Troubles on the Horizon for the 401(k) Plan

There’s a new crisis looming in the way Americans plan for retirement, and it’s not a much feared stock market correction. The crisis is much more fundamental.

For years, the accepted wisdom has been this: Invest all you can in that 401(k) or you are crazy. Not contributing to a 401(k) is akin to not going to the dentist or refusing to change the oil in your car. Sure, the stock market goes up and down, but over the long haul — the very long haul – returns between 5 and 10 percent have been nearly guaranteed.

People with money think this is changing, however. The stock market has increasingly become a sucker’s game. Investing is a good idea. Investing in publicly traded companies? Not such a good idea.

And you can bet mom-and-pop investors will be the last to know about this.

The Economist summed up a series of trends this week in good overview of the problem called “Reinventing the Company.” The upshot: The stock market is only for entrepreneurs who are suckers. Clever companies are using private funding and staying private. The insanity of trying to make quarterly numbers while growing a firm’s long-term prospects has been exposed. People who invent something would rather answer to a few private investors than the wolves on Wall Street. Also, taking a company public is distracting and expensive.

“After a century of utter dominance, the public company is showing signs of wear,” the Economist says.

If you rely on stock market gains for retirement, bells should be ringing in your head right now. Instead of the first place that upstart companies go for funding, the stock market is now the last place firms go when founders want a big exit — if they go public at all. So you, solid long-term investor, no longer have access to the best and the brightest. Smart companies are growing in an investment ecosystem outside your reach. You have access to the big, old, lumbering duds.

What has changed? Plenty of things. I think the biggest factor is something we described at length in our book “The Plateau Effect” — the end of the dreaded step function.

Step functions are among the biggest obstacles to growing companies. Once your little restaurant is full of diners each night, you have little choice but to buy the place next door and double your size. But that’s a big leap fraught with risks – a step function. What if you only grow 50 percent? Then you’ve wasted 50 percent of your investment. Many small firms die after a poorly calculated step function choice.

The Internet has flattened steps. Need more server space for your e-commerce company? You don’t have to add a server farm. You can buy it one byte at a time from a cloud provider. This reality plays out over and over again. Uber can add one driver at a time. A small inventor can raise a few thousand dollars on Kickstarter. And with no step functions, there is no need to make that enormous leap into the public markets in order to raise a huge chunk of capital. Instead of every entrepreneur’s primary goal, going public now seems like the last resort.

“A growing number (of startups) choose to stay private — and are finding it ever easier to raise funds without resorting to public markets. Those technology companies that list in America now do so after 11 years compared with four in 1999,” the Economist says.

So you, dear 401(k) investor, are now betting your future on someone else’s last resort.

Does this mean you should stop putting money into your 401(k)? No, of course not. If your firm matches contributions, that’s still free money you are getting. You should maximize that benefit, always. And you probably should be putting in even more than the 6 percent your firm might require to max the match, given the tax advantages of 401(k) plans.

However, it’s high time you took a really hard look at where your money is inside that 401(k). Far too many workers simply pick two or three of the seven available options and never think about it again. Remember, even if you picked intelligently when you signed up, things change as the market ebbs and flows, and you need to review your choices at least once each year, and preferably more often.

Find out:

What companies you are invested in: Yes, yes, you are probably invested in mutual funds, but those funds are probably composed of stocks, and in all likelihood, your various funds are composed of the same giant companies. It’s easy to look up where the mutual fund manager is putting your money — the top 10 holdings in the fund (here’s one example). You might be shocked at the number of old, depressing companies that you’ve bet your future on.

How much you are paying in fees: Your 401(k) is free, you say? Far from it. The managed mutual funds you pick suck out about 1 percent of your money every year through expense ratios. So those old, slow companies are costing you even more.

What your options are: If you are young — 20 or more years from retirement — you can afford risk. So take some risk. There might be an interesting emerging market fund to try. Dip your toe in with 10 percent or so. On the other side of the risk equation, there might be a bond fund that gets your money out of the stock market. Try that. (Though it might be invested in corporate bonds issued by old, slow companies, so be sure you understand it).

If you are skittish, put a little of your money into a money market fund that won’t lose any value unless the entire economy goes under. Actively invest your money, even if you lose a little along the way. That’s the only way to really learn what’s going on.

How much of your money is invested in your employer’s stock: That’s playing roulette. Move most of it elsewhere. Never have more than 5 percent in your company’s shares. That ties too much of your financial prospects to one entity.

Most of all, make alternate plans: Now that you know smart people are turning their backs on Wall Street, don’t just sit there, do something. You know how 40-somethings think of Social Security today — either it will be gone when we retire or it will be paltry — well, 20-somethings are likely to feel something similar about 401(k) plans. Sure 401(k) balances recently reached a record, averaging just more than $100,000. Know what that amount means to you at retirement? Assuming you don’t spend it all on your first post-retirement health problem, something like $500 a month. You’ll get more from Social Security (if it still exists).

So, what other plans?

Chiefly, save money: Once you’ve maxed out the tax benefit of your 401(k), think of your emergency fund as part of your retirement money. Soar past the recommended three to six months of living expenses and see if you can’t pile up one to two years’ worth of cash in a high-yielding savings account. When interest rates finally rise — and they will — cash really will be king.

Don’t sleep on the new economy: You’ve read it here and 100 other places. Big companies won’t take care of you in your old age. You have to find something new and become a part of it. Start today dabbling in making products for Etsy or musing about Airbnb possibilities. Better yet, talk to friends about what they are doing. Find one with an interesting startup idea that’s not too risky and won’t require a lot of money. Be open to investing in yourself, or better still, inventing something yourself. Don’t risk any money you’ll need in the next few years. And do ask a lot of questions first. But now is the time to think like a 21st century investor, not a 20th century investor.

Don’t panic: All bad money decisions are the result of panic. Don’t panic. Don’t throw all your money at a smiling man in a white shirt who says he’ll take care of you. He probably can’t do any better than you. Sure, there are great financial planners. But far too many people trust someone else to manage their money simply because they don’t want to think about it. Trust me, this is no time for outsourcing. You are the only one who can really plan for your financial future.

And the good news is this: Things are changing, and that means there’s opportunity for folks who recognize it. If the downside of this change is regular investors can no longer access great startup companies through the public markets, the upside is that private startup investment is more accessible than ever.

Let me be completely clear: I’m not saying you should pull all your money out of the stock market, or you shouldn’t utilize a 401(k) or 403(b). Old, slow stock market companies may very well provide you with a tidy sum that can be a nice part of your retirement planning, like Social Security. But also like Social Security, if you think your company retirement plan will take care of your old age needs, you are delusional.

What’s your strategy for retiring comfortably? Share with us in comments below or on our Facebook page.

Editor’s note: This column represents the sole opinion of Bob Sullivan, a regular contributor to Money Talks News.