What should pilots do with their 401(k)?
Updated: Apr 29, 2020
“Never take financial advice from a pilot." These wise words were shared with me early on in my aviation career, and it's stuck with me all these years. Most of you know what I'm talking about: you're paired with a fellow pilot for a week and he or she shares their latest financial triumph with you by the 3rd leg of the trip (of course they're always silent when it comes to their financial mis-steps). With the market currently experiencing some moderate turbulence, we wanted to get some perspective from an actual financial expert, not a day-trading captain or a co-pilot who watched six YouTube videos on iron condor option spreads. Greyson Geiler, Lead Consultant with Secure Estate Solutions, joined us for a very informative discussion on the current market in Episode 30, here are some key takeaways about retirement investing you can put to work now:
1. Take advantage of your company match in your 401(k)
I wish we could just assume that every pilot is capturing their entire compensation package, but here’s a stunning statistic: only 38% of employees take advantage of their company’s 401(k) program, according to the Bureau of Labor. The vast majority of pilot jobs today have a company sponsored 401(k) plan with some sort of company match, yet there are still airmen out there who literally choose not to accept free money. Let’s stop the madness right now by making sure we all understand the meaning of company match. It can be expressed in a couple of different ways and can be confusing. We’ll use SkyWest Airlines for our first example: They offer a 4% match for a year one First Officer*. That simply means if you contribute 4% of your paycheck to your 401(k), they’ll throw another 4% into your 401(k) at no cost to you. That’s about $1,600 for free!
There’s another, slightly more confusing way you might see a match advertised. It will be a much larger percentage, like 57-60%** at NetJets, for example. At first glance, this looks WAY bigger than the 4% at SkyWest, but it’s actually a different calculation. To figure out the company match in this format, multiply your contribution by the match percentage. Let’s say you contribute $100 every paycheck, the company will match 57% of it, or $57. This type of match is a double edged sword, and here’s why. If you don’t contribute a lot, your match isn’t very much. If you put in 4% of your paycheck, the match will only be 2.28%, in which case you’d be better off with SkyWest’s model. If you can crank up your contribution to 10%, however, the company match becomes 5.7%, which is significantly better than what you’d get at SkyWest. Regardless of the specific type of match your employer offers, make sure you’re taking advantage of it to maximize your compensation.
2. Learn the lingo: Expense Ratio
If there's only one thing you remember after reading this, it should be what an expense ratio is: the fee you are charged each year to invest in a fund. Each fund on your 401(k) will have a fee, and the financial institutions are betting that you're not going to take the time to google what a fair expense ratio is. Unfortunately, many people will gladly sign up to overpay without even knowing it. Fun fact, the average fund expense ratio for Fidelity 401(k) plans is 0.52%. That means, for every $10,000 you have invested in that fund, you'll pay $52 per year to the fund manager. Invest in a fund that gets a 4% return but has a 1% expense ratio? Congratulations, you just gave 25% of your return back to 'the man'. You can't control the market, but you can control how much you're paying in fees, which leads us to takeaway #3.
3. Investing in your 401(k) provider's target retirement fund: good idea?
Target funds sound great: someone else does the work of picking the funds in your portfolio while you can focus on moving metal through the sky. Set it and forget it, music to a pilot's ears. These funds are popular, too. In 2015, 49% of twenty somethings held target date funds in their portfolio. Unfortunately, there's a catch...the fees. Aside from the fee in the target fund, (average expense ratio is about 0.51%), you get charged the fee for each individual fund you are put in by the parent fund. Yeah, that 0.51% expense ratio could easily double to 1% or more. Over a 40 year career, investing in a fund with a 0.01% expense ratio vs. a typical 0.51% ratio can save you close to $100,000.00 in fees. There are some low fee target funds offered by Vanguard and Schwab, so check to see if your plan offers them. If not, I know what you’re thinking…”I’m not a financial guru, I don’t have the time or the knowledge to research my 401(k) funds.” Fortunately, we have some very simple advice from a financial guru for takeaway #4!
4. Avoid high fees by following Warren Buffet's advice
In 2014, the Oracle of Omaha recommended that the cash left to his wife be invested in 2 simple things: 90% in a very low cost S&P 500 index fund and 10% in short-term government bonds. In fact, Buffet famously bet $1 million dollars that a S&P 500 Index fund would out perform a basket of 5 hedge funds over 10 years. Final result: hedge funds annualized gain was about 2.2%, S&P 500 was 7.1%. Wanna hear the best news of all about index funds? Their expense ratios! Vanguard's S&P 500 ETF (VOO) has an expense ratio of just 0.03% ($3/yr for every $10,000 invested). Fidelity’s 500 Index Fund (FXAIX) has an even better expense ratio of just 0.015%! Your specific 401(k) may not have the exact funds listed above, but it should have a similar offering. Here’s a list of S&P 500 funds to check out.
5. What about all those old 401(k)s I have from my old jobs?
Roll ‘em over to an IRA! There are a multitude of reasons to do this, namely increasing your investment options. Most company sponsored 401(k) programs only give you access to a limited amount of funds, whereas an IRA gives you many more fund choices, which, you guessed it, allows you more flexibility to avoid fees.
6. Still want more? Max out your HSA and Roth IRA
Once you have your 401(k) ducks in a row, there are a multitude of other investment opportunities worth investigating. You can take a deep dive into the world of HSAs and why fully funding them might be a great idea. (Spoiler alert- the HSA may actually be superior to the 401(k)!) If you fall below the income limits, a Roth IRA account should also be funded. (There are ways to get around the income limits, too.)
The bottom line: make sure you’re maximizing your compensation by capturing your company’s 401(k) match and protecting your nest egg by keeping an eye on those fees. If you want to hear our in depth conversation with Greyson on all things 401(k), check out Episode 30. Most importantly, remember, never take financial advice from a pilot!
*According to APC as of 4/28/20
**up to 20% of eligible compensation.