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STOP: African Americans should NOT be maxing out their 401(k)

“At the bottom of education, at the bottom of politics, even at the bottom of religion, there must be for our race economic independence. “ – Booker T. Washington

If two people are running a race and one has a head start can the person behind run at the same speed as the one in front and catch up? Obviously they cannot. The African America median net worth is shown to be dead last in a 2004 report by the UCLA Center for Asian American Studies out of the four major ancestral groups studied. The current order shows Asian America 1st with a median net worth of $144,000 followed in 2nd by European America with $137,200 then in 3rd Latino America with $19,300 and bringing up the rear is African America at $12,000. Arab America was not reported but it is not hard to imagine they too are well ahead of us. It is indeed time we rethink our financial strategy.

So then why am I saying we should NOT be maxing out our 401(k)? Suze Orman told me it’s a great thing. Flag on the play. One of the major issues is we continue to try to answer African American questions with European American answers. You can’t do as another is doing when your situation is not the same as a group. Most of the so-called financial help that we see on TV is based in an Eurocentric view of American life and reality.

To max out your 401(k) would mean to contribute $16,500 pre-tax income per year or $1,375 per month into it. We currently contribute at a median of approximately $175 dollars a month or $2,100 annually to our 401(k)’s as reported in the Ariel Capital Charles Schwab Black-White Investor Annual Survey. Its not hard to see why though when the median income for African America is approximately $32,500 (Asian & European America stand at $65,500 and $54,500 respectively) according to the latest U.S. Census Bureau data so the likelihood that we would be able to reach that plateau without putting our families into poverty ($22,000 is the poverty income level for a family of 4) is as likely as a year without a rap beef given that you’d be taking the median taxable income down to $16,000 by contributing the max. I don’t know many places in America you can make it on $16,000 a year. Unfortunately as noted in the census as well 25% of African America is below the poverty line.

Let’s make sure we understand though what the 401(k) as a vehicle is built to do and what it does. The major contention with the 401(k) is that its primary investment vehicle is mutual funds. Per Investopedia a mutual fund is “An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets.” These funds are “actively” managed funds. That is there is a manager who buys and trades actively trying to beat the market. They of course then past that expense on to you. Usually you can find a mutual funds management cost as the expense ratio. Unfortunately, as Motley Fool points out in its mutual fund study “more than 80% of mutual funds underperform the stock market’s average returns.” The other problem with mutual fund for African America is that it does not equate to direct ownership of any company. In a self-directed Roth IRA you have direct control of where that money is going. So you can buy Google stock directly or you can place it in Index Funds, which have historically outperformed mutual funds because they are not actively managed and so have less cost built into them leaving more money in your pocket for the long-term.

So what SHOULD we be doing as African Americans?

1)    Build a six to nine month emergency fund. An emergency fund for African-Americans is a tricky dynamic because any money we hold in cash is capital that is earning very little and could be used in building long-term wealth. However, we are also more likely to suffer job loss, hospital visits with no insurance, helping family members, and other unforeseen needs so how one manages their cash (it is king after all) balances in short-term and long-term investments might be the most vital element to wealth creation.

2)    Try to max out your Roth IRA contribution (max $5,000 per year), which will give you control of where the funds are invested and can place them in less costly investment products. If you do no more than put them in index funds, which as stated have historically had better returns than mutual funds and also cost you less. Roth IRA’s also have tax-free earnings, which means when you have to take the money out at retirement in 30 plus years you won’t have to pay any taxes on it. And as the cost of living rises you will need dramatically more dollars tomorrow than you do today for the same standard of living. Because I believe we need more equity ownership though I’d suggest no more than 50% of your Roth IRA be in index funds. The majority should be in individual stocks and bonds.

3)    Next if your company matches 401(k) contributions then put in the percentage they will match and not a penny more. Its free money and so there is no reason to pass it up. At that point you want to treat the money in the most conservative manner possible. Remember if your company is giving let’s say $0.50 for every $1.00 you put in you’ve already made a gain of 50%! At that point there is no need to get cute and become greedy with an aggressive mutual fund that as we see is almost guaranteed to lose money. Or as I tell former clients if you walk into a casino and they give you free money. Put it in a bag and walk right back out (and say thank you of course).  That is to say get the return from your company matching and then put it in a safe product. Don’t gamble the free money away in high-risk mutual funds.

4)    All monies after that should be going into either starting a business of your own or an individual (or joint) brokerage account where you will buy and trade stocks, bonds, and other investment vehicles. This by far should be your largest account as it is the account that can give you the most direct ownership of companies through direct ownership of their stocks (equity) and bonds (debt) of companies with unlimited contributions.

This is a very basic game plan to address wealth creation. Wealth creation in of itself is a simple and complex creature. But these basic steps can help you and your families get started off on the right path. Recognizing where we are in the game and that is dramatically behind in the ownership category we cannot afford to put money into investment vehicles that do not give us any. Knowing is half the battle to quote a GI Joe. Now go out there a bit more armed to build for future generations.

Mr. Foster is the Interim Executive Director of HBCU Endowment Foundation, sits on the board of directors at the Center for HBCU Media Advocacy, & CEO of Sechen Imara Solutions, LLC. A former banker & financial analyst who earned his bachelor’s degree in Economics & Finance from Virginia State University as well his master’s degree in Community Development & Urban Planning from Prairie View A&M University. Publishing research on the agriculture economics of food waste as well as writing articles for other African American media outlets.

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10 Things You Didn’t Know About Social Security

The Social Security program turns 75 this week. Since Franklin Delano Roosevelt signed the Social Security Act on August 14, 1935, few workers have not been impacted by the social program. Almost all Americans pay into the system, and Social Security is the largest source of income for citizens age 65 and older. Yet this huge entitlement has many facets, some of which are not widely known. Here are 10 things you may not know about Social Security:

The system is bigger than the economy of most countries. For the past 20 years, the Social Security program has been the largest single item in the federal government’s budget. “The amount of money flowing through the Social Security system each year is larger than the total economies of all but the 16 richest nations in the world,” says Larry DeWitt, the U.S. Social Security Administration historian. The Social Security program has collected $13 trillion in income and expended $10.6 trillion in payments since the first tax collections began in 1937 through 2007. That’s an amount of money that Social Security’s first beneficiary, Ida May Fuller of Ludlow, Vt.–who collected initial payments of $22.54 a month for 35 years–probably never dreamed of.

[See 10 Places to Reinvent Your Life in Retirement.]

It’s not just a retirement program. The original Social Security program paid benefits only to retired workers. Later, disability benefits and payments for a beneficiary’s spouse and children and were added to the program. “If you graduated from college four years ago, you are already protected against disability,” says Edward Berkowitz, professor of history and public policy and public administration at George Washington University. “If you are married and have children, your dependents are protected.” Annual Social Security Administration mailings to all workers age 25 and older include an estimated amount that you would be paid if you become disabled and how much your spouse and children would receive if you should pass away.

You pay 6.2 percent of your income into the system. Almost all American workers (94 percent) pay 6.2 percent of their taxable income, up to $106,800 annually, into the Social Security trust fund. Employers pay a matching 6.2 percent for each worker. Self-employed workers must contribute 12.4 percent of their income annually.

There haven’t always been cost-of-living increases. Annual cost-of-living adjustments didn’t become a part of Social Security until 1975 (as a result of a 1972 law). Prior to 1975, an act of Congress was required to increase benefits to keep up with consumer prices. “Before then, benefits were protected from inflation only when Congress chose to notice it,” says Berkowitz. Now increases in payments are tied to the Consumer Price Index for Urban Wage Earners and Clerical Workers. Annual increases have ranged from 1.3 percent in 1996 and 1998 to 14.3 percent in 1980. For the first time in 2010, there was no cost of living boost because the index did not increase between the third quarter of 2008 and 2009.

Retirees can increase annual payments by waiting to claim. Workers can begin receiving Social Security benefits at age 62. But payouts increase by 7 to 8 percent for each year you delay your start date, up until age 70. Workers who sign up early receive smaller monthly checks over a great number of years, while those who delay claiming receive bigger payouts for the rest of their life. “If you know you are going to live past the age of 80, you are better off delaying Social Security,” says Lita Epstein, author of The Complete Idiot’s Guide to Social Security and Medicare. “Baby boomers who know they are going to have a long life are much better off waiting.” Epstein, who is spending down her Roth IRA assets in order to delay claiming Social Security, says her benefits will increase by about $500 each month by waiting until age 70 to sign up.

Couples have extra options. Spouses are entitled to Social Security benefits of up to 50 percent of the higher earner’s check if that amount is higher than the payments based on his or her own working record. Widows and widowers are entitled to the higher earner’s full retirement payout. Duel-earner couples who have reached their full retirement age can even claim twice by first signing up for a spousal payment, then claiming again later based on their own work record (which will then be higher due to delayed claiming). Ex-spouses are also eligible for benefits if the marriage lasted at least 10 years.

[See 6 Ways Couples Can Maximize Social Security Payouts.]

Existing beneficiaries can get a do-over. If you’ve already signed up for Social Security and received a reduced payout, it’s not too late to boost your check. If you pay back the entire amount you have already received from Social Security without interest, you can then qualify for higher payments for the rest of your life.

Social Security numbers have significance. The first three digits of your Social Security number are assigned based on geographical region, with the lowest numbers being assigned in the Northeast and increasingly higher numbers assigned to residents in the West. The middle two digits, called the group number, are allocated in a precise but nonconsecutive order between 01 and 99. The last four digits are issued in a sequential order. Over 420 million unique numbers have been issued and they are not reused after a person’s death. Social Security numbers have been assigned shortly after birth since 1989, which makes younger American’s Social Security numbers somewhat predictable if you know a person’s date of birth and home town, which is common information that young people list on social networking websites, according to research by Alessandro Acquisti, an associate professor of information technology and public policy at Carnegie Mellon University. “Do not offer personal information such as date of birth and hometown publicly,” he advises.

Paper Social Security checks will soon be retired. Social Security recipients will be required to collect payments by direct deposit into a bank account or a government Direct Express Debit MasterCard beginning on March 1, 2011. Existing beneficiaries must switch to electronic payments by March 1, 2013. Paperless payments are expected to save $300 million over five years, according to Treasury Department estimates.

[See 12 Ways to Fix Social Security.]

The trust fund has a projected deficit. The Social Security trust fund is currently projected to be sufficient to provide payments until the end of 2037. Then, unless changes are made to the program, there will only be sufficient resources to pay about 78 percent of scheduled benefits. Congress is currently considering a variety of potential fixes, including tax increases, benefit cuts, and pushing back the retirement age. A U.S. Senate Special Committee on Aging report released in May found that relatively minor tweaks could put the trust fund back on sound financial ground for at least 75 more years. “It’s a shame that the tone of the 75th celebration is sort of nostalgic,” says Berkowitz. “I would hope that the 75th anniversary is not only about how good things used to be, but also about how good things could still be in the future.”