How To Make Your Retirement As Profitable As Possible

James Altucher thinks 401k retirement plans are scams.

In a video that went viral after being posted last year on Business Insider, the 48-year old hedge fund manager, entrepreneur and best-selling author says that “I honestly think that you should just take your money out of 401ks.”

His reasons?

He lists three. You’ll have no idea what’s happening to your money when it’s tied up in a 401k. You won’t be able to touch it for years, maybe even decades, without paying a penalty. And, his most serious condemnation: “I mean, the average 401 k, they won’t really tell you this, probably returns maybe 0.5% a year.”

Don’t get me wrong, Altucher is a brilliant guy. But this is wrongheaded analysis, pure and simple, for reasons I’ll share below. Even so, there’s a grain of truth to his warning.

And that’s what we’re going to talk about today.

If you don’t understand 401ks “Total Wealth-Style,” you’ll probably fall victim to the kinds of dire returns Altucher predicts.

Here’s what you need to know about planning for retirement.

“Buy and Hold” Isn’t a Viable Investment Strategy – Even for Retirement

Altucher makes a fabulous living by saying and writing things that see him pilloried by the masses. He’s witty, obviously highly intelligent, and very entertaining. I love the fact that we both believe you have to break free of the old ways of doing things in order to succeed in today’s world.

But that’s where we part company.

It’s almost too easy to knock down Altucher’s arguments against 401ks one by one.

First of all, there’s nothing hidden when it comes to 401k’s.

Anybody with the desire to learn what’s in them can do so at the touch of a button. The index funds that are part of many funds, for example, are required to show investors what companies they invest in. There’s even a tool from Morningstar called “X-Ray” that will allow you to compare your holdings in great detail if you’d like. There’s nothing hidden about it.

That said, you should never put money into a fund without knowing what its holdings are, even if the fund has a pretty good track record over the last few years. Past performance never guarantees future results, so the fact that a fund beat the markets over the last few years doesn’t mean you should concentrate all your money there, wait a few decades, and expect it to continue to outperform.

But are 401ks really so lousy that the average one returns “maybe 0.5% a year” as Altucher claims?

Yes… and no.

A quick look at Vanguard funds will show you that there are a few funds with the dismal performance that Altucher claims is normal.

(Click on image to enlarge)

For example, the SPTN Index Fund (FSIVX), has returned barely 0.5% over the last five years as of last February, according to Vanguard. That’s an extremely serious underperformance, and harmful to the retirement prospects of anyone who bet heavily on that fund in their retirement planning strategy.

But Altucher’s not telling you the whole story.

There’s a variable that sends this kind of thinking right out the window: employer matches.

According to the American Benefits Council, nearly 80% of America’s workforce – that’s about 88 million people – had access to some kind of employer-sponsored retirement plan in 2014. Many include matching, meaning your employer will match your contribution up to a specific limit. Fifty percent up to 7% of your paycheck pretax is not uncommon, to give you an idea.

This means that, if you earned $1,000 each pay period in gross income, and automatically deducted 6% pre-tax to stow away in a 401k, your account would grow by $90 each pay period. That’s an automatic 50% return on every dollar of yours that the company matches. And, it makes almost any underperformer downright appealing.

All you have to do is decide to put it there, but that’s a conversation for another time.

Dinkytown.net offers a financial calculator that lets you game out how much you’d have in a 401k amount accounting for all sorts of variables like how much you start out with, what your employer match is, what the rate of return is, and how early or late you start.

Here’s what happens if you start out with a paltry $1,000 at age 25, pick a fund with the puny 0.5% annualized return Altucher sets out, and have an employer match of 50%, up to 6% of your paycheck:

Guess what?

You still wind up with $85,367 more money.

Source: Dinkytown.net

My point is that it’s absolutely possible to start out with just $1,000 – a relatively small amount of money – and manage a return that would be regarded by most investors as pathetic, while on your way to building an eventual $428,070 in 40 years. When you factor in all your contributions out of your own paycheck down the road, you’ll be sitting on $428,070 after having put in just $295,728 into the fund.

That’s a 44% gain that may not seem all that inspiring even when compared to a 0.5% annual return – but keep in mind, we’re discussing one of the worst-case 401k scenarios here.

Take a look at what happens if you invest under all the same circumstances – same pay, same meager 2% salary increase every year, same employee match – but change the abysmal 0.5% rate of return for the fund to a still-modest but obtainable 4%.

Now you’re up to $799,449 after contributing just $295,728 of your own money to the fund over time. That’s a 170% gain over time, and if you put off retirement just two more years, you’d be looking at a nest egg of $892,564 in this scenario – a more than 180% gain that could be a great complement to whatever Social Security payments you’d be receiving.

If you’re wondering if a 4% return is too optimistic given the year that 401ks have had so far, consider Christine Benz’s advice. She’s the director of personal finance for Morningstar, a very useful source for investors because of its independent financial research. In her opinion, 5% is a good annual rate of return over time to assume if you want to err on the side of caution, so our more conservative example of 4% is all the more powerful.

Again, you never want to pick a retirement fund without doing the research to make sure your expectations are realistic given past performance. When I first started, that meant reading reams of documents. But now, online brokerages and thousands of websites allow you to see the various holdings a mutual fund offers.

If you check out the John Hancock Funds Disciplined Value Mid Cap Fund (JVMAX), for example, you’ll find that it’s managed an eye-popping average annual return of 9.94% over the last decade. Its performance is so strong it rates an overall five stars from Morningstar’s analysis, even though its 1.13% expense ratio is about average.

The cost of JVMAX calls to mind one of my first articles for Total Wealth readers, where I cautioned them not to be put off by higher-than-normal expense ratios if performance justifies it.

How to Recognize Funds of the Future

You might be thinking that it’s tough to identify stars like JVMAX when there are so many duds out there. And, for 99% of investors, that’s indeed the case.

The companies aren’t the most famous, nor are they glamorous. But they’re definitely “must haves.”

Crown Holdings Inc., for example, manufactures metal cans for food, beverages, and specialty packing. This ties it in neatly with the Unstoppable Trend Demographics, since as the population explodes globally, demand for food and therefore food packaging will also rise exponentially.

Edison International distributes electric power to whole cities while investing in energy technologies of the future, making it an especially promising company to back even indirectly through a 401k.

And Equity Residential, as a real estate company with holdings in the most in-demand markets like San Francisco, New York City, and Boston could also continue to outperform as properties become more and more valuable.

With companies tapped into the Unstoppable Trends making up all 10 of JVMAX’s top 10 holdings, it’s not surprising at all that the index fund outperformed others in such a dramatic fashion. And that’s something no analyst will tell you because they don’t look at Unstoppable Trends the way we do.

Keep in mind – every successful 401k company you’ll want to put your retirement money into will line up with at least one of our Total Wealth Unstoppable Trends. Any other company, as I’ve written before, is a waste of your time and money.

A Note to Late Starters

If there is a valid criticism when it comes to 401ks, it’s that they’re only “worth it” for investors who are lucky enough to be able to start stowing away significant portions of their paychecks early. There’s no doubt that’s true thanks to the power of compound interest.

What most people don’t realize though is that it makes no difference whether you’re in your 20’s or 70’s when it comes to tapping into the market’s enormous potential. And if your employer offers you a 401k match, take it!

It’s the closest thing you’ll see to free money and something everybody can use to make up for lost time – and then some.