Don't Max out Your 401(k)

If you were to get on the Internet and poll the financial
gurus, the message you would get load and clear is: Save
No matter how much you've saved, you will be woefully
short when you get to retirement.

The first suggestion of these pundits? Put money in your
(I will use "401(k) as a surrogate for all retirement
savings plans: 401(k), 403(b), SEP, SIMPLE etc.)
I'm not against 401(k)s. Actually, I'm a big fan. However,
think the advice is wrong.

Here's my message: Save 10% of your income. Put your money in
a savings account. This will become your emergency fund.

Accumulate 10% of your annual income in your emergency fund if
you've got a regular job. 20% if you worry you're on the
brink of losing your job or are self-employed.

For the first 6 months or so, this amount might seem measly
and the whole project might seem like it's not worth it. You
can supplement your saving by putting in money from any cash
gifts, tax refunds, or other windfalls. Don't put 100% of the
unexpected money in your saving. Put 33% to your savings, 33%
toward your credit cards or other debt, and 33% go out and
spend. If you don't have any debt, the proportion is 50/50.

Once you're got a fully funded emergency fund, start saving in
your 401(k).
But even then, don't max out your 401(k). Find
out what your company match is. (Your company match is how
much your company puts into your 401(k) for every dollar you
do.) Instead of putting the 10% of your saving into your
emergency fund, contribute to your 401(k) up to the company
match. If your company doesn't have a match, start putting 3%
into your 401(k). With the other 7% of the earnings you are
setting aside, start saving for a house.

Don't max out your 401(k) until:

You have an emergency fund
You have paid off your credit cards
You have bought a house or condo
(or know that you either have
enough saved for a down payment, or that you will never buy a house.)

That means that
if you are maxing out your 401(k) now and
don't have an emergency fund, stop maxing out your 401(k).

Does this sound like heresy? I'll say it again. STOP.

I recommend this because
the number one thing you can do lower
your financial angst is to have an adequate emergency fund.

Grow up and stop living paycheck to paycheck. Adding to your
401(k) won't lessen your current angst, establishing an
emergency fund will.

What if you try this and, after a year, you haven't
accumulated any savings? In other words, what if you're
incapable of leaving the money alone? Cut up your credit
cards. Start paying for everything with cash. A colleague of
mine, Ken Robinson, has a terrific book that just came out
about how to start saving. It's called
Don't Make a Budget.
If you can't figure out how to save, or if you try and you
just can't do it, get his book.

Sometimes people object to this advice. But Bridget, they
say, money in a savings account isn't doing anything. It's
just sitting there.

I tell them,
instead of thinking your money is just sitting
there, think it's meditating.
Your money is meditating so you
can relax.

Besides, these days, with the Internet, there are
high-interest savings accounts. I like
INGDirect, and a lot of advisors I know recommend Emigrant Direct.

These are online savings accounts that make it easy to
transfer money from your checking account, are insured up to
$250,000 per account by the FDIC, and offer a higher interest
rate as part of their marketing strategy. The two banks I
mentioned have offered high rates for more than 5 years, so I
don't believe their interest rates are one-time teasers.

What's the difference? ING Direct is paying 1.3 percent now.
I saw a recent Fidelity statement showing a money account
earning .07 percent. Chase currently pays .01 percent for the
standard savings account. That means that if you have $10,000
in your savings account, you'd make $130 a year at ING Direct,
$7 at Fidelity, and $1 at Chase. At Chase, you could argue
your money wouldn't be doing much.

But one thing you know for sure is that
it won't be going
down. There's some charm in that. People who have lost money
in the stock market plunge can see a lot of charm in that.


Shameless self-promotion
I've been invited to contribute articles to the
FI Guide, which is a blog of fee-only financial
planners. My recent article "Is Now the Time to Get Into
Real Estate?" is their number one viewed article!

by Bridget Sullivan Mermel