401k-plan

401(k) Plans: There Is No Free Lunch

First in a series of articles about retirement plan costs for investors, business owners and plan administrators

 Key Takeaways401k

  • Think of the long-term impact when it comes to making the decision to participate in your company retirement plan.
  • Respect the power of compounding.
  • Time and discipline make for successful investment outcomes.


This article series is based on my years of experience, backed up by empirical research and by thousands of client interactions. It is designed for individual investors (i.e. plan participants) as well as for owners (i.e. plan sponsors and trustees), plan administrators and human resource (HR) professionals.

At one time or another, most of us have those valuable, but often painful “learn it the hard way” experiences. My first 401(k) account was one of those experiences for me. Imagine being an eager, yet inexperienced 21 year-old who moved from Nebraska to Chicago immediately after graduation for his first “real job.”

I began my career in the trust and investment department of a typical “old-school” trust bank. Armed with double majors in economics and finance, I presumed I knew all there was to know about saving for my own retirement. Of course, at age 21, I had more pressing things on my mind than my far-off retirement.

When I started work, I was given a basic introduction to retirement benefits and more than one senior colleague informed me what a fantastic vehicle the bank’s 401(k) plan was. Like many young professionals, I thanked him indifferently for the advice, and proceeded to put just the bare minimum amount into my account.

At the time, I figured I would start saving more for retirement when I got older and was further along in my career. Like many of my peers, I thought I would have plenty of time to worry about that bridge when I came to it. Even though I was saving only minimally, the bank instructed me to contribute at least up to the “match” amount so that I was not leaving free money from my employer on the table. That sounded logical, so that’s exactly what I did. Even at my meager savings rate, I was amazed at how quickly my retirement account grew. In just over three years I had accumulated the respectable sum of about $25,000.

Early adversity, long-term impact

Then, without warning, my world was rocked. I walked into the trust department one morning and saw “that look” on my vice president’s face. As soon as all of my co-workers arrived at the office, he called us into an emergency meeting at which I first came face to face with the term “redundant.” Apparently our bank had been purchased by a larger, more aggressive bank and the services of our entire department—including mine–were no longer needed. It was all so surreal and I was not sure what any of it was going to mean for me as an unemployed 25 year-old during the horrific job market of 1994.

The job market was so bad then, that professionals who had 10 years more experience than I did, were taking positions that I would normally be considering. I had a number of difficult career decisions to make during that time and perhaps the one I regret most was deciding to liquidate my 401(k) account so I could cover my living expenses. Some might argue that I had no choice. But as the old saying goes, “if I knew then what I know now,” I would have given more thought to other potential cash flow solutions, such as reducing my expenses or taking out a loan.

Why do I regret my 401(k) decision? The first reason is that my account balance was decimated before I even saw any of the funds. When you liquidate a retirement account prematurely, your account balance is taxed as ordinary income (rather than at the lower capital gains rates), and you also incur a 10 percent penalty for taking an early withdrawal (i.e. prior to age 59 ½). So my nice, tidy sum of $25,000 had just turned into a much smaller amount. The reason that troubles me the most though, is that to this day, I can’t stop thinking about what would have happened to my account if I had left the funds alone and remained fully invested.

Respect the power of compounding

There is an oft-quoted calculation called “The Rule of 72” which is a shorthand way of determining approximately how long it will take for your money to double at a certain annual rate of return. Here’s how it works: You take your expected annual rate of return and divide it into 72. The resulting product tells you how many years it will take your money to double excluding any additions or withdrawals. For example, if you have an investment that’s expected to generate a 10 percent rate of return, then your money would double in 7.2 years (72 divided by 10). At 10 percent a year, my $25,000 would have doubled nearly three times over (to roughly $200,000) in the 20-plus years since I left the bank—and that’s without contributing an additional dime to the account.

Even at a more conservative 6 percent annual rate of return, my money would have doubled every 12 years (72 divided by 6)—in other words it would have doubled almost two times over—to about $100,000–in the two decades since leaving the bank. Again, that’s without making a single additional contribution.

What I gained from this experience was a true understanding of the power of compounding and the advantage of having time and discipline on your side when it comes to investing. If you use time and discipline to your advantage, it does not take large sums of money to substantial accumulate wealth if you are able to remain patient, keep your costs low and prevent yourself from making bad choices. These are reasons that why I preach transparency, cost control and discipline to my clients and it’s why I ask them to remind their children to do the same.

What we are going to cover in this article series

In this article series, you’ll get a comprehensive overview of 401(k)s including how they came about, how they became so popular, the biggest myths and misconceptions about 401(k)s, the different types of plans (and their costs). Then we’ll talk about the seismic shift in fiduciary responsibility and how that shift affects you directly whether you’re a plan participant, a plan sponsor or a plan administrator.

Armed with that knowledge, we’ll explain how 401k’s fit into a comprehensive wealth management plan—regardless of the market cycle–and the pros and cons of tapping your plan early, deferring it late and protecting it in the event of death, divorce or other major life events.

Finally, we’ll share valuable 401(k) resources, calculators and assessment tests with you and explain the competitive advantage that Independence Advisors brings to the table.

About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES

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