If you’ve been reading or hearing about the stock market lately, you may be wondering why you’re contributing a percentage of your monthly income to your company’s 401k plan instead of just putting that money directly into the stock market.
Indeed, stories of people who bought stock in Google or Apple early abound on the internet, as do articles stocks about people who followed a gut feeling and struck it rich.
The advantages of a 401k
While a 401k isn’t as liquid as a normal investment account, that isn’t to say that there aren’t any benefits to 401ks. One of the biggest benefits of investing in your company-sponsored 401k plan is the fact that you will likely get some form of an employer match in addition to the percentage of your income you elect to invest. While different employers match a different amount of your contribution, many employers do offer some form of match, which means that if you aren’t contributing to your company’s 401k, you’re leaving money on the table.
A 401k also offers you several tax advantages. For one, when you file your taxes, you don’t need to worry about claiming the capital gains you earn from interest on your 401k savings year-to-year. Additionally, with stocks the contributions you make to your 401k are deducted from your paycheck before taxes are taken out, meaning that you’re saving some money when you contribute to a 401k.
The freedom and challenge of the stock market
While 401k plans are limited to certain allocations and target date funds, investing your money in the stock market is a completely different ballgame. Offering you unlimited freedom — and with it the risk for unlimited success or loss — many people see the potential for making more money by picking the right mixture of stocks and mutual funds.
Stocks can often post incredible gains over the long term, blowing the more conservative interest rates of 401ks out of the water. For example, if you invested in a company like Amazon when it first became public in 1997, you would have made over 100,000 percent of your initial investment. While that ship has sailed for most, there are plenty of trading strategies you can follow to still make impressive yearly gains. The average yearly gains of a 401k are between 5 percent and 7 percent. Meanwhile, stock performance averages out to about 7 percent growth as a baseline, with some stocks performing considerably better over time.
Which option is the best for most people?
When both options have their pros and cons, it can be challenging to figure out which option may be the best choice. That said, there’s certainly one that requires less effort and still puts up good results.
Thanks to most employees’ 401k employer match, investing in your company’s 401k is the safest and most conservative option for investing. In fact, employer matches may make this strategy even more appealing, since a match can effectively double your overall contribution guaranteed, a fact that the stock market cannot boast. However, if you already have a 401k and are maximizing your yearly contributions, there’s no reason that you shouldn’t also look into investing into another form of stocks.
While it is possible to pick stocks that perform better than your 401k, it’s worth noting that this can be harder than it seems at first blush. Choosing to invest in the open market instead of in your employer’s retirement vehicle ignores tax benefits which can ultimately maximize your earnings over time.
You’re certainly entitled to your own course of action if you’re looking to save for retirement, but with consistency and a guaranteed match, it’s no wonder many people prioritize their 401k contributions.