I'm 24 and I've been working for 2 years. Despite the fact that my
coworkers insist that I'm losing money by not taking advantage of 401k,
I feel like it isn't worth it. Let me explain why I feel this way, and
then proceed to tell me why I'm wrong :)
Let's start with some assumptions. Assume I work for 30 years, put an
average of 4k into 401k each year, and my employers match 50%. Before
returns/interest that is a total of 180k. Let's assume that after
everything, including taxes, that I get about 200k out of it. So, I
would have an extra $80k at the cost of tying up $120k for about 30
In 30 years I doubt $80k is going to get me very far at all. What
It seems to me that I could generate a whole lot more money by using
the original $120k to invest elsewhere over the course of the 30 years.
I'm thinking particularly about investmests in which I would be able
to apply leverage. For example, after saving $20k I could get a loan
and purchase a condo for $220k and rent it out. Not only is the
original money available to me before I become an old man, but the
investment is nicely protected against inflation.
Forgive my simplistic view of all this and help me out :)
First, if you want to get into real estate, that's another story and
another job. This has been discussed here, and it seems those most
successful do put time into it, and carry multiple units.
If you put 4K in and are matched by 50%, that's 6k/yr.
I'll assume 4K is 10% of your income. I also assume 3% raises, and an 8%
return per year. In 30 years your salary will be $97K, and the savings,
The point is this - you will have 10X your income in savings by 54,
enough to replace your income by the time you retire. Amazing what a
below historical average return (8% is below most stock average numbers
that you will see quoted for the last 60+ years) will do over a few decades.
The match is free money. Get it while you can, and if you change jobs,
keep that money growing. I am 44, and I can tell you time has a way of
passing. It will pass just as fast whether you save or not.
Everyone is wrong from time to time. It is a much worse thing
to not correct a mistake when you learn that you are wrong. In
this case, it is great that you are thinking and asking questions.
A lot of folks don't think about this stuff until it is far too
late to do anything about it.
OK, you didn't take finance in school. You need to learn a little
more about the time value of money. Or get you a blank Excel
spreadsheet on your PC and figure it out. Set up 30 rows, with
a column for your start account balance, your annual contribution,
your return on investment, and your end balance. Feed the end
balance from one year into the start balance of the next year.
You will be amazed at the bottom line numbers that you get even
assuming a modest 8% return. Hit a few years like this year, and
you are off to the races.
Next, consider where that money comes from. The money in a 401K
is pre-tax. If you didn't put it in the 401K, you would have to
pay 1/4 to 1/3 of it as taxes. So, might as well save the money
and get the free money from Uncle Sam.
Good point. Then again, how far are you going to get with $0 saved
up? In that case, you will be fighting with the stray cats and dogs
over the leftovers in the nearby dumpsters. Not a good plan.
You earlier said that you were concerned about having money tied
up for so long. In this case, you are considering a $220K
investment. How much do you plan to rent this place for? Can
you get $2800 a month in your area? If not, the monthly rent
doesn't begin to cover operating costs (payment, condo fee,
utilities, insurance), maintenance (fixing faucets, appliances,
etc), or routine replacements (carpet, water heater, roof, etc),
let along leave you with any kind of rate of return. And we
haven't even factored in risk.
John A. Weeks III 952-432-2708 email@example.com
OK, you didn't take landlording in school. Your figure of $2800 is way
off. Interest on $220K at 6% is $1100/month. Typical condo HOA fee at
this level would be maybe $400/month. Utilities are either included in
the condo fee (sewer, garbage, hot/cold water) or paid by the tenant
(gas/electric, cable, phone/internet). Ditto for insurance, except
maybe landlord liability insurance which you may or may not need.
Appliances are depreciated over five years even though they typically
last longer, faucets last much longer than that, a good carpet will last
eight years and any excess wear caused by the tenant comes out of the
security deposit. The roof is included in the condo fee. You didn't
include property tax, but let's say that is $300/month, YMMV quite a bit
depending on what state the property is located in.
So, your net cash flow is zero at a rental of about $1800/month. Taking
tax effects into account (depreciation) you have a net loss which can be
used to offset ordinary income for tax purposes. (Gee, kind of like
deferring taxes on 401k contributions, no?) The long-term capital gains
when you eventually sell are tax-deferred earnings which are, for now,
taxed at a favorable rate.
Risk is a factor, of course. It doesn't take too many months of a vacant
unit to wipe out some significant profit. Nevertheless, comparing a
long-term real-estate investement to a job-related 401k investment is
not the no-brainer you seem to think it is.
OK, first of all, if your employer gives you a 50% match, that's an
immediate 50% return on your investment. You're not going to get that
Second of all, I don't know where you got your $80K earnings from. The
annuity formula says you would get a LOT more:
F = D(exp(rt) - 1) / r
where F is the future value, D is the annual deposit, r is the annual
rate of return and t is the number of years.
So let's plug in your numbers and see what we get. You didn't specify
a rate of return. I'll use 7.9%, which is my estimate of the
after-inflation return from Vanguard's S&P 500 index fund.
F = $6,000 * (exp(7.9% * 30) - 1) / 7.9%
Note that the future value is in current dollars. That's because I
used an after-inflation rate of return and kept the annual deposit
constant (in today's dollars).
Finally, you are correct that you can potentially make a lot of money
by leveraging yourself. But don't forget that you have to pay interest
on your leverage. I'm not saying it's necessarily bad, but it does
expose you to extra risk.
Without going into details as others have already done so, you are
giving up a 50% gain in your funds immediately without risks. That's
not a smart thing in any language. You must consider your investment
with risk factored in. You can't earn 50% without risks anywhere
anytime. So giving that up is pretty, well, dumb.
Second, when you put money in your 401K, you'd be investing it. Even
if they are just earning interests (currently about 5%) they are making
you money. You can potentially gain a lot more (again factoring in
risk) in the stock market. You can even invest in the real estate
market with mutual funds, which is something you cannot do, even with
leverage, with your $4,000 a year. You'll have to save up a lot more
before starting our in real estate.
Remember, if you leverage your investments, you are assuming even more
Bottom line, you are wrong.
In this assumption, you are thinking 180k grows to 200k over 30 years.
This is a really low expected rate of return. 20/200/30=.33% annual
rate of return. 8% is a more likely target for expected rate of
$125,000 saved by age 32 can become $2,000,000 by age 68 with an 8%
return and saving NOTHING after age 32.
You need to understand compound interest. If you have $100 and it
earns 10% in a year, at end of year 1 it is worth $110. Year 2 earns
$11 for a total of $121 (you earned an extra dollar because of interest
on the interest). Year 3 is $12/$133, year 4 is $13/$146. Year 5 is
$14/$160. Year 6 is $16/$176. Year 7 is $18/$194.
In 7 years this doubled the original $100, simply by earning interest
(no additional deposits). The longer you let the money grow, the
larger this compounding effect helps you.
======================================= MODERATOR'S COMMENT:
Thank you for trimming the previous post.
Beware of schemes where you take money out of a safe investment and put it
into something else that supposedly would have a better return over 30
years. Invest in your company pension to the max and then think about
getting a better return in other things later. And don't underestimate the
forced discipline of having the money automatically invested before you see
the monthly check. If you have it in hand it is hard to resist temptation
and spend it.
If you are really serious about your financial future, consider putting
money into something else regularly over and above your company pension
contributions. Besides, it is not all about finance: If your co-workers and
supervisors find out you have declined the company plan, they might begin to
doubt your judgment, and promotions might be slow in coming.
Lots of folks have given lots of good answers, but I don't think anyone
has pointed out that the money you put into a 401K is _before_ tax
money, and the money inside the 401K grows _tax free_ (until you take it
out sometime in the far future when you will probably be in a lower tax
The fact that you receive "free" money from your employer and the money
you contribute and that the money grows tax free is what makes 401K's so
Believe me, If I didn't take advantage of my employers 401K as soon as I
could, I would not have been able to retire when I was 59.
Don't ever turn down free money.
The money in a 401k does not grow "tax free", if it grows at all.
(What's so hard about saying "tax-deferred", as you almost-but-not-quite
did in the full context of this quote?)
Then of course you should expect a higher salary. All other things
being equal, an employer who matches 401k salary deferrals will offer
lower salaries than one who doesn't.
If you have, say, employer 401k-matching of 50% at your current job, but
you can find another job that pays $12K a year higher salary without the
401k matching, you're better off with the higher-paying job.
401k matching is not "free" money, any more than the printer you get
with your computer purchase is a "free" printer. Contrary to what is
commonly believed, 401k plans are part of your overall compensation,
just like employer-subsidized health insurance, employer-provided
vehicles, employee stock options, cafeteria plans (section 125),
employee discounts, and so on. They are primarily a way for employers to
shift the risk of the old-fashioned defined-benefit pension plan away
from themselves and onto the employees.
Why don't employers give you the choice of putting the matching amount
into your 401k or paying it to you directly? Because in the latter
case, they'd have to pay payroll taxes, of course. Many people don't
understand that the employer *already* pays you "matching" on your
regular wages to the extent that you are earning Social Security credits.
The government started bundling tax benefits with employment back during
World War II, and it has just become more complicated and difficult to
deal with ever since. In my experience, anytime someone starts offering
bundled products to you, it leads to more profit for them and a worse
deal for you, since your ability to comparison-shop is greatly hindered.
After all, tax-deferred investments (capital gains) and tax-free
investments (municipal bonds) have always been around. Whether or not
you take advantage of investments with special tax treatment should not
have anything to do with your employment status, but nowadays
unfortunately it does. (Similarly, your car or house insurance has
nothing to do with your employment status, so why should your health
insurance be any different?)
Think back 30 or more years ago, before IRA's and 401k's existed in any
meaningful way. Where did working-class people invest their money?
Primarily real estate (a.k.a. home ownership) and savings and loans and
such. Back in the 60's, can you imagine advising the young couple in
their twenties, just starting a family, to put every spare cent into the
stock market? No, they were advised to pay down their mortgage (tax
deferred investment in real estate), subsidize one spouse to stay at
home and raise the kids, and avoid consumer debt (which was relatively
easy before the introduction of bank credit cards). Investing heavily
in something where you could lose your principal to the tune of 20% or
more was almost unheard of, except for the well-off who could afford to
Now, younger people don't pay down their mortgages and instead throw
mega-bucks at Wall Street for reasons they probably don't understand,
while paying strangers to raise their kids. Maybe someone is making a
lot of profit off of this change... ya think?
I have about half my net worth in employment-related retirement plans
(which includes IRA's, of course) but that's because I understand (or
like to think I do, at least) how and why I got here. I also walked
away from a defined-benefit pension (less my vested amount), a 75% 401k
employer match, and lots of cushy job security because I was able to
greatly increase my salary by doing so, and make other profitable
investments that I never could have, had I stayed.
I believe all that Ernie was trying to convey was that the OP's employer
may be offering a benefit that the OP is not taking advantage of. Most
people call this "free" money, Ernie is not unusual in this. But you're
right, strictly speaking the money is not free. So we'll pick a new
word for this, say "bozzle". Therefore the advice to the OP should be,
"Don't leave bozzle money on the table." There, that's much more clear.
I'm in, Will. When I showed a client the tax law that allowed her to
direct some IRA RMD directly to a charity, it wasn't $300 'saved', it
was really $300 I bozzled her, or I bozzled for her.
(ironically, 'bozzle' is actually a word, slang, meaning mistake or
screw up. I'm all in favor of hijacking it for the purpose you suggest.)
Will Trice wrote:
> Therefore the advice to the OP should be,
The OP wasn't asking about whether or not to take an employer match --
you and all the others are correct, in that if the employer match was
part of one's decision to take the job, then of course one should take it.
The OP was asking whether a 401k was a good "investment" compared to
rental real estate. This is a different question than whether or not
to take an employer match on a 401k.
I won't belabor the point, but I did say that the money grows _tax free_
until you take it out, which to me is just another way of saying
"tax-deferred", that seemed obvious.
Which is why I quoted "free". If my employer offers a match and my
fellow employees choose not to take advantage of it and I do, then I am
receiving something that they are not getting and it doesn't cost me a
thing call it what you want, but I call it "free money".
The most important thing is try to save and invest at least 15% or more
of your income.
You can save for a car without loan interest, a house without mortgage
being unemployed, the wife and kids, and eventually retirement.
The you look for "tax freebies". An employer 401K match of 50% is
six years of investment returen immediately. Appreciation in a house
is untaxed for the fist quarter million and so on.
There are some subtle arguments there may be better investments than
a 401k beyond matching. But the most important thing is to save at
then invest in something you feel comfortable with.
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