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Too Much Money In IRAs And 401(k)s

By Sammy of Stone Marmot

Oct. 20, 2008

In a previous rant I argued that the best place to put your money to get safe and high returns is to pay off your debts. But many people who do have a reasonably amount of money saved up will have a difficult time doing this. Why? Because almost all that money is tied up in IRAs and 401(k)s.

Many advisors argue that no where near enough people are taking advantage of these government created means for saving for retirement. I would tend to agree with them that too few take advantage of these plans. But I also think that, of the ones who do take advantage of these means for saving for retirement, most have way too high a percentage of their savings in these plans.

IRAs and 401(k)s are great if the world is perfect and nothing ever goes wrong. But, as we are repeatedly reminded and are really having it rubbed in our faces right now, that is not reality. There are so many restrictions on IRAs and 401(k)s that they are horrendously inflexible. Right now, people with these plans are seeing their value drop very dramatically and have the choice of either accepting the drop or moving the money into fixed income investments, such as bank certificates of deposit (CDs) or Treasury securities, that are paying next to no interest, which is a guaranteed loss after factoring in inflation. But the best thing for most of these people and the economy at large right at this moment is to get rid of as much debt as possible. IRAs and 401(k)s can't help in this regard without the holders of these plans suffering severe tax penalties.

If you are really serious about saving for retirement, the first thing you should do is to get rid of your debt. The interest you pay on debt is almost always greater than any return you can get on any reasonably safe investment. So you are ahead of the game by avoiding this debt interest. But few financial experts will recommend this path because they and their colleagues make their money off your investments. If you are paying off your debts, you won't be giving them any of your money to invest.

Paying cash for everything and/or paying off your debts early also flies in the face of the “instant gratification” message being continually pounded into us by the media and, as a consequence of media brainwashing, our peers. Saving up for something is frowned upon by our society. You are called a tightwad, a Scrooge, miserly, and other derogatory terms if you live within your means.

Once debt-free, you next should have at least three months of living expenses in a relatively secure, readily accessible form, such as a checking account, savings account, and/or money market fund to cover possible emergencies. More would be better, especially if you have a rather insecure job or iffy health. But you can't put everything in these kind of accounts as you will never keep pace with inflation and your money will be continually losing buying power.

Once you have a comfortable amount put away for immediate access for emergencies, then you can start to seriously save for retirement. A better mix for retirement savings is for about half your money to be in IRAs or 401(k)s and the rest in investments outside these government-encouraged plans. This keeps about half your money flexible to respond to any disturbances in the economy or your life with minimum government restrictions and penalties.

If your company offers a generous match for 401(k) contributions, such as dollar for dollar up to 8 % of your paycheck, you may want to take advantage of that before you do any investing outside of the 401(k). But realize that you are setting yourself up for having most of your money tied up in a 401(k). I personally would still match my own 401(k) contributions with the same contributions outside my 401(k) plan. In this case my total savings would 16 % of my paycheck, which shouldn't be too hard if I am truly living within my means and debt-free.

What is a good mix between fixed income and stock? That depends upon your age, how comfortable you are with risk, etc. There are plenty of good articles and studies on this subject and you should probably seek them out.

Note that I am not a licensed investment professional. This is just based on my own personal observation and experience. I myself have followed this approach and am very happy with the results, even now. I'm just exercising my right to free speech and sharing what has worked for me. But obviously your results may vary and follow at your own risk.

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