Advanced Personal Finance

For many people (me included), maxing out both a 401(k) (or 403b) and Roth IRA isn’t feasible. (Ok - for us, it’s feasible, we’ve just chosen to go a different way with our money.) Everyone must make the same decision with their money - how to allocate it. You could max out a Roth IRA, but maybe you’d rather eat out often. That’s a perfectly valid decision assuming you’ve actually made the decision consciously.

So if, like many people, you’ve decided maxing a 401(k) and Roth IRA is an either/or proposition, you have a big decision to make.

Is it better to save in a 401(k) or a Roth IRA?

Here is a head-to-head comparison of the 401(k) and Roth IRA. Assuming you’re eligible for both, this guide should help guide you to the right retirement savings account for you.

• Investment Options

Many 401(k) plans offer an inappropriate number and type of investment choices. Plans can have either too many or too few choices. Too many can cause investor paralysis or a ‘little bit of everything’ allocation. Too few choices can cause a dangerous overweighting in one asset class and other problems. Another problem with 401(k) plans can be the investment options themselves. Funds that are expensive in terms of load and/or management fees directly and dramatically affect your account balance at retirement.

On the other hand, a Roth IRA can be invested in almost anything. You can invest in Exchange Traded Funds (ETFs) with their low-fee advantage. You can choose mutual funds, fixed income assets (e.g. bonds), Real Estate Investment Trusts (a kind of real estate ‘mutual fund’), or most anything else. Being able to invest in whatever you want obviously is a great advantage because you’re not limited to your company’s investment choices.

Advantage: Roth IRA

• Access to Funds

You might need access to your savings prior to retirement for any number of reasons. While it’s almost never advisable to withdraw money you’ve saved for retirement before actually reaching retirement, circumstances sometimes dictate that course of action. For example, an extended job loss may require you to dip into retirement savings.

Most 401(k) plans offer an option to borrow some of what you’ve contributed. If you take this route, you pay the money back just like any other loan. Effectively, the loan payment comes right out of your paycheck and goes back into the 401(k) account.

The main thing to note about 401(k) loans is that, with most plans, you must pay any remaining balance in full immediately upon leaving your place of employment. If you can’t, the loan becomes a distribution with all the major disadvantages that come with those.

You can get money out of a Roth IRA in an emergency, too. There are two major differences with a Roth, though. First, the money you take out is not a loan. You can’t put the money back into your IRA once you take it out. That’s a major downer because you’re forgoing all the compounding that money would have had until retirement.

Second, you can always withdraw your initial contribution penalty-free. In other words, you can get at the money you put into the Roth IRA any time, but cannot get at the gain on that investment without penalty. So if you invested $1,000 and the account balance is now $1,500, at most you can withdraw the $1,000 without penalty.

Advantage: Depends. If you are confident you’ll be able to repay the money and will remain employed until you do, a loan from a 401(k) is the way to go. If the money won’t likely be repaid (e.g. a house down payment), use the Roth IRA.

• Creditor Shielding

The 401(k) is protected from creditors under federal law. You can be forced to surrender part in a divorce, but not in the event of a judgment or bankruptcy.

The Roth IRA, on the other hand, is at the whim of state law. As such, it’s possible a creditor could attach your Roth IRA depending on the state you live in.

Advantage: 401(k)

• Matching Contribution

Some 401(k) plans include a employer match. Typically, for some percentage, your employer will match your contributions. If your plan offers a match, not contributing up to this maximum is leaving free money on the table. There are times, however, when it may make sense to forgo an employer match and save outside the 401(k).

Naturally, the Roth IRA offers no matching contribution. You’re on your own with a Roth.

Advantage: 401(k)

When weighing whether to invest in a 401(k) or a Roth IRA, give these four points some thought. The answer won’t be the same for everyone, but thinking it through will help get you to a nice comfy retirement.

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One of the biggest reasons people shy away from investing is because, to the novice, it’s very confusing. There is a whole universe of choices when it comes to investment options. Even if you know a little bit and narrow it down to mutual funds, there are still thousands to choose from.

To help keep things simple, I often recommend what are called, variously, asset allocation funds, lifestyle funds, or target funds. In short, these are funds of funds that do the work of asset allocation for you. You simply pick a target date (usually it’s for retirement, but not always) and let the fund manager do all the work. It’s Ron Popeil at its best - set it and forget it.

I have been remiss, though, in doing some homework on these types of funds.

It turns out that the asset allocations between similar funds among different fund companies varies wildly.

For my analysis, I looked at three different target date funds for each of the ‘Big Three’ fund companies - Vanguard, Fidelity, and T. Rowe Price. All have very similar cost structures - management fees are below 1% in all cases. All three are reputable, consumer-friendly firms. There is a striking difference, however, in each firm’s apparent risk tolerance.

Vanguard

Vanguard offers target dates in increments of five years. It also has a target fund for those already in retirement. The longest time horizon it offers is a 2050 fund.

Here’s how Vanguard’s asset allocation looks for their 2025 fund:

As you can see, Vanguard has a roughly 80%/20% stock/bond mix. I’d say, for a target date about 20 years out, this mix is pretty decent. For my taste, maybe it’s not quite aggressive enough, but that’s a small point.

What I particularly like about Vanguard’s fund is it invests in indices. Specifically, for the 2025 fund, fully 63% of the fund’s assets are in the Total Stock Market Index Fund. I like that a lot - you’re getting the whole market. If there’s anything to complain about, it’s that emerging markets only get 3% of the fund’s money - to me, a little low.

T. Rowe Price

T. Rowe Price also offers funds in five year intervals. Their 2025 fund looks like this:

T. Rowe Price has the most aggressive stock/bond balance. Fully 85% of the fund’s assets are in stock funds. International funds are 13.5% of assets. Interestingly, only US bonds are represented. T. Rowe Price’s 2025 fund uses actively managed funds almost exclusively. Only one index (S&P 500) fund is listed.

Fidelity

Fidelity has greater ‘granularity’ in its fund offering. You can choose from funds at intervals of two years. As a result, for this analysis, I used the 2024 fund as a proxy. Here’s their asset allocation:

Fidelity is the only one of the three that has anything in cash equivalents, and it holds 14% there for this fund. That’s a shockingly high number. For someone 18 years from retirement, I’d say none of their money should be in cash. Even if you look at a target 2034 fund, they have almost 8% in cash. That’s just too much.

In addition to the cash position, this fund has a less than 40% stake in equities. Again, that number is just too small for someone with almost 20 years to invest. For this reason, I can’t recommend the Fidelity target date funds. Which ain’t so great, because my company’s 401(k) plan uses them.

I was surprised by this analysis. I figured all comparably-dated funds would have more or less the same asset allocation. As this post shows, that assumption couldn’t be more wrong.

This finding kind of sucks because the big appeal of target date funds is their easy application and selection. If a novice investor still has to understand asset allocation, I think these funds have largely failed to address one of the big obstacles to beginning investing, which is really too bad.

Here’s what some other PF writers have written about target date funds recently:

• Jim at Blueprint for Financial Prosperity recommends them after you’ve maxed your 401(k) and IRA.

• Jeremy at Generation X Finance addresses target date funds generally and brings up a good point about overlap in particular.

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Little known fact: You can employ the oft-derided ‘Latte Factor’ while simultaneously continuing to drink your Starbucks cappuccino.

Impossible you say?

Ever wonder why the smallest cup of coffee you can get at Starbucks is a ‘Tall?’

Because it’s not the smallest cup of coffee you can get at Starbucks, that’s why.

Though the menu never shows it and the web site doesn’t mention it, there exists a ‘Short’ cup of cappuccino at Starbucks.

It’s cheaper and better than a Tall. That’s because you get the same amount of espresso as a Tall, just less milk.

So now you can save two zillion dollars by the time you retire and keep drinking your daily Starbucks.

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For some reason, I find getting my friends to actually act and get a will to be one of the toughest sells I try to make. Maybe it’s me and I’m just not a terribly persuasive person. People I talk to about this agree that having a will is a great idea and it’s something they should do. Getting them to do it is something else altogether.

Whenever I mention having a will to friends, I also tell them it’s important to have a power of attorney. A power of attorney is a legal document that allows someone to act on your behalf. You can make the powers conferred on this person as broad or narrow as you like.

A power of attorney is not scary, but not having one is. If you cannot act on your own behalf for any reason (commonly, the reason is medical), your bills still need to be paid. You need a trusted person to take care of things if you can’t.

Here are the 4 bad reasons for not having a will and power of attorney.

“I don’t want to focus on death.”

You know what, neither do I, but we’re all going to die. When you do, you need to know your loved ones and your affairs are taken care of. It’s not really that painful an exercise. Plus, once it’s done, you can stop ‘focusing on death’ unless you have a major change to your life (e.g. birth of a child).

“I don’t have much in the way of assets anyway.”

Maybe not, but you have an opinion on how your money is spent before you die. You should also have an opinion on where it goes afterward.

“I don’t have kids. If I die, my wealth will all go to my spouse by default.”

Absolutely incorrect in many cases. In many states, if you’re survived by a spouse and your parent(s), they share your property equally. You may want your spouse to get everything, but that might not be the case. Note that any assets that are Joint Tenant With Right of Survivorship (JTWRS) do automatically go to the other person. But I’ll bet you have plenty of assets not in that category.

“It’s too expensive.”

It’s really not. A basic will drawn up by an attorney (not a piece of software) might cost between $200-$300. I don’t think that’s too expensive to make sure your wishes are fulfilled when you die.

So getting a will is not hard, not expensive, yet it’s valuable both practically and for piece of mind. You really have no good excuse for not having one. As for us, we have to get ours updated since we have a new child. I’m waiting for the SSN to come in the mail before we go, though.

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I went into Dunkin Donuts to buy some bulk coffee.  I had a coupon, and with it, the whole bean coffee they sell wasn’t a bad price.  A funny thing happened when I went to pay for it, though.  The cashier (are they still called that?) tried to upsell me - and I am actually glad she did.

It seems when you buy one pound of coffee, the second is a third of its normal price.  I had no idea, but the cashier clued me in.

I was surprised by this incident for two reasons.  First, the discount isn’t advertised on the display materials in the store.  Second, I’m sure the woman behind the counter made minimum wage.  The fact that she even bothered to try to upsell me was surprising.

So I was just upsold and I appreciated it.  Who knew?

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