Pros and cons of relying on a 401(k) for retirement savings
Jim’s consistent 401(k) contributions have helped him grow his net worth, and there are plenty of benefits for Jim if he were to continue investing as he's done.
- Simplicity: After signing up for a 401(k) with his employer and setting up automatic deposits from his paychecks, Jim can continue investing in his 401(k) without lifting a finger. He doesn’t have to work with a financial advisor, nor does he have to manually transfer funds from account to account. Just set it, and forget it.
- Tax benefits: Jim can contribute to his 401(k) with pre-tax dollars that give him the benefit of tax-deferred growth, and getting a tax break for contributions makes investing more affordable.
- Employer matching: Many employers match 401(k) contributions, including Jim's employer, so Jim is essentially receiving free money when he invests in his 401(k).
However, there are also drawbacks to keeping all of your retirement savings in a 401(k).
- Limited investment choices: Many 401(k) accounts offer fewer options for investments, so Jim is limited in what he can invest in.
- Lack of liquidity: Since the IRS imposes a 10% tax penalty on 401(k) withdrawals made before full retirement age, Jim’s savings aren’t easy to access. This will make it tough if he ever decides to spend some of his savings on a big purchase, such as a house.
- Potential fees: Depending on your 401(k) plan and the investments available, you may be stuck paying higher fees and buying investments with higher expense ratios.
Employer-matching funds make investing in a 401(k) worthwhile, so Jim should continue investing enough to earn the full match from his employer. However, beyond that, some of the downsides to keeping all of his life savings in a 401(k) could be significant.
Since he’s worried about how the stock market is going to perform in the Trump era, Jim could do well with a few more investment choices at his disposal.
With this in mind, it may be smart for Jim to invest just enough into his 401(k) to earn the full match from his employer, while also diversifying his portfolio with other investments, allowing him to gain exposure to assets that may be less impacted by Trump's policies.
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Learn MoreNavigating economic uncertainty under Trump
While there are benefits to investing money into different kinds of assets and accounts, it's important to have perspective on the potential impact of Trump's policies.
For Jim, he’s 30 and is likely decades away from retirement. If the stock market were to continue to struggle under Trump’s policy decisions, Jim would have plenty of time to recover before he calls it a career. No one wants to lose money, but Jim is young and has time to make up for any potential losses before he retires.
Tax policies may also change in the decades leading up to Jim’s retirement, which means he shouldn’t assume that policy changes under Trump are going to impact the taxes that Jim will be paying in 30 or 35 years.
While Trump’s second-term policies are cause for concern, Jim shouldn’t be making investment decisions based on short-term worries. After all, Trump’s second term will come to an end long before Jim decides to retire.
Instead, Jim would be wise to follow some best practices that apply to any investment strategy, regardless of the political climate or the president currently occupying the oval office.
- Create an emergency fund for surprise expenses and, in Jim's case, to help see him through a potential recession. Experts recommend saving three-to-six months’ of expenses in a high-yield savings account.
- Invest 15% of income in a mix of different accounts and assets to limit risk. One option is to set up a brokerage account, where Jim can invest in publicly-traded assets such as stocks, bonds, mutual funds, ETFs and derivatives.
- Invest for the long-term, so that you don't let short-term fear cause you to make rash decisions.
If Jim were to continue investing enough into his 401(k) to earn his match, while also picking other safe and well-researched assets for investment, what happens during Trump's presidency may not be as significant as he may believe. With this strategy, Jim has a good chance to set himself up for success no matter what happens with this administration.
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