Motley Fool Hidden Gems Investing - Maximizing Your 401(k), and Is Retirement Bad for Your Brain?

Starting point is 00:00:00 making the most of your 401k and does retirement make your brain decay that and more on this Saturday personal finance edition of the Motley Fool hidden gems investing podcast I'm Robert Brokamp and this week I lay out 11 steps to making sure you're maximizing the value of your work-based retirement plan but first up some headlines that caught my eye this past week The S&P 500 is up 6.4% so far this year, while the S&P 600 index of small caps is up 15.7%. And the FTSE Global All Cap X US Index of international stocks is up 10.6%. And I came across a couple of articles this week on both of these asset classes that I thought were worth highlighting.

Starting point is 00:00:46 The first was published on wealthmanagement.com and comes from Larry Swedrow. He points out that the so-called small cap premium, and that's the amount that small companies have historically outperformed large companies, seems to have disappeared in recent years and many have questioned whether it actually ever existed. Larry cites a study from the Bridgeway Capital Management Group, which argues that the problem isn't the premium itself, but how we define small cap. Their key insight, two groups are dragging down returns and obscuring a premium that is actually robust and persistent. The first group were labeled fallen angels, which are former large caps that recently crashed in value. If you take out the stocks that became fallen angels over

Starting point is 00:01:26 the trailing three years, the returns of small caps improve by 1.57% annually since 1960. And the other group is new market entrants like IPOs, SPACs, spinoffs, which tend to underperform often by 2% to nearly 6% per year. Moving on to international stocks, a recent article from Morningstar's Christine Benz pointed out that after years of underperformance, non-U.S. stocks surged in 2025, returning 32% for the year compared to 18% for U.S. stocks. This marked a dramatic reversal from the prior stretch. So when you go from 2009 to 2024, non-U.S. stocks returned about 7.6% compared to 14.5% for domestic equities. But beyond better recent returns, international stocks also began to decouple from the U.S. market, which enhances their value

Starting point is 00:02:16 as diversifiers. So the Morningstar developed markets ex-U.S. index had a 0.92 correlation with U.S. stocks over the three-year period ending in 2022, but that figure dropped to 0.71 by the end of 2025. And for those who slept through statistics class, remember that a correlation of one means that two investments move in lockstep. So a lower number means less correlation and potentially more diversification. Emerging markets have generally exhibited even lower correlations with U.S. equities, partly because their dominant sectors, such as energy and basic materials, differ from the tech-heavy U.S. market, and because countries like China follow a different economic cycle. And on a sort of kind of related note, I thought I'd mention

Starting point is 00:02:58 a recent chart from Paul Kudronsky, which highlighted that no other country invests in the stock market like Americans. 55% of U.S. households have exposure to the stock market. the next three countries with the highest levels of stock ownership are Canada at 49%, Australia at 37%, and the UK at 33%. We Americans invest in the stock market mostly so we can retire, but retirement might not be so good for us. This brings us to our next item, which is a study from the University of California, Irvine entitled, Does Employment Slow Cognitive Decline? And the answer is yes. The study included approximately 40,000 older adults from 1996 to 2018 and found that, quote, correlational evidence suggests that leaving the workforce before retirement age could accelerate the pace of cognitive decline. end of quote, and that, quote, employment near retirement age appears to reduce the risk of

Starting point is 00:03:53 cognitive decline, which can in turn forestall the onset of dementia, end quote. The effects are particularly concentrated among men ages 51 to 64. And this is just a recent example of many studies which have found that retirement may not be so healthy for people physically, mentally, psychologically, or socially. That said, there are plenty of happy, healthy retirees. I know many. the ones who seem to do the best, according to the Mass Mutual Retirement Happiness Study, are more likely to fill their free time with multiple kinds of activities, including spending time with loved ones, exercising, pursuing hobbies, and travel. Also, make sure you're doing things to keep your brain sharp. Now let's move on to the number of the week, which is

Starting point is 00:04:35 100.2%. That's the U.S. government's debt-to-GDP ratio, according to data recently released by the Bureau of Economic Analysis, which noted that the debt held by the public on March 31st was $31.27 trillion, while GDP over the last year was $31.22 trillion. We Americans now spend more on the interest to service our debt than we do on defense or Medicare. According to a statement from the committee for a responsible budget, quote, the national debt is now larger than the U.S. economy, about twice the historic average. We've heard plenty of alarm bells in the past few years about our fiscal path, but this one rings especially loudly. The real question is whether or not our leaders in Washington will listen. With debt now above 100% of GDP, it's only a

Starting point is 00:05:22 matter of time until we pass the all-time record of 106% reached in the immediate aftermath of World War II. This time, the borrowing isn't born from a seismic global conflict, but rather a total bipartisan abdication of making hard choices. End of quote. Next up, what choices you should make with your 401k when Motley Fool Hidden Gems Investing continues. When WestJet first took flight in 1996, the vibes were a bit different. People thought denim on denim was peak fashion, inline skates were everywhere, and two out of three women rocked the Rachel. While those things stayed in the 90s, one thing that hasn't is that fuzzy feeling you get when WestJet welcomes you on board. Here's to WestJetting since 96. Travel back in time with us

Starting point is 00:06:04 and actually travel with us at westjet.com slash 30 years. If you're like most working Americans, your number one strategy for accumulating enough money to retire is by contributing to a defined contribution plan, such as a 401k, 403b, or the federal savings plan. Consequently, when you retire will depend largely on how well you manage the account. So here are 11 tips for making the most of your employer-sponsored retirement plan. And just a note, I'm going to use the term 401k to apply to all types of defined contribution accounts. Step number one, save enough and get the full match. So the consensus among experts these days is that workers should aim for a savings rate of 15% of their household

Starting point is 00:06:48 income and even higher if they're getting a late start on saving for retirement. Fortunately, the majority of workers don't have to come up with that 15% all on their own. More than 90% of employers match contributions with the most common formula being a match of 50 cents for every dollar saved up to a savings rate of 6%. So those workers need to save 12%, and then the employer kicks in 3%. Unfortunately, most people aren't saving 15%. In fact, a third of employees don't even contribute enough to receive the full match, according to Vanguard. At the very least, make sure you're grabbing that free money your employer is offering. Step number two, choose the right type of account. So most 401ks allow for both traditional and Roth contributions. So your

Starting point is 00:07:32 first decision is when do you want your tax break? If you want it today at the cost of paying taxes on withdrawals in retirement, then go with the traditional account, but then do something smart with the money you save by having a lower tax bill this year. You know, use it to save even more money for retirement or some other goal like college, just don't squander it. On the other hand, if you're willing to give up a tax break today in exchange for tax-free withdrawals in retirement, perhaps because you expect to be in a higher tax bracket in retirement, then go with the Roth. The other benefit of the Roth is that you aren't forced to take required minimum distributions at age 73 or age 75 if you were born in 1960 or later. This doesn't have to be an either-or decision.

Starting point is 00:08:10 You can contribute to both the traditional and the Roth account as long as the combined amount doesn't exceed your annual contribution limit. Additionally, some plans nowadays allow employees to decide the type of account that the employer match goes into. So for the large majority of us, the match goes into a traditional account. that way it's not taxable income to us, but the withdrawals will be taxed. If your plan allows you to have the match deposited into a Roth account, the match will be added to your taxable income for the year, but then the withdrawals will be tax-free. And I'll also point out that there are some situations in which an employee actually has a choice of the account provider. And this is most common for teachers, where some school districts allow for more than one 403b or 457

Starting point is 00:08:51 provider. A good resource for teachers and other employees of nonprofits is 403bwise.org, which rates the plans offered by many of the school districts in the U.S. Step number three, save more each year. So everyone loves getting a raise, but a 2020 report from Morningstar found that it actually can postpone a worker's retirement. Why? Because many people use a raise to increase the cost of their lifestyle, which in turn increases how much they need to have saved before they can retire, because everyone wants to maintain their lifestyle in retirement. The report found that even workers who save a percentage of their income, say 10% or so,

Starting point is 00:09:26 contribute more to their 401ks after a raise, but it's often not enough. They also need to increase their savings rate. Morningstar suggested a few guidelines with the most effective being a rule that they dubbed spend twice your years to retirement. So for example, if you plan to retire in 15 years, spend 30% of your raise, but then contribute the remaining 70% to your 401k. Step number four, max out the account early or don't. So as the old saying goes, it's not about timing the market, but time in the market. After all, the S&P 500 has historically made money in about three out of every four years. So in most scenarios, the sooner you invest your money, the more money you'll eventually have. Therefore, contributing the maximum to your 401k as soon as

Starting point is 00:10:09 possible, rather than gradually over the course of the year, should result in a bigger nest egg in retirement. However, before you pursue this strategy, it's very, very important to make sure this won't reduce the match you'll receive from your employer. In most situations, the match is distributed on a per paycheck basis, and if you max out your 401k early, you may miss out on some of those matching contributions. The key here is to find out if your plan offers what is known as a true-up, in which any missed matches are deposited toward the end of the year. If your plan doesn't offer a true-up, then you should avoid maxing out the account before the final paycheck of the year. Since we're on the topic, the 401k contribution limits in 2026 are $24,500

Starting point is 00:10:49 for workers who are 49 and younger, $32,500 for ages 50 to 59 and 64 and older, and $35,750 for ages 60 to 63. And the worker's age on December 31st determines the applicable limit. Step number five, create a mega backdoor Roth if your plan allows it. So in addition to those aforementioned limits, there's another all-in limit in 2026 of $72,000 plus the relevant catch-up limit for those who are 50 and older, or 100% of compensation, whichever is less. So this includes the employee and employer contributions. If your account hasn't reached that annual limit, you can make additional so-called after-tax contributions if your plan allows it. Now, don't confuse those after-tax contributions with Roth contributions, which are also technically after-tax, but the

Starting point is 00:11:40 growth attributed to these after-tax contributions is tax-deferred. That is, you don't pay taxes until you make the withdrawals, which are taxed as ordinary income. Furthermore, when you leave your employer, you can segregate these after-tax contributions from the growth and transfer the former assets into a Roth IRA and the latter into a traditional IRA. Technically, actually, what you're doing is you're converting those after-tax contributions to a Roth. However, because the converted amount doesn't involve any pre-tax money or growth, the conversion won't cost you anything. On top of all that, some plans allow for in-plan Roth conversions of these after-tax contributions, which then allow them to accumulate tax-free. This strategy is often

Starting point is 00:12:20 called the mega backdoor Roth. This can get very complicated, so make sure you learn more starting with finding out whether this is even available in your plan. Step number six, don't crack your account. So withdrawals for retirement accounts before age 59 and a half may be partially or fully taxed and penalized 10%. There are some exceptions to that penalty, some of which apply to both IRAs and 401ks, others that just apply to one or the other. A notable exception for 401ks is that withdrawals at age 55 or older, or age 50 or older for some government plans, will not be penalized, but it only applies to the plan offered by the employer you were working for at age 55 or older, and only if the plan allows it. Unfortunately, many people raid their retirement

Starting point is 00:13:04 accounts long before retirement. So more than one in three workers cash out their 401ks when they change jobs rather than rolling it over to an IRA or a 401k at their new job. This costs them thousands of dollars, perhaps tens, maybe even hundreds of thousands of dollars in taxes, penalties, and foregone growth on what that money could have earned if it were left in a retirement account. Step number seven, choose the best investments. So one of the biggest drawbacks to most 401ks is that their investment choices are limited to a collection of mutual funds. The situation has improved over the past 20 years or so as more plans now offer index funds, and target date funds, but many plans still also include at least some underperforming actively

Starting point is 00:13:44 managed funds. So to evaluate the funds in your 401k, listen to our May 2nd episode in which my colleague Amanda Kish and I discuss the factors to consider. If you prefer to invest in individual stocks, you may not be out of luck. Approximately a quarter of 401ks offer a side brokerage account that allows participants to buy stocks, bonds, ETFs, as well as choose from among thousands of other mutual funds. This option isn't always well publicized within companies, so check with your HR team or plan provider to see if you have the ability to open a brokerage account within your 401k. Step number eight, coordinate your 401k allocation with your other accounts. So ideally, you have at least a couple of really good fund options within your 401k. You can choose those

Starting point is 00:14:24 to play their respective roles in your asset allocation and then round out your portfolio with other accounts, such as your taxable brokerage accounts, your IRAs, or even your spouse's accounts. So for example, let's say your 401k has a particularly good international stock fund and a higher yielding cash account, you could overweight those in your 401k and focus on other asset classes in your other accounts. Many Motley Fool members and even employees, myself included, like a mix of index funds and individual stocks. Since almost all 401ks offer index funds, many Fools use their employer plans primarily for the index portion of their portfolios. Step number nine, take advantage of features offered by the provider. So many of the financial

Starting point is 00:15:02 services firms that operate 401ks offer additional benefits, right? They can include online tools, educational articles and webinars, even access to a financial professional who can discuss your 401k, asset allocation, and maybe other aspects of your personal finances. So some will also offer wealth management services, though usually for an additional fee. Step number 10, move your money if you can. So if you have a less than excellent 401k, roll over the money to an IRA. And you can do this anytime you switch jobs or retire. Just note that if you're retiring between the ages of 55 and 59 and a half, you may want to leave the money in the 401k to utilize that age 55 exception to penalties on early withdrawals. You might also be able to move the money while still working for

Starting point is 00:15:45 your current employer. This is known as an in-service distribution and is most commonly available to employees at ages 59 and a half or older, but not always. So check your plan provider to see if this is available to you. And finally, step number 11, advocate for a better plan. So everyone at your company, you, your boss, the HR department is in the same 401k boat. If the plan has high costs, subpar investment options, and or limited flexibility, right? There's no brokerage account, no in-service distributions, no after-tax contributions, no mega backdoor Roth, then everyone's retirement prospects suffer. So do some research, gather data and recruit allies who can help persuade your employer to improve your company's

Starting point is 00:16:25 401k. Over the years, I've heard from listeners who have successfully convinced their employers to at least add features to their 401ks, if not change the plans altogether. In fact, that's what a few other employees and I did at The Motley Fool many years ago, because in the early days of our company, our 401k frankly wasn't very good. Fortunately, leadership at The Fool was very open to us forming a committee and creating what is now an excellent plan, if I may say so myself. So there's no harm in asking, and if you're successful, your future retired self and those of your colleagues will thank you. It's time to get it done, fools, and I just laid out a lot of things to think about when it comes to your work-sponsored retirement plan. So go log into

Starting point is 00:17:05 your account and poke around. Evaluate the funds you own and the funds you could own. Click on the various tabs and links. Find the document that describes the features of your plan. You may discover resources that you didn't know were available to you. And that, my friends, is the show. Thanks for listening, and thanks to Bart Shannon, the engineer for this episode. As always, people on the program may have interest in the investments they talk about, then The Motley Fool may have formal recommendations for or against. So don't buy or sell investments based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational

Starting point is 00:17:42 purposes only. To see our full advertising disclosure, please check out our show notes. I'm Robert Brokamp. Fool on, everybody! Thank you.

Motley Fool Hidden Gems Investing - Maximizing Your 401(k), and Is Retirement Bad for Your Brain?

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