Email question: I don't trust 401(k)s, is there an alternative?

Written by
Peter Dunn

Hey Pete ,

Been following your blog for a couple years now. It's given me the support I need financially. Here's my question: I have no faith in 401Ks. After having read tons of horror stories of hardworking people who lose all the value in their 401K whenever some random blip occurs I simply refuse to put my [very] hard earned money into one. What are my options and alternatives?

Thanks in advance, Vida

Hey Vida,

Thanks for the question. I find this interesting because there is a lot at play here. There is distrust of the government, but there is also a bit of a misunderstanding involved in this question too. So let's clear up what a 401(k) is and how it works.

A 401(k) is actually just part of the tax code, like a 529 Plan or 501(c) organization. So on its own it's not a risk. The money is held by a third party administrator, like Fidelity for instance. What happens is your company wants to take advantage, in a good way, of a tax loophole. By hiring a third party to administer their 401(k)s, they and you are able to put yourselves in a better position on your taxes. By matching your contribution, they are able to pay you without being taxed via an income tax. This is a legal and encouraged way to shelter money from taxes. So where do things get tricky? When risk comes into play.

Risk is when your 401(k) is invested in securities or other stock market instruments. There are two primary types of investments within a 401(k), stocks in the form of mutual funds or stock in your company. Some companies offer the option to invest a portion of your 401(k) in their company stock, and while this isn't bad, it can go wrong. So your 401(k) can sit in a money market account with little to no risk or you can choose to put a portion of your 401(k) toward your company's stock. Remember Enron? Enron encouraged a lot of their employees to invest 70-90% of their 401(k)s back into the company. We all know how that turned out. All those horror stories you hear about people losing their hard earned money is almost always going to be a situation like this. I recommend you invest no more than 10% of your 401(k) back into the company. You want to limit your risk, and the best way to do it is by having a diverse investment strategy.

Investing smaller portions of your 401(k) into different types of investments is good for you and your money. The market goes up and down, so a diverse 401(k) will protect you for the most part. But the reality is your 401(k) will fluctuate. You can lose 40% of your 401(k) in a year, it happens. But that isn't what screws people, it's the freak out following the loss. If you freak out and cash out of your investments when the market goes down, you may feel better and safer, but what you've done is prevented your money from regaining its value when the market inevitable goes back up.

I hope that answers your question Vida. This is a complex one, so I also answered it this week on The Pete the Planner Radio Show on 93 WIBC. Listen below for a more in depth answer:

Step up your financial wellness game.

Stay up-to-date with the latest in employee wellbeing from the desk of Pete the Planner®. Subscribe to the monthly newsletter to get industry insights and proven strategies on how to be the wellness champion your team wants you to be.