The Great (Inadvertent) 401(k) Rip-Off

Raise your hand if your company has a qualified retirement plan (QRP). Your QRP can be a 401(k), profit-sharing plan, SEP-IRA, pension plan or any one of the many other QRPs.

Columns From: 2/1/2008 Modern Machine Shop,

Raise your hand if your company has a qualified retirement plan (QRP). Your QRP can be a 401(k), profit-sharing plan, SEP-IRA, pension plan or any one of the many other QRPs.

As a tax guy, not an investment advisor, I ask every one of my clients: “What is your average annual rate of return on your investments?” These can include personal funds, QRP funds, excess funds in the business and other funds my clients control.

The shocking answer is that 80 percent of my clients earn less than 10 percent per year, which is the percentage of the general market measured by the DOW or S&P. About one-third of my clients only average 6.5 percent or less. What’s even more interesting is that almost all of those in the 80-percent group do their own investing. They may be great business people, but they are lousy investors.

So, how did the other 20 percent beat the general market growth most of the time? Almost all of them had a professional money manager. When this 20-percent group used professionals to manage their QRP funds, their employees enjoyed the same investment success. My client files are bulging with hundreds of examples.

During the years, I’ve done some extensive research to show you the best way to improve your investment results. Let’s start with a chart of what the impact of a better rate of return can do for your retirement nest egg over time.

The following chart shows you what happens to $1,000 contributed to a QRP and invested over a 36-year period (the typical length of employment time for the business owner or a longtime employee in a QRP) at various rates of return. Hold on to your chair. The differences are astounding. (Note: The chart is a simple application of the rule of 72, which tells you how long a specific amount of money takes to double, depending on the rate of return.)

 

Rate
Of
Return

Years
To
Double
Times Will
Double
In 36 Years
Growth of
$1,000 In 36 Years
6%
12
3
$8,000
8%
9
4
$16,000
9%
8
4.5
$24,000
10%
7.2
5
$32,000
12%
6
6
$64,000

You don’t have to be a rocket scientist to see the results. It’s easy to see if you put about $10,000 into a QRP (every year) for about 36 years and earn just 10 percent per year on average (a good money manager consistently earns more), you’ll have many millions of dollars by retirement age.

So why do about 80 percent of you mess up? You sign up for a “cookie-cutter” (CC) type plan. CC plans focus on two things that sound terrific but in practice put you in that unwanted 80-percent group: (1) low cost and (2) lots of investment choices.

My research continues to show that the costs, which may be hundreds or thousands of dollars per year depending on the number of employees, are miniscule compared with the potential investment results, which can be in the millions of dollars.

Actually, I could write a small book about the pros (not many) and cons (a long list) of a CC plan, and why it almost automatically puts you and your employees in the low-return, 80-percent group. This happens because you and your employees are expected to become investment gurus (and beat the pros). A few do, but most fail. Let’s face it, if your QRP has 142 (more or less) investment choices, you are locked out of every other possible investment. Worse yet, it is a rare employee (or business owner) who knows which of those 142 to pick in the first place or when to switch to another investment. Many of the employers overwhelmed by the investment choices invest a large portion, or sometimes all of their funds in cash. This is a disastrous long-term investment choice.

Think about this example to drive the point home: Every year, about 81 percent of mutual fund managers (remember, they are paid professionals) fail to do as well as the general market (DOW and S&P). They too are locked into a limited choice of investments, because almost all mutual funds specialize in something. For example, some of the popular funds invest only in emerging companies, energy stocks, large-cap, small-cap and about 6,000 more funds. You want a fund or a money manager that can select any and all of the wide range of investment possibilities.

Here’s the suggestion I’ve made to everyone who has a CC plan or is in the horrible 80-percent, self-investment group: go professional. First, hire a professional QRP consultant to create the best plan for you and your employees because there are many important decisions not available in CC plans.

Second, hire a professional money manager. Surprisingly, the costs are competitive with CC plans. To check them out, just check their rate of return after fees for the years they have been in business.

One more point is that the boss (usually the business owner) probably has the largest account in the entire QRP. So, having a professional money manager to manage your account is a terrific tax-free perk. So, how big of a deal is this? Stop for a moment, and write down the balance in your account. Then add just a 1-percent increase in growth, on average, that your account would enjoy per year. Take one more minute and estimate what that 1 percent (or more) would mean to all your employees in your company QRP.

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