Why a 401(k) is Not Your Best Option

When it comes to saving for retirement, there are a few common options out there. People who work traditional jobs, including both my parents, have 401(k) plans. Their employer matches their contribution or pays a percentage on the dollar. To be clear, this is only when you contribute out of your own wages. For example, if an employer pays 50 cents on the dollar and you put $3,000 in your 401(k), your total savings will be $4,500. With a 401(k), you get to contribute more money per year than if you had an IRA - $19,500 versus $6,000 if you under the age of 50, $26,000 versus $7,000 if you are over the age of 50. These limits are current to the 2020 and 2021 years.

So, a 401(k) doesn't sound too bad because an employer is sometimes matching your contribution, but there are three disadvantages that come with a 401(k). Solely saving for retirement with a 401(k) limits your ability to create long-term wealth. Here is why.

High Fees

Most 401(k)'s charge hearty administrative fees that erode your returns. You do have the choice to invest in certain funds over the others, but you can't bargain with the high administrative fees. At the end of the day, you are still generating profits, but they will likely be lower than a Roth IRA.

Limited Investment Options

401(k)'s don't give you the option to invest in most of the market. Individual stocks are off the table, and you are limited to a select number of funds to chose from, sometimes as low as a dozen. With an IRA, you can invest in index funds, individual stocks, ETFs, and many other investment options.

I see two problems with the lack of investment options a 401(k) offers.

Problem 1: You are stuck paying high fees for funds with the best performing track records

Problem 2: Fewer choices make finding investments that align with your wealth-building goals scarce and more difficult to come by

Auto-Enrollment in Target Date Funds

A target date is a date that switches up your investment strategy to follow along with your age and investment goals. The younger you are, the more risk the fund will autogenerate your money to. The older you get, the 401(k) will set a target date to switch up your investments into less risky options. Many 401(k)'s will auto-enroll you in these target dates, but they are not necessarily the best move for you. Here is why. Because these funds take out a lot of guesswork and actively manages your portfolio for you, the fees 401(k)'s charge are too high and too conservative to generate explosive gains. You always have the option to move your money into a separate fund, but most 401(k) savers don't know how to do this.

If your employer's 401(k) plan is not among the highest match rate or investment diversity plan, don't limit yourself to a 401(k). Explore other options like a regular IRA or a Roth IRA. In the previous article before this one, I give across the board reasons why a Roth IRA is the best option for saving long-term. This applies mostly to people in their 20's, but young adults in their 20's are my audience, so I write these articles with their interests in mind. Check out How to Get the Most Out of Your Roth IRA.

Good investing,

Dan Sarver

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