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The Myth of the 401(k)
05/28/2013 5:45 am EST
Your 401(k) may not be the answer to your dreams, in retirement or otherwise, says Andy Tanner of the Rich Dad Organization.
Nancy Zambell: My guest today is Andy Tanner of Tanner Training, which does online training for investors, and he's also part of the Rich Dad Organization, as an advisor. Welcome Andy, I'm so pleased to speak with you today.
Andy Tanner: Thank you so much for having me Nancy. It's good to speak with you.
Nancy Zambell: You're quite welcome. I know that 401(k)s are a subject near and dear to your heart, and they are to mine. I've heard complaints about 401(k)s for as long as I've been investing. Choices are so limited, and no one explains them to you. Why don't you talk a bit about your philosophy?
Andy Tanner: Well, I guess one of the good places to start is right at the beginning, There are very few people who know how we made this tremendous shift—from traditional pension plans, a defined benefit, where a company you worked for took care of you for life—to this idea of a 401(k).
In the 1960s and 1970s, the Studebaker Company went out of business, and all their pensioners were upset, which laid a foundation for some laws called ERISA. That created some tension between labor and management, and in 1978, the Internal Revenue Code had this little arcane, tiny little paragraph called 401(k). It was actually originally designed to be a tax loophole on deferred revenue, or deferred income, for business.
In 1980, a tax attorney named Ted Bennett was working for a client—a bank—and he found that he could use this tax loophole on deferred revenue to transfer the burden of retirement from a company to their employees. If they would make a contribution, they could defer the tax.
Well, this bank said, has anyone done this before? He said no, and they said well, we don't want to be the guinea pig. But he took it back to his bosses, and sure enough they thought it was brilliant, and that's how the 401(k) started.
So it's important for people that have one to understand that there was never a brain trust or a think tank that got together and said let's improve retirement. This was an accident that was tweaked by an attorney, and it caught on like wildfire, because it really helps two things:
- It really, really helped the corporate world to reduce the liability of lifetime pensions, and transfer that responsibility of the worker.
- It brought billions of dollars into the Wall Street mutual funds, because now every time someone got a paycheck, a portion of that money was automatically going to Wall Street. And of course, the fund managers get expense ratios off all that money.
So before someone hops into this, they ought to realize where it came from, and that it's not a perfect system, because it was never designed to solve the burden of retirement.
Nancy Zambell: It's pretty interesting, sort of one of those deals like we're from the government. "We're here to help you."
Andy Tanner: Yes, law of unintended consequences, so…
Nancy Zambell: Tell me about how 401(k)s are different today than they were in the beginning. They still have a lot of very limited choices, in my mind.
Andy Tanner: They really do. Generally, there's a choice of maybe 15 or 20 funds that you can choose from. Generally, most people don't. Much of this has been automated.
In 2005, President Bush signed the Pension Protection Act, which really doesn't protect pensions—it really promotes 401(k)s, where companies can automatically enroll people and automatically increase the amount they contribute every year in the name of saving more.
And that's probably the biggest change between today and when they started. Many people are putting money into this, not really realizing what they've been opted into, and the other alternatives that might be available to them.
Nancy Zambell: Let's talk about some of the alternatives. For the average working-day Joe, what does he have? He can do an IRA, a Roth IRA, or a 401(k). Or if he's self-employed, there are a couple of other options.
Andy Tanner: I think my view may be a little bit different than many financial advisors would suggest, in that I look at assets in two types. If, in your mind, you understand the financial statement of income expenses, assets, and liabilities, that's the first place that we at Rich Dad like to educate people. And income is what we use to offset expenses.
If we have an expense, we need income to offset that. Well, a traditional pension did exactly that. When a person retired, they would receive an income from the company at a finite amount to offset their expenses. Oddly enough, their liabilities were not reduced, and their assets were not increased. Their balance sheet was not affected.
With the 401(k) system, we're actually putting assets in there to offset expenses, and that doesn't make sense, because assets are supposed to offset liabilities.
When I look at assets, there are two kinds. There are assets that we hope that appreciate, and then there are assets that produce income. Largely in 401(k)s—or even in IRAs—people have assets they're depending on to appreciate.
I don't like that idea, because now people are no longer in control of their retirement. They put the stock market in control of retirement, so this shift from defined benefit pensions to 401(k)s is actually major.
Before, a person could just go to their job and do a good job, and the company had to figure out how to write that check. The person had control over their retirement, because the company was responsible.
Now, we're gambling our money in the stock market, which we can't control, and I'm concerned about the Federal Reserve policies pumping this market up, making people feel good.
I'm concerned about our sovereign debt policies that can have an effect on this stock market. So rather than saying it's an IRA or 401(k), what I like to recommend is people get educated on assets that can produce income, rather than assets that depend on a capital gain.|pagebreak|
Nancy Zambell: What kind of assets are you talking about for the average investor?
Andy Tanner: Well, there are four different types of assets that people can generally get into. There are paper assets, which are stocks and mutual funds and options and things like that. There's real estate, and there's commodities. And, if you're fortunate, you can have a business.
All four of these have that same approach. For example, if we took a real estate investor, you could have the person that tries to flip houses. I think that's unwise.
Nancy Zambell: Especially in this economy.
Andy Tanner: Yes, you can't control the price, but you can have someone who rents a house and you can control the debt-you control the renter. I love my rental income.
The same is true with the stock market. Rather than trying to flip a stock—buying low, selling high—we find stocks that pay a strong dividend. Or what I really like to do is teach people how to write covered calls or conservative income strategies in the options market, and also how to use options to protect their original investment.
Here's the capstone, Nancy. If I had one message for anyone that listens-an investor has to decide whether they want to be someone who's hands off and doesn't want to get their hands dirty with the work of investing, or if they want to be educated.
A person should not get into real estate without knowing anything. A person should not get into stocks without knowing anything. If someone asks me, Andy, should I buy gold, and I say no or I say yes, they didn't get any smarter. But if someone wants to learn about commodities, we really try to help people to increase their education in some of these more intricate and advanced investments.
Nancy Zambell: You guys have done a great job with your Rich Dad books, and I know you have a new book coming out in July, correct?
Andy Tanner: We do. Our book, 401(k)aos, is very much about problems, and so we felt we better follow up with some solutions. The title of my new book is Stock Market Cash Flow, and it's about what people need to learn. There are four areas people need to study if they want to learn how to get cash flow from the stock market to offset expenses.
If we just have assets that appreciate to deal with our expenses, eventually, those assets will deplete. If we have to sell assets to deal with expenses and retirement, we create a race against time to where we're likely to outlive our assets.
But if we can use our assets to create new money and create cash flow, we now have a golden goose instead of a golden egg. And that's the purpose of the book—to give people insight on what they can learn and what they can do to change the way they invest.