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I've been working for a company that offers me a MassMutual 401(k) plan as a benefit. The employer's match is 50% of my contribution. I've contributed 3% of my gross salary to the plan, and planning to increase it. All the money in my plan is invested in a mutual fund- Vanguard Retirement Fund (one of the mutual fund options). My question is - Is it safe to invest in a 401(k) plan?

This is what I found on Investopedia:Why Is My 401(k) Not FDIC-Insured?:

"The good news is that deposits contained within a 401(k) are covered if the plan is administered by a FDIC-insured financial institution. Checking accounts (including money market accounts), savings accounts, and certificates of deposit (CDs) are considered deposits and insured by the FDIC"

Assuming MassMutual is FDIC-insured or has some kind of insurance, then the account is safe. But, what if the mutual fund goes bankrupt? Is that possible? If that happens, my account will hit zero?

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    The value of a mutual fund is the value of the underlying stocks (or other securities like bonds &c that it invests in). Unless the company is being run by a scam artist (see e.g. en.wikipedia.org/wiki/Bernie_Madoff ) it can't really go bankrupt. The company that runs the fund could go bankrupt, but the investments should still be there. – jamesqf Oct 28 at 16:20
  • Is the employer match limited or capped in anyway? Will they always match a flat 50% or is there an upper limit to the percentage they will match? – Freiheit Oct 29 at 16:39
  • @Freiheit It's almost 50% flat. In fact, it's calculated as follows: up to 1% of my compensation, company's match is 100%. 1% to 6% of compensation, company's match is 50%. And, the Match contributions may not exceed 3.5% of my pay. – domino Oct 31 at 10:24
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Mutual fund investments within a 401(k) plan (or outside a 401(k) plan for that matter,) are NOT covered by the FDIC regardless of whether the plan administrator is FDIC-insured or not; they are not on the list of things covered by FDIC insurance. So, you have no FDIC coverage to keep your money "safe" when you invest in a mutual fund. Mutual funds rarely go bankrupt because mutual funds that are "in trouble" are usually merged into other mutual funds by the investment company running the funds. So, your investment will never hit value $0 though you may end up getting back less money than you put in. If you are investing in a Vanguard Retirement Fund, I strongly recommend that you worry about things other than the possibility that you will lose money if the fund goes bankrupt.

Note: I wish to emphasize that the last sentence above is not intended to suggest that that there are many things about Vanguard funds that one should be worried about (cf. Tracy Cramer's comment). All my retirement money is in various Vanguard funds (of which there are plenty that are not index funds, contrary to Barmar's assertion) though not in Vanguard Retirement Funds. The Vanguard (Target Date) Retirement Funds are funds of funds meaning that the Retirement Funds invest their money in other Vanguard funds and the composition of these investments changes from a more speculative "more stocks and fewer bonds" mix to a more conservative "more bonds and fewer stocks" as the target date approaches. There is, of course, a small fee (over and above what the other Vanguard funds are charging as their own expense ratio) for this rebalancing service that one pays to the Vanguard Retirement Fund, and this fee can be avoided by investing in the underlying Vanguard funds directly and doing one's own rebalancing within the 401(k) plan. But this requires enough money in the 401(k) plan to meet the minimum investment requirements for the individual funds, and of course, having these mutual funds available as investment options in the 401(k) plan. Many 401(k) plans have only a few investment options available within the plan. I repeat: I see nothing to object about or pooh-pooh regarding the OP's choice of investing in a Vanguard Retirement Fund. It is a good choice for one just starting a career.

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    Maybe you should tell OP what those 'Other things' are ? – GamerGypps Oct 28 at 9:08
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    @GamerGypps Sorry, that was a typo. What I meant to write was "... worry about things other than...." rather than "... worry about other things than....". I have corrected the typo. Besides, I do not want to put new ideas in the OP's head; he has enough to worry about based on what he reads on the Internet anyway. – Dilip Sarwate Oct 28 at 14:02
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    Vanguard funds are all index funds, AFAIK. If you're going to invest in the stock market, it's probably the safest vehicle. Of course, if there's another recession like 2008, it will lose value. – Barmar Oct 28 at 16:00
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    Are you suggesting there are other things wrong with the Vanguard Retirement Fund (like fees or mismanagement) than it going bankrupt - or other things completely outside of retirement fund investing? – Tracy Cramer Oct 28 at 19:24
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    @GamerGypps, and Tracy Cramer, I think Dilip Sarwate, meant that OP shouldn't worry about the Vanguard Retirement Fund going to $0, but to worry about other things such as whether it will rain tomorrow, or if the major powers will nuke each other - you know, things that are more likely to happen. – Glen Yates Oct 29 at 15:15
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Investments are usually insured by SIPC instead of FDIC, however it is a different kind of protection. Essentially it just protects you from the broker going under, not the investment losing value.

When you invest in securities there is always some risk of your investment decreasing in value, however if you diversify properly that risk is mitigated pretty well over the long term.

It is important to realize that an FDIC insured cash account isn't without risk either. It is very likely your bank account will lose value to inflation over time unless you are getting a crazy good interest rate (more than 2.5% ish). So if your time horizon for needing the money is longer (5+ years) mutual funds and other equities tend to be lower risk than cash accounts for retaining value of your initial investment.

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"Risk" is a funny word.

If you play Russian Roulette with all 6 bullets in, it stops being risk at that point. That's what you're doing by passing up that juicy employer match. The universal advice with 401Ks is contribute at least to the employer match, because that's free money!

I gather the interior mechanisms of a 401K are a "black box" to you. That's normal when starting into this, but it's curable. For now, you can select uber-safe money-market or bond funds.

But the REAL money is in understanding how investing works, and growth vs volatility, and understanding what that means for risk.

Universities do it...

I manage an endowment, which is a corpus of capital whose investment earnings pay for things like professorships at universities. Needless to say, this money is invested in the most conservative way conceivable, under the watchful eyes of university Boards, who are thick with money experts such as investment bankers. The very law which defines endowments is UPMIFA, P for Prudent. Now here's the eye-opener. Endowments are invested very heavily in the stock market. If I was not, I might have to explain to the Attorney General why not.

And honestly, once you understand how volatility and growth interact, and why endowments are that way, then long-term investment such as in a 401K becomes forehead-slappingly simple. It is easy in a Vanguard retirement find to emulate how endowments are invested. And with Vanguard this can happen at amazingly low annual cost. Our endowment is burdened by about 1.1% management costs. Yours can be about 0.1%. Which is 1%/year guaranteed ahead!

Yes, there is a lot of very complicated stuff in that black box. But 99% of it was put there by investment bankers to confuse the public into buying complex products with high management fees. That is unnecessary!

Locking it into a 401K

You can get your money back out of a 401K by paying a 10% excise tax. The excise tax goes away at age 59-1/2. You will also need to pay income tax on it, but you didn't pay income tax on it before, so that's fair.

So you win with a 50% match. Deposit $2000; collect $1000 match.. Withdraw $3000, pay $300 excise tax. You just got $2700 for $2000. You have to pay taxes on it, of course.

However. Once you understand how investing works, you will realize retirement is the smartest investment a young person can possibly make. When you are getting endowment-style returns, the power of compounding interest gets exponential. $10,000 at age 25 buys you hundreds of thousands of dollars at retirement. Of course, a young person can't possibly know that, can they? And retirement seems so far away.

The far-away-ness is exactly why the compounding is so powerful.

  • A bit off topic, but I'm curious: if your endowment has 1.1% management costs, and Vanguard (or other large mutual fund companies) have 0.1% costs, why doesn't your endowment just buy the funds? – jamesqf Oct 30 at 15:56
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    @jamesqf because somebody has to convince us to do that, and by "us" I mean a quarrelsome Board of Directors with differing experiences and philosophies toward money. Our Board has no incentive to go "full Boglehead" without professional assurance that that isn't suicide, and the professional assurer costs the 1%. – Harper - Reinstate Monica Oct 30 at 16:01
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My question is - Is it safe to invest in a 401(k) plan?

Yes, with the match you're probably safer than FDIC (see last paragraph)

  1. Long term (5+ years) investing in a mutual fund is a good bet.
    Vanguard is one I would consider a good company. I have invested with them before.

  2. You are in an even better position than many people - everything you put in is increased 50%.

    Number 2 Explained:
    a. you put in $100, you get a 50% increase (100+$50=$150)
    b. if your investent goes up, no problem.
    c. However, if your investment drops 33%:
    d. the money that is 'gone' is $50 that you did not contribute
    e. you will still have the $100 value you put in.

    i.e. if the market goes down 33% and (unlikely) stays there...
    you still have all of the money ($100) you put in.


I can't promise you, but I'd say the odds are really good that you will have more in five years than you put in to it.

If you plan to use this money within five years (for the downpayment on a house or something, then stick it in a Money Market account or something FDIC insured) but considering the +50% match this "normally good" advice may not be the best advice for you.

If you put it in for the same 5 years in an FDIC insured account, inflation will decrease the value of your money (even though the amount of money is slightly higher).

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OP Question is, "What if the Mutual Fund goes bankrupt?" in relation to OP's contributions (i.e., the "principal investment") into a specific fund, the "Vanguard Retirement Fund."

Broadly, the risks of investment into any Vanguard Retirement Funds, are detailed in the corresponding Fund's Prospectus. The Prospectus is a legal document made available to investors directly from Vanguard, and also possibly made available through OP's retirement account website.

Here is an example Vanguard Target Retirement Fund Prospectus from Vanguard's website:

http://www.vanguard.com/pub/Pdf/p308.pdf

Refer to the section called "Principal Risks" on page 4:

"An investment in the Fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency."

Therefore, and in combination with the first paragraph which states:

"The Fund is subject to the risks associated with the stock and bond markets, any of which could cause an investor to lose money"

The OP's contributions to the Vanguard Retirement Fund may therefore be at risk of losing an indeterminate amount of money over time, up to and including becoming worthless, simply because the Vanguard Retirement Fund is ultimately investing the money in stocks and bonds.

OP uses the term "Bankruptcy." It is unclear which entity OP is referring to. Generally, there is the previously-discussed risk that companies in which the Vanguard Retirement Fund invests may go bankrupt, ultimately reducing the market value of those corresponding investments.

It is also possible that the Vanguard Retirement Fund itself becomes insolvent due to debt or liquidity issues. Rather than fully explain this scenario, OP could find the answers defined in the Vanguard Retirement Fund Statement of Additional Information (the "SAI").

Here is an example Vanguard Target Retirement Fund SAI from Vanguard's website:

http://www.vanguard.com/pub/Pdf/sai059.pdf

Importantly, in the section called "Shareholder Liability," note the following:

"...a shareholder of a Fund generally will not be personally liable for payment of the Fund’s debts."

So, while it is possible that OP's principal investment becomes worthless, it is not possible that OP's principal investment becomes less than worthless.

There is a further risk that Vanguard as a firm declares bankruptcy. In short, Vanguard is hired by the Vanguard Retirement Fund itself, to manage the Fund, among other things. Again, check the SAI. The Fund could theoretically simply hire other services providers instead of Vanguard, or it could liquidate, giving the OP's money back (at the current price).

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It depends on what you consider risky. When you put your money in a 401(k) you are agreeing to play by the rules of the Internal Revenue Service. Yes your funds may be managed by Vanguard or BlackRock, but the money is not there for you to use or not use as you please, this was a repeated pain point between customers and myself as an ex-employee of Vanguard. "It's my money and I want it now!" was the broken record complaints I had to hear everyday. Your money is subject to IRS rules, you cannot just go get it whenever you want.

Point number two that people forget is that its not a savings account, its a form of investment, albeit passive investment on your part. You are telling Vanguard or BlackRock I am okay with you figuring out how to invest my money and the accepted narrative is that it will be invested wisely.

Point number three, the day you do draw money form your 401(k) it will be subject to a certain percentage of taxation that people who are in the role I used to be will tell you is no big deal. What they don't tell you is, politics change. That tax hit could be much higher ten years from now and if you decide, nope I am not cool with that, there is nothing you can do about it, your money is now in the hands of the IRS for all intents and purposes because its subject to their rules. Again, BlackRock and Vanguard is managing it for you in terms of where to invest it, but they are following IRS rules in regards to everything else that happens to your 401(k).

Point number four, 401(k)s and IRAs lost about $2.4 trillion in the final two quarters of 2008, and the average loss that year for workers who had been on the job for 20 years was, according to one estimate, about 25 percent.

So these are all important points to consider and I would also consider extreme or edge cases that have never happened before but could happen. For example, the government could say hey we are going to hold on to your 401(k)s indefinitely to keep the economy afloat or fund Medicare or Social Security, its a patriotic thing to do and in lieu of this we will cut you a check for $1,000 a month. It's not that far-fetched if Democratic incumbent Andrew Yangs' platform is UBI. You might get that UBI money as a thanks for your patriotism in giving up what you had in your 401(k) to keep our nation strong. Don't scoff, point number four I cited above was never supposed to happen either.

The theme here is you are engaging in an investment tool that is known as passive investment, which means you have little control over its movement. This has been sold as low risk due to frame of reference. In other words, having to figure out where to invest your money is looked at as high risk, but someone trained on Wall Street would look at 401(k) as high risk because of the passivity and lack of control of where to invest, how and when and how to pull out.

So really risky is how you look at it. Do you prefer to go duck hunting yourself, or do you trust that Perdue and Tyson are going to provide you with good quality duck meat?

One of my key points above that I will reiterate once again is as follows, 401(k) plans are often touted because of the perceived tax benefits, but the benefits may not materialize in the long run as tax laws change.

Also, the suggestion that if a Vanguard goes bankrupt your money will still be there, that's not how bankruptcy go. Shareholders are the first to be made whole, what is left after that, if anything then will go to their customers.

Once again, a 401(k) is passive investing, putting your money in an index fund, but its actually exposed to all sorts of systemic risk that you may not be aware of, but more importantly, you do not control the investment of that capital. Don't be passive, take control of your capital, this way you are more likely to get returns that are more satisfying and sustainable in the long run.

  • Note that "the last two quarters of 2008" was one of the most marked downturns in history, and that even with that, the OP would have got out more than he put in (because of the employer 50% match) if he had retired 31st Dec 2008. – Martin Bonner supports Monica Oct 29 at 15:26
  • @MartinBonner, what did he put in it? When did he put it in? Did he in fact retire on the 31st of December of 2008? Can you guarantee him/her that another 2008 event will not happen again? Nevermind that the OP would be okay with a 25% loss of his 401(k) or any loss at all. End of day, you are investing in stocks and bonds same as everybody else, you will be affected as everyone else, 401(k) is saying, let Vanguard and BlackRock do the investing for you, thats all. – Daniel Oct 29 at 17:32
  • If someone like the OP who gets a 50% match had invested $1000 on 1st July 2008, their pot would be worth $1500. If they retired on 31st December 2008, a 25% fall would have left their fund worth $1125, so they would have been $125 ahead. That is despite investing and withdrawing at the worth possible moments in the last 50 or 100 years. A normal retirement fund (where money is drip fed in over decades) will be much safer. Yes, it is theoretically possible to get out less than you put in, but your figures suggest that with a 50% match it would be historically unprecedented to do so. – Martin Bonner supports Monica Oct 29 at 21:21

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