Reasons to Put Less in Your 401(k)

Jul 30, 2011 by

Many people will provide you reasons for saving more money in a 401(k) – a special retirement account that lets you put away money before paying taxes. While I always think saving money is a good thing, there are some reasons why you may wish to do less saving through your 401(k). These should be considered in conjunction with the standard arguments for saving more in a 401(k).

One major problem with 401(k) plans is that they typically restrict you to a limited menu of investments, most of which are mutual funds or index funds (ETFs). The only equity is often the employer itself. I do not advocate for people to invest in their own employers, as then their retirement savings will be highly-correlated to their employment. While there is a penalty for early 401(k) withdrawals, 401(k)s can act as an emergency source of capital in the event of job loss. When job loss is caused by corporate bankruptcy, any investment in the corporation will become worthless. Thus, investing in one’s own company reduces one’s financial security.

Furthermore, I am not an advocate of only investing in mutual funds and index funds. Mutual funds are typically loaded with management fees, hampering their returns. While index funds have lower fees, if they are broad, they are often highly correlated with one another. As a result, I feel that it is most prudent for people to invest in a mixture of equities and index funds. By targeting a few specific industries with positive trends and neglecting industries with awful trends (i.e. the publishing industry), it may be possible to get better returns than simply owning everything at once.

My final reason for tempering 401(k) investment is that having money locked up in a 401(k) precludes it from going elsewhere. There is a 10% penalty for withdrawing money from a 401(k) before the age of 59, unless one of several exceptions applies. The return on paying off debt, having a lower mortgage, investing in a business or real estate, or spending money on additional training may far exceed the returns of the menu of investments in the 401(k). Thus, there may be benefits to saving money outside of the 401(k) to use in a more flexible manner. While 401(k)s provide a tax-advantaged way of saving for retirement, they may not be the best home for all your long-term savings.

Related Posts

Share This

Leave a Reply

Your email address will not be published. Required fields are marked *