At the risk of sounding like a broken record …
I realize this will be about my third post on this issue, but the things people are writing about 401(k)s just get more and more absurd, and it’s tough to sit by and let this go unchallenged.
Now the editors of The New York Times are claiming that “Even with recent stock market upswings, account balances are roughly 25 percent lower than before the crash.”
I’m not sure where this number comes from (no source is given), or even if it’s true, or if they think that by saying “roughly” they can get away with whatever round number they like. Nevertheless, even if there was a day before the downturn when balances were so high that they are still, at this point, down 25%, it’s precisely this type of peak-to-trough analysis that I was complaining about a couple weeks back.
Looked at from the end of 2007 through June of this year, the Employee Benefit Research Institute estimates that the median defined contribution plan balance was down by a less-dramatic 16.4%. With the stock market up even further since June 30, the current number is likely even lower. And all of this in the wake of the worst markets in more than 50 years.
Beyond being frustrated by incomplete and selective use of data that is used for effect—as opposed to analysis—I guess what I struggle with most in these pieces is understanding what exactly the folks writing this stuff think they are going to accomplish for people.
At one point, the editorial says that proposed 401(k) “reforms” would “shift risk that is currently borne by individuals onto corporations and the government.” I’m sorry, but who exactly do they think is backing the risks borne by corporations and the government? Have we learned nothing in the last year? It’s not like the shifting of risk is such that running it through corporate balance sheets or government accounts makes it disappear. Individuals are still ultimately going to bear it. The only question is which individuals.
Shifting risk doesn’t eliminate it; it just focuses it on a narrower group. Maybe that sounds like a good thing now, but when this narrow group of investors becomes far wealthier than other groups as a consequence of bearing these risks, we’ll have different issues.
The Times editorial also cites an analysis illustrating both the perils of saving at a rate of 4% as well as the inequities/differences in hypothetical 401(k) balances at retirement for investors who started saving in different years. What allows anyone to expect to accumulate a decent retirement account balance by saving only 4% of income is simply a mystery to me. What’s more, Vanguard’s data on 401(k) plans shows median deferral rates that are 50% higher—at roughly 6% of salary—and employer matches add another 3%.
And in terms of the “inequity” in balances when people retire: When will we recognize that no one’s financial situation in retirement is determined once and for all, in one fell swoop, on the day, or in the month or year, he retires?
The reality is that people who retired with any invested wealth in late 2007 or 2008 are very likely to have maintained an exposure to the market through today. Almost no one converts his or her 401(k) balance into an immediate annuity in one single transaction. Even people with traditional pension plans, who don’t have “balances,” generally prefer to take a lump sum at retirement—presumably to invest it. Retirees’ portfolios fell significantly in value last year, meaning less spending and some real pain for some people who needed to spend all of that money in early 2009. But most people didn’t spend all of their retirement wealth between October 2008 and March 2009. For example, if you were a moderately aggressive retiree in Vanguard Balanced Index Fund (which holds 60% of its assets in stocks) as of July 31, 2008, as of July 31, 2009, your total return for the year was –8.73%. For some investors who were a bit more conservative, results were even better.
Maybe the real risk we should worry about is investment-risk fearmongers frightening retirees into cashing in their assets at a single point in time and permanently locking in a low stream of income.
Last year did make it crystal-clear that Social Security plays a vital role in providing a financial backstop for retirees. It does a vital job of protecting people who because of financial or other misfortune find themselves in a situation in which their wealth has crumbled and cannot support them late in life. What’s more, it does this in a way that is standardized and relatively efficient. But it was never designed to be the sole source of income for retirees. In fact, Social Security is very well complemented by the 401(k) and other individually directed savings and investing programs that allow a broad section of the public to not just bear the risks that corporations and other entities take in their operations, but also to share directly in the rewards. Historically, these rewards have appeared on average and over time, and have been subject to broadly diversified risk.
In 2008 and early 2009, we all saw what that risk was all about, and it absolutely had real consequences for many people. But the “40% declines” in the stock market wildly overstate the change in the overall value of the wealth most retirees held, which included their Social Security benefits as well as their 401(k)s and their homes.
If we don’t think Social Security benefits are adequate, then by all means, let’s debate the merits of not only restoring long-run actuarial balance in the program but also potentially expanding it. But there’s absolutely no need to gut the 401(k) system to do this. I have yet to see any supposed benefit of “radical 401(k) reform” that would not be more efficiently achieved by changes that would somehow expand Social Security. So I am still at a loss as to what explains the fixation on “fixing” 401(k) plans—which simply aren’t in need of radical repair.
P.S. The comments on my last post reveal that I could have been clearer about the issue of the market crash and investor surprise. Of course, everyone was stunned by the market crash last year; no one expected such a disaster. My point was only that given those events, there weren’t many people who were shocked that their k-plan balances were also down. I love behavioral finance as much as the next guy, but I simply don’t accept the notion that a significant portion of 401(k) investors with stock market investments are unaware that they have an exposure to the market.
Notes:
- Fund performance data mentioned here represent past performance, which is not a guarantee of future results. Investment returns and principal value will fluctuate, so that investors’ shares, when sold, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data cited. You can view standardized performance (1-, 5-, and 10-year returns) and expense ratio information for Vanguard Balanced Index Fund on Vanguard.com.
- Links to third-party websites mentioned in this blog post will open new browser windows. Vanguard accepts no responsibility for content on external sites.
Should the government mandate a minimum rate of retirement savings?
I think many of the criticisms of 401K plans come down to the fact that a large number participants simply do not save enough (and many do not save anything). Traditional Benefit plans did not give employees the option to “not” save. I also think your 6% figure gets highly skewed by higher-income employees who have a greater propensity to save because of tax incentives, and simply more money. What is the figure for people who earn under $40,000 per year, from Vanguard’s 2008 data.
For 401k plans, why should the employee be limited to the company’s choice of investement company and funds? I happen to work with a company that uses Vanguard, but I worked for another company where the 401K options were with other higher cost providers. This is similar to the problem with health insurance: why should my choices be tied to the place of employement.
I agree 100% with Mr.J. Americks article. Sometimes things have to be said over and over again in order to sink in.
New York times they can write what ever they wish but proving them is another matter.
If invstors were to practice (apply) only few of the many articles about sound investing that our Vanguard has writen in the past they would have been in not as a bad shape even with last year’s crash. market .
“frustrated by incomplete and selective use of data that is used for effect -as opposed to analysis ” I think you have nailed the bulk of media reporting in that one elegantly stated line.
Simply makes the point that investors have to be diversified. Retirement investors ARE diversified, whether they know it or not, because of their homes and Social Security.
Problems with 401(k)s include
1) Most people are not competent to manage an investment portfolio. They over-invest in the stock of their employer. They don’t come up with a rational allocation. Etc. Etc. Part of the problem is education, part is lack of time to focus on these issues, part may be lack of ability in this area.
2) Costs are generally way too high. Vanguard is an exception. This is especially a problem due to the restricted choices in most 401(k) plans.
3) Funding with tax deductions is regressive. High tax bracket (generally high income) people get more of a tax benefit than low bracket people. It’s not clear why high income people deserve more of a subsidy than low income people.
We need more than a bit of tinkering.
This is the first article on the Vanguard blog that I’ve read, and I’m glad I did. I too am frustrated by the absurd financial advice and commentary being bandied about in the media lately. Much of it is beyond naive, and borders on completely irresponsible. Mr. Ameriks needn’t worry about sounding like a “broken record” and should keep his brand of sound, reasoned financial advice coming. It’s just the kind of music we need to hear in the current fiscal environment.
Risk shifting is not as futile as this article implies. Reforms would shift risk away from 401K investors, many of whom are in 401K plans that do not give them the freedom to select less risky securities or even force them to invest in their employer’s own stock. Risk would be shifted to the employers, and ultimately to the individual investors who hold the employer’s stock in taxable accounts or IRA’s. These investors have chosen to invest their money in stock, and in the stock of that company. By doing so, they have volunteered to accept the resulting risk in return for possibly higher returns. That is not true of all 401K investors.
I am a Vanguard investor and I fail to understand the verabage about shifting the risk to a narrow group and them becoming more wealthy. How is this possible ? Explain!
“…So I am still at a loss as to what explains the fixation on “fixing” 401(k) plans—which simply aren’t in need of radical repair….”
I repectfully disagree with this statement. I do love how Vanguard tries to educate people but my experience after 15 years in Vanguards program at a plant of ~ 100 people is dishearting. Most have been doing things like Money Market Funds for 15 years, getting out of stocks 6 months ago and locking in losses etc.
Like another comment I also wonder if many of the statistics are skewed by the richer/smarter inverstor that frankly probaby is pretty well off without depending in part on the 401k
Another seldom disccused risk is mine to bear (get it -growl-). Being forced out of the 401k plan at bad times. I have placed risky bets knowing the markets up and downs historically. I can handle the downs. I always kept an eye out for us closing the plant -force me out of the plan and I couldn’t then meet many minumums on rollovers for the same choices-. What I didn’t see was us getting out of Vanguard next month. I will now lock in losses and lose the funds getting to write off taxes on new gains.
My personal belief is history may very well not repeat itself (populism, lack of intellectual elite media and a newspaper reading public, lobbiests, disfunctional governments etc.). on market returns and the 401K is probably bad for the normal hard labor working man? Yes, a stronger social security net or back to defined…
401k should be mandatory for all employees but only when it is required that investment options be limited to a half dozen or so indexed equity and bond funds with very low fees. Most major US oil companies have 410ks with equity and bond fund fees as low as 0.01%. And yes, I have the decimal in the right place!!!
I have two 401(k) accounts, each from different employers. As of this morning, one account is still 18% below the peak just before the crash, and the other account is 23% below, so it’s hard to say one way or another whether account balance comparisons are a reason for reforming 401(k)s . More importantly, both accounts have YTD returns of over 27%, so I’m allowing myself the hope of reaching pre-crash levels within the next 3 - 6 months. I understand that not all retirees can wait a year or so for their 401(k) balances to recover, but it seems the risk of “losing it all” isn’t so severe–even in one of the worst market downturns in recent memory–that it requires radical reform. The issues raised by some readers above about poor or ill-informed participation seem to be problems not with 401(k)s per se but with plan administration. For example, I worked at a company where the 401(k) program was changed from an “opt-in” plan (where employees have to agree to participate) to an “opt-out” plan (where employees have to agree NOT to participate). Such a simple change yielded dramatically positive results in participation without making any changes to the 401(k) program itself. Perhaps the federal government’s role is provide better guidelines in setting up corporate 401(k) programs.
As of the end of business September 16, 2009, my retirement IRAs are down 2.2% from December 31, 2007. No new money was added in this time period. I attribute this to my asset allocation policy and re-balancing.
Re: September 8, 2009 at 8:27 pm -
“Most major US oil companies have 410ks with equity and bond fund fees as low as 0.01%. And yes, I have the decimal in the right place!!!”
There are no 401K plans with 0.01% fees. Vanguards very respectable lowest fee is 0.08 - 0.10% eight to ten times higher than 0.01%.
Please check your “facts” or correct mine.