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Saving for Retirement as a Software Engineer

01.03.2014
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How Fees Kill You

Most companies do not manage their own 401k plans. Instead, they outsource it to someone like Fidelity, Schwab or Vanguard. You might think that, like a bank, just having the utility of your money would be compensation enough for these companies. But in reality, they charge high maintenance fees. Most companies pass these costs on to their employees.

As exposed in a 60 minutes episode last year, most employees don’t realize they are paying these fees. Indeed, if you ask your 401k provider point blank about costs, they will likely tell you that there are no fees.

This is technically true, but ingenuous. What is happening is that you elect to put your savings into one or more mutual funds. Those mutual funds have what’s called a load, also known as an expense ratio. The load is a fee; it’s a percentage that the fund managers charge you every year. Average mutual fund loads are in the 1.3% to 1.5% range. Your typical 401k will raises these loads by as much as a full percentage, to 2.3% to 2.5%, and pocket the difference.

That’s the difference between making a 7% return on your investments over time, or making 6%. Here again the magic of compound interest is at work, but this time it’s to your disadvantage. A 1% difference in return rates could cost you 30% of your retirement savings over 45 years.

fees

This is just over 20 years. Notice that the gap is widening over time! Not all providers charge this much. Vanguard, for example, is known for low fees. However, the employee at a company usually has no control over which provider the employer uses.

Index Funds

Even if your 401k provider does not add much load to your funds, you still have the base load of the fund itself. This is the aforementioned 1.3% to 1.5%. These fees go primarily to the bottom line profit of the fund managers themselves, with some portion going to trading fees overhead.

You’re effectively paying these managers 1% of your savings every year to invest your money for you. These are known as actively managed funds. But there are also index funds.

Index funds are not managed by a person, but by an algorithm. They closely follow some well-known index like the S&P 500. As a result, they provide a return rate very close to the overall return rate of the stock market in general, and do it with much lower fees, typically in the 0.1% range.

Do actively managed funds out perform index funds, to justify their extra fees? Many industry experts don’t think so:

Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals. - Warren Buffett

Only about one out of every four equity funds outperforms the stock market. That’s why I’m a firm believer in the power of indexing. - Charles Schwab

Mr. Schwab is talking about a single year. The chances of an actively managed fund beating an index vanish to almost zero over larger times scales:

If you go back to 1970, there were only 355 equity funds. Only 169 of them survive today, so right away you are dramatically skewing the numbers by not counting the losers. Of those 169 survivors, only nine beat the S&P 500 through 1999. - John Bogle

Other Vehicles

There are many other types of retirement savings accounts. Here are a few:

Traditional IRA

Also pre-tax, but limited to $5k a year. There are also income limits. For example, if are married and make over $115k combined, then your contributions to a traditional IRA are no longer tax deductible.

Roth IRA

With a Roth IRA, you put money in after taxes, but the proceeds are not taxed when you withdraw them in retirement. There is a limit of $5.5k. One interesting difference is that you can take funds out of a Roth IRA at any time with no penalty. You can also convert a traditional IRA to a Roth IRA at any time by paying the taxes due. Roth IRAs have their own income limits; you can’t contribute at all as a married couple making over $178k.

403b, SEP, Pensions

These are not commonly available to software engineers.

How to Start

The best time to plant a tree was 20 years ago. The second best time is now. – Chinese Proverb

If you can’t swing $17.5k a year just yet, you can surely do 1% of your gross pay. Getting started is as easy as logging in to your 401k provider’s website, setting a dollar amount and a percentage split of one or more funds. Hopefully you now have some idea of what funds to pick. But you can hardly go wrong! Saving something in ANY account is better than saving nothing.

Many providers allow you to automatically increase your percentage over time, say by 1% a year. Another common tactic is to start low, but when you get a raise put the additional amount into your 401k.

More Reading

For those interested, I would recommend the following resources:

Published at DZone with permission of Chase Seibert, author and DZone MVB. (source)

(Note: Opinions expressed in this article and its replies are the opinions of their respective authors and not those of DZone, Inc.)

Comments

Seb Cha replied on Fri, 2014/01/03 - 10:35am

Oops... This article is a "strong sell" signal. You know what i mean ...

Wal Rus replied on Fri, 2014/01/03 - 7:07pm

The last thing you want to do is to entrust 'funds' and so called experts with your money. The truth of the matter is that inflation if far more productive at eating your surplus then the interest at building it.

So what I choose to do is to pay out all my debts first and educate people that the system built on debt is inherently not sustainable. 

Think 50 year ago: a family could have a very decent life with only man working. One man could support a wife more then two kids, have a house, a car etc. 

What does it look like now? 

What can you tell of the trend? Do you think you want to give money into the hands of people who continue to manipulate the markets in a system that continues to borrow money pushing inflation higher and higher? 


Fixing the system! That should be our primary goal at the moment. Until the system if fixed don't entrust it with your money.  Pay out your debt, I am sure that will take care of the question of where to put the money you've got.

Cej Hah replied on Fri, 2014/01/03 - 3:27pm

If you think the stock market is going to continue to gain 9.5% over the next 100 years, I have a bridge to sell you.

Rick Fisher replied on Sat, 2014/01/04 - 1:27am

 This is a very cynical bunch here :)

Look, whether the stock market returns 9.5% or not, and whether someone is selling something, or not, the fundamentals of the blog are still the same: we as working IT folks *should* invest in our retirement to provide an income in our non-productive years.

7.6m is an ambitious number, but anticipating an amount to return any amount of cash in the future is always wise.

Dave Ramsey (http://www.daveramsey.com/home/) recommends 15% of gross.

And Lastly the wisdom of saving goes beyond this article:
> Proverbs 13:11
   Wealth gained hastily will dwindle,
   but whoever gathers little by little will increase it.

> Proverbs 10:4-5
   A slack hand causes poverty, but the hand of the diligent makes rich.
   He who gathers in summer is a prudent son, but he who sleeps in harvest is a son who brings shame

So get to saving for the future.

Navyn Rajoo replied on Wed, 2014/01/08 - 10:40am

Those who devour usury will not stand except as stand one whom the Evil one by his touch Hath driven to madness. That is because they say: "Trade is like usury," but God hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for God (to judge); but those who repeat (The offence) are companions of the Fire: They will abide therein (for ever). ~ Quran 2:275

Withholds his hand from iniquity, takes no interest or profit, obeys my rules, and walks in my statutes; he shall not die for his father's iniquity; he shall surely live. ~ Ezekiel 18:17

You guys are smart and logical. Seeing the mess, the unfair distribution of wealth, control and slavery of nations through lending of money and compound interest having paid their debt many times over. I'm preaching to the preached. These are just a fraction of reasons why it is forbidden.

Adedayo Abiodun replied on Thu, 2014/01/09 - 10:36pm

I love software folks... See folks churning out scriptures (Bible and Quran).  Kinda appreciate the level of consciousness folks have.  

We deny his existence, yet the non existence of a proof is to some a proof of His existence, greatness, majesty....




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