Another look at 401(k) accounts
I elicited some grief from certain Vanguard Blog readers by talking about a recovery in 401(k) accounts earlier this year. Allow me to provide an update on the issue.
Recall my basic premise: As a result of ongoing contributions, as well as portfolio diversification, the wealth level of many 401(k) participants had not fallen as dramatically as commonly perceived. In fact, some workers had experienced growing 401(k) account balances even during falling markets. These were, admittedly, mostly employees starting out their savings careers, where contributions are large relative to balances.
We’ve updated our analysis, looking at participants beginning on September 30, 2007 (just before the early October 2007 market peak), and ending two years later, on September 30, 2009. As of that date, the median 401(k) account holder at Vanguard had more in retirement savings, despite the market decline, than two years ago. The reasons are the same: ongoing contributions and diversification. (Read the full report)
As expected, younger people (whose contributions are large relative to their balances) are doing much better than older people (whose contributions are small relative to balances). Still, over half of those in those critical preretirement years, ages 55–64, were ahead of where they stood two years ago. And most of those with large losses were participants with ultra-aggressive portfolios invested largely in stocks.
In the report, my coauthor Jean Young and I discuss the criticisms of this perspective—echoed by some of you—that we are conflating investment returns with contributions. But retirement wealth is a combination of contributions and returns. Moreover, to anchor your retirement perceptions at the high-water mark of fall 2007 is just as much a mistake as to set expectations at the low-water mark of March 2009.
In any event, to me these findings underscore the fact that the risks of 401(k) savings are misunderstood. For participants who are regularly saving even in the face of large market losses, the road to recovery is rocky, but still manageable. And, for the median 401(k) participant at Vanguard, the road to recovery was relatively short—two years, in fact.
The real risk to 401(k) savings stems not from market risks, but from a toxic combination of market decline and job loss, and the ensuing pressure to access retirement savings. I’ll return to that perspective on 401(k) risk in a future post.
Note: Diversification does not ensure a profit or protect against a loss in a declining market.
This is an excellent analysis of the Vanguard 401k plan. Although I was retired in 2000, I maintained the ultra aggressive portfolio even during my 10 years of retirement. Although down 24% from the high water mark of October 2007, I am still ahead of my retirement savings in 2000. It should be noted that I have been withdrawing 3-5% per year from my 401k to meet expenses in retirement.
I never worried about my supplemental retirement accounts while I was still contributing. Now retired I worry a lot.
Sure I have $5 more in my account now than I did 2 years ago. I had close to $200k in my account then and $50000 of contributions later, I’m back to $200k again. At age 34, this fact doesn’t thrill me!
The number of people (roughly 50%) who are back to their levels of two years ago may be a better indicator of just how many people have underfunded their plans in the past.
I think the issue of concern is not if the money has grown, but when an advisor includes your contributiion as part of the growth. So, while my portfolio does grow because of my contribution, it may be stagnant or at a loss in the money already contributed, the inclusion of monies we’ve earned seems like smoke and mirrors.
The brighter you try to paint this picture, the uglier it gets. If “over half of those in those critical preretirement years, ages 55–64, were ahead of where they stood two years ago”, the only logical conclusions to draw are that either they were invested very (too?) conservatively and did not face steep declines, or–more likely–as of 2 years ago, they had not saved enough in their plans to retire comfortably–enabling the impact of recent contributions to outpace investment losses.
On the other hand, you seem to cast aspersions on the “ultra aggressive” portfolio choices made by some of these investors–a choice that, while unfortunate, is entirely logical. Realizing that they are likely under prepared for retirement, they face a combination of 3 choices: save more; work longer; or take a more aggressive portfolio position to earn higher returns. Door number 3 was, in hindsight, a poor choice, but a logical one, compared to reducing post-retirement spending.
In summary, you have combined the Beardstown Ladies’ method of calculating investment returns (treat capital contributions as investment returns) with some empirical data to lead us toward some feel good analysis that discounts the dismal returns of the recent past.
I have to agree that my 401k has done much better through the market downturn that I would have expected. In my particular case, I benefited by investing in a target date fund, which automatically rebalanced the fund holdings when the market was at the bottom. I was inactive (with fear) during the market downturn, and I would have never rebalanced on my own. I was also fortunate that my company made their 401k match just at the bottom of the market, so I was able to buy a large chunk of fund shares when they were cheapest. The fund I invest in has a net positive return over the last 10 years, and my personal return is higher due to dollar-cost averaging, and the effect of the timely 401k company matches. When I look at a graph of my 401k balance for the last 12 years, the effect of the market downturn is completely cancelled out by the market increase of the last 18 months, and my account balance is significantly higher than it’s ever been.