One of the main reasons that people choose not to start up their 401(k) (or 403(b) or TSP or other such plan) at work is because they’re simply overwhelmed by all of the options available to them and they’re worried about not choosing the “best” one and losing money. This was a concern I had at my first job when signing up for my retirement plan for the first time, and it was voiced by others in the room during the orientation session. It’s also been a concern noted by many readers over the years. They didn’t sign up because of option overload – they partially filled out the form, then felt overwhelmed by the options, then just sat it aside and took no action on it.
This is a bad move. You are better off choosing almost any investment option and starting to save now rather than putting it off.
Let’s look at two case studies.
Jane is 25 years old. She has her first “real” job and plans to retire at 65. On the first day, she goes in to sign up for her retirement plan and chooses an investment that offers a 7% average annual return on her contributions. She starts contributing $2,600 a year and her employer matches that, also contributing $2,600 a year.
After 40 years of this, when Jane is 65, she’ll have $1.15 million set aside for retirement.
Now, let’s look at Robert. He’s also 25, at his first “real” job, and also plans to retire at 65. On his first day, he goes in to sign up for retirement and balks at the options. He stuffs the forms in his desk and forgets about them. At age 30, he is finally nudged by his parents and wife into contributing to his retirement account, so he carefully studies the options and chooses that same 7% option that Jane chose. He starts contributing $2,600 a year and his employer matches that, also contributing $2,600 a year.
After 35 years of this, when Robert is 65, he’ll have only $800,000 set aside for retirement. Waiting just five years cost Robert $250,000. Another way of looking at it: waiting for 12.5% of his working years cost Robert around 22% of his total retirement savings. That’s a big loss.
There’s almost no doubt that starting now is better than starting later, but what about the fear of choosing a bad investment? Wouldn’t you be better off waiting and doing the research and choosing a much better investment in a year?
Here’s the issue with that: you can do that regardless of whether you’re contributing right now or not. If you start contributing right now and put it in a money market fund – meaning there’s virtually no risk and something around a 2% annual return – you can still make your investment decision a year from now and already have a year’s worth of contributions sitting there. If you don’t do that, you have nothing a year from now. In the case of Jane and Robert, that means they’d have about $5,250 or so ready to invest in something at the end of the first year if they just chose a money market account (with basically no risk) instead of choosing no contribution at all.
So, starting now and contributing to something extremely safe, then choosing a better investment and moving later is better than contributing nothing now, choosing a better investment, and starting later.
Let’s address another common issue that comes up in these discussions: the “market timing” scenario. You’re about to sign up for your 401(k) but you’re simultaneously afraid that the stock market is about to have a 1929 or a 2008 year and drop 40% in value, so you don’t sign up.
In this scenario, the same thing holds true: Just start contributing now and put it into something safe, then move it over when you feel the time is right. By not signing up, you simply miss out on those years of contributions.
However, the idea that you can time the market is a fallacy. As I wrote late last year in Why You Can’t Time the Market: Thoughts on Investing in Stocks:
Do you have a time machine? No? Then market timing isn’t worth it.
You can’t guess day to day where the peaks and valleys of the market are, and if you miss it by much, you’re going to cut enormously into any advantage you might get from market timing. Add into that the fact that you’ll be paying brokerage fees and you’re devoting a lot of time to study, and the disadvantage grows.
The much better approach is to do things passively. Only invest in stocks if you have a goal that’s more than a decade in the future. Buy a broad based index fund (like the Vanguard Total Stock Market Fund) and reinvest the dividends. Then ignore it until you actually need the money. The market will go up. The market will go down. It doesn’t matter.
If you’re not able to actually predict the day to day peaks and valleys of the stock market – and even large scale investors who do this for a living can’t do it really well over a large period of time – then market timing isn’t going to help you. In fact, if you’re very much off the peaks and valleys at all – and as a casual investor, you will be – you’re likely going to do worse than if you just put money in there and didn’t think about it at all.
In other words, for people just signing up for a 401(k), timing the market is a fool’s game that will probably result in losing money.
What about the worry of a “lemon investment”? This is another concern that people often bring up in these situations. They’re concerned that the retirement investment option they choose is a “lemon” with poor returns and high fees.
That’s true – you might wind up in an investment that doesn’t have great returns or might have high fees. That’s still better than contributing nothing. A 6% return on your money when you could have had 7% (by picking a better investment) is still way better than a 0% return on your money when you could have had 6% (by contributing to the lemon).
Furthermore, with almost every retirement account out there, you have the ability to change your investments at any time. If you keep researching and realize you’re in a lemon, you can move your money to a better investment within that account with no tax consequence. Just log in and change it.
In short, if you end up making a bad choice, you can always correct it later, and whatever reduced amount you earned in that investment is better than earning nothing by not contributing at all.
Okay, one final question. What if you literally have no idea what to choose, and that fear keeps you from making a choice?
The first thing I’d do is simply ask the human resources officer or other employee that is helping you sign up for retirement for their recommendation. They’re typically given some basic guidance to help people find a retirement option that’s right for them. Follow that advice for now. Often, this advice will lead you to a “target retirement” fund, which is a solid default choice.
Later on, as you learn more about investing (or you have someone advising you), you (and/or your advisor) can research the investment you’ve chosen as well as the other options available within your retirement account and, again, if you find something that seems to be a better option, you can move at that time.
The moral of the story is this: You are better off saving for retirement right now rather than later, regardless of how you choose to invest that money. If you choose to leave it in cash for a year or two within your 401(k), you’re still better off in the long run than doing nothing at all. If you put it all into stocks and the stock market bottoms out next year, you’re still better off in the long run than doing nothing at all. If you put it into an awful investment and don’t figure it out for a few years, you’re still better off than doing nothing at all.
Why? Because even after all of those potential issues, you still can’t beat the sheer power of saving for retirement early and letting the power of compound interest work in your favor for as long as possible. The only way to do that is to start now.
If you have a retirement plan at work that you haven’t signed up for, do it today. Don’t wait. Start the contributions now, even if you can afford very little. If you don’t have a retirement plan at work, sign up for a Roth IRA and start contributing, even if you can afford very little. Make moves in your life (like adopting frugality or paying off debts) that will allow you to bump up those contributions as soon as possible. That way, you’ll be as ready for retirement as you can possibly be, and that’s one less little piece of background stress on your shoulders as you move through the many years of your life.