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Does It Still Make Sense to Max Out Your 401k?

A reader wrote in this week to ask:

“Considering the current plight of the stock market, do you still recommend 20-somethings max-out contributions to their 401k’s, or should they invest in something safer like a high-interest savings account instead?”

Should You Contribute to Your 401(k)?

The question of whether or not to contribute to a 401(k) doesn’t have anything to do with the stock market. I’ve yet to see a 401(k) plan that didn’t offer a single bond fund, and most plans even offer a very low-risk option such as a money market fund or a stable value fund. In other words, you can contribute to a 401(k) without investing a dime in the stock market.

So the primary question is this: Is this money intended for retirement? If so, it’s probably a good idea to take advantage of the tax breaks that come with investing via retirement accounts.

That said, there are some circumstances in which it makes sense to contribute to a Roth IRA before maxing out your 401(k). Specifically (assuming you’re eligible to make them) Roth IRA contributions should be a higher priority than 401(k) contributions if:

  1. Your employer does not offer a matching contribution (or you’ve already contributed enough to get the maximum match), and
  2. You expect your tax bracket in retirement to be greater than or equal to your current tax bracket.

Update: As has been noted by a couple savvy readers, an additional advantage of Roth IRAs is that contributions can be withdrawn free from tax and penalty at any time.

Alternatively, contributions to a traditional IRA should be the highest priority if:

  1. Your income is such that you’re eligible for deductible contributions to a traditional IRA,
  2. Your employer does not offer a matching contribution (or you’ve already contributed enough to get the maximum match),
  3. You expect your tax bracket in retirement to be lower than your current tax bracket, and
  4. The investment options in your 401(k) aren’t as good as those you would have access to in an IRA.

Should You Be Investing in Stocks?

As to the implied question of whether or not it makes sense to invest in the stock market, I don’t think that’s changed at all in the last month. The stock market was high-risk, and it still is high-risk. At the same time, it still has higher expected long-term returns than other asset classes.

So, for most 20-something investors, yes, I still think it makes sense to have some of their assets allocated to stock funds. But how much should be allocated to stocks varies from person to person. Some investors are risk-tolerant. Some are risk-averse. There’s nothing wrong with either one–it’s just important to understand which of those two you are, so that you can invest accordingly.

In other words, if you’re feeling the need to use a more conservative asset allocation in the future, that may be a good idea. But, as we discussed last week, remember not to hike the risk level back up (by moving more back into stocks) when stocks start to rise again, otherwise you’ll be setting yourself up for another selling-during-a-downturn scenario.

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  1. 20 something investors should put as much as they can in stocks. Stocks are on sale. You’ll make more buying at $10 /share than at $15/share. If your income is low take advantage of the Roth.
    In 1987 the stock market crashed – down over 20% in one day! In 1988 the word “internet” first appeared in the Washington Post. Think about it! It’s not easy to get a long term perspective. Go back and look at where stocks were in 1988.

  2. >Considering the current plight of the stock market, do you still recommend
    >20-somethings max-out contributions to their 401k’s, or should they
    >invest in something safer like a high-interest savings account instead

    Mike makes a very good point that investments in a 401K don’t have to be stocks- there should be bond and even fixed return investments available… However, especially if you are young and won’t be retiring for over 40 years:

    What makes more sense- buying when stocks are at a high (like 1999) when people feel the market can only go up… or when stocks have taken a beating and people are afraid to invest in the market (like 2009)?

    As long as I’m buying stocks, I know I want the value to be as low as possible so that I can get a better deal on it. So while stocks losing value may not make you feel good- if you are in your 20’s you really should celebrate whenever the market tanks, I even wrote an post about it:

    -Rick Francis

  3. I agree with both responses above, but my feeling is also that 10-20% in bonds or other fixed income is not a bad idea for a tax-deferred account even for a 20-something, as the bonds may help cushion the blow when stocks are at a low, and you also you have more funds available to buy stocks at this time.

    But what I’d really like to know is where the reader above found anything like a “high-interest savings account” in this day and age.

  4. @ Larry

    I was wondering the same thing! Let me know if you find out! 😉

  5. I did a quick Google search- “high interest savings” turned up an add from Ally that turned out to be a 1% interest rate.
    That really stretches truth in advertising… yes, 1% is much higher than 0.1% or 0% but who other than the bank’s marketing department really thinks 1% is REALLY high interest?


  6. A point worth keeping in mind – you haven’t lost or made anything for that matter until you liquidate investments to go to cash for drawing down funds in retirement or otherwise. Many times people walk around like a peacock when the market is higher thinking they’ve made money. The opposite holds when markets are down.

  7. YES!!!
    Contributing to your 401k should have NOTHING to do with what the stock market did this week, month, year, or even decade. In the long run stocks will provide a much higher rate of return an overpriced and very risk bond market at current prices. A combination of CASH (yes, I know it pays nothing) and dividend growth stocks is the combination investors should be looking at now. Find the right asset allocation of cash and dividend growth stocks and forget bonds. I have written an article titles “Sell Bonds and Buy Dividend Paying Stocks” at:

  8. I have been giving this some thought lately…does #2

    “You expect your tax bracket in retirement to be greater than or equal to your current tax bracket.”

    Include the 50% of Americans that don’t pay income taxes? Since they effectively (ignoring EIC) can’t have a lower tax bracket.

  9. As you mentioned in a previous article about the need (or not) for an emergency fund, Roth lets you have an emergency fund without extra savings. If it really is an emergency, you can remove the funds tax free.

  10. Evan: I would say yes. If you’re already in the 0% income tax bracket, another deduction doesn’t do much good, so there’s not much reason to prioritize tax-deferred saving over Roth saving (aside from getting matching contributions from an employer perhaps).

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