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Reader Question: Should I Invest in My Non-Matching 401(k)?

This article was written by in Investing. 8 comments.


Occasionally, Consumerism Commentary readers send in questions about handling their finances. I am not a financial planner, so I have no certification claiming I’m qualified to give financial advice. I am not an investment adviser, so I certainly won’t be recommending stocks. I like the opportunity to address financial questions that other readers may be concerned about, and if I have an opinion or two on the matter, I’d be happy to share.

Readers may disagree with my opinion, or they may agree. Addressing these questions is also an opportunity to instigate discussions. As with any advice you may receive, it’s always good to check with a professional beforehand, particularly if the decision could have significant effects on your financial condition.

Here is a question I received from Steve:

I’m 24 years old and I haven’t started any retirement savings, but I know I need to start. My company offers a 401k benefit but does not offer any match. I was wondering, would this 401k’s tax benefits still be worth taking advantage of over other retirement investment vehicles? Would a Roth IRA be wiser? Or something else?

There are two primary tax benefits to investing in a 401(k) plan. You contributions and earnings grow tax-free until you retire, and your contributions can be deducted from your income for tax purposes if your income is low enough. I describe and explain the 401(k) contribution limits here.

Taxes are a distant second next to the best benefit of most 401(k) plans: matching contributions from your employer. Employers can structure the matching contributions in a variety of forms. One of the most common is for your employer to match 100% of your contribution up to a certain percent of your salary. For every dollar you take out of your paycheck to invest in your 401(k), your employer might also contribute a dollar of its own money. This is an immediate 100% return, much better than what you can expect from any of your investments. If your employer matches your contributions, find a way — any way — to contribute to your 401(k) at least enough to take advantage of the maximum matching benefit. Don’t turn down free money.

The choice to invest in a 401(k) gets more difficult when there is no matching contribution from your employer. At that point, your 401(k) becomes just another tax-advantaged investment account. Unless your 401(k) gives you access to low-cost investments, this account should no longer be a priority. Most 401(k) plans include fund choices that are not as inexpensive as choices you can find elsewhere, like at Vanguard or Fidelity. Low costs correlate to better investment results over long periods of time, and at age 24, this particular reader could be waiting many decades before accessing this money.

You can compare costs by reading the prospectuses for the investment choices in your 401(k) and comparing the expense ratios and other fees with similar funds managed by Vanguard.

Without an employer match, consider maximizing your IRA before contributing to your 401(k). A traditional IRA offers the same tax benefits as a 401(k), and a Roth IRA forgoes the tax deduction for your contributions today for a tax deduction in retirement. That’s a good choice if you expect that you’re in a lower tax bracket today than you will be in retirement. Considering the economy today, it’s probably a good bet that all taxes will be higher in thirty or forty years as the country struggles to pay its expenses, but you never know without a crystal ball.

While your investment choices in your 401(k) are limited, you can invest in almost anything in your IRA, depending on how you open the account. Your investments in IRAs are subject to an annual limit. If you have a strong enough cash flow to schedule your IRA investments throughout the year to the maximum and still have free cash flow, then you should consider investing what you can in a 401(k) without an employer’s matching contribution if your income isn’t above the maximum for taking advantage of the tax deduction. Otherwise, just invest using a taxable (regular, non-retirement) brokerage account. You can name the account “For Retirement” and leave it alone for forty years.

I wish I had been thinking like Steve when I was 24. I’m not sure I knew about the existence of 401(k) plans when I was that age. My employer didn’t offer a 403(b) plan — the non-profit version of the 401(k) — until the following year or two, and my cash flow was so tight, there was no matching contribution, and the investments were so expensive I just laughed. My only investment was in the form of a recently-converted UTMA or UGMA invested with what was probably savings bonds I received as gifts as a kid.

In reality, just making any choice for investing is better than making no choice. Whether you invest in a 401(k), IRA, or taxable account, just the act of putting money aside for retirement puts you ahead of half of all Americans in taking steps to ensure you have a stronger future.

Do you agree or disagree with the strategy outlined above? Share your thoughts on what you might do if your employer were not to offer a matching contribution on your 401(k).

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Young Americans Likely to Be Unbanked Regardless of Income Level

This article was written by in Banking. 13 comments.

In discussing unbanked and underbanked American consumers, we tend to focus on low socioeconomic status communities. The mainstream opinion is that building wealth and long-term financial stability relies on the use of traditional banking and investing products and the knowledge to use these products effectively. The financial industry tends to avoid low socioeconomic status communities for a variety of reasons, but the bottom line is that these customers have not been proven to be profitable. Taking the place of these mainstream institutions are check-cashing facilities and payday loan outfits, designed to be very profitable while providing the immediate services required in these communities.

These “low-class” financial product purveyors are part of a growing industry. As with any burgeoning industry, there is beginning to be more research into its consumers. The unbanked and underbanked consumer is becoming better defined, and traditional banks see this as an opportunity to create products that directly compete with the successful check-cashing and payday loan market.

Check CashingWith this new research comes some interesting findings. Prepaid debit cards are products designed for consumers with low or no credit scores, a condition that is more common among low-income households, though there are many reasons anyone in any income bracket could have damaged or undefined credit. Think Finance has determined that the use of prepaid debit cards is the same regardless of income level. Among the consumers surveyed, a representative sample of the Millennial generation, someone earning up to $74,999 a year is just as likely to use a prepaid debit card as someone earning less than $25,000 a year.

The statistics pertaining the check-cashing services show a similar trend. For a fee of usually 1 to 4 percent, a check-cashing storefront can immediately give you cash. So can any bank branch, but you often need to open an account first, and that requires patience, the willingness to share your personal information and submit to a ChexSystems verification, and the openness to endless marketing. In many cases, it’s just easier to just pay the fee. 34 percent of Millennials with the lowest income make use of check-cashing services outside of traditional banks, only 5 percentage points higher than those with the highest income.

An article in USA Today addresses what might representative of the fact that the status of unbanked or underbanked is pervasive in this age group regardless of income:

Ammy Orozco, 30, who works as an executive assistant at a Check Cashing USA branch in Miami, has a checking and savings account with Bank of America but often chooses to cash checks at work instead. She says she’d rather pay to cash a check immediately than pay for gas to drive to the bank. She has also taken out payday loans in emergencies. She’s tried to get a loan from the bank, but it was “stressful.”

“They wouldn’t confirm right away… You’re there sitting and you need the money, and you’re like, is this going to happen or not?”

Millennials expect instant gratification and are willing to look past fees and unnecessary expenses in order to feed this desire, regardless of income. For a generation whose defining economic moment has been the Great Recession, the credit crunch, and high unemployment, as well as the media environment dominated by stories about bank executives behaving badly, poor use of taxpayers’ money, and class-action lawsuits pertaining to anti-consumer practices, it’s understandable that a mistrust of the mainstream financial industry keeps people away from banks regardless of income. Half of Americans are not saving for retirement, and while unemployment certainly plays a role, lack of trust in the industry and in markets in general is an important factor.

With the proliferation of services targeted to the unbanked and underbanked reaching a wider set of customers — that is, popularity and use has moved beyond low socioeconomic status communities — regulators have begun to take notice. (In other words, these products and their negative effects were acceptable when they took advantage of only the poor and whoever you might assume is more likely to live in poor neighborhoods, but now that the middle class is targeted, it’s an issue worthy of consideration.) The Consumer Financial Protection Bureau is looking into designing regulations for these products. Meanwhile, traditional financial institutions are taking advantage of this regulatory grey area to create products that compete with check-cashing storefronts and payday loan issuers, and to use these products as profit centers with the intent of eventually mainstreaming these customers into other profitable services.

Are you a Millennial who prefers immediate services like check cashing, payday loans, and prepaid debit cards instead of checking accounts, bank loans, and credit cards? This is not the primary audience of this website, but I’d love to hear some feedback from the millions of Americans who fit this description.

Photo: Daquella manera
USA Today

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The College Education Bubble and Crash

This article was written by in Education. 13 comments.

A new survey takes a look at the critical state of today’s recent college graduates. The survey questioned a nationally-representative sample of 444 recent college graduates between the ages of 22 and 29, about their employment situation and experiences. The questions also lightly touched upon these graduates’ financial condition. I’ve included a link to the full survey at the bottom of this article.

The necessity of choosing a major in college can put quite a bit of pressure on any student, particularly those who have either a wide variety of interests and talents as well as those who may not feel themselves pulled in any particular direction. There’s always the hope or the expectation that the bachelor’s degree will define a career path for the rest of one’s life, and that career path will follow a straight line or an exponential curve.

GraduationAn economist’s opinion is that students, who often go into debt to obtain their degrees, should simply look at the expected rate of return. I can’t tell you how many times I’ve heard or read that students should choose majors like engineering, physics, computer science, or applied mathematics to guarantee high salaries and easy job placement. Not everyone is interested or talented in these areas, and the pure financial approach says that those who aren’t shouldn’t bother spending money for a college education. The return on investment for an education is about more than just money, but that opinion doesn’t exactly make me popular in certain communities.

The financial reality is dire according to this survey. And as much as a college education has value beyond the expected return in the form of salary, no one can ignore the money-related part of the equation. Many decades ago, a college degree was a sign of differentiation, and gave holders the ability to market themselves well and qualify for the best jobs. At the same time, culture put such an emphasis on higher education that as it became available to more people — through grants and loans, not through lowered costs — it’s become less of a distinction. Colleges are basically unchecked in their tuition increases because they know that students will keep coming and the government will continue providing opportunities.

In good economic times, that can be ignored. With a low level of unemployment among graduates, former students can receive jobs, healthy incomes, and can pay down their student loan debt. In difficult times — when Baby Boomers aren’t retiring and there aren’t opportunities for younger workers, for example — the buy-now-pay-later model of education begins to fail. And it always fails for those with degrees in fields that take longer to recover their costs, like the arts and humanities.

Mark Cuban offered an apt analogy. College education is similar to the practice of flipping real estate. In the heyday of oversized, abnormal growth in the real estate market, any fool could make
money by buying a house relying heavily on debt, selling it to a bigger fool, and using the proceeds to repeat the process. There was a promise of success, and it worked well for a while — until the real estate market meltdown, followed by the Great Recession and credit crunch. A similar experience is happening today with the investment in a college education. Cuban argues that it used to be able to “flip” a college degree for a good starting salary and a solid opening to a life-long career, but the investment no longer performs so well.

With the run-up in real estate prices, it became very easy to access credit. Banks would give loans to as many customers as possible, with the knowledge the banks could repackage and sell those loans to reduce their apparent risk. The credit crunch required banks to tighten up their lending standards to the point where credit wasn’t available anywhere. Cuban believes this is where we are heading with student loans.

Years ago, policies were designed to ensure that everyone who wanted to become a homeowner could afford to do so. Taxpayers subsidized a great expansion in homeownership, and the real estate industry thrived. Education for all has been just as much a part of the American Dream, and taxpayers are subsidizing college educations for those who can’t afford it on their own. When it’s so easy to get an education for little money down, and everyone is taking advantage of free-flowing credit, we should have expected that making a return on that investment has become more difficult.

There is more student loan debt in aggregate in the United States than credit card debt, and Mark’s conclusion is that the economy won’t improve until this student loan bubble bursts. He promotes non-traditional universities — though not diploma mills, as he later warns — as the answer, because they can provide a better deal.

While colleges and universities are building new buildings for the English, social sciences and business schools, new high end, un-accredited, branded schools are popping up that will offer better educations for far, far less and create better job opportunities. As an employer I want the best prepared and qualified employees. I could care less if the source of their education was accredited by a bunch of old men and women who think they know what is best for the world. I want people who can do the job. I want the best and brightest. Not a piece of paper.

The competition from new forms of education is starting to appear… You would think traditional university educators would take notice. Beyond allowing some of their classes to be offered online, they haven’t. They won’t. Its the ultimate Innovators Dilemma. They don’t believe they should change and they won’t. Until its too late. Just as CEOs push for that one more penny per share in EPS, University Presidents care about nothing but getting their endowments and revenues up. If it means saddling an entire generation with obscene amounts of school debt, they could care less. This is how they get their long term contracts and raises.

It’s just a matter o[f] time until we see the same meltdown in traditional college education. Like the real estate industry, prices will rise until the market revolts. Then it will be too late. Students will stop taking out the loans traditional Universities expect them to. And when they do tuition will come down. And when prices come down universities will have to cut costs beyond what they are able to. They will have so many legacy costs, from tenured professors to construction projects to research they will be saddled with legacy costs and debt in much the same way the newspaper industry was. Which will all lead to a de-levering and a de-stabilization of the university system as we know it.

Just over half of recent college graduates have jobs. Many of those who do have jobs settled for a position for which their four-year degree was not necessary. 40 percent of recent graduates haven’t even begun paying off their student loan debt. Most recent graduates, while happy with their time in college, would have chosen a major after more consideration, taken different courses, or sought out more working or internship opportunities.

Photo: NazarethCollege
Blog Maverick, John J. Heldrich Center for Workforce Development

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Repair Cafe: Bring Your Broken Doodads and Gadgets

This article was written by in Consumer. 10 comments.

We live in an era of cheap, disposable goods. My closet full of clothing, much of it rarely worn, even though I sort through my wardrobe about once a year to eliminate items I no longer need, is a good indicator of this situation. For a good period when I was a kid, I wore hand-me-down clothes — as the eldest child, I received clothing from a family friend — and when an item became damaged, my mother fixed it with her sewing machine.

Prices for clothes have certainly increased over the last few decades, but clothing is not expected to last. When a piece of clothing becomes damaged, it’s easier and cheap enough to replace.

Broken ToasterBroken kitchen appliances, lamps, and other household devices past their warranty periods can’t be fixed with a sewing machine. Many would need specialized care by a professional, and with today’s disposable consumer culture, many people just opt for replacement rather than finding a repair shop and paying nearly as much money as they would to buy a new item.

Additionally, retailers and manufacturers have embraced the concept of planned obsolescence. To keep manufacturing costs low and to maximize profits, there is little concern for making products that last as long as their owners. This is a primary feature of high technology — a house phone sold fifty years ago may still function properly today, but a cell phone purchased five years ago not only doesn’t keep up with the latest technology, but it likely doesn’t work at all. Furniture built in the eighteenth century was made to last in a family for generations; IKEA furniture might last a few years under regular stress of use.

In Amsterdam, there is a small movement in opposition to this disposable consumer culture. The community has come together to repair its members’ broken items. Volunteers bring their tools and sewing machines to an open building several times a month and offer to fix any broken item brought to the gathering. This Repair Café helps reduce waste by encouraging reuse of broken items, and makes fixing an affordable alternative to replacement.

The government in the Netherlands, private groups, and individual donors have helped the Repair Café Foundation raise $525,000 over the past few years, and these funds have helped the organization create these gatherings at various locations across the country. These Repair Cafés provide a chance for consumers to make better use of their goods and for volunteers, particularly those with repair skills that might no longer be in demand, use those skills for a good cause.

Would Repair Cafés; be welcome in the United States? It’s not exactly a profitable business venture, and as such, is unlikely to draw much attention. The model, however, could easily be recreated, perhaps in low socioeconomic neighborhoods, to provide a money-saving alternative for spending money to replace slightly damaged items. Strong marketing encouraging consumers to exist in a cycle of buying and replacing comes at a price to retailers and manufacturers. If these expenses were redirected towards making better, durable products without planned obsolescence, consumers might lose the desire to constantly have new items, and would be able to hold onto the same products for a longer period of time. There would be less waste. Companies and their shareholders would find they have more loyal, life-long customers. Customers would shop with a focus on the differentiation in quality rather than with their tunnel-vision focused solely on price. Companies that build their products to last would succeed while those focused on the short-term would fail.

Could Repair Cafés be an answer to the consumer culture of disposable products? Would the availability of free repairs in the United States change the way consumers buy goods, and thus force companies to build products that are made to last rather than go obsolete? Is the trend towards disposability reversible at all?

Photo: phozographer
New York Times

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Tavis Smiley: Poverty Is a Threat to Democracy

by Flexo
Tavis Smiley

Tavis Smiley and Dr. Cornel West have been working hard to bring the issue of poverty into the consciousness of the citizens and political discourse of the United States. As a team, Smiley and West have been touring city to city, speaking to audiences concerned about the increasing wealth gap in this country. Their book, ... Continue reading this article…

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Facebook IPO Approaching: Will You Buy Shares?

by Flexo
Facebook

A few weeks ago, a Consumerism Commentary reader asked me on Facebook whether it would be a good idea to purchase shares of Facebook at $48 a piece. I do not give stock buying advice, but I mentioned that shares had recently been sold for $44.10 on the secondary market, so if someone were to ... Continue reading this article…

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Get to Work If You Want to Be Rich

by Flexo
Movie marquee

How much time do you spend in front of the television, socializing with friends, or watching movies? I freely admit that I spend too much time watching television. There are certain television programs that entertain me, and particularly during stressful times in my life, I need some type of outlet that makes me laugh, raising ... Continue reading this article…

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Podcast 157: Credit Card Application Fees

by Flexo

Today on the Consumerism Commentary Podcast, Jay Frosting and Flexo talk with Matt Schulz, Vice President of Content for InvestingAnswers.com. They discuss the implications of a recent legal ruling that excludes credit card application fees from the limit on fees that credit card issuers can charge within the first year. Consumerism Commentary Podcast Credit Card ... Continue reading this article…

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