The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: undig on September 17, 2014, 05:41:03 AM
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I discovered MMM a week ago and love it. I have a lot of work to do.
I have the following question: I have no employer matching for my 401k. Am I better off investing in stock funds instead of contributing to my 401k? Thanks
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I should clarify....Very poor 401k options with high expense ratios.
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It depends how much you have available to invest.
The general advice would be to max out a traditional IRA then start putting money into the 401(k). The high expense ratios and no matching sucks, but it still doesn't outweigh the tax benefit that you receive.
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Another part of it is how long do you expect to be at your current employer?
Let's say your 401k has this as it's best option: LousyMutualFund 2.0% ER
Let's say you are single in the 15% tax bracket with a $50,000 annual income.
Suppose you are able to put $5,500 per year in a Roth or Traditional IRA and also put $17,500 per year in the 401k. After 3 years you leave the company.
You have $(17,500*3 +AnyGains&Compounding -AnyLosses&Expenses) in your 401k. You also did not pay 15% federal income tax on $52,500 during that time. And you don't have to start paying that income tax on it or its earnings until you start taking it out in retirement. Since you have left the job, you can now roll your 401k over into a Traditional IRA at any financial institution you want.
15% of $52,500 is $7,875 in delayed taxes--not counting savings on state taxes.
2% for three years based on $52,500 in contributions and on an estimated 8% average annual stock market return is $1,114.26 in fees.
If I were in this case, I'd take the tax deferred option and use the 401k even though it would be costing me in fees until I got to another job. After you leave the job, you'll pick a place with funds you want for your desired asset allocation and low expenses.
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But what if you didn't want to leave the company? What if it was a really good job except for the lousy 401k options? Are you willing to do some work to find out if you can talk the company into changing its 401k policy? http://www.bogleheads.org/wiki/How_to_campaign_for_a_better_401(k)_plan
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Very useful, thanks for spelling it out ybserp.
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In general the tax savings will always be the best option. All things being equal; return on investment, options for investment...etc. saving the taxes on the amount being invested now means you'll have more money later.
Essentially paying 15% to earn the same 7% return means you have automatically lost 8% doing after tax investment. This is the oversimplified view of it. What you need to do is work out what your goals are for this money, how you will access it in the future, and how much of it you will spend per year in the future. Those things will guide a more specific set of "what to do's" regarding your various options for retirement vehicles. In the meantime saving in a 401k first and foremost is not going to hurt you until you can get into the specifics of your situation.
Also read - http://forum.mrmoneymustache.com/index.php?topic=22721.0