless of price. So that’s what you own. A fund that has no regard for price and doesn’t even pretend to care about price. It is your narrative that pretends you own stocks, but you don’t own stocks. You own a fund. In regular times the fund when orders are trickling in tracks some benchmark and you feel safe.
Don’t feel safe. The probabilities of a black swan are remote only so long as what is called tail risk is small. That means if volatility is “normal” or pretty normal small changes in vol do not matter much. But vol is an exponential function so when vol is small if it varies 2% or .02 who cares. If it goes to 200% now the distribution changes and the tails of the curve get real fat and there is much more risk. If vol goes to 200% black swans change their color to white and the probability of a catastrophe goes off the charts. It’s like going from the energy contained in a summer breeze to the energy contained in a hurricane from a mathematical perspective.
A target date fund is a market derivative like an option is a market derivative and in my opinion is a completely different thing than owning a stock. In stocks you can discover the market price. In funds price is unknown. It’s what ever the algorithm says it is. Then when all is said and dome you owe taxes to boot as ordinary income. If the market is down 50% and your 401K is down 50% you still owe taxes on the required distribution, case closed.
We have lived in a land of summer breeze for a long time. We’ve lived in a land where boomers have been working and accumulating. We are changing into a land where boomers no longer work and consume less that half of their pre-retirement consumption. The economy runs on consumption. Less consumption less GDP, less GDP less return on money. We live in a world where there is more corporate debt than ever in history. The debt is BBB NOT AAA BBB is one level above junk and the junk market can’t absorb that much BBB debt if it were to default. Pensions own BBB debt out the ying yang and most pensions wont allow junk in the portfolio so if the BBB craps it gets sold for pennies on the dollar and pensions fail. Pensions fail, GDP fails. You now see what tail risk is all about. It’s multiple individual Gaussian risks combining to give you big fat tails of risk in the distribution and fat tails is a place where black swans are common. In the mean time the government collects its taxes, No conspiracy to see here, none at all.
You’re right, I’m a classic accumulator! Not a bad thing to be really. I’ve accumulated well north of 7 figures over the last 27 years while raising a family. Almost all of that was by 401K fund investments. Early days, we never took vacations and a big night out was going for pizza. In later years there’s been significant lifestyle creep. You’ve got to enjoy life now while still keeping an eye on retirement savings. I’ve never made a huge income but I’ve been very fortunate to never be laid off from a job and my income has slowly increased over those years by about 3% a year on average. A lot of people are not so lucky, and I’m thankful. I question the narrative that retired boomers spend half their pre-retirement spend. I suspect they just spend on different things. Like health care. Or if they don’t spend, it’s because they didn’t save the money in the first place. I certainly do share your concern about the horrendous debt levels, public and private. I know the difference between a fund and stock and bonds, but I still choose to invest mostly in index funds. Not the Boglehead formula, but low costs funds for sure. I respect your efficient frontier approach, but I have a different one that employs some stop loss techniques. It’s worked well so far, but we can never be sure what the future will bring. I try to educate my self as much as I can, especially now that I’m approaching retirement. I keep a close eye on my investments. Anyone who isn’t willing to do that may not have a prayer going forward. The 401K system is better than all those company pensions that evaporated, but it doesn’t well serve those unwilling or unable to educate themselves. I’m not sure what the answer is to that.
My only competition is with myself in trying to understand and optimize my future. In no respect do I claim to be right because the future is unknowable and all you can do is play the odds. There is a toy called a Galton board which will create a Gaussian distribution out of ball bearings falling don a waterfall of 50/50 decision points. I keep one on my desk a present from my good friend and consider its meaning often. In a Gaussian distribution half win and half lose, some win big some lose big. My question is what can you do as a single ball flowing down the decision waterfall to wind up on the winning side of the mean.
Congrats on a successful accumulation. The most intense part, distribution, is yet to come for you. The strategies are different. In the first half, accumulation, you live under the protection of a job and your risk is not your own. Your employer manages your risk for you. Accumulation therefore has the luxury of focusing on, well accumulation. There is no upper limit to accumulation and risk is not in the picture.
In the distribution phase, it becomes all about risk and it’s management. Accumulation is secondary or maybe doesn’t matter at all. To wind up in the upper half of the Galton Board, you need to sequence your decisions. You need to make as much as you can as quickly as you can for as long as you can. In distribution you need to spend as little as possible, as efficiently as possible, for as short a time as possible while being able to cover the inevitable disasters for both you and your spouse. The day the universe changes is the day after you retire. The rules of accumulation are worthless during distribution.
In fact my spending dropped in half on a risk adjusted basis. When I was working my actual income was significantly higher than my reported income because the cost of my risk was born by my employer. If you use that number compensation plus the cost of risk as your real income, I pay about half back into the economy that I paid when working including risk. My insurance cost is much less. I bought a new car the year before I retired and have only 30K miles on it in 3+ years. I actually travel less than I did while working. So as a retired boomer my contribution to economic activity is much reduced. Despite all the blogger honking virtue signaling their amazing consumption demonstrating their “freedom” It’s likely they have experienced no bump up in actual consumption and likely spend less overall. I know I do. 10K boomers a day retire and will do so for the next dozen years. Their gen x and millennial brothers are in hock up to their eyeballs due to the college rip off so their ability to start a life, much less plan for a future is stilted and also causes a decrease in GDP. Millennials with college debt means they start later and will not have the means to buy the McMansions of their boomer parents causing a downward spike in house prices and a hit on the boomers’ presumed wealth, further depressing their spending ability. I do not think what we have experienced as boomers will repeat anytime soon. I think the future is quite a bit more bleak. The shit has hit the fan. Prepare for a slo-mo train wreck.
Where are those boomer McMansions going to go if not inherited by their millennial children?
It’s been presumed RE will appreciate, not necessarily so. The worth of the property is determined by the market and if nobody can afford to buy at 1M inflation adjusted, you’re 1M boomer McMansion may wind up being worth 250K in real dollars as a bequeathment and then the kid is stuck with a depreciating asset.
You’re right, our children and their children are likely not going to have the kind of future we had in our day. My kids are in their 30’s and doing okay, but are so many are not, and it’s not getting any better. Well, if we’re both still here in 10 years I’ll check back and we can commiserate on how it’s played out!