401(k) performance: The numbers add up
I’m a little tired of reading about how “buy and hold” is dead, and diversification doesn’t work, and how “target-date funds don’t work,” and that there was too much risk, especially for pre-retirees, in these balanced funds. These stories seem to continue regardless of what’s going on in the real world.
So I won’t discuss much. Instead, here’s some math.
Suppose you were 54 at the end of 1999. You had $50,000 in your 401(k). You planned to retire in 2010, when you turn 65. You were a big fan of diversification and balance, and wholeheartedly believed the buy-and-hold story, and so you used Vanguard Balanced Index Fund (view standardized performance) in your 401(k). Then, in June 2006, when Vanguard introduced the Target Retirement 2010 Fund (view standardized performance), you switched everything to that. You dutifully put $500 a month into your k-plan at the end of each month, every month, starting January 2000. What would your balance have been in September 2009?
This chart assumes funds were held in Investor Shares of Vanguard Balanced Index Fund (view standardized performance) from 12/31/1999 to 6/30/2006, then in Vanguard Target Retirement 2010 Fund (view standardized performance) from 7/1/2006 to 9/30/2009. The chart also assumes $500 deposits were made monthly at the end of each month beginning in January 2000, and that all fund distributions were reinvested. All returns are net of fees.
Two observations:
1. Your ending balance would have been a little less than $135,000, and your overall annualized internal rate of return (IRR) over this period would have been 3.07%. Nothing to write home about, but certainly not the end of the world. If you made regular deposits, you would have built a decent nest egg, in spite of two major bear markets. And you still have a year to go before you plan on retiring.
2. Even at the low point—the end of February 2009—your balance would have been roughly $101,000 (before your monthly contribution), and your annualized IRR would have been –0.50%. So, yes, you lost money—but, again, it’s not the end of the world.
I suppose things could have gotten a lot worse in February. And maybe they could get much worse from here. But even with little more than a single year’s time in between us and the beginning of the financial crisis, I can’t see what supports the notion that balanced investing “doesn’t work” or that the 401(k) system is dangerously broken …
Notes:
- Investments in bond funds are subject to interest rate, credit, and inflation risk.
- Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the work force. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date.
- The performance data shown above represent past performance, which is not a guarantee of future results. Investment returns and principal value will fluctuate, so 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. For performance data current to the most recent month-end, visit Vanguard.com.
More of these - ‘here are the facts’ articles is what everybody needs. I very much like the note that at some time periods, money was lost after 10 years of dutiful investing - that’s life - it’s a reality - but can anyone suggest a better method of handling these unpredicatable events? No. Bravo Vanguard.
Amen. And none of this was cause to put everyone through the horrible ordeal of trying to figure out how to administer RMD waivers for 2009.
I was reviewing a recently retired 401(k) participant’s account with him and was surprised at the numbers this participant presented (taken from recordkeeper). With all the media hype and academic dishonesty about the inadequacy of the defined contribution system I thought these real world numbers might draw a more accurate picture.
This participant’s numbers show the transactions that have taken place over the last ten years. What is truly amazing is the gain for this participant. I know he is happy with his $90,000 gain. Unfortunately, he recently had to withdraw some of his money for some medical bills.
As Tom Cruise once said, “we live in a cynical world”; but the cynicism surrounding 401(k) Plans don’t make sense to this recently retired gentlemen. He thinks it was the best decision he ever made!
Beginning Value (10/02/1999) $65,671.53; Contributions $73,394.09; Withdrawals -$21,027.73; Gain/Loss $90,870.35; Ending Total Value (09/29/2009) $208,583.24
Estimated return = 4% to 5%
Hi,
As an employee benefits manager I am going to have to disagree with your view here. The problem is more with your approach in thinking that participants will merrily buy and hold and re-balance over time their portfolio. After being in the industry for over 20 years now, individual account investors never do this. Plan sponsors simply never educate their plan members. ERISA has no fiduciary enforcement any longer and in fact 404(c) of ERISA often gets plan sponsors off of the hook altogether. Until the mutual fund industry and the securities laws are improved to meet the needs of individual investors, 401(k) Plans and all individual account plans will never meet the needs of retirement income replacement objectives. The U.S. government needs to only allow employers favorable tax deductions for sponsoring and maintaining defined benefit pension plans - just like in the 1950’s.
John,
It seems much is being written by bloggers, financial experts, and journalists comparing the merits of a defined pension for the “average” American worker (whatever that means!) versus the value of owning a 401k as a retirement modality for that same “average” American worker. Some tout the defined pension as best for that worker…others adhere to the flexibility and limitless possibilities for investment of the 401k for that same worker.
Perhaps, the answer can be found within having both, rather than an either/or approach. The ubquity of today’s 401k seems to be either the albatross or the lifejacket for the future American investor. I am reminded of the often cited depiction of being either a head coach or quarterback of a football team: “When all is well, they are given to much phrase; when all is hell, they are given too much blame.”
Just as one is guided with finding an appropriate mix between risk, time horizon, and asset allocation (or location, perhaps?)for one’s portfolio, might a sensible approach be to include an annuity for those only involved in a 401k senario, as well as include an IRA perhaps for those who have a defined pension plan?
Wow ! 3.07%
Simple CD’s would have blown you away.
Not sure of your point here, unless it’s to stay away from stocks.
regardless of your math and how nicely you write this, it is unacceptably risky to own stocks for 3% annualized in a 10 year period, which is why people are going outside the US, buying gold, etc.
How would the chart have looked if the Target 2010 had been ignored?
I’m more than “a little tired” with misleading “math”. Just chart your
recommendation against a bond index and your “buy and hold”
strategy is a big loser.
I appreciate the general Vanguard philosophy on private investing and that is where I prefer to keep my investments, but let’s not get carried away. In some countries, at some times, markets have fallen, investments have been lost, and people have starved to death. The poor, elderly, and least sophisticated are always the hardest hit. 401Ks are not immune to national catastrophes. A national pension system, like those in the European social democracies, would a better way to ensure the basic human right to a subsistence in old age (or any age). 401Ks should of course be encouraged, but I resist the “in the box” thinking that because 401Ks are THE current alternative in the US, this is best system there is or could ever be.
There are no guarantees, but dollar cost averaging and diversification, with periodic rebalancing, are the best ways that I know to build wealth.
Article was nice. But the performance was poor. If the people runing the Fund had tried to save the investors money, They would have a better return then 3.07%. Investors have to do their part. But the people runing the Fund have to do their part also, not set back and get paid to do nothing. If you were planing to use the money to add some cash to your SS check it will not last long. 200,000.00 is no money this world.
3.07% return on a 401K over a 10 year period is a huge underperformanace for most of my middle income financial planning clients relative to the returns they NEEDED to get to achieve their goals. Let’s not “look at the math” in a vacuum that compares the Balanced Fund/TR2010 performance to nothing and doesn’t relate the results to the client’s needs!! Most of my clients absolutely need to work longer now because of “buy and hold” losses suffered last year. No, not the end of the world to be sure, but there can be no doubt that buy and hold let them down. They’d we WAY ahead of a 3.07% 10 year annualized return if they had staged themselves out of stocks as sheer speculation pushed the P/E10 every higher in the late 90’s. The P/E10 still suggests strongly that people near to or early in retirement should be almost completely out of stocks right now.
I think you’ve made the case that buy and hold is dead better than I ever could have!
Over short periods of time, anything is possible. Buy and Hold is a very long term philosophy & comparing it against any other strategy for a period of 10 years is futile.
The system is flawed because of the large pot of ’stupid’ money that is placed with active management. I say ’stupid money’ respectfully because its unrealistic to expect most 401K contributors to do the required research for success, as most people have no clue and are too trusting, or too fearful. This is why the target retirement funds are needed and if the Vanguard index approach is the winning strategy, time will tell. Unfortunately, we invest now in this developmental age of getting retirement savings ‘right’, given the pension drought. So diversify with 50% or more indexed, the balance placed based on your own research, which may point to more indexing, or if you give it sufficient attention, maybe a winning active manager, they certainly exist. I do believe that indexing is stress reducing, maybe you can love your family or dog with greater focus. After awhile, placing funds correctly pays more than your job, then you’re ready to take more risk (active management) or reduce it with more indexing. Good luck, you are on your own.
I remake my point…putting the money into a 6% CD back in 99…you would have ended up with just about the same return, but no headaches.