You’ve set up your 401k plan with your employer and consistently put money into it each pay period, but how does the plan actually work? Can you lose money? Can you make money? Let’s find out.
If you were unfortunate enough to have a 401k plan during the housing market crash of 2008, then you probably saw a drop in your 401K balance. Many people experienced significant loses during that time, with balances dropping by 5 and 6 digit dollar amounts. But how did that happen? What did the housing market crash have to do with your 401k plan?
It turns out, that there is a direct correlation between what your 401K plan does, or will do, in relation to what actually happens in the stock market.
The money inside of your 401k plan is held and invested by the financial institution that manages the plan. When you set up your 401k plan, you select what areas you would like to have the money inside of your plan invested; typically with mutual funds, broken down into percentages of cash, stocks, bonds or mixtures of the 3.
When the market is doing well and flourishing, it’s not uncommon to see stock values raise from low single to double-digit percentage gains. Everyone is elated when this happens because his or her 401k balances mirror those same gains and increase during that time. We all know that the stock market tends to have roller coaster like highs and lows, and with one low, which your 401k plan also mirrors, your account balance can suffer an extreme loss. If you’re lucky, you’ll have 20+ years to recover from the loss and build your balance back up. If not so lucky, like many clients we saw following the 2008 financial disaster, you’ll be nearing retirement and never have a chance to recover your losses in this lifetime.
Set aside the losses your plan can endure due to the stock market, and it is important to also note your 401k balance will be affected by the money management fees and expenses charged by the financial firms who are managing your plan. There’s no way around paying the fees. If you’ve looked at your 401k statement, you’re probably not even aware that you’re paying them. If you are aware, you pay not think 1 or 2% is significant enough to make a difference. Think again!
If your 401k balance is $500,000 and you’re paying an annual fee of just 1%, that’s over $5,000 each year you’re paying in fees, whether your plan earns money or not. That can really add up!
There are benefits of course to contributing to a 401k plan, but it’s important to understand the losses. Combine the fees, uncertainty in the stock market, and the taxes you’ve yet to pay at a rate you’ve yet to know, and you may be shocked by the ending results.
Take a look here at how some Americans were affected by their 401k losses.
If you’d like help or insight on your plan or alternative savings options and vehicles, without fees or stock market losses, we’re just a consultation away.