August 26, 2019: Employer 401k Match: Yet Another Free Lunch Not To Be Missed

Aug 27, 2019 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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For regular SAA and TAA portfolios, the next re-balance will be on Monday, September 9, 2019. You can also find the re-balance calendar for 2019 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Employer 401k Match: Yet Another Free Lunch Not To Be Missed

People tend to be very short sighted and possess strong inertia (a stronger word: laziness). For years, we have detailed a low interest rate phenomenon: with some small efforts, one can get a much higher interests (as much as 1-2%) over their bank and brokerage cash by switching/transferring to a high paying money market fund (such as a very safe Vanguard Federal Money Market fund (paying as much as 2.12% at the moment) or a high yield savings account. Other examples are investing in index funds with much higher expenses instead of much lower cost index funds that track the same indexes. 

Speaking of missing out free lunches, we see another obvious one in retirement investing: employer matching contributions that are totally free and no risk. In this newsletter, we look at the latest (2018) Vanguard’s retirement plan studies and see how people save.

Some data in Vanguard 2018 retirement plan studies

Vanguard’s studies is drawn from its 1,900 qualified plans with about 5 million participants. Here are some key data from the studies:

  • Participant rate in 2018 is about 74%. This means about one quarter of employees didn’t contribute to their employers’ plans. 
  • Plans with automatic enrollment have 91% participation rate while those with voluntary enrollment have only 60%. Talk about insensitive to one’s retirement future. 
  • Average account balance for Vanguard participants was $92k while the median balance was just $22k. 

About 95% of plans provide some sorts of employer matching contributions. Unfortunately, there is a wide variation of employer-matching formulas. In 2018, Vanguard estimated more than 150 distinct match formulas. Most common one is so called single-tier match formula, such as $0.5 on the dollar on the first 6% of pay. Other types include multi-tier formulas like $1 per dollar on the first 3% and then $0.5 per dollar on the next 2% of pay. There are also maximum dollar cap on the matching contribution. 

The $0.5 per dollar on the first 6% of pay is the most commonly cited, about 1 in 5 plans provided such a match formula, covering 13% of participants. 

The following chart shows that about 1 in 3 participants didn’t fully take advantage of the match, i.e. had contribution that didn’t maximize the employer matching contribution: 

Employer-matching contributions

So now we know that about one third of retirement plan participants didn’t contribute enough to maximize out their employer match. Some common sense on why you shouldn’t do so:

  • The typical 3% employer matching contributions is like a free raise of your pay, much higher than the average 2% salary increase in 2018. 
  • In fact, this 3% ‘raise’ is actually better than a normal 3% salary increase as the 3% match is before tax. This is especially beneficial to those who have contributed maximum ($18,500 $24,500 for 50 years or older) as the employer match is not subject to any IRS contribution limit. 

Of course, there are quite some detailed restrictions on employer matching contributions that include vesting schedule (how long you have to be with the plan or with the company), mid-year change of contribution rates etc. Regardless, it’s still very much worth to try to maximize your employer-matching contributions, a ‘free’ lunch.  

Market overview

The inherent danger of the US-China trade war reared its ugly head last week: a tic-for-tat tariff raise wreak havoc an already tired and extended financial market. Stocks registered yet another wide ride. S&P 500 index closed at 2847 last Friday, just a bit above its 200 day moving average. On the other hand, as we have shown many times, NYSE composite index, small cap and mid cap indexes had all closed down below their 200 day moving averages. Fundamentally, the current trade war is increasing uncertainty in business investments and thus decreasing business confidence. This, along with the tariffs enacted, will and have affected consumer confidence that eventually will weaken economy in the near term. 

The upcoming recession (there will be one for sure, it’s just a question of when, not why) will most likely be induced by global market/trade realignment because of countries’ protectionism or whatever you call it. This will surely strain external (foreign) supply, raising import costs. In such a scenario, conventional lowering interest rate/quantitative easing policies will no longer be effective, in fact, if anything, lowering interest rate and/or quantitative easing will depress the country’s currency which in turn will increase import costs, a vicious cycle. At any rate, investors should not be delusional. We are now entering an era that’s very different from the past 30 years or so. 

This also means the investment methods that have worked well for the past 30 years or so might not be effective for the coming years. It’s important to review one’s investment portfolios and manage risk accordingly. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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