The Problem With 401ks

The problem with employer sponsored 401ks is that you're often limited to what the company plan decides to invest in. Now as somebody who works primarily with high net worth and ultra high net worth investors myself, many of whom do have 401ks from their employers or from previous employers, I am on a mission personally to empower people to take responsibility of their own financial future and their financial education and not just to rely solely on passive investments. And the data absolutely backs me up on this one. According to Vanguard's 2026 How America Saves Annual Report, 45% of Americans with a 401k are offered a self-direct option, meaning that the plan that they're in allows them to pick individual companies, ETFs, and securities themselves. But the data also shows that only 1% of people have actually ever taken advantage of it. The problem with employer sponsored retirement plans, not that they're bad per se, they're a lot better than what came before and they're better than nothing at all, the problem is that they were designed so that their beneficiaries never had to make a decision. And when a system is designed so that people don't have to make decisions, then they don't make decisions. But let me show you today why that lack of decision making can actually cost you hundreds of thousands of dollars. Let's start with that one thing that people forget about a 401k. In a regular brokerage account, you have the freedom to invest in whatever you want. In an employer sponsored 401k, you can buy whatever the employer has decided to put on the list. So that's the defining feature of the entire product overall. What exactly goes on to that list? Well, the average Vanguard plans offer a few options. The problem is that majority of them are in target date funds. What shocks me the most is by going through this report, realizing the number of participants that opt to put all of their investments in a single target date fund. And that keeps increasing. In 2025, this number is 61% and it's grown steadily from 56% in the last five years. So imagine putting all of your savings into a single target date fund and then crossing your fingers and setting and forgetting it until you actually retire. I personally believe that if you don't engage in some degree of active oversight over your investment portfolio, then you're basically leaving your retirement up to chance. And like I said, the options are somewhat limited when it comes to employer sponsored 401ks. Only 23% of plans offer a self-directed brokerage window. Only 36% offer any sort of sector diversification or sector funds. And only one third offer emerging markets exposure. It's also not evenly distributed either because companies with more employees tend to offer brokerage windows. Bigger plans get more. 39% of plans with 5,000 participants offer a brokerage window versus 15% of plans where the employer had less than 500 people. 80% of the largest plans offer managed account advice versus 23% when it comes to the smaller plans. Now I don't think that the quality of your retirement should be dictated by how many employees your company has on payroll. Honestly, it just so happens that larger companies can offer more flexibility in their retirement plans, but your retirement shouldn't be impacted for that reason. What exactly are target date funds? It's basically a fund that holds a bunch of other funds. They tend to be a mix of stocks and bonds usually. Basically as an investor, you get to select a target date fund based on your retirement date. So if you are 25 years old today and you plan to retire at 65, you're going to be working for 40 years, you might pick a target date 2070 fund because you intend to retire at year 2070. Target date funds are extremely popular for retirement. They're often used as a default menu option for 401ks. It can be a good option if an investor really just wants to pick one fund without any sort of personalization or customization. The downside with target date funds though is that you are just picking one fund that is not customized to you and that customization can include timing. So if you want to early retire, risk tolerance, your other assets that you have generate you income. It does not account for liquidity and how you allocate your capital. It doesn't account for pensions if you do get one, social security income or what you intend to spend in retirement. It does not account for whether you own real estate or not. If you own a lot of real estate, should you make adjustments to how you invest in stocks? I personally would say yes and I get my clients to make these adjustments. And all of these things that I mentioned should impact your investment decisions. It should impact how you allocate assets. It should impact your retirement plan. Targeted funds, they all have their own glide path, which is basically the schedule of how and when exposure shifts more and more towards bonds and less and less towards equities as you get closer and closer to the target date. In the past, bonds have always been seen as a cushion against equities, especially when there are stock market crashes. But in 2022, this thesis was tested and it started to change because in 2022, when there was a lot of inflation, sharp inflation, interest rates spiked dramatically over a very short period of time. And as a result, it hurt both stocks and bonds. So as a reminder to investors from this experience, bonds don't always provide that protection that we've always thought. So while the traditional 60-40 portfolio can provide some good exposure to most U.S. companies, there's also no magic stock or bond ratio that works for everyone. I personally have clients that are 100% invested in individual equities and also in real estate. And with the stock market performing so, so well in the past three years, there are a lot of people that have been able to achieve early retirement just because of the bull run that we've been in. In target date funds, sometimes the de-risking process starts earlier than people even realize. Vanguard's target date funds begin gradually shifting towards bonds well before retirement. So for example, a 2050 fund already holds a small bond allocation, even though that is roughly 24 years away from today. And so with the way that these defined contribution plans are set up in the first place, a lot of times placement tends to be permanent. It's staggering that there are so many participants in this report that just hold a single target date fund. The median number of funds used across 4.6 million Vanguard accounts is one. My argument against this is that it limits so much upside and it does not account for any sort of individual investor risk appetite and holdings that they might have in other accounts. Putting your entire retirement plan in a single target date fund, especially if you have a sizable amount of capital, is not the best use of capital for retirement planning. 69% of plans offer what Vanguard calls an index core. So these are low cost index funds that cover U.S. stocks, international equities, bonds, and cash. 95% of participants are offered a large cap U.S. index fund and 23% of them actually do use them. So let me show you what that decision has been worth. I want to put two funds side by side. The first is the Vanguard target retirement 2055 fund. So if you are in your 30s right now, this is very likely something that you own. The second is VOO, Vanguard's S&P 500 fund, which sits on the menu in almost every plan in the country. Now over the last 10 years, the target date fund returned 11.65% a year, whereas VOO returned 15.4%. That's a pretty big gap of 3.75 percentage points every single year for an entire decade. Three points might not sound like a lot until you actually let the math run. $10,000 invested at these two rates after 20 years, the target date fund would get you to about 90 grand, but VOO would get you to 175 grand. And after 30 years, the difference is even more dramatic. We're looking at 270k versus 734k. Same money, same markets, just one decision apart. One reported benefit of the target date fund is that it also protects you on the downside. So if you look at the worst drawback year, the target date fund fell 31.4%, whereas VOO fell 34%. Now, again, that's a 3% difference. For one really, really bad drawdown year, compared to all of the potential upside that you're giving up in all of the good years, I would barely call that protection. Definitely not a hedge by any means. I'm not bashing target date funds entirely. They can have some benefits as well. If you take a look at that 2055 target date fund, 90% is in equities. Some of them are in international stocks. Now, international equities for many years would have been a drag to this portfolio, but in 2025, international stock returns had a huge win coming at 32%. And I'll get back to this in a second. One good stat that the report has shown is that the median 401k participant already has 89% of their count in equities. Under 45 years old, around 91%, which is pretty good because only 2% of planned participants are not holding any equities at all. And this number is down from 13% in 2005. So overall, for exposure, plan participants are getting more and more into equities, which is good. When it comes to volume of trades in 2025, 11% of participants made at least one trade in their 401k, which is down from 20% in 2004. If you strip out managed accounts, where basically an advisor is actively rebalancing for the plan participant, only 5% moved any sort of money themselves. For any plan participants that own single target date funds, trading is pretty much at the lowest level possible. Because again, if you put all your money in a single target date fund, the idea is that you would buy and hold and keep it forever. And the data shows that less than 1% of people who hold single target date funds actually do any sort of active trading on top of that. The good thing to infer from this is that people are sitting more and more through volatility. People are not panic selling. But at the same time, if an investor has never logged into their account, they've never actually looked at their allocation, and they never actually chose a fund in the first place, because the plan chose it for them, then they're not really resisting selling, right? So even though 82% of plan participants are registered with website access, only 48% of people are actually using the site in a given year. Now if you were to compare that to anywhere else in retail investing, like for example, if you were to look at Robinhood accounts or you pulled up user behavior across a large number of accounts to get a sample size, I think you would pretty much get the exact opposite of that. You would see constant engagement, probably people picking individual names all day in the same country. And oftentimes, people with active trading accounts, they can check their trading app a couple times a day. And so it's not uncommon. Because this report is only showing Vanguard data specifically, it doesn't mean that a person couldn't have 401k with Vanguard with their employer and then on the side have an active account that they trade, that they check multiple times a day. Two more things you can't control. With the employer match, your employer decides what that is going to be, how much free money you actually get. The spread can be pretty big. According to Vanguard's data, the standard match is about 4.7% on average, and the median is 4%. There's also a very small proportion, 4% of plans that unfortunately do not make any sort of match against what you've put in yourself. Where I see that this can make a big difference, if you made $90,000 a year in annual salary, the difference between an employer matching you at 3% and 5% would be about $1,800 a year. And according to Vanguard, only about 49% of plans do let you keep that match immediately, the rest of them vest them over time. So keep these numbers in mind the next time you're looking for a new job. But plans are also affected by people changing jobs. Because 401ks are often offered as a form of compensation, obviously the longer you stay at a company in terms of tenure, the greater your 401k balance with the company is going to be. Now if you change jobs, your 401k would get rolled into an IRA or could potentially even get cashed out. So sometimes plan balances do not necessarily reflect lifetime savings as well. So right now, according to Vanguard, in 2025, the median account balance is $44,115. But it's not perfect data in that it's not necessarily what the median person has saved. It is what they saved at their particular job related to the plan that the company has offered them. Target date funds are not entirely terrible, they are better than nothing at all. Automatic enrollment plans have a 94% participation rate. Voluntary plans where you opt in yourself are around 64% and employees in auto enrollment plans do save an average of 12.2% of pay including the employer portion versus 7.5%. The counter argument is that going full DIY also has its potential drawbacks too because individual investing can lead to a lot of behavior bias as well. When Vanguard looked at do-it-yourself investors and these stats around people who built their own portfolios, instead of using target date funds, a fraction of them, 24% of them held extreme allocations, 7% had no equities at all, so presumably in ETFs or some other sort of low cost index funds, and 17% of people were 100% all in on equities. So it's all about that risk reward balance. On the bright side, in all of 2025, the average participant received a 19.3% return and the S&P in 2025 returned about 17.9%. The total US stock market was 17.2%. So the average 401k participant did beat the US market because of that international seed exposure that I mentioned earlier in the video where I said in 2025 did really really well, which in an odd year can be a benefit for target date funds. So the actual problem when it comes to 401k isn't just necessarily that you are forced to pick a target date fund. The problem is that the system was designed so that people don't make decisions. Decisions are made for you. That's why it's called passive investing. And on the other hand, your retirement nest egg is something that needs to last you for 2030 and even up to 40 years. And by just leaving it in a single target date fund, you are leaving your retirement up to chance if you don't have additional diversification or extra exposure. And I want to challenge this very specific concept that owning individual equities is something specific to hedge funds, for institutional investors, for wealth management firms that won't take on clients unless you have a million dollars in invested assets. And it's almost like by default, everyone else gets stuck with buying low cost indices or with passive income investing. And I want to, again, challenge that idea because I don't think that needs to be true. So if you take away anything from this video, I would empower you to learn and understand what is inside your 401k. Don't just treat it as this thing that your company gives you that you don't really actually know what's going on inside. So figure out whether you have an index core or whether you have a brokerage window. Look at your investments holistically as well. When you take a look at your entire portfolio overall, take a look at what's in that 401k, but also what's in your Roth IRA as well, what's in your taxable brokerage accounts. Don't just rely on a single source for retirement. Now, with the rise of ETFs and apps like Robinhood, investing has become much more democratic for individual investors, which I think is an amazing thing because you no longer need to have a million dollars in a private banker just to have an opinion about a business or to have conviction about a stock. That never should have been a thing in the first place anyways. But that 1% statistic means that people might not even know that they can. If you guys like this video at all, make sure you like and subscribe and I'll see you guys in the next one. Till next time.