If you make decent money and have absolutely no self-control, then 401ks are great. Otherwise, I’d take a more skeptical view. It all depends: if you’re happy socking money away in order to live the good life when you’re too old to enjoy it, then a 401k/Retirement Account mentality is perfect for you. But if you’d like to see the mountaintop before you’re too creaky to climb it without the help of a chair lift, then you should consider the downside of the 401k.

Let’s put the critique of the 401k into the context of this book. First, I don’t consider a 401k to qualify as our “asset under development” because it’s just not liquid enough. The penalties for early withdrawal are prohibitive. A 401k can fit into the overall financial picture nicely, but it rarely deserves to be put in the center.

Companies are less likely to offer comprehensive stock plans these days. We’ve seen enough people lose their shirts to know that a good 401k should have much more than one company’s stock in it anyway. If you plan to have a retirement account as part of your strategy, I would suggest an asset allocation approach.

“Asset allocation” simply means that your portfolio will be broad enough to buffer you from down markets. Studies of asset allocation have shown that a diversity of investment holdings protects from worst case scenarios while providing a good upside. To me, a good retirement account goes beyond stocks and bonds to include other asset classes such as real estate funds and even some precious metals. International investments are also a piece of the puzzle, and of course it should all be tailored to match your age and risk tolerance level.

A well-balanced 401k is nice because it doesn’t require fretting and fussing. A sudden market dip won’t hurt a diversified portfolio nearly as much. Obviously there are reams of books on these topics, so you’re probably more interested in hearing why I have problems with IRAs.

Beyond the liquidity problem, the next point of contention is that IRAs violate our law of focus. The most valuable assets are the ones we focus on. Most folks with retirement accounts are not exactly market experts. We’re lucky if we know the most basic things about the investment philosophy of the funds we put our fate in. Most portfolios I’ve seen are a mixture of hunches and “infatuation picks” like technology stocks.

I like real estate better. When you buy a property, you are in on the “ground floor” of an investment. By the time you invest in a stock, it’s already been through an initial public offering and chances are good that insiders have already made their millions by the time you buy in. I suppose the same is true in real estate, but no one is stopping us from buying a piece of land and building something of value. Getting in on an IPO is another matter entirely.

You can make a go of the stock market as your “asset under development” if you make it a focus. I remember my grandfather huddled over the stock listings at the crack of dawn clutching a big magnifying glass. He did a couple of things right – I wouldn’t have managed my tuition without his savvy investing. But he put in the hours. He understood the companies and industries he invested in; he knew the philosophy of the management teams. He did everything but visit those companies and kick tires. How many of us can say the same? Is it smart to put a crucial part of our savings into investments we don’t monitor carefully and don’t know a heck of a lot about?

Investment gurus will cry foul, pointing to the rates of return that stocks have typically provided, which do seem better than stashing money under a pillow. But who wants to be part of an historical oddity? What if we’re living in an era that turns out to be the exception to the historical average?

A case could be made that global conditions, such as the surge in the Chinese and Indian economies and the declining power of the dollar – not to mention the increased scarcity of natural resources – could create, at best, a volatile investment climate, and at worst, a significant market crisis. Should we really pin our hopes on the smiling faces of the discount brokers who profit from each of our transactions while offering reassuring advice about historical rates of return?

Sure, there are always good buys if you know which bottom-feeders are going to turn around, but that sport can prove frustrating. I subscribe to the argument that overall, most U.S. stocks worth owning are either over-valued or fairly-valued. The average price-to-earnings ratio of NYSE stocks supports my argument, and you can’t get the true benefit of the rare “ten baggers” through the comparative safety of a mutual fund. The biggest gains are made by picking individual winners yourself, and that’s where the homework comes in.

Even if you do ok, there is an opportunity cost to stock investing: you could be using that same cash to develop assets you have more control over. Why not pour our funds into our own ventures as opposed to some water cooler stock pick? Becoming an entrepreneur is the best way to change our financial circumstance. That doesn’t necessarily mean starting a business, but it does mean that sandbagging your money and crossing your fingers isn’t going to cut it. By the time most of us reach retirement age, water is going to cost $5 a bottle. How that will affect the stock market is anyone’s guess, but I wouldn’t put all my eggs in that basket.

The most dangerous thing about 401ks is that they are a tax-protected vehicle, so the temptation to shelter pre-tax income in these vehicles can be overwhelming. The paranoid desire to avoid taxes will be the subject of another chapter. For now, let’s just say that putting money into a tax-free IRA can have a problematic consequence from a cash flow standpoint.

A cautionary tale from my own amateur investments: in the mid-90s, I was making the best salary of my life. I thought I was a business genius, but it turns out the forgiving dotcom economy was the true source of my largesse. Cash flowed – it wasn’t hard to sock a bunch of money into tax-protected mutual funds.

When I went online and saw my retirement fund in six figures, I thought I was a pretty cool guy. I had a vague feeling that a lot of the stocks in my mutual funds were overpriced, but I didn’t have a clue how to correct that. Since everything I invested in went up, I didn’t trouble myself. But when the bubble burst, I lost about 70 percent of those holdings. It was only a decent level of asset allocation that saved me from losing more.

After that debacle, I left that company and started my own. Cash was at a premium. Money made from real estate holdings got me off the ground, but to get through the post-9/11 years, I had to liquidate what was left of my retirement account and endure a sizeable penalty.

Looking back, there’s no question in my mind that I should have avoided 401Ks, taken a tax hit on all my income, and stockpiled cash. Some of that cash would have been an emergency fund, the rest would have gone into real estate and maybe into my books. During those years, my construction partner in Maine found some waterfront land we might have bought that ended up going up in value at least six times. It’s not an exaggeration to say there was a million dollar upside to some of the land deals we saw. But we did not have the resources to get in.

I’m not complaining; I would not have a business today without the two real estate projects we did complete. Yes, I took a big tax hit on the profits. But the end result was cash I had access to now, earned from investments I understood in an industry I was very comfortable with. We had a relationship with a realtor who knew every pothole in a particular Boston neighborhood, and she led us to two great properties we bought at the right price. I’ve never had that kind of inside track on any stock. And with real estate, there are other ways of legally shielding money from taxes also, rolling the sale into another property.

Jon Reed notes, December 2009: if you’re serious about investing for the long haul, Morris Rosenthal of FonerBooks.com has put togther an excellent “Self Directed Investing for Long Term Income and Retirement” guide that is well worth a look. It’s structured as a flow chart with jumps to detailed explanations about each step along the way.

A 401k fits the classic model of “work hard, save, and retire.” But I have to wonder if that mentality suits the workplace we find ourselves in now. I am not going so far as to say 401ks are a bad idea. If you’re aware of the risks, and you still have money to develop other assets, then by all means, use the 401k as a piece of your financial strategy. But if the money going into the 401k is preventing you from investing in yourself, take a harder look. Mastering one industry is enough of a challenge. There’s something to be said for only buying into things we understand.

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