January 14, 2021

JF2326: Highlights From 401(k)aos by Andy Tanner | Actively Passive Investing Show With Theo Hicks & Travis Watts

Actively Passive JF2326

Today Theo and Travis will be sharing their opinion of the 401(k)aos book written by Andy Tanner, as well as their personal experience with 401k retirement investments.

For Travis, this book was one of the defining moments that helped him determine what kind of investor he’d like to be. Travis shares five bullet points made by Andy Tanner in the book and his personal takeaways.

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow. 

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Theo Hicks: Hello, Best Ever listeners, and welcome to another edition of the Actively Passive Investing Show. I am Theo Hicks and as always, I am back with Travis Watts.

Travis, how are you doing?

Travis Watts: Theo, really excited to be back. We took a few weeks off, so I’m really excited about this topic and good to be here.

Theo Hicks: Yeah, so this is Travis and I’s first time recording in the new year, even though this will air a little bit later… But yeah, it’s great to be back, and we’ve got a fun topic today about the 401(k)aos. It is actually a book written by Andy Tanner; it’s a play on words – a 401(k) is an investment vehicle that is probably one of the most well-known investment vehicles, at least for people who’ve worked in corporate jobs before, because it’s kind of constantly getting pushed down your throat to do the 401(k) plan.

And I remember back when I was working in the corporate world, everyone invested in the 401(k), right? It was the best thing ever. It was free money, right? All these different things that I’m sure Andy talks about in his book. But Travis read the book, has some highlights he wants to go over today. Of course before we get into that, Travis or me are not tax professionals, we are not financial advisors. This is all just our opinions on our experiences with 401(k)’s, and obviously Travis reading this book. So this is just strictly for educational purposes, but I’m really excited to talk about it.

So Travis, do you want to jump into the takeaways or going to kind of go over maybe the background of the book, why you picked this topic and kind of what we usually do to start the show?

Travis Watts: Yeah, a couple of reasons I really wanted to highlight this book – we’ve done other books of Tom Wheelwright and Kiyosaki books and whatnot… But really, these are the books that stood out to me early on as kind of those foundational books that helped me decide what path to go down as an investor. And I think that, to your point, the 401(k) is widely known in the US, and a lot of folks that work for companies have 401(k)’s, and I think that it’s a worthy conversation to be had. I’m not the professional myself, but do check out this book if you want to dive deeper into it.

My intention here is to give everyone kind of the spark notes so to speak, just the high level of a couple things to think about. That way, maybe you don’t get too far along the path before you decide that maybe this isn’t an account that I really want to have, or what’s the best strategy to use this type of account in my portfolio. Again, not being a financial advisor, but a couple relevant points.

I read this book early in my 20s, and at the time I had a 401(k), but I had a pretty low balance. I had a Roth, a traditional, I had all these retirement accounts. This goes beyond the 401(k), this book; it helps explain how these things came to be, why they’re in existence, how the tax code works in relation to them… And the more I researched and read, the more I just started deciding that, “I don’t want to make these types of accounts part of my personal strategy.” I’ll go into that a little bit later.

And what prompted me to make this episode more than anything is thinking back years ago – I was with my wife, we were at one of her work conferences; I’d just read the book, and of course, I like to give her the rundown after everything I read, though she probably doesn’t care about most of it… So she had told a co-worker, I guess, that I had read this book, and this lady walks up to me, who I hadn’t met, and she goes, “Hey, your wife says, you know a lot about 401(k)’s,” and she said, “My husband and I, we max out our 401(k)’s,” and she goes, “What’s wrong with doing that?” And she was like, calling me out, and I thought, “Oh my god.”

And long story short, we didn’t really have a conversation over it, because I didn’t want to take that standpoint of trying to defend myself or something… But later, I thought I could have added value to her though by just sharing a few things objectively; not saying you should or shouldn’t do something, just saying, “This is what I researched and learned, and that’s why I feel the way that I do.”

So that’s what this episode is; that was kind of a long intro. So what I want to do, Theo, is do what I believe to be the five main takeaways from the book that Andy’s trying to get across to folks, and then I’ll give you kind of my personal takeaways and where that lead.

Theo Hicks: Yeah. Perfect. Start with those five major takeaways from the book.

Travis Watts: Okay, cool. So the bullet points that I made – I had to go back and kind of refresh myself last week, but it’s that first and foremost, a 401(k) builds net worth, it doesn’t build cash flow. So if you’re interested in the whole basis of our podcast, the Actively Passive Show, we talk all the time about passive income and cash flow and real estate. Well, if that’s kind of your niche and your thing, this is certainly not an account that’s going to help you with that. This is treated almost like a savings account; you’re going to dump money in it, cash, and then when you’re in your 60s, you’re going to pull that cash out, whatever you’ve made over the years. So that’s what it is. I think these things came out in the late 70s, and initially, these were intended to be just one supplemental account in the big picture of having the average American retire. This was not to say, “Here is the retirement account”, like a lot of people treat it today. “Oh, my 401(k) will bail me out one day when I’m in retirement.” Not at all. You’re supposed to basically have your pension, Social Security, Roth IRAs, traditional IRAs, brokerage accounts, personal investments and a 401(k). This was just one little tiny piece of the puzzle. The tragedy and the chaos of it that Andy points out is that we’ve made this the centralized vehicle for retirement, and in most cases, statistically, it’s just not going to be enough for the average person to retire on. So that’s number one.

Number two is that mutual funds, which is notoriously what’s in a 401(k) as far as an investment option, is not going to protect you against a systematic decline in the market. When you read the headlines and the S&P and the Dow Jones are down 5%, really good chance that your 401(k) is down roughly 5% too, right? Because it’s all just tied into the same Wall Street system. So there’s not a lot of downside protection like you would have in a brokerage account, where you could do a stop loss or something like that, and if things start declining, you’re out. Can’t do that in a 401(k). So it’s a bit riskier in that sense.

Number three is that 401(k)’s really, at the end of the day, if you read the research on why these were even created in the late 70s, it was to help fund Wall Street. It was because Wall Street wanted more of a prop up obviously, right? They wanted more fees, obviously, right? So this was a way to get virtually a ton of Americans, I would probably say, the majority (I don’t know the real numbers) to participate in the stock market. It would be your choice, but it’s not that you really want to be investing in the stock market privately, but you’re kind of forced to every time you get a paycheck, you’re contributing to Wall Street. So that was really the main purpose, just to recognize what this was. It wasn’t so much about Americans individually benefiting, it was about Wall Street benefiting.

Number four – this is just a foundational Rich Dad philosophy, but investing should be a life skill. And I’ve always believed that philosophy anyway; there’s your professional education, and college, and high school, and degrees and all this, and that’s great… But also, everybody should take little emphasis on learning the investing world to a point, just so that you are aware of what this stuff is and how it works and how the taxes work.

Number five that Andy makes is that 401(k)s create an artificial demand on the stock market. So as you’re looking at these historic graphs and the stock market, you hear it said all the time, “The market always recovers, it always goes up.” Well, yeah, because you’ve got all these people contributing every two weeks through their paycheck, sometimes more frequently, into the market. So that creates – I don’t want to call it a bubble, but artificial demand on the markets is the way that he coins it.

So I’ll stop there for Andy’s takeaways, what I believe them to be. He doesn’t lay them out exactly like that, that was just after reading the book. Any thoughts, Theo, on that?

Theo Hicks: Yeah, just really what I’d like to add based on what you said, as I understand all the things. Two things; number two, you talked about the lack of protection against systemic risk. I remember I went to college at the beginning of the crash of 2008, and I got out, and then I got my first job and I made some friends who had started working maybe a little bit before 2008 or something; I can’t remember exactly what it was. I just remember that they’d gone all-in with the 401(k), right? They put as much as they possibly could, they got the employee match, and it went up, it did really well. And the crash happened and they heard their 401(k) got cut in half, and it took them 5+ years for it to even go back to what it was before the crash even happened.

I remember the same thing for the underlying mutual funds. I remember when the crash happened, the college fund my parents were saving up for us for 18 years got cut in half overnight. And I think a few years ago, my sister’s finally got back to what it was pre-2008. So when you were talking about that, it kind of brought up those memories.

And then number three, when you were talking about the lump sums of cash for institutions, it reminds me of that TV show “Billions”. Have you seen that show “Billions” before?

Travis Watts: I have not. No.

Theo Hicks: It follows this guy in Wall Street who has this big hedge fund. And one of the plotlines is, he’s trying to get a police pension fund, because he wants to have all that cash and make all those massive fees off of handling all that cash. And so that’s what came to mind when you talked about the conception of the 401(k). And I didn’t know exactly why they started it, but kind of what you said totally makes sense.

Travis Watts: Yeah, one of the guys that actually helped make this thing possible and launch it initially has since, in recent news, I think in the last 5-10 years, come out to say basically the same thing Andy Tanner is saying, “This has become chaos. This was not what we intended for this to be. This is not supposed to be your one retirement account.”

And as you know, Theo and anybody listening, pensions have virtually gone away at this point, and Social Security is taking hits, so you’re likely going to get less in the future than past recipients. And too many people are just relying on the 401(k) as the only other substitute here, and that’s a very scary thing.

One other point, to your story, Theo, about your friend who said his 401(k) went down 50% – think about this; you’ve got a 401(k), it goes down 50%, so now what do you have to earn on the 401(k) to get it back to where it was? 100%. That’s just nuts; that’s a mind trip to me. You actually have to double your money just to get back to where you were, just because you lost 50%. So it’s just kind of a weird thought process.

But anyway, I’ll go into my three takeaways back when, that made me decide to pursue other options, including real estate and making my own retirement account, so to speak.

So number one was, as many of you know, the 401(k) is intended for you to use in your 60s and 70s and beyond. So if you’re the type of individual that wants to retire early, or use cash flow or investments to help you out in life now or in the near future – obviously not a good account, right? Because you’re going to be penalized 10% penalty if you pull out the money early, on top of not a very advantaged tax situation, which I’ll go into I guess now.

Think of it this way – as I mentioned earlier, most of your investment options in a 401(k) are going to be mutual funds.  So if I go to a brokerage firm, like a Fidelity Investments, Charles Schwab, Janus, whatever, and I buy a mutual fund in a non-retirement brokerage account, and I buy today, it’s 10 bucks a share, it goes up to 12. I sell it more than a year later, I have a long term capital gain, and that has a tax advantage to it. For most people, you’re going to pay a 15% tax on that, and it gets capped. For really high-income earners, you might pay 20% and it’s capped. And for low-income earners, you might pay 0%, according to our current tax plan. Not a CPA, not a tax professional, just pointing out from a high level, that’s how it works.

So if I made that same investment, that same mutual fund, virtually speaking – usually institutional class and individual class or whatever, but same thing, S&P index or whatever – in my 401(k) and I held it more than one year and I sell it, same game, same increase, and then I pull out those gains, assuming I’m over 59 ½, I’ll pay up to 37% in tax if I’m a high-income earner, with a proposal outright now from the Biden folks that it could go up to where it was before, which is 39.6%.

So essentially, the takeaway here for anyone that lost me in that conversation is, why would you want to pay double the tax on the same investment you could make privately? Essentially, you’re just paying more in taxes. And to that point, the 401(k), when you pull out the money – it’s not until you pull out the money, but whenever that comes, you’re paying ordinary earned income tax rates. So you’re taking something that otherwise would have a tax advantage, and you’re eliminating it and saying, “No, I’d rather pay the highest taxes on that.”

So Andy asked the question, he said, “When you retire, do you intend to make more income than what you make now, or less income?” And that’s a fair question, because people are going to have different responses to that. But for me personally, it was, “I hope I’m making more money as an investor” right? You’re compounding and you’re making more investments, and so if that’s true, then why do you want to take a tax advantage today, defer the taxes, to pay higher taxes in the future? Why would you want to do that? So that was one of those foundational things. That was number two of my three takeaways.

And the last thing is this – quite simply, anyone who’s got a 401(k) knows this – very much a lack of investment options. I think the MarketWatch put out an article recently about the average 401(k) plan in America has 12 investment options… Twelve. Compared to, again, a brokerage account, where you have 1000s of options. And then outside brokerage accounts, 1000s more of options; you can invest in private companies, and like you and I invest in real estate privately… We have so many things we can put our money in, not 12 options.

So it’s just simply that — when I used to work for a brokerage firm… It didn’t last very long, but I used to do that. This was one of the primary reasons why I left the firm, is because they try to teach everybody – or they do teach everybody – that we’ve got A, B, C, D, E, F, G mutual funds, and those should be right for everybody in one capacity or another. If you’re old, it’s this one. If you’re young, it’s that one. And it just didn’t make sense to me. I thought, “No, there’s so much more to it than just that.”

So those were my three takeaways. I was fortunate to read that book early, and not have a lot in my 401(k). So I paid the penalty and I just got out of it. I started opening my own LLCs and trust and whatnot, and I just did my own private thing, and brokerage accounts as well. So with that, any thoughts, Theo?

Theo Hicks: What you said about the taxes is — when I found that out, I was instantly turned off from the idea of the 401(k). I was like, “This doesn’t make any sense.” I didn’t [unintelligible [00:18:36].07] point of it at that point. The way you presented it, it was really nice, about how you just take that money that you would have put in the 401(k) and invest in basically the exact same thing, and pay half the taxes.

And I think another question you mentioned – the one question was, do you expect to make more money or less money when you retire? Another question that I thought about is, do I think taxes are going to be higher now or when I retire? Again, who knows? But it seems like they’re trending higher; and we can look at like back in the day taxes were like 70%, 80%, or something crazy like that; like, how 30% is kind of low historically. They’re probably going to go up, so why would I forego the most likely lower tax rate now, pull all my money out and do whatever I want to with it, as opposed to having it be used before taxes for these investments? And I pull it out and it’s taxed at 70% in 20-30 years from now. When you think about the taxes, that’s probably the biggest thing.

And I remember all the different packets they gave me for the 401(k), and the corporate world never talked about any of that stuff. They just talked about how great it was, the historical increases of the underlying funds, and something we’re going to talk about here in a second, which is the employee match, and things like that… But never talked about, “Hey, if the stock market crashes, you’re kind of screwed.”

Travis Watts: Yeah, the whole tax situation right now is very parallel to the conversation around interest rates, right? We’ve seen crazy interest rates in the 70s and 80s, same as taxes back then, and now we’re pretty near zero. So it’s kind of like taking a bet on that. What do you think’s going to happen in the future? We could go negative interest rates, I guess, but we’re not going to go negative tax rates, where the government’s paying us. So yeah, something to definitely plan for and think about.

And to your point, I don’t want to make this whole episode seem like we’re bashing 401(k)’s; I’m sure a lot of people are thinking this in their head, if they haven’t already put a comment on here, but what about the match? Isn’t it free money? Isn’t that a great idea? Again, I’m not giving anybody advice, but I’ll tell you this – if and when I was working for a corporation that offered me a 401(k) and they offered a good match; 4%, 5%, 6% or 7%, meaning I put in 100 bucks, they put in 100 bucks, I would always contribute up to the match. When you start going beyond that, that’s a whole different conversation about taxes and risks, and what-if’s, and this and that and the other… But I personally always did the match; my wife still has a 401(k), she does the match, but she stops right there, and she fully intends on taking this 401(k) out when she leaves her employer.

So again, everybody’s different on that. But it is, I guess, you could say, free money; just take it or leave it. They’re either going to give it to you or you’re going to forfeit it; it’s like 100% return on investment without really taking any risk, because you put in 100, they give you 100. That’s a pretty good investment.

So they’re not all bad. I don’t want to paint the picture that way. But that’s definitely a way to look at it, we’ll say. And as they were originally intended, this could be a diversification strategy. There is some asset protection to a point inside of a 401(k), you do have that company match option… This could just be one of your assets, basically; think of it that way. That’s just one investment that I have. The average millionaire has 7+ income streams. It’s not really an income stream, but it’s an asset that you could turn into an income stream in retirement. So that’s the way I would look at that.

And man, I just couldn’t agree more with Andy Tanner that investing needs to be a life skill. You don’t have to be an expert in all this; you don’t even have to read his book, but you just need to understand from a macro level, the tax code, the history of some of this stuff, the pros and the cons of these different accounts, because it really is a tragedy when folks finally get it, but they’re in their 50s or what have you, and it’s, “Ah, shoulda/coulda/woulda”, and “I wish I never would have done that. I should have done (whatever it is) whole life insurance when I was 18” and all these things. It’s better to try to get on the ball early, get to understand how these work so you’re not in that situation, trying to live off a menial social security and a 401(k) that’s not really going to bail you out for more than 10 years or something like that. So those are my closing thoughts on it. Anything else you’ve got, Theo?

Theo Hicks: Yeah, there’s one other benefit that we didn’t talk about – the fact that you are able to, at least last time I looked into 401(k), which was a while ago, but I’d imagine it still exists, is their ability to take a loan against your 401(k). I can’t remember exactly what the interest rate is; maybe it’s like 5% or something. And you obviously had to pay it back. I’m not even exactly sure what the requirements are and what that money is used for. I don’t know if you can just take it out and go on vacation or something, I don’t know what it is. The same buddy whose 401(k) halved, I think he took the maximum loan at the time, which was $50,000, to invest in real estate. So obviously, you need to figure out what the requirements are for paying that back. But it kind of reminds me of like the whole life insurance strategy where you can take a loan against it, use that money to maybe do like a BRRRR strategy, or a shorter-term passive investment strategy. And once you get that money back, hopefully, like doubled or increased by 50%, you put the original 50K back in there and then you use the profit plus another $50,000 loan, and keep repeating that process over and over again. That’s a way to leverage the money that’s in there, but it still doesn’t take away everything else we talked about, about the 401(k). But you are able to take a loan against it.

Travis Watts: Yeah, great point, Theo. Every 401(k) plan is going to be slightly different, so interest rates might vary. Some people may not have the ability to take the loan out, others may. Sometimes it’s 50% of your vested balance, sometimes it’s 100%… So check with your employer HR your plan, if you have one.

But I think just from a high level, the takeaway here is that – is it right for you to have a 401(k)? Is it right to max out your 401(k)? Is it maybe the right strategy just to do the match on your 401(k)? These kinds of things. And ultimately, I think it could be a good diversification strategy as I pointed out earlier, if nothing else, if you have the option to do it. If your employer is not going to match you and circumstances are different, you’re not going to stick with that job very long, maybe it’s not the right thing for you.

But anyway, those are some of the things. The book is 401(k)aos, Andy Tanner. It’s a good read if you want to dig a little deeper into it.

Theo Hicks: Perfect. I guess one more maybe closing thought for me that I thought of is that – it’s kind of one of those things where it’s like if you already have your 401(k) or you’ve been maxing it out, it’s not the end of the world. But the question you need to ask yourself is, now that you have this information, what’s the next step? So if you’re a high schooler or you’re in college and you haven’t started working yet and you plan on maybe doing a corporate gig, but you also want to invest on the side, you’re going to be presented with information on a 401(k), and you’re going to have to ask yourself, “Is this something I want to start doing?” If you already have a 401(k), then ask yourself, “Do I want to continually invest the same amount of money in that 401(k)? Do I want to stop and maybe start taking loans out against it? Or do I want to pull that money out, take the penalty and then apply that to something else?”

So as Travis said, I guess the idea wasn’t just to completely bash on 401(k)’s. The idea is to present information on the 401(k), and you decide what to do moving forward… Not to say, “Hey, you’ve invested in a 401(k). That’s a horrible idea.” It’s like, “No, here’s information.” This might be a great idea for you, but most likely if you’re listening to this and you’re an investor, it’s probably not. This is more for people who aren’t investing, and it’s better than doing nothing. But the main point is that, “Okay, I have this information. Now what am I going to do?” as opposed to maybe thinking back  “Over the past 20 years I’ve invested my 401(k) – was that wrong, was that bad?” That’s over. Now, what are you going to do?

I’m really glad we got to talk about 401(k)’s today. That’s definitely an interesting topic, and I definitely learned something from this, specifically about why the 401(k) started. I always wondered, I was like—another thing I want to know is, why do the companies match? Why do they give you free money? I’d be curious to know what’s behind that.

But anyway, Travis, as always, thanks for joining me today. Best Ever listeners, as always, thank you for listening, happy belated New Year, and we’ll talk to you next week.

Travis Watts: Thanks, Theo. Thanks, everybody. Take care.

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