MONEY Master the Game: 7 Simple Steps to Financial Freedom (23 page)

—DOUG WARREN, author of
The Synergy Effect

Many ideas or inventions start off with great intentions. Nuclear fusion opened the door to free energy for mankind and now can be used to provide electricity to an entire city. By contrast, if stuffed into a warhead, it can level an entire city.

It is often with a dash of man’s greed and ingenuity that we can turn something great into something that can cause more damage than good. Such is the 401(k). A great little piece of tax code that, if used right, can power our retirement for years to come. But if used as it is in most of today’s plans, it can damage our chances for financial freedom.

And since the 401(k) is the only retirement account most people will ever have, this chapter could be the most important one in this book. In the pages ahead, we will show how to use the 401(k) system and not let the system use you. You will discover how to implement much of what we have learned thus far so that your 401(k) becomes a great retirement plan for
you
(not a retirement plan for the broker or the mutual fund managers). But first a bit of backstory is important.

HOW DID WE GET HERE?

The 401(k), given to us in 1984, gave us the opportunity to participate in the stock market. To own a piece of American capitalism. And we could save on our taxes by making tax-deductible contributions from our paychecks.

But the 401(k) was never meant to be the sole retirement plan for Americans. I reached out to John Shoven, professor of economics at Stanford. He
made it perfectly clear when we spoke by phone: “Tony, you can’t save just three percent of your income for thirty years and expect to live another thirty years in retirement with the same income you had when you were working!”

And let’s not forget that this social experiment is only a few decades old. We are only now starting to see a generation where the majority will attempt to retire having used only a 401(k) during their lifetime.

When we look back at history, what started out as a loophole for highly paid executives to sock away more cash became a boon for companies that decided to eliminate the cost and obligation of traditional pensions and shift
all
the risk and expense to the employee. That’s not to say that pensions didn’t have their own problems: for instance, you couldn’t move them from job to job.

Interestingly, employees didn’t mind taking on this new responsibility because at the time, stocks were soaring. Who wants boring guaranteed pensions when stocks could make us rich?

Money then flowed into the market like never before. All that new money being deposited means lots of
buying,
which is what fueled the bull markets of the ’80s and ’90s. With trillions up for grabs, mutual fund companies began an unprecedented war to manage your money. The stock market was no longer just a place where companies turned to the public to exchange cash for ownership. It was no longer a place for only high-net-worth investors and sophisticated institutions. It became every man’s savings vehicle.

WELCOME, CAPTAIN

When the 401(k) came to be, it represented freedom. Freedom that often gave us the illusion of control. And with markets on the rise, we sometimes mistake luck for being a “good investor.”

Dr. Alicia Munnell, the director of the Center for Retirement Research at Boston College, is one of the top retirement experts in the country. We spoke for nearly two hours regarding the retirement crises facing the vast majority of Americans. In her view, “We went from a system of defined benefits—where people had a pension; they had an income for life—to the idea of the 401(k), which was obviously cheaper for employers. And on
the surface, it seemed like it was beneficial to individuals because they had more control of their own investment decisions.” But even Alicia, a former employee of the Federal Reserve and member of the president’s Council of Economic Advisers, made some serious missteps when it came to her own retirement. “So, I have a defined benefit plan [guaranteed lifetime income] from the Federal Reserve Bank of Boston. When I was at the Treasury, one of my colleagues said, ‘Oh! Take it early. You can invest that money much better than the Federal Reserve can.’ That money is long gone.”

Being solely responsible for your investment decisions is a scary thought for most (especially before reading this book). As captain of your financial ship, you must navigate all the available investment choices, generate returns sufficient enough to support your retirement, be a part-time investment expert, and do it all while holding down a full-time job or business and raising a family.

Teresa Ghilarducci of the New School for Social Research authored a brilliant article in the
New York Times
titled “Our Ridiculous Approach to Retirement.” In it she managed to pack all the challenges we face into a single paragraph:

Not yet convinced that failure is baked into the voluntary, self-directed, commercially run retirement plans system? Consider what would have to happen for it to work for you. First, figure out when you and your spouse will be laid off or be too sick to work. Second, figure out when you will die. Third, understand that you need to save 7% of every dollar you earn. (Didn’t start doing that when you were 25, and you are 55 now? Just save 30% of every dollar.) Fourth, earn at least 3% above inflation on your investments, every year. (Easy. Just find the best funds for the lowest price and have them optimally allocated.) Fifth, do not withdraw any funds when you lose your job, have a health problem, get divorced, buy a house, or send a kid to college. Sixth, time your retirement account withdrawals so the last cent is spent the day you die.

Yes, the system needs to be fixed, and yes, it will take time and some major progress on both Capitol Hill and Wall Street. But the good news is that for
those of you who are informed, you will be able to navigate it. You can use the system as an insider would, and let it work to your advantage.

COME AGAIN?

So let’s do a little recap. We now know that actively managed stock-picking mutual funds don’t beat the market. And this is exactly what you find in the vast majority of 401(k) plans (but not all). We also know that these expensive funds charge hefty fees, which can erode 50% to 70% of our potential retirement nest egg. Depending on your age today, think of how much you have already left on the table to this point? Is it $10,000? $25,000? $100,000? Scary, huh?

Now, stick those expensive mutual funds inside a name-brand 401(k) plan, usually offered by a payroll or insurance company, and it will charge you a whole host of
additional
costs. (See box on following page.) The sum of all these costs forms an insurmountable headwind. With the vast majority of plans out there, the odds of you winning the 401(k) game are slim to none.

401(k) plans receive the benefit of tax deferral, but most are loaded with up to 17 different fees and costs between the underlying investments and the plan administration.

COMMUNICATION EXPENSES

• Enrollment (materials)

• Ongoing (materials)

• Enrollment (meetings)

• Investment advice

RECORD-KEEPING AND ADMINISTRATIVE EXPENSES

• Base fee

• Per participant fee

• Per-eligible employee fee

• Distributions

• Loans origination

• Loans maintenance

• Semiannual discrimination testing

• 
5500 filing package

• Other expenses

INVESTMENT EXPENSES

• Base fee

• Individual (mutual) fund expenses

• Manager/advisor fee

• Other asset fees (revenue sharing, wrap, administration, and so on)

TRUSTEE EXPENSES

• Base fee

• Per-participant fee

• Asset charge

But now the good news! With the right 401(k), one that is lean, mean, and doesn’t take your green, you can turn the headwind into a tailwind. You can gain momentum by taking advantage of what the government gave us.

AMERICA’S “
BEST
” 401(K)? OKAY, PROVE IT!

Once I truly grasped what Jack Bogle calls the “tyranny of compounding costs,” and realized the destructive power of excessive fees, I immediately called the head of my human resources department to find out the specifics of our own company 401(k) plan. I wanted to know if my employees, who I care about like my own family, were being taken to the cleaners. Sure enough, we were using a high-cost name-brand plan loaded with expensive funds and excessive administration and broker fees. The broker assured me that the plan was top notch, lean on fees, and right on track. Sure it was! Right on track to make his BMW lease payment.

Convinced that there had to be a better plan out there, my team and I began to do some research. After a frustrating process of looking at a bunch of garbage plans, a good friend of mine referred me to a firm called America’s Best 401k. That’s a bold name. I called the owner, Tom Zgainer, and said, “Prove it!”

In the first five minutes of meeting Tom in person, it’s obvious he has immense passion about helping people get free from crappy, fee-loaded 401(k) plans. He calls the 401(k) industry “the largest dark pool of assets
where nobody really knows how or whose hands are getting greased.” A pretty grim diagnosis of his own industry. “Get this, Tony, the industry has been around for three decades now, and only in 2012 did service providers become required by law to disclose fees on statements. But in spite of the disclosure,
over half of all employees still don’t know how much they’re paying!
”
In fact, 67% of people enrolled in 401(k)s think there are
no fees,
and, of course, nothing could be further from the truth.

“How are you different, Tom? How is America’s Best truly the ‘best,’ as you say?” Having been burned once, I felt like Papa Bear looking after his cubs because I knew this decision would directly impact my employees and their kids. They had already been paying excessive fees for years, and I couldn’t allow that to happen again. I came to find out that, as the owner of the company, I am also the plan
sponsor,
and I discovered it is my legal duty to make sure they aren’t getting taken advantage of. (More in the pages ahead.)

Tom explained, “Tony, America’s Best 401(k) only allows extremely low-cost index funds [such as Vanguard and Dimensional Funds], and we don’t get paid a dime by mutual funds to sell their products.” I had just interviewed Jack Bogle, and he confirmed that Vanguard does not participate in paying to play, a common practice where mutual funds share in their revenues to get “shelf space” in a 401(k) plan.
By the way, what this means to you is that the so-called choices on your 401(k) plan are not the best available choices. They are the ones that pay the most to be offered up on the menu of available funds.
And guess how they recoup their cost to be on the list? High fees, of course. So not only are you failing to get the best performing funds, but also you are typically paying higher fees for inferior performance.

“Okay, Tom. What about the other plan fees? I want to see full disclosure and transparency on every single possible fee!”

Tom proudly produced an itemized spreadsheet and handed it across the coffee table. “The total cost, including the investment options, investment management services, and record-keeping fees, is only 0.75% annually.”

“That’s it? No hidden fees or other pop-up-out-of-nowhere fees?”

We cut our total fees from well over 2.5% to just 0.75% (a 70% reduction!). As you recall from earlier in chapter 2, when compounded over time, these fee savings equate to hundreds of thousands of dollars—even millions—that will end up in the hands of my employees and their families. That makes me feel so great! Below is a simple chart showing a sample 401(k), similar to the one my company used to use, versus America’s Best 401k, and how those savings compound directly into my employees’ accounts.