It’s All About The Asset Allocation
How your 401 account performs depends entirely on your asset allocation: that is, the type of funds you invest in, the combination of funds, and how much money you’ve allocated to each.
Investors experience different results, depending on the investment options and allocations available within their specific plansand how they take advantage of them. Two employees at the same company could be participating in the same 401 plan, but experience different rates of return, based on the type of investments they select.
Different assets perform differently and meet different needs. Debt instruments, like bonds and CDs, provide generally safe income but not much growthhence, not as much of a return. Real estate or real estate mutual fund or ETF) offers income and often capital appreciation as well. Corporate stock, aka equities, have the highest potential return.
However, the equities universe is a huge one, and within it, returns vary tremendously. Some stocks offer good income through their rich dividends, but little appreciation. Blue-chip and large-cap stocksthose of well-established, major corporationsoffer returns that are steady, though on the lower side. Smaller, fast-moving firms are often pegged as “growth stocks,” and as the name implies, they have the potential to offer a high rate of return.
It sounds like an advertising cliché, but it bears repeating anyway: Past returns of funds within a 401 plan are no guarantee of future performance.
Americans In Their 60s
- Average balance: $182,100
- Contribution rate: 11%
Most people would like to step away from their career at some point in their 60s so they can focus on time with family or time to pursue other passions.
Looking at the average numbers, though, we see a different story. Lots of Americans will keep working well into their 60s. Maybe youre okay with that. In fact, a recent survey found that 30% of American workers say that their retirement dream involves some sort of work.3 Thats great! But if youre going to work in your retirement years, it should be because you want tonot because you have to.
Adjusting Your Portfolio For Inflation
Since inflation affects different asset classes in a variety of ways, diversifying your portfolio can help ensure that your real returns remain positive, on average, over the years. But should you adjust your portfolios asset allocation when inflation changes?
Gahagan says no because people are likely to make tactical errors based on the news and fears of the day. Instead, investors should develop a sound, long-term strategy. Even in retirement, we usually don’t invest for the short term. For example, at age 65, were investing for the next 25 to 35 years or longer. In the short term, any number of unfavorable things can happen, but over the long term, these things can balance out, he says.
The same guideline that applies during your working yearschoose an asset allocation appropriate for your goals, time horizon, and risk tolerance, and dont try to time the marketapplies during your retirement years. But you do want to have a diversified portfolio so that inflation doesnt have an outsize effect on your portfolio during a particular period.
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Choose A Withdrawal Rate Based On Your Time Horizon Allocation And Confidence Level
CSIA updates its return estimates annually, and withdrawal rates are updated accordingly. See the disclosures below for a summary of the Conservative, Moderately Conservative, Moderate, and Moderately Aggressive asset allocations. The Moderately Aggressive allocation is not our suggested asset allocation for any of the time horizons we use in the example. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product and the example does not reflect the effects of taxes or fees. Past performance is no guarantee of future results.
Again, these spending rates assume that you will follow that spending rule throughout the rest of your retirement and not make future changes in your spending plan. In reality, we suggest you review your spending rate at least annually.
Balancing Risk And Returns
Now, it’s time to return to that 5% to 8% range we quoted up top. It’s an average rate of return, based on the common moderately aggressive allocation among investors participating in 401 plans that consists of 60% equities and 40% debt/cash. A 60/40 portfolio allocation is designed to achieve long-term growth through stock holdings while mitigating volatility with bond and cash positions.
On the risk/reward spectrum, the 60/40 portfolio is about in the middle. For instance, if you invest in a more aggressive portfoliosay 70% equities, 25% debt, and only 5% cash you may expect higher, double-digit returns over time. However, the volatility within your account may also be much greater.
Conversely, if you went more conservative75% debt/fixed-income instruments, 15% equities, 10% cashyour portfolio would have a pretty smooth ride, but returns of only 2% to 3% .
Typically, an individual with a long time horizon takes on more risk within a portfolio than one who is near retirement. And it’s common, and prudent, for investors to gradually shift the assets within the portfolio as they get closer to retirement.
As a one-stop-shopping way to accomplish this metamorphosis, target-date funds have become a popular choice among 401 plan participants. These mutual funds allow investors to select a date near their projected retirement year, such as 2025 or 2050.
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A Case Of Bad Timing Can Ruin Everything
The real problem with investing for retirement is the stock markets can do really unpredictable things when you may not want them to happen. Ive often said the stock market is not predictable or controllable so the variability can be really destructive to the timing of peoples retirement. Just think back to the last 10 years and how the stock market delayed many peoples retirement. The stock market hit retirees hard during severe corrections.
End date bias can change a portfolios return dramatically within months, weeks and even days. The last thing anyone wants it to retire just as the stock market takes away 20%, 30%, 40% or more. Projecting rates of return is essential but the biggest problem is the risk of the markets can change that return very quickly I call this the retirement risk zone. For more on stock market risk and retirement, check out an old article called 6 perspectives on why retirees need to be more conservative with their portfolios.
What Is Sequence Of Returns Risk
Sequence of returns risk, sometimes called sequence risk, is the risk associated with the order in which you experience yourinvestment returns. This risk is heightened in a withdrawal period when you are living on savings and investments and dont have income from employment to offset losses and maintain cash flow. If you have low or negative returns in the first few years of retirement versus having those bad years near end of life, the outcome of your portfolio experience can be much different even though your average rate of return may be the same.
If a significant percentage of your portfolio is composed of asset classes that are more volatile, sequence of returns is one of the biggest risks that you need to factor into retirement income planning.
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Stay Flexiblenothing Ever Goes Exactly As Planned
Our analysisas well as the original 4% ruleassumes that you increase your spending amount by the rate of inflation each year regardless of market performance. However, life isn’t so predictable. Remember, stay flexible, and evaluate your plan annually or when significant life events occur. If the market performs poorly, you may not be comfortable increasing your spending at all. If the market does well, you may be more inclined to spend more on some “nice to haves,” medical expenses, or on leaving a legacy.
Here’s A Look At Some Of The More Popular Investment Options:
Stocks for growth
The majority of savers still buy stocks either directly or through a mutual fund or exchange-traded fund which are shares in a publicly listed company. Stock prices tend to rise over the long-term, which is why people buy them. Since 1926, the S& P 500 has posted a 10.24% average annual return with dividends reinvested, according to S& P Dow Jones Indices. In other words, if you invest in equities in your 30s and retire in your 70s, there’s a high likelihood that your money will have grown over those 40 years.
The downside is that stocks can fall. In the Great Recession of 2008 and the more recent pandemic stock market plunge, stock prices dropped by more than 35%, which caused a lot of problems for those in and nearing retirement.
Bonds for safety
Bonds are another popular investment for savers as they can move a lot less in price than stocks. Investors lend money to a government or company in exchange for an annual payment based on a predetermined interest rate. At the end of that bond’s term usually between one and 30 years you get back your original investment. Investors like bonds for two reasons: they get some guaranteed annual income and there’s less risk, depending on the kind of bond you buy, of losing any money. Because of this, bonds tend to fluctuate less than stocks and so they balance out a portfolio’s overall ups and downs.
Alternative asset classes
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Risk And Returns Of Stock Market Investments Held In Individual Retirement Accounts
Congress and the public are rightly concerned about the future of Social Security. Many people have proposed novel and dramatic reforms to the system to assure its solvency or improve workers rate of return on their contributions. One popular proposal is to establish a new system of individual, privately managed retirement accounts that could be invested in high-return private securities, such as common stocks. This approach can push up workers returns in the long run. But this can only occur if we increase the level of reserves that back up future pension promises. In other words, our retirement system must move away from pay-as-you-go financing and toward greater advance funding. This in turn requires that some Americans accept a temporary reduction in consumption, either by making larger contributions to the pension system or accepting smaller pensions.
Since the basic goal of a government mandated pension system is to ensure workers a predictable and decent income in old age, the reform plan we ultimately adopt should be one in which the collective, defined-benefit plan provides the bulk of mandatory pensions, especially for workers with average and below-average lifetime wages. A single collective fund exposes these contributors to far less financial risk than an alternative system in which most of their retirement income is derived from individual investment accounts.
Risks and returns of individual accounts
Average Roth Ira Interest Rates
Many banks and credit unions offer a Roth IRA savings account. Its essentially a Roth IRA that holds a savings account instead of investments. Your funds will earn the savings account interest rates and you’d be covered against losses up to $250,000 with FDIC insurance.
However there are downsides to these accounts, including the rate of return on them. Savings accounts generally return significantly less than you could make with other investment choices like stocks and bonds. The rate of returns is not likely to keep up with inflation rates, meaning you could lose money.
As of March 2022, the national average interest rate offered on savings accounts was 0.06%. By contrast, the average inflation rate in the U.S. was 8.5% from the 12 months ending March 2022. So your money would become less valuable every year that you kept it in the IRA savings account, not more.
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Average Retirement Savings Return Error #: Single Percentages
And now an error that even many experienced do-it-yourself-ers make: We want to avoid using a single percentage value for your estimates.
In other words, you might be tempted to use a 6% average retirement savings return for your retirement calculations. That would seem to make sense since over the last 150 years or so, the stock markets average, median annual return has run about 6%.
But heres the problem. A 6% median annual return doesnt mean youll earn 6%. It tells you theres a 50% chance youll earn more than 6% and a 50% chance youll earn less. Almost surely, youll experience some percentage very different from that median.
The little table below gives more details using the example where someone annually saved $5,500 for retirement over 35 years and invested 75% of their savings in stocks and 25% in bonds sometime in the last roughly 150 years:
| Outcome |
|---|
| 8.28% |
Make sure you understand the numbers in the preceding tablebecause too few people do.
The numbers show that the median outcome equals $620,358 an amount that reflects the median 5.99% return.
But in truth, wide variability occurs:
To summarize: You and I dont want to use a single percentage in our plans. We should use a range of percentages.
My suggestion? Of course, start with a median return for calculations. But you probably also want to estimate a likely downside outcome perhaps using as your average retirement savings return the median return minus 1% or 1.5%.
Mutual Fund Returns Vs Etfs
Mutual funds and exchange-traded funds are similar in that they are both pooled investments that hold a large number of underlying assets. They can either track the performance of a particular index or be managed by a professional fund manager.
The key difference between mutual funds and ETFs is the way they trade. An ETF trades in a similar way as a stock, while trades on a mutual fund work a bit differently.
One significant difference between mutual funds and ETFs is that while mutual funds trade only once a day at the end of the day, ETFs trade throughout the day, said Dann Ryan, a CFP and the founder of Sincerus Advisory. So while this means you get one price a day on a mutual fund, you get many for an ETF.
When you decide to invest in a particular index, youll often find both mutual funds and ETFs for that index. For example, there are S& P 500 mutual funds and ETFs, and they both hold the same underlying assets.
The biggest difference in your returns when you have a similar mutual fund and ETF is likely to come down to the fees. For example, Vanguards S& P 500 mutual fund has an expense ratio of 0.04%, while its S& P 500 ETF has an expense ratio of 0.03%. The difference between the two is so minimal youll barely notice it in your returns. But if you had expense ratios that were significantly further apart, the difference between your returns would also be larger.
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Average Retirement Savings In The United States
8 Minute Read | November 16, 2021
In the coming years, America will face a retirement crisis. Nearly half of Americans arent saving at all for retirement, and those who do save arent saving enough.1 Instead of packing their bags for their dream vacation in their 60s and 70s, millions of Americans will be packing their lunch for another day at the office. Thats the bad news.
The good news is, its never too late to improve your situation. You dont need anyones permission to start making your dreams a realityyou can do something about it today.
Lets take a look at what average Americans have saved for retirement by the decade. Then well talk strategy so that you can get closer to your retirement goals.
But What About The Lost Decade
Until 2008, every 10-year period in the S& P 500s history has had overall positive returns. But from 2000 to 2009, the market saw a major terrorist attack and a recession. And yepyou guessed it, the S& P 500 reflected those tough times with an average annual return of 1% and a period of negative returns after that, leading the media to call it the lost decade.4
But thats only part of the picture. In the 10-year period right before that the S& P averaged 19%.5 Put the two decades together and you get a respectable 10% average annual return. Thats why its so important to have a long-term view about investing instead of looking at the average return each year.
But thats the past, right? You want to know what to expect in the future. In investing, we can only base our expectations on how the market has behaved in the past. And the past shows us that each 10-year period of low returns has been followed by a 10-year period of excellent returns, ranging from 13% to 18%!
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How Your Investment Choices Affect Your Roth Ira Returns
Lindsay VanSomeren is a credit card, banking, and credit expert whose articles provide readers with in-depth research and actionable takeaways that can help consumers make sound decisions about financial products. Her work has appeared on prominent financial sites such as Forbes Advisor and Northwestern Mutual.
A Roth IRA offers investors a number of benefits like flexibility for withdrawals and tax-free growth on your assets.
You may wonder what the average return rate is for a Roth IRA. However this retirement account can earn money in a number of ways depending on your investment choices, so there is no “average Roth IRA return.” Your return with your own IRA could be significant or minimal, or you could even suffer losses.
Lets learn more about how your investment choices can affect the rate of return in your retirement investing account.
Savings In Cash And Cash Equivalents
Positive real rates of return are essential to not outliving your means. If too much of your savings are in cash and cash equivalents, like CDs and money market funds, your portfolios value will shrink because these investments pay interest at a lower rate than the inflation rate. Cash always earns a negative real return when theres inflationand deflation is historically rare in the United States. But cash does have an important place in your portfolio.
A liquid reservesomething over and above your normal outflowis a good idea for retirees, Gahagan says. In the event of a market downturn, your liquid reserve lets you shut off the tap from the portfolio and draw on cash instead. By avoiding taking money out of your portfolio when the markets are falling, your portfolio will recover better.
Gahagan says most of his clients are comfortable with 18 to 24 months worth of cash reserves, and sometimes 30 months. It depends on their personal comfort level, what other resources they have to draw on , and whether they can cut back on spending. But even after a dramatic recession like the one we saw from December 2007 through June 2009, he says his clients portfolios had largely recovered by mid-2010.
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