Smart Couples Finish Rich, Revised and Updated

by David Bach

  NOW THAT YOUR MONEY IS IN THE PLAN, HOW DO YOU GET IT OUT?

  Another concern that keeps people from contributing to a company retirement plan is the mistaken notion that once they put their money in the plan, they will lose control over it. Nothing could be further from the truth. It’s true that you’re not supposed to take any money out of a 401(k) or similar retirement plan until you reach the age of 59½. But that doesn’t mean you can’t. It’s your money, and in most cases you can get hold of it if you really need to.

  Of course, as soon as you take money out of a 401(k) plan, it becomes subject to taxes as ordinary income. And if you’re younger than 59½, you’ll generally have to pay an additional 10 percent penalty to the government. (There are ways you can avoid this penalty. I’ll tell you about them later.) In any case, I don’t recommend that you withdraw your retirement money prematurely.

  YOU CAN BORROW FROM YOUR 401(K) PLAN…BUT I DON’T SUGGEST IT

  If you’re really strapped, one way to make use of your 401(k) money without actually making a withdrawal is to borrow against it. Most plans allow you to lend yourself a portion of what you’ve saved, up to a maximum of $50,000. While this can be a simple process (in fact, some companies now allow you to do this over the phone), it is a very serious decision. First of all, any money you borrow from the plan must be paid back with interest. Second, most companies require you to repay the loan within five years. Third, if you are ever laid off, your company could force you to move your 401(k) money out of the plan. If this happens and you can’t pay back the loan, it’s considered a withdrawal and you could be hit with taxes, penalties, and interest charges. I’ve seen this happen, and it can be very sad and stressful.

  Because of this, even though borrowing against your 401(k) can seem like a painless way of getting money out of the plan, you should regard it as a last-resort option.

  Unfortunately, a lot of people don’t. According to Kiplinger’s magazine, one out of every five Americans with a 401(k) account borrows against it. Even worse, according to the Wall Street Journal, people are doing this to fund all sorts of short-term projects, such as vacations, second homes, and even boats.

  In my view, these people are asking for trouble. Remember, you put money into a retirement account for one reason and one reason only: for your retirement. If you take 401(k) money out early (or borrow against it) to pay down your credit-card debt or buy some luxury you couldn’t otherwise afford, you’re only cheating yourself. Smart Couples who want to finish rich don’t borrow against their 401(k) plans; they let the money grow for retirement!

  And don’t worry about locking yourself into a burdensome commitment. Any decision you make now regarding the size of your 401(k) contribution can always be changed. If you suddenly find yourself in a financial squeeze, you can reduce your contribution. Indeed, most companies will allow you to change the size of your 401(k) contributions just by making a phone call.

  TWO COUPLES, SAME PLAN…A $700,000 DIFFERENCE!

  If you think I’m being a broken record here, going on about the importance of maxing out your retirement plan, consider this story of two couples who came into my office a few years ago.

  The first couple, Marilyn and Robert, had spent 30 years focusing their retirement efforts on funding Robert’s retirement account at work. When Robert’s employer, an oil company, first began offering a retirement account that would allow workers to put away as much as 12 percent of their income, Robert and Marilyn figured it made sense for Robert to participate, but they weren’t sure they could afford to put so much of Robert’s paycheck aside. In the end, Marilyn’s father put it in perspective. “Robert,” he said, “the two of you can’t afford not to do this. Just make the sacrifice now, and you’ll be very glad later on that you did.” With that sensible advice ringing in his ears, Robert elected to make the maximum contribution at the time of 12 percent.

  At the same time, Robert and Marilyn’s best friends, Larry and Connie, were wrestling with the same issues. Larry had a job very similar to Robert’s, and the two men earned roughly the same amount of money. But Larry and Connie made a different decision. After a great deal of discussion, they decided to put away just 3 percent of Larry’s income. They simply didn’t feel they could afford to put away any more than that.

  Thirty years later, when Robert and Larry were in their mid-fifties, they were both downsized. Shortly after that, they and their wives attended one of my retirement seminars. Later, they made appointments to come see me (separately) in my office.

  Robert and Marilyn were excited when they showed up for their appointment. They were ready to retire and they knew they had saved enough to be able to do it. Indeed, when I looked at their 401(k) records, I saw that they had more than $935,000 in their account.

  “I BLEW IT…”

  Not so for Larry and Connie. When they came into my office the day after Robert and Marilyn, they were plainly worried. In fact, the first thing Larry said to me was, “I blew it.” Larry and Connie had only about $250,000 in their 401(k) account—almost $700,000 less than Robert and Marilyn.

  To her credit, Connie refused to let her husband take all the blame. “It really wasn’t Larry’s fault,” she said. “I was worried about our bills and I thought we would eventually put more money away, but we just never did. Things came up—college costs, a new kitchen, a few trips—and the next thing you know, we’re sitting here facing retirement. Now we’re in trouble. We know we can’t afford to retire and we are seriously worried about whether Larry can find a new job at 56.”

  Learn from Larry and Connie’s example. Don’t make the same mistake they did. Maximize your retirement contribution now.

  NOW THAT I’M CONTRIBUTING TO THE PLAN, HOW DO I DECIDE WHERE TO INVEST IT?

  Another big question concerning 401(k) and 403(b) plans is: How do I invest the money I’m putting into my account? It’s actually quite simple. Included in the sign-up paperwork for your plan is a list of different investments for you to choose from. A typical 401(k) plan will offer at least three types of investment options: (1) a guaranteed fixed-rate investment; (2) a selection of mutual funds; and (3) stock in your own company (if it happens to be public). Generally speaking, you can put all your money into one of these choices, or divide it up as you see fit.

  The single biggest mistake people make when it comes to 401(k) plans is not spending enough time reviewing their investment options before they decide which ones to pick. Often what happens when we get the huge pile of sign-up materials is that we let it sit unread on our desk until the sign-up deadline arrives. At that point, we’ve got to make a decision. The problem is, we have no information on which to base it.

  So what do we do? We do what we used to do when we were in school and hadn’t done our homework. We ask the guy or gal at the next desk what he or she signed up for.

  This works great if they know what they’re talking about. Unfortunately, all too often they don’t have a clue.

  BEWARE OF “CUBICLE COPYING”

  When I make this point in lectures, people always laugh because so many of them know they are guilty of this sort of “cubicle copying.” (That’s what I call the practice of turning to the person in the cubicle next to yours and asking, “Which box did you check off?”) The problem with this system is that those little boxes you are checking off determine where your money will be invested—and that, in turn, may determine whether you wind up being rich or poor. What’s really scary is that even though this decision can determine your family’s entire financial future, many people spend less than 15 minutes making it.

  So here’s my suggestion. If you’re already signed up for your company’s 401(k) plan (or 403(b) plan if you’re at a nonprofit), pull out your last quarterly statement and review the investment choices you made. Then call the benefits department and ask them for a current list of investment options and a summary of how each of these investments has been performing recently. In addition, ask your benefits person if the firm tha
t administers your company’s plan has an advisor who will go over the investment options with you. Most likely, the firm that set up your company’s 401(k) plan promised to provide “free financial advice” to all plan participants. Unfortunately, most employees are not aware that this valuable advice is available at no cost, and so they never take advantage of it.

  I also strongly suggest that you review your investment options with your partner, and if you have one—which I hope you do—with a personal financial advisor as well. Most financial advisors will review your 401(k) plan options with you at no cost.

  LOOK FOR “TARGET DATED MUTUAL FUNDS”—IN YOUR 401(K) PLAN

  Since I originally wrote this book, target dated mutual funds have radically changed the investment landscape of retirement plans, specifically 401(k) investing. If you have a company plan, I will be candidly surprised if you don’t have a target dated mutual fund option. What is a target dated mutual fund? Very simply put, it’s a one-step solution to investing in your 401(k) plan with a single fund that is totally diversified and professionally managed based on your anticipated retirement date. The fund you select should be close to your anticipated retirement date. If you are shooting for a goal of retirement in 2040, then you would select the fund with a 2040 date on it. The mutual fund is professionally managed, and the asset allocation (the mixture of the investments from stocks to bonds) becomes more conservative as you approach retirement. How big has this type of investment become and how popular? As I write this, target dated mutual funds are approaching a trillion dollars in investments and now make up 20 percent of assets in 401(k) plans. Aside from how simple these investments are proving to be for investors, they can also be very low cost (or they should be). The four biggest providers of these funds are Vanguard, TIAA-CREF, Fidelity, and T. Rowe Price. If you have a plan run by any of these companies, you have some very solid target dated mutual funds to choose from. They will be professionally managed, totally diversified, and regularly rebalanced. It is truly a “set it and forget it” approach. And that’s why they are working so well for investors.

  THE BIGGEST MISTAKES YOU CAN MAKE WITH A TARGET DATED MUTUAL FUND—DON’T MAKE THESE!

  As great as these funds can be, you can also mess up investing in them. The biggest mistakes we see people making with target dated funds is that they select more than one. Don’t select two or three of these target dated funds in order to be “extra-diversified.” You’ll just have a diversified mess. I recently did a seminar where a couple named Bob and Vicky approached me. Bob and Vicky did even more: they had selected five target dated mutual Funds each. That means that, between them, they had 10 funds. Bob thought that going this route was the safest plan because all their money was not in the same basket of investments. In fact, I explained that they were in the same basket of investments, but now it was a messy basket. Then Vicky asked: “Well, what if we really don’t know when we’re going to retire?” It’s a great question. You may not know the exact date when you will retire but you can probably guess it to within five years. You can always switch the fund to a later target date if you continue to work longer. And if you want to be conservative, select one fund with a target date that is five years before you expect to retire. For instance, if you want to retire in 2040, select the 2035 target dated mutual fund, which is a more conservative approach. Lastly, find out the fund’s glide path. A glide path is industry speak for whether the fund is set up to run right to your retirement date or through your retirement date. Ideally, you want a target dated fund that runs through your predicted retirement date because hopefully you are going to live three to four decades or more after retirement! The exception to this rule is if you plan to retire in your eighties or nineties, at which point a “to fund” (i.e., one that runs just to your retirement date) could work fine. Taking action on this book’s advice should enable you to retire well before your eighties if you want to.

  IT’S TIME TO DO YOUR OWN RESEARCH

  Finally, do your own research. Today, with the Internet, gathering information about fund performance is a snap. There are literally thousands of websites that offer financial information. To make it easier for you to find a good financial website, I’ve listed some of my favorites below. At these sites, you can review everything from stocks to bonds to mutual funds and learn a lot about overall financial planning:

  www.morningstar.com Morningstar is the company that really started it all in terms of ranking mutual funds, and its website is probably the best of its kind. This company offers unbiased commentary on funds with a straightforward rating system of “Gold,” “Silver,” and “Bronze,” meaning they expect a fund to outperform its peers over the next five years. It also rates funds like movies, with a star system based on the funds’ risks and returns. The website has loads of useful information for investors on trends and stocks. Go to the Morningstar homepage and click on “Funds.” Then click on a section called “Fund Quickrank,” which allows you to quickly screen funds based on their performance, their Morningstar ratings, or their volatility. Registration is required for this section, but it’s free. To get full details you will need to pay a subscription fee. You can also screen for stocks at this site.

  Yahoo Finance (https://finance.yahoo.com/​screener/​mutualfund/​new) Yahoo offers a nice full-service financial portal with stock and mutual fund analysis, portfolio tracking, message boards, research, and more. Try the Mutual Fund Screener tool at the URL given above. Clicking on the link for Top ETFs or Top Funds will take you to a screener where you can easily do a search based on categories and Morningstar ratings.

  www.wsj.com The Wall Street Journal offers a useful screener for ETFs and funds that is free to the public but hard to find (Google “etf screener wall street journal” and you should find it). Subscribing to the Journal is a good idea for serious investors. I subscribe, and I still get the paper sent to me daily “old-school style” as well as read it online.

  www.mfea.com The Mutual Fund Education Alliance website is a great site with a lot of educational information on mutual funds. The site is designed to be a financial education center to help investors learn the basics about mutual fund investing. It includes investment tools, fund data, and links to resources and fund companies (that are members). Morningstar also provides the fund data on this site.

  www.ishares.com iShares is the largest provider of exchange-traded funds (ETFs) in the world. If your plan has ETFs, there’s a good chance they were created by iShares. They currently offer more than 800 funds and manage over a trillion dollars in ETFs. iShares is owned by Blackrock, one of the largest asset managers in the world. You can learn all about about ETFs at this website, as well as screen through them and build a sample portfolio.

  DON’T LET ANYONE TALK YOU OUT OF JOINING YOUR COMPANY’S 401(K) PLAN

  Many people make the mistake of not enrolling in their company’s 401(k) plan because someone they know told them it isn’t any good. This is by far the number-one reason people cite at my seminars and lectures when I ask them why they haven’t signed up. Some nice person will raise his or her hand and say, “I don’t use my 401(k) plan because a friend told me that the investment choices it offers are lousy and I can do better on my own.”

  That may sound reasonable, but the truth is that it’s not. The fact is, even if you’re a phenomenal investor, on your own—that is, investing outside a tax-favored plan like a 401(k)—you would be hard-pressed to outperform even a mediocre 401(k).

  Why do I say this? Because every dollar you invest in your 401(k) investments is a pretax investment. When you invest on your own, you lose that advantage. Moreover, many companies will supplement your 401(k) contributions with a contribution of their own, kicking in as much as 50 cents for every dollar you contribute. Some even match you dollar for dollar. That’s free money from the company you work for.

  Let’s do the math. Let’s say you invest $100 in your 401(k) plan. If your company is typical, it will contribute an additional $50—which mea
ns now you’ve got $150 working for you in your 401(k) account. If the plan generates an annual return of just 10 percent, at the end of a year you’ll have a balance of $165.

  To do better than that investing on your own, you’d have to generate an annual return of nearly 154 percent! Remember, you’d be working with after-tax dollars, which means that right off the bat your $100 in earnings would be reduced by income taxes to just $65 or so. If you think you know an investment that will consistently turn $65 into $165 in just one year, you don’t need this book. The reality is that the stock market has generated an average return of about 10 percent a year since 1926.

  Of course, you will have to pay ordinary income tax on your 401(k) money when you start withdrawing it after you reach the age of 59½. But having been able to grow tax-deferred, your nest egg will be so large by then that you’ll still be way ahead of the game.

  Another reality is that most 401(k) plans today provide employees with an excellent series of investment options, offering participants as many as 10 to 15 mutual funds from which to choose—generally including an index fund (whose performance will match that of the stock market as a whole). So ignore that naysayer at your office who complains about the lousy investment options in your 401(k).

  WHAT ABOUT ROTH 401(K) PLANS?

  Since I originally wrote this book, the biggest change to the 401(k) space other than target dated mutual funds is the Roth 401(k) option. The Roth 401(k) allows you to invest after-tax dollars (that means no tax deduction up front) into the plan, and then the money grows tax-free and comes out later tax-free. Because you won’t get a tax deduction up front, it basically costs you more out of pocket to fund it. I personally like the tax deduction up front, and I have used only tax-deductible retirement accounts myself. Many investors are now choosing to use both options (if their plan allows). This is how it works: some money goes into a tax-deductible 401(k) and some goes into a Roth 401(k). If you’re not sure which way to go, using both is a solid option. Typically people who do this split their contributions 50/50.