Don’t get scared! But we thought it’d be fun to share some spooky stories from 401(k) nightmares. Take a deep breath and cue that one song...you know that piano theme song from the Halloween movies…yeah, here it is on YouTube.
The Job Change Withdrawal
Our first nightmare could be occurring right next to you in Suburbia, USA, perhaps even on your local Elm Street. It’s the all-too-common job-change cash-out.
When employees change jobs, they should be rolling over their 401(k) account to the new plan (at least in the vast majority of cases). But too many employees choose to cash out their 401(k)—and then suffer a terrible three-headed monster of punishment.
First, they pay an early withdrawal penalty. Second, they pay taxes. And finally, they pay the opportunity cost from stopping their compound interest.
And even though he’s old as a ghost, Charlie Munger is still sharp as a wizard. Charlie famously opined, “The first rule of compounding is to never interrupt it unnecessarily.”
Don’t live this nightmare. Don’t cash out your 401(k) too soon.
Too Much Candy in One Basket
Many companies offer 401(k) funds containing their own stock. Thus, it is possible for employees to rely on the company for their paycheck, and to rely on that company for their long-term investment returns. This is a classic case of putting too many eggs in one basket. If the company fails, it is terrible for the employee.
This is what haunted Enron employees (and still haunts some to this day).
Sure, some people will benefit from this lack of diversification (e.g., if their company outperforms the average market return). But is that a worthwhile risk?
Just ask a child. Is the upside of all candy worth the risk of all floss? No way. Diversification wakes you up from this nightmare.
An Actual Blood-Sucker
Vampires don’t exist. Or do they?!
Ok, no they do not. But there is a vampire lurking in America’s 401(k) plans.
It’s fees. Specifically, it’s high fees. Dracula? More like Dragula!
The prototypical vampire is often illustrated as imperceptible to the victim. Gentle enough not to wake the sleeping damsel, such that the vampire can return night after night to fulfill its bloodlust. Of course, these small visits compound to drain the victim of their very life.
Similarly, high investing fees do not feel that bad in the short run. What’s a 2% fee compared to a 15% return, right?
Investors need to understand that a 2% fee compounded over a 35-year timeline results in one losing half of one’s potential return. That sucks. Just like a vampire.
A Stitched-Up Abomination
It’s hideous! A piece-meal corpus made from mismatched parts. Some components still living, others clearly dead. Ewww! What kind of madman would create such a…thing!
No, this isn’t Frankenstein’s monster. This is a client with far too many disparate accounts from previous employers, just begging for consolidation.
Just like Frankenstein’s monster, this client’s retirement plan is a stitched-up abomination of mismatched pieces. Some pieces are fresh and lively. Others haven’t seen the light of day in decades (gross). And yes, their…ahem, rot…is showing (double gross!). Encourage your participants to consolidate their accounts into one coherent plan.
Feeling scared? Don’t worry. Today ghouls and ghosts are not real. But they can be worrying!
Thanks for checking out our 401(k) nightmares. Join us next month for, “Don’t be a Turkey – What Thanksgiving Dinner Teaches Us About the US Tax Code.”