Let’s talk about 401k and outline the benefits and drawbacks of investing in it. As you might already know, 401k is a retirement plan that was created back in the 1970s when people wanted an option to a defined benefit plan. The 401k plan came into being as a defined contribution plan, meaning you could say how much you are going to put into it but not so much how much is going to come out. Back then corporations put it together as an option for top executives who had extra money that they needed to live on and they wanted a tax qualified plan to put money away for retirement. What happened next was the stock market took off like a rocket and these 401k plans were outperforming the defined benefit plans that many people had at that time and people started asking to change their defined benefit plan, which supported a fixed amount, into something that can grow with the stock market. So 401k’s became a boon to corporations. They no longer had to worry about supporting their retirees. They could just worry about getting the retirement money into an account and then it was up to retirees about what happened to it. So is it really worth putting your money into a 401k? Let’s uncover that.

Investing is almost always better than not investing and that is the first answer to the question. 401k is absolutely worth it and making more money with your money is the best way to grow your wealth over time. If you have an employer that is going to match your contribution then 401k is something you should absolutely do. It is the largest retirement chunk you can put away pre-tax of most of the things people can get their money into. So having your employer to match an amount of money that you invest in your 401k is a really good thing. Essentially it enables you to double your investment right out of the gate if they match dollar-for-dollar and this is something that is certainly worth taking advantage of for sure.

At the same time, if 401k is your only investment for retirement there are a few things you should know about the downsides of a 401k. Just because investing in a 401k is the most common investing strategy with corporations it does not mean that it is the best. The first thing is you usually have a limited number of things you can invest in. The reason corporations do that is because they are afraid that you will get angry if you lose your money and sue them for letting you do it yourself. They usually restrict you to mutual funds, ETFs, and money market funds. The downside is that you could be missing an opportunity to make much more rewarding and much more profitable investments.

Another downside is 401k fund managers are paid very generously for their services and they generally love these kinds of accounts. They get payment that comes out of your pocket regardless of whether the fund is earning money or not. That means that even when your 401k is performing poorly you are still being charged a fee by the administration of the 401k. Unfortunately almost all providers operate under that model. In fact when Vanguard’s founder John Bogle took a look at what goes on in most 401k programs he was appalled at what happens to the account size by the time you retire.

Limited investing options is the next downside of investing in 401k. When you invest in a 401k you do not have enough choices regarding how and where your money is invested. All the money invested in many 401k’s ends up in mutual funds and ETFs. The problem is these funds almost always fail to outperform the market average. In other words, simply putting your money into an index such as the S&P 500 and leaving it there with zero management would still net you more returns than you are likely to see when you invest in a 401k. One of the reasons why mutual funds fail to outperform the market once again goes back to the fact that the managers of these funds charge a considerable fee for their services and invest in broad diversification that shadows the market.

Over diversifying your investment portfolio in a 401k through mutual funds and ETFs does not inherently mean that you are lowering your potential for risk. Diversification through mutual funds does not protect against the market drops. You are essentially banking on the whole market going up and of course the market does not always go up. In a period of decline having an over diversified portfolio means your portfolio is going to decline along with the overall market. You do not necessarily face as great a risk if you are investing in just a few stocks that you have carefully chosen, carefully researched and bought. Risk could be much lower and returns much higher.

You will be much better off setting up an IRA and choosing for yourself the companies you want to invest in. If you want a big pile to retire and live well, invest in individual companies using an IRA or a Roth. IRA enables you to enjoy the same tax benefits offered by a 401k while also avoiding the fees charged by fund managers and the risks that come with over diversification. And what is even more important is having the ability to choose the companies you invest in enables you to apply various investment strategies which will lead to much better returns.

So stick to the employer match but investing anything more than that in a 401k is a wasted opportunity. You would be better off to open an IRA account and invest any additional money in it and manage it yourself.