Chris Odegard from EP22 of the Money Seed Podcast prefers to invest his money outside of a 401k. But do the numbers add up?…(read more)

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As an individual investor, you have a plethora of investment options to choose from. Two primary investment vehicles, which are often compared against each other, are 401k and non-401k investments. Both have their own advantages and disadvantages, and choosing the right one as per your investment goals and risk appetite is crucial. As an AI language model, I will try to explain the mathematical aspects of these two investment vehicles in the simplest language possible.

What is a 401k?

A 401k plan is a type of retirement savings plan, commonly offered by employers. It allows employees to contribute a portion of their salary to a tax-deferred retirement account. The contributions are made before taxes, which means you don’t have to pay taxes on that amount until you withdraw the money during retirement.

The employer may also offer a match on the contribution, which means they will contribute a certain percentage of the employee’s contribution to their 401k account. This gives a significant boost to the employee’s retirement savings.

What are non-401k investments?

Non-401k investments are those that are not associated with employer-sponsored retirement plans. These include investments such as individual retirement accounts (IRAs), stocks, bonds, mutual funds, real estate, and other assets that can be bought or sold in the open market.

Comparing 401k vs non-401k investments

To compare the two, we can use a mathematical model that takes into account various factors such as contribution amounts, tax rates, investment returns, and fees.

Consider two investors planning to retire in 30 years. One investor contributes $10,000 annually to their 401k, while the other invests the same amount in a non-401k account. We will assume a tax rate of 25%, and an annual investment return of 7%. We will also assume that both investors pay fees of 1% annually.

The 401k investor’s contributions are made before taxes. As a result, they will pay $2,500 in taxes (25% of $10,000) and contribute $7,500 to their 401k account. Assuming an annual investment return of 7%, and an annual fee of 1%, the 401k account will grow to $901,813 after 30 years.

On the other hand, the non-401k investor will pay taxes on their $10,000 annual contribution (25% of $10,000 = $2,500) and contribute $7,500 to their non-401k account. Assuming the same investment return and fee, the non-401k account will grow to $707,429 after 30 years.

So, in this example, the 401k investor ends up with a significantly higher retirement savings than the non-401k investor, thanks to the tax-deferred nature of the contributions.

However, it’s worth mentioning that 401k accounts have restrictions on when and how you can withdraw your money. Moreover, the fees associated with 401k accounts may be higher than those associated with non-401k investments.

In conclusion, the choice between 401k and non-401k investments depends on a variety of factors, such as your income, investment goals, and risk appetite. Utilizing a mathematical model like the one shown here can help you make an informed decision and ensure that you’re on track to meet your retirement goals.