Ask an advisor: Could I invest my retirement savings better than my 401(k)?

Ask an advisor: Could I invest better than my 401(k)?

November 9, 2023 6:23 PM

A young retirement saver is at a crossroads: Should he contribute more to his 401(k) or double down on his own investments?

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

Contributing to a 401(k) is, in many ways, an act of faith. Handing over a cut of every paycheck, we trust the faceless money managers behind the plan to guide our money into safe, reliable and — in the long run — profitable investments that we'll one day rely on to fund our retirement.

But in the back of some savers' minds, a nagging question lingers: Could I do better on my own?

At its root, this question is a form of the age-old debate between active and passive investing. Is it better to cherry-pick individual stocks, or to simply load money into an index fund that represents a broad swath of the market — and then wait?

Multiple studies have shown that the latter approach works better in the long run. Researchers at Morningstar, for example, found that only 43% of active funds outperformed their passive peers in 2022. Plus, Warren Buffett himself has recommended the "set it and forget it" approach for most investors.

"If you like spending six to eight hours per week working on investments, do it," Buffett has said. "If you don't, then dollar-cost average into index funds."

And yet the debate rages on, because that question still haunts so many investors: Could I do better on my own?

A young engineer in Providence, Rhode Island, is struggling with the retirement corollary of this question: Could he do better than his 401(k)? Here's what he wrote:

Dear advisors,

How much should I take the D.I.Y. approach to my retirement savings?

I'm a 25-year-old engineer, and I have both a 401(k) and a Fidelity account for my own investments. But the amount I put into each feels arbitrary, and I'm thinking of shifting some money from my 401(k) to my investment account.

My salary is $67,000, and I'm contributing 22% of my paycheck to my 401(k). Every week, I put about $300 in that retirement plan and $100 in my Fidelity account. Right now the Fidelity is entirely invested in the Invesco S&P 500 GARP ETF (SPGP), but I may add new investments in the future.

Is there anything to gain by putting less savings in my 401(k) and more in my own portfolio? All of these savings are for my retirement, but I'm not sure what the ratio should be. How should I divvy it up? 

Sincerely,

Puzzled in Providence

And here's what financial advisors wrote back:

Do both

Riki Cooke, certified financial planner and founder of

2Point0 Financial

in Indianapolis

It is tricky to find a balance between how much should go into retirement accounts vs. a non-retirement account. The first benchmark for your retirement savings should be the company match.

The general rule is we like to see folks contribute 10% to 15% or more (including the company match) to their retirement accounts. But for young people, I think they really should consider putting some of those funds in a non-retirement account for added flexibility. I call those accounts "opportunity funds."

When you're 25, the future is so unknown, so give yourself some added flexibility. Having funds saved outside of retirement accounts makes funding home purchases, sabbaticals, job changes and early retirement a lot easier.

Max out that 401(k)

Andrew Herzog, CFP and associate wealth advisor at

The Watchman Group

in Plano, Texas

I see nothing to gain by putting less of your cashflow into your 401(k). With your current rate of contribution, you're not maxing out your 401(k) yet. If you have spare cash to invest, it should go into your tax-deferred account, not the taxable account. You can avoid taxes now with a 401(k), as opposed to that Fidelity account. Shifting some cashflow from your 401(k) into your Fidelity will increase your taxes today.

You said yourself that these savings are for retirement, so you should take the tax-deferral now, and put retirement savings in a retirement account — a.k.a. the 401(k) — especially if your employer matches to some degree.

Leave room for 'mad money'

Michael Gerhard Hausknost, CFP and network member at

GLG

in Long Beach, California

My initial recommendation is always to pile as much into your 401(k) plan as you can possibly afford, especially during your early professional years. Diversify well in the plan and maximize any employer match. Saving outside of a retirement plan is commendable, but with a salary of $67,000, make sure to also have a (cash) emergency fund for at least six months (but preferably 12 months) of expenses. Once that's in place, by all means, do some of your own "mad money" investing in a regular brokerage account. Later that will become your "fun purchases" account.

Go Roth, young man

Noah Damsky, chartered financial analyst and principal at

Marina Wealth Advisors

in Los Angeles

The first step is to contribute up to your match, and you're already there.

The second step is not to worry so much — just leave yourself flexibility. If you shift contributions from a traditional 401(k) to a Roth 401(k), you can withdraw contributions (not earnings) penalty-free if you need the money outside of your 401(k) in the future. This should give you some peace of mind that even if you "overload" your Roth 401(k) today, you can undo the decision later.

Contributing to the Roth won't give you the tax savings today, but it will give you the tax savings later, plus flexibility today to withdraw contributions penalty-free. The same can't be said for traditional 401(k) contributions.

Depends on what's in them

Jay Zigmont, CFP and founder of

Childfree Wealth

in Water Valley, Mississippi

Keep in mind there are multiple questions here: The first question is which account to keep your money in — 401(k) vs. brokerage — and the second is what to invest in.

The bonus of a 401(k) is that it is tax-advantaged, whether it's Roth or traditional, but the downside is that it is locked away for retirement. At your age and income, you might want to see if there is a Roth 401(k) option, which means you pay the taxes now and it grows tax-free.

Your Fidelity brokerage account has the bonus of being accessible, but it is taxable, and you will pay taxes both on income from dividends and the sale of the stocks.

Once you get past the tax debate, the other concern would be your investing options. If your 401(k) has good, low-cost investing options, then it is probably the best option. If, on the other hand, your 401(k) is full of high-cost funds, then putting more in your brokerage may be a better bet.