Is it better to invest in 401k or ETFs?
Many ETFs offer tax efficiency due to their structure, but this becomes irrelevant in a tax-deferred retirement plan such as a 401(k). It might be more tax-efficient to choose non-tax-deferrable investments to use in a 401(k) and keep ETFs in the investing portion of your portfolio.
The Bottom Line. For most people, the 401(k) is the better choice, even if the available investment options are less than ideal. For best results, you might stick with index funds that have low management fees.
Furthermore, Colavita says that the intraday trading flexibility of ETFs is another popular feature over mutual funds, however, since 401(k)s are more so viewed as long-term wealth-building accounts, and not trading accounts, plan providers likely don't see value in that trade flexibility feature.
Although 401(k) plans are an excellent way to save, it may not be possible to set aside enough for a comfortable retirement, in part because of IRS limits. Inflation and taxes on 401(k) distributions erode the value of your savings.
Bottom Line on ETFs for Retirement
ETF benefits, including simplicity, low expenses and tax efficiency, make exchange-traded funds a worthwhile investment for retirement. Popular types of ETFs for retirement include dividend ETFs, fixed-income ETFs and real estate ETFs.
Pro: You'll Save on Taxes While Working
When you contribute money to a traditional 401(k) plan, the amount is deducted from your salary. You won't be taxed on it during the year you make the contribution. If you earn a salary of $100,000 and place $20,000 into a 401(k), your taxable income will be $80,000 for a year.
- Greater flexibility in contributions.
- Employees may contribute more to this plan than under IRA plans.
- Good plan if cash flow is an issue.
- Optional participant loans and hardship withdrawals add flexibility for employees.
- Administrative costs may be higher than under more basic arrangements.
One of the biggest reasons Ramsey cautions investors about ETFs is that they are so easy to move in and out of. Unlike traditional mutual funds, which can only be bought or sold once per day, you can buy or sell an ETF on the open market just like an individual stock at any time the market is open.
Costs Could Be Higher
Most people compare trading ETFs with trading other funds. Yet, if you compare ETFs to investing in a specific stock, then the ETF costs are higher. The actual commission paid to the broker might be the same, but there is no management fee for a stock.
The one time it's okay to choose a single investment
That's because your investment gives you access to the broad stock market. Meanwhile, if you only invest in S&P 500 ETFs, you won't beat the broad market. Rather, you can expect your portfolio's performance to be in line with that of the broad market.
Is 6% too little for 401k?
However, regardless of your age and expectations, most financial advisors agree that 10% to 20% of your salary is a good amount to contribute toward your retirement fund.
However, the general rule of thumb, according to Fidelity Investments, is that you should aim to save at least the equivalent of your salary by age 30, three times your salary by age 40, six times by age 50, eight times by 60 and 10 times by 67.
As a very basic example, if you had $5,000 in your 401(k) today, and it grew at an average rate of 5% per year, it would be worth $10,441 in 20 years—more than double. If you withdraw those funds early, however, you're not only facing a stiff tax penalty, you're losing all of that additional growth.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
Hold ETFs throughout your working life. Hold ETFs as long as you can, give compound interest time to work for you. Sell ETFs to fund your retirement. Don't sell ETFs during a market crash.
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
While 401(k) plans are a valuable part of retirement planning for most U.S. workers, they're not perfect. The value of 401(k) plans is based on the concept of dollar-cost averaging, but that's not always a reliable theory. Many 401(k) plans are expensive because of high administrative and record-keeping costs.
According to Fidelity, there were 378,000 millionaires with 401(k) accounts in the second quarter of 2023, up 10% from the year-earlier period. (Fidelity also reported nearly 350,000 millionaires with IRA accounts, up 13%.)
Some alternatives include IRAs and qualified investment accounts. IRAs, like 401(k)s, offer tax advantages for retirement savers. If you qualify for the Roth option, consider your current and future tax situation to decide between a traditional IRA and a Roth.
- Most plans have limited flexibility as it relates to quality and quantity of investment options.
- Fees can be high especially in smaller company plans.
- There can be early withdrawal penalties equal to 10% of the amount withdrawn before age 59 1/2.
At what age is 401k withdrawal tax free?
Once you reach 59½, you can take distributions from your 401(k) plan without being subject to the 10% penalty. However, that doesn't mean there are no consequences. All withdrawals from your 401(k), even those taken after age 59½, are subject to ordinary income taxes.
As a rule of thumb, you can subtract your age from 110 or 100 to find the percentage of your portfolio that should be invested in equities; the rest should be in bonds. Using 110 will lead to a more aggressive portfolio; 100 will skew more conservative.
Buffett's favorite ETF is the Vanguard 500 Index Fund ETF. Another ETF -- BlackRock's iShares Core S&P 500 ETF -- owns the same stocks and has the same expense ratio. Investing regularly over a long period in either of these ETFs has the potential to make you a millionaire.
Risks of Covered Call ETFs
If the overall market declines, the ETF may decline in value, even if it generates income through the sale of call options. Option risk: Selling call options also comes with its own set of risks.
The Inverse Cramer ETF (SJIM) will be liquidated in February, according to a filing with the Securities and Exchange Commission. The actively managed thematic ETF aimed to make investments that were approximately the opposite of CNBC personality Jim Cramer's recommendations.
