There’s almost nothing more exciting and more enticing, it seems, than something that is free, right? Who remembers the free toy in the Happy Meal, or the free prize that used to come in Cracker Jacks? Today we might like “free WiFi” or “free refills”. We’re sort of wired to get all excited about free things. It’s amazing. People will stand in line for crazy amounts of time for something that is nowhere near the amount of time they sacrifice for it. Yet, it’s something people do all the time. Black Friday is (or used to be, back in the hey day of Black Friday) a great example of this phenomenon too. Although things weren’t given away for free, some things were deeply discounted. It felt to many like “free money”. So, if you wanted to save a few hundred bucks on something, you could stand in line from 3am until the doors opened (I did it ONCE, for a stupid meat smoker at Bass Pro Shops – never again!). People have actually trampled other people in their madness over Black Friday deals. It’s nuts! Anyways, there’s a pretty strong alure to things that appear to be free, but are they really free?
When it comes to personal finances, the enticement of what appears to be free is a big issue. We see it in terms of a “free” employer match on a 401(k), or more deeply, we see it in terms of people believing they can “invest” without putting forth any effort, gaining no knowledge, and somehow they’re going to be able to retire in the manner that they hope for in the future. That’s another form of “free”. We might call it “free returns”.
Today let’s just tackle the “free match”. It’s certainly one of the strongest attractors for employees to want to contribute to their employer-sponsored retirement plans. But, as we all know deep in our hearts, nothing is free. Employers offer group benefits, such as a group retirement plan, for two reasons, to hire and retain employees. They employ something called “the reciprocity rule”, which is a social rule, adopted innately by almost everyone around the globe. The reciprocity rule basically states that if someone gives you something, you are somewhat beholden to give something back to them. Robert Cialdini, in his book Influence, gives this example of how the reciprocity rule works:
The beauty of a free sample, however, is that is is also a gift and, as such, can engage the reciprocity rule. In true jujitsu fashion, the promotor who gives free samples can release the natural indebting force inherent in a gift while innocently appearing to have only the intention to inform.
Similarly, the employer gives a “gift” of a free match, which indebts the employee (engenders loyalty). And if that’s not enough, the employer sets a “vesting schedule” which means the “free match” really doesn’t belong to the employee unless they stay with that employer for at least a certain period of time.
The “free match” certain isn’t free for the employer, but it’s a lot more desirable and feasible than the pension plans of the past. However, over the past two decades in my career, I have seen many employers decrease or even eliminate their matching contribution altogether. It’s becoming unnecessary for them to compete, so they are getting rid of it.
Is the “free match” free to the employee? If nothing is free, what is the cost? In the case of a free match, the employee doesn’t have to wait in line for hours or days like they do for Black Friday. But there has to be a cost. What is it?
To get the match, the employee must contribute. And because not enough Americans are contributing, according to Wall Street’s desires, they have successfully lobbied to get legislation passed that automatically enrolls employees into their employer’s retirement plan (that is, without consent). If the employee doesn’t want to contribute, that’s when they have to do something. Signing up – do nothing. Opting out – you have to do something. Pretty sneaky on Wall Street’s part, forcing people to contribute. But I digress.
In order for an employee to get the match, they must contribute some of the money they have earned to the plan. Another way of saying it is that the employee must give up control and use of the money they earned in order to receive the matching contribution. How long does the employee give up control and use of the money they earned? It depends on when they contribute. A 25 yr old must wait at least 34.5 years. A 40 yr old must wait at least 19.5 years. The rule is the 59.5 Rule. Surprisingly few employees actually know the rules associated with their employer’s retirement plan, but contribute anyways. It’s like playing a board game with a friend, but you don’t know any of the rules. You’re just hoping your friend will play nice. So, the first cost we can clearly see is that we lose the control and use of the money we contribute to the plan, usually for very long periods of time (sometimes many decades).
The second cost is knowledge. Everyone knows that the less you know about something, the more risky it is, and vice versa. However, Wall Street has promoted the idea that you really don’t need to know anything, because they do, and they will manage your money for you. Imagine going into a Casino and the manager of the casino says, “Just hand me your money. I’ll play the games for you tonight, and do it for your benefit. You can use your time and go watch a movie or go to dinner instead. Don’t worry! We’ll take care of you.” The problem is, no one would believe the manager of the casino, but somehow, many believe Wall Street will manage their money in the clients’ best interests, although the evidence suggests otherwise.
What is the cost of investing in something that you have little to no expertise? Potentially, the cost is that you could get scammed. If you aren’t expert enough in whatever is being presented to you, it’s much harder to say no. It’s much easier to be lured by “sales tactics” and slick marketing (or projected rates of return – which is the same thing). The allure of investing in retirement plans (in particular) is the lack of thinking that is required. Henry Ford made a powerful statement about this in his autobiography, My Life and Work. He said, “Thinking is the hardest work any one can do – which is probably the reason why we have so few thinkers.”
The financial industry has promoted the idea that rates of return are tied to the level of risk someone is willing to take. That’s false. It’s a cover up for encouraging the mass public to invest almost entirely blindly. Risk is actually associated with knowledge. The less a person has about something, the more risky it is. What’s also true is that the more someone knows about something, the less risky it is. And contrary to the “risk equals return” false-principle, rates of return increase the more a person knows about what they are doing. The old adage, “knowledge is power”, is true regarding money as well. The opposite must also be true, which is “lack of knowledge is weakness”. Lack of knowledge is the second cost to getting a “free match”.
The last cost I want to talk about, and this is certainly not the last of all of the costs or potential costs, is cash flow. Would a financial institution ever purposely invest their money into something that, by law, would not provide cash flow back to them for decades? Of course not. In fact, cash flow is what matters more to financial institutions than anything else. Why? Because the sooner they get their money back, the sooner they reduce their risk and the sooner they can use the money again to multiply their return. While financial institutions would never purposely invest their money into something that provides no cash flow for decades, they definitely encourage us to do just that. That’s what a 401(k) and IRA is designed to do – provide zero cash flow until at least age 59.5 yrs of age.
Some say “cash is king”. I say, “cash flow is king”. In fact, Robert Kiyosaki says that that’s how you can differentiate assets from liabilities. It’s the direction of the cash flow. If it’s flowing to you, it’s an asset. If it’s flowing away from you, it’s a liability. He says, “The rich buy assets. The poor and the middle class by liabilities thinking they are assets.”
To summarize: There is no such thing as a “free match”. The matching contribution on a 401(k) costs something. In fact, it’s likely an enormous cost. 1) No control or use of your money. 2) Little or no knowledge of where the money is being invested, which means high risk of loss. 3) No cash flow for decades. Again, financial institutions would never do what they are encouraging you and I to do with our money. Not even for a “free match”.
Whenever you hear the phrase “free” anything, you naturally and rightfully feel to question it. In your mind you think “What’s the catch?” Those are prompts from your brain telling you that there’s more to the story. You should always stick with the knowledge that tells you nothing is free.
