Monday, March 9, 2009

Should You Contribute To A 401(k) Plan BECAUSE Of Matching Employer Contributions?

The conventional “golden rule” seems to be:
You should contribute to a 401(k) (or whatever) program your employer offers, if your contributions are matched. In other words, the test to determine whether you should contribute (or not) is if your contributions are matched.

This may come as a surprise; but that notion is one of the greatest financial myths of our time. Don’t get me wrong, matching benefits may be very useful (after all who doesn’t want free money? especially from their employer). But, (and that’s a BIG but) we need to examine these opportunities carefully, as these benefits have their limits.
Matching Stock
A good number of employer matching contributions come in the form of company stocks; and you know how they are turning out these days. You go to sleep and by the next morning your company’s stock has dropped from $40 per share to 18 bucks per share. And by the time you finish your morning cup of coffee (or tea); they are worth $8 per share.

To give you an idea, I looked up the price per share of two well-known giant companies over the past 30 (three, Zero) years:
General Electric: March, 1979 -$46, March, 1989 -$45.63, March, 1999 -$100.12, March 6, 2009 -$7.06.
General Motors: March, 1979 - $56.88, March, 1989 -$41.50, March, 1999 -$87, March 6, 2009 - $1.45
Matching Cash
OK, your employer’s matching is in cash! But you MUST invest that cash inside the portfolio choices offered by your employer’s plan. What if those funds are bogus? Is it possible you may end up losing ALL those matching dollars, and then some of your own contributions?

Let’s assume in 2008, you contributed $3,000 and your employer matched your contributions with $1,500 so you had $4,500 of seed money (I’m aware this may be different for some but I hope you grasp the concept and free yourself from the myth surrounding this issue once and for all). I can safely assume that this money was invested directly in the stock market via mutual funds and/or individual stocks. I am also going to assume that you lost roughly 35 percent. So at the end of 2008 your $4,500 seed money is down to $2,925 - You lost the $1,500 from your employer plus $75 of your own money.

Wait, before you say I am being too simplistic by focusing on only one year, let me remind you that you just lost 35 percent (based on my example) of the ENTIRE amount you had accumulated up until this point. So where does that leave you? How do all those years matter to you now? – Just ask those you know who have lost some money.

And, most importantly, what is the likelihood that the market will post a gain of 53.85 percent THIS YEAR so that your account will regain its value? You see, for the $2,925 to gain $1,575 so you can recover, your portfolio must gain 53.85 percent NOT the 35 percent you lost.

Now, do you think the test to determine whether you should contribute to a 401(k) (or not) be simply if your contributions are matched? Or there are a lot more variables to be considered before making such a critical move?

I believe that if employers are for real about matching employees’ contributions, they should be willing to do that regardless of the kind of plan employees choose (qualified or non-qualified).

Let me emphasize that my goal is to shed light on this question in a general manner, by providing a perspective that seems to elude a considerable number of good-minded working folks (I don’t care much for those in the financial planning field who should know better, yet remain totally clueless about the issue).
If you are in need of a specific solution, you may request a FREE consultation with a licensed Laser Financial Group professional.

4 comments:

  1. It's obvious from what you're saying that there's so much that most of us don't understand and need to get enough information before "signing up" for what we clearly don't understand.

    I will be following this discussion to get a better understanding and the education I need to help me with my finances, especially my retirement account, going forward.

    Thank you for the information and the insight - very different from what's out there!

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  2. You have a very good point...We always do what everybody does but that does not mean it's the right thing. So we need to get as much education as we can so we don't end up working when we want to retire.

    ReplyDelete
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