The 401(k) Rollover Mistake that's Costing Retirement Savers Billions

I have a chart that when I go into high schools and talk to some younger folks who I hope to be leading toward becoming investors, I ask them if they have a job, if they're earning an income yet and about half the hands go up and then I ask who's actually saving their money and half the hands go down and I ask who has been investing their money and there's usually like one or two kids in the classroom and I show a chart of the time value of money with a compound investment rate of return versus an interest-bearing account. I say look it's great that you're saving, but we really need to shift that mentality to an investor's mentality so that we can get the growth that's offered and is necessary for your money to help you achieve your goals long-term. Peter, good to see you.

Welcome back everyone. Today's topic very important. We are going to cover the 401k rollover mistake that is costing retirement savers billions. There are so many benefits to rolling your 401k into an IRA, but it turns out workers are missing out on billions in investment gains by pulling their retirement savings out of the stock market after switching jobs. So we're going to talk through how and why you need to avoid that mistake. So there's new research from Vanguard, Peter.

Here's a look at this white paper which we can link to as well. So tell us about what's happening when people roll their 401k into an IRA. Well and Vanguard focused on the rolling it like it was a conscious choice and decision taken proactively.

It doesn't always happen that way. This same phenomenon is happening when people are locked out of their fund or frozen or their company gets sold or liquidated or what I've seen is that older 401ks get rolled to a trust company where the funds essentially, no matter what that circumstances applied to you after you're done with a 401k, it ends up sitting in cash. So if you rolled it over, whether it be by no choice of yours or a conscious decision, you take that 401k, you roll it over to an IRA, but then you forget the important secondary step of actually investing the money, getting it into the market, into positions. Unfortunately, a lot of times it just ends up sitting in cash and that's the crux of the Vanguard article here is that this mistake is costing investors billions of dollars because of the loss of the opportunity for growth in the investments as opposed to sitting in cash, which even cash now is more attractive than it was maybe five years ago, but it does not keep up with the potential growth that the investment in the market and the exposure to those investments offers. Especially during high inflationary times. So just to state the obvious though, Peter, explain why sitting in cash is so detrimental to saving for retirement.

Yeah, the compound growth effect. I have a chart that when I go into high schools and talk to some younger folks who I hope to be leading toward becoming investors, I ask them if they have a job, if they're earning an income yet and about half the hands go up and then I ask who's actually saving their money and half the hands go down and I ask who has been investing their money and there's usually like one or two kids in the classroom and I show a chart of the time value of money with a compound investment rate of return versus an interest bearing account. I say, look, it's great that you're saving, but we really need to shift that mentality to an investor's mentality so that we can get the growth that's offered and is necessary for your money to help you achieve your goals long term. There is a time and a place for cash. Don't get me wrong on that, but there's got to be investment potential along with it as well and if you miss that over time, you're missing out on the end of that hockey stick of the time value of money and compound growth. One of the things I like, Peter, is you can't save your way to rich. No, no, you really can't. I mean, I've got to get rich quick strategy. It just takes 40 years of investment to work, right?

That's a different definition of quick. Okay, though, let's move on to another thing that I want to talk through, which of course is near and dear to your heart. Peter, as you mentioned that you talk to young investors, this is a real problem for young investors. So this is, again, according to Vanguard here, among these IRA holders in 2022, cash allocations were mostly flat across the age distribution with investors 25 to 34 and investors 65 and older, both showing average cash allocations of about 11 percent.

Yeah. And again, there is a time and a place for cash, but it's not generally inside of your investment account at high levels or percentages. There will generally be a little sliver of cash in almost every investment account.

One, two, maybe at times three to five percent. But you don't want to just hold cash long term in an investment account and forget to get it invested. And the age disparity there is is one part of it. I think that there's some recency biased from younger investors if they have seen a recent market downturn where they get a little gun shy, whereas more seasoned investors understand and realize that that's just part of being invested. But right now, what I'm seeing is that that is counteracted by the hesitancy for older investors to put so much money and risk on the table, which is appropriate as we get closer to our retirement date, our target.

We don't want to take as much risk. And this is where specifically within this article, I've got the commentary that older 401ks versus your current 401ks probably should appropriately be invested differently in your new 401k. Let's say you have built up over a career, you know, this five hundred thousand dollar million, a sizable balance in the 401k, and then you leave that job and start a new one. Well, if there is a large market correction, it makes a very significant impact on the total life savings that you've had on the existing balance. Whereas with the new 401k, it probably does not make as big of an impact. So in the grand scheme of things, your new 401k where you are making contributions probably should be a little bit more aggressive than the remnant life savings that you've built up to that point, especially as we get closer to a retirement timeline. Plus, the new 401k is taking advantage of dollar cost averaging. So even if there is a bigger market downturn, your next check is going to take advantage of buying in at those lower prices where the older 401k is just floating with the market where it is. So maybe it should be skewed a little bit more conservative, but it should not completely give up on the potential for growth and gains and just sit in cash either. It's a it's an individual balance that you must look at for your situation, right where we're talking conceptually here. But in your situation, you've got to look at it and then you've got to make sure that each dollar is assigned a task and a name and a job to do and that it's doing it. And the money in 401ks, their job is not to sit around and wait for emergencies like cash in the bank. Right, right. So according to Vanguard, for investors under age 55, researchers estimate that the long term benefit of investing in a target date fund versus sitting in cash upon rollover is equivalent to, on average, an increase of at least one hundred and thirty thousand dollars in retirement wealth by the age of 65.

Yeah. And I sort of have a little bit of a problem with putting a specific dollar value on this, because, again, it's very individual and specific. It's going to be based on your balance and your contributions. But they're giving this based off of average numbers. So proportionally, wherever you're at, it's going to be the same kind of proportion.

Some may be much larger than that number. Some it may not make much of a difference. But the point is that the target date fund compared to sitting in cash is going to make a significant difference. And I could go into the target date funds a little bit more in detail as to why they're beneficial and the issues that I have with them, because there's pros and cons to everything. But conceptually, a target date fund is going to give you the market exposure that is appropriate for your age and timeline as you move toward that date.

So it balances and controls it. Theoretically, as you get closer, it automatically takes some of the risk off of the table for you, as opposed to taking all of the risk off the table and just sitting it in cash for years and years. And as the Vanguard article stated, some third who have rolled over a 401k stay sitting in cash for seven years. That is a lot of growth potential. I mean, even though we've seen some challenges in the market over the last seven years, think about how much progress that we have made and looking back over almost any seven year period that you would want to choose.

It can make a huge difference. But people get gun shy and maybe just don't know where to invest or how to get those dollars invested. And that's why this problem is happening.

And as the Vanguard article states, costing investors billions of dollars, billions. Yeah, you're right. No, it's it's something that we always have to be. We have to advocate for ourselves.

Right, Peter. And we were talking offline to same thing with HSA's. We think we're invested. You have to actively invest. So now HSA's that is actually there to cover what is an emergency potential event, right, that you've got to come up with out of pocket dollars to cover health care needs. So I actually think that some money inside of an HSA probably is appropriate to keep in cash. But once you're over your annual out of pocket cost, you're you're out of pocket potential expense. Absolutely, you want that money invested. But what you might have to be forced to come up with in that worst case scenario in a given year, that should probably be more conservative. So but the same issue is happening.

You're absolutely right. Topic for another day, my friend, I'm sure if somebody has questions about, you know, making sure they are properly invested in their 401k, IRA or HSA, how can they reach you, Peter? Give me a call. Happy to talk over these questions or really any financial issue or question that is on your mind concern and help you map and plan for the future. So give me a call 919-300-5886, 919-300-5886.

Or you can visit us online, we've got a revamped website, lots of resources available at richonplanning.com is what it looks like it's Rashaan planning, but it looks like richonplanning.com. And the retirement tax bill calculator, I want to give that website out to 919 retired.com 919 retired.com because it's not just the loss of purchasing power of sitting in cash, but also the loss of dollars if you are not tax efficient on those 401k accounts. So we need to definitely look at being as tax efficient as possible.

And that can be a significant, significant savings for you, often with far less risk than investing in the market, which people like. Right. Okay. Peter, thanks so much for your time today. Thanks Aaron.

Hey folks, Peter Rashaan here with Rashaan planning. So glad that you are enjoying the podcast planning matters radio. You know, one of the tools that we've put out there that people really seem to appreciate and really are our finding of value is at 919 retired.com. It is your retirement tax bill calculator. If you've got any kind of retirement account, your tax deferred 401k or IRA, this is the website.

This is the resource where you can go. You can plug in your own numbers, your information. You can slide the, the, the tool calculator up and down for your tax rate or your amount of savings and see what your tax bill is likely to be. If you default and defer to the IRS as plan versus what you could potentially bring that tax bill down to a lot of times it is a very significant savings.

So if you have not yet go to the website 919 retired.com run your numbers on the retirement tax bill calculator. This has been planning matters radio. The content of this radio show is provided for informational purposes only and is not a solicitation or recommendation of any investment strategy. You are encouraged to seek investment tax or legal advice from an independent professional advisor. Any investments and or investment strategies mentioned involve risk, including the possible loss of principal advisory services offered through Brooks own capital management, a registered investment advisor, fiduciary duty extends solely to investment advisory advice and does not extend to other activities such as insurance or broker dealer services. Advisory clients are charged a quarterly fee for assets under management while insurance products pay a commission which may result in a conflict of interest regarding compensation.