Rapidly declining account balances are raising questions about how Americans save for their retirement. But is the 401(k) or IRA really to blame for this mess or are the Wall Street custodians that manage them to blame?
America needs to wrestle back control of their retirement accounts from the Wall Street custodians that have been managing, and limiting, the investments options. According to the Congressional Budget office, a whopping $2 trillion dollars of retirement savings has been lost over the last 15 months due to the market’s decline. As losses mount, many, including Congress, are beginning to question the current 401(k) based savings model. But would the entire system need overhauling if individual portfolios were better diversified? If custodians allowed all of the investment options that are allowed by law, would the mess we’re in be as dire?
The 401(k) is rightfully expected to go under the microscope with the new administration and overwhelming popular sentiment that retiring at sixty-five for most Americans is a pipe dream. But don’t blame the 401(k). The 401(k) is a well-structured retirement vehicle that encourages employees to save with tax-deferred contributions. It also allows the corporation or small business to contribute to the employee’s account and earn tax savings of their own. A 401(k) can provide a significant amount of retirement savings over the course of a career if the contributions are invested wisely. So what’s the problem?
The problem is that most 401(k)s are managed by banks and Wall Street custodians that only allow investments from their portfolio of products. Since the custodian doesn’t profit from other types of transactions, they aren’t allowed. But are they legal?
“Absolutely,” according to David Coe, founder of Freedom Growth, a California company that helps investors incorporate real estate into their retirement accounts. “Self-Directed IRAs have been legal since the inception of the 401(k) and the IRA. The law provides a very broad range of investments, allowing for well-diversified retirement accounts that are less impacted by severe market declines like we’ve experienced in the last year.”
Then why aren’t more retirement portfolios truly diversified?
When the 401(k) and IRA were first created in 1974, the law required a third party custodian to manage the accounts. Wall Street brokerage houses and banks quickly seized this role and anointed the stock market the sole asset for growing wealth. To date, nearly 85 percent of all assets owned in 401(k)s and IRAs are invested in stocks and mutual funds, according to the Investment Company Institute. And for the first thirty years, the stock market produced unusually high gains, so no one questioned this model.
In 1974, the Dow Jones closed around 1,000. In 2000, the Dow closed at 11,000. That produced almost a 10 percent compounded annual growth rate. But for the century, the Dow grew at a 5.3 percent growth rate. So for the first twenty-five years that the 401(k) was in effect, the market was delivering a return that was twice its normal rate. Everyone was profiting, so no one questioned the system. Since 2000, the Dow has been losing money at -3.6 percent every year. Naturally, questions about how the system provides for retirement are surfacing.
It’s not the 401(k) that needs to be fixed, but the current system that perpetuates this over-investment in the stock market. Investors need to wrestle away control of their retirement accounts and start exploring the greater range of investment options that are available to them. If investors aren’t sure what to invest in, they should seek professional guidance through a fee-based certified financial planner that makes their living on growing their clients’ account, not by selling specific investments products. And according to Coe, “Eight out of ten millionaires made their fortunes through real estate. It’s a proven long-term asset that can play a substantial role in your retirement account. Real estate helps diversify the overly-invested stock portfolio and the next two years will provide excellent buying opportunities for both asset classes.”
Should more Americans save more money? Absolutely. And maybe if more investment options beyond the flailing stock market were available, they would.