I realize this is an almost impossible question to answer without knowing how the economy is doing, what the retirement date is, etc., but I’m a novice at retirement planning and know little of what to expect.
What is an anywhere-near-reasonable ballpark figure for how much a 401(k) should grow annually?
1%? 5%? 12%? 20%?
Assume that one just simply sticks $10,000 into the 401(k,) selects an investment strategy exactly midway between “cautious” and “aggressive,” and leaves the account untouched for 30 years. No matching funds from employer, etc.
A good rule of thumb assuming you have a reasonable basket of equities is a long-term annual appreciation of around 12%. (This is what the S&P 500 does over the long term.) Let’s be extra cautious and say 10%.
$10,000 at 10% a year, assuming no additional contributions, after 35 years will be $281,024.37.
Of course, you don’t want to just leave it alone for 35 years, you want to contribute lots more every year, so in reality you’ll have more than that.
Historic rates of return over long periods range from about inflation (bonds and the like, let’s call it about 2% these days) to a bit over 10% (the stock market, at about 10.8% historically). Individual stocks could do better, but of course you can’t reliably pick those ahead of time. For a 401K with managed funds in a mix of the two, I’d expect 8% over a 30 year period, with a low of 5% if you pick a bad year to have to take it out, and a high of about 12% if you get exceptionally lucky.
Of course, that’s assuming past performance equals future performance, which I’m pretty sure I’ve heard something about before, and I’m not a money manager.
ETA: freido posted while I was composing. I think his (her?) numbers are a bit optimistic, historically speaking. Returns have been higher twice lately, and it’s coloring perceptions of what “normal” should look like for the market.
If I were just starting my retirement savings, I would start with the advice in this free e-book (PDF) by a very respected advisor.
In my experience with two retirement accounts beginning in 1980 and 1990, I consider myself quite lucky to have had two separate accounts that (ignoring inflation) returned roughly 9% and 10% compound returns through 2013. As always, past is not future, YMMV, yada yada…
I stayed fully invested in equities in the face of 30-40% losses during the big market downturns - just gritted my teeth and held on. My accounts recovered. Friends who tried to time the market never recovered their losses.
Always always subtract inflation from these numbers. Inflation averages about 3%, although it can vary significantly.
Adjusted for inflation, that 12% Rate of Return is really only 9%, and it’s only 7% if you choose a more conservative 10%.
Also keep in mind that economic expansion cannot go on forever. There’s physical and institutional limits. The numbers we’re quoting are averaged over historical periods when there have been revolutions in technology and a complete revamping of society.
And don’t forget fees. Fees in 401k accounts are often underestimated. Many employers lock employees into 401k plans with exorbitant fees. A 1% fee means that even if you achieve the 10% rate you’ll give back 10% of it and end up with 9%, and they don’t care if you lose money, they still collect their 1%, and 1% is considered reasonable. A lot charge more.
I don’t think the OP quite understand what a 401k is. Contributing money pretax and getting an employer match is what they’re all about. If you just have $10k burning a hole in your pocket and you want to put it on ice in a retirement account you would get an IRA, Roth (taxed money in, no tax on money taken out in retirement) or traditional (pretax money in, tax on all withdrawals).
I rolled over an old 401k from Prudential into a Vanguard traditional IRA at the beginning of the year. I don’t intend to contribute any more money to this account just to see what happens over 35 years. I selected a low fee target date fund for 2045 or 2050 (I don’t recall which) and I’m up about 10% so far.
I don’t think 10% is an unrealistic average over a long period of time, based on historical averages for stocks and bonds, but there are certainly no guarantees. And you have to factor in fees and inflation, but there’s not much you can do about those.
While it’s impossible to time the market, you can make adjustments based on long term bull and bear markets. These shifts can help boost your return, but then again…
You can save a lot on maintenance fees by choosing index funds (versus actively managed funds), assuming your account has that option. While such fees are typically a small part of the account balance, the difference between, say, 2% and 0.5% is considerable over time. That money comes out every year, whether the fund makes money or not.
And there is a growing consensus that actively managed funds don’t do any better over the long run than index funds.
The data would tend to disagree. From March 4th, 1957, the date of the S&P index creation until July 3rd, 2014 the annualized growth rate was 6.87%. The growth rate of the Dow Jones Industrial Average over the same period was slightly lower, 6.44%. That’s not factoring in fees or inflation. 10% growth rate is wildly optimistic. If a professional money manager were saying a 10% long term growth rate was possible I’d say damn near criminally optimistic.
One problem is, any “overall rate of return” is going to change from one month to the next. I have been graphing the federal Thrift Savings Plan (the federal employee 401(k), or at least something very close to a 401(k)) for years, and money put into the stock-based plan in 1990 started out making something like 10% a year - until the market crash, at which point it turned into 5% a year (that’s not 5% a year since the crash; that’s 5% a year since when you put the money in in 1990). The 1990 value is now back up around 10%/year. However, the only rate that matters is the one when you take the money out.
Sure. But with dividends reinvested (which is how I personally do these things), the S&P500 return rate is a hair over 10% for that period. Adjusted for inflation, we’re looking at a 6% annualized return, but that’s pretty damned good (in my opinion.)
I just got a 30 year forecast from my financial planner. They didn’t do a single number - instead we got a range of probabilities. The report gave a pessimistic value - only 20% of forecasts were worth, an average value. 50% were worse, and an optimistic value - 67% were worse. Since this was for a retirement forecast, the situation was more like that of the OP, with no more deposits.
The 20% forecast showed a hole at 90, the 50% showed me roughly keeping the value of my investments constant while taking enough out to live on, and the 33% model showed me making money while living on the returns of the investments.
I haven’t reviewed these with him yet, but I suspect they are done by looking at lots of models, just like weather forecast probabilities are done looking at lots of weather models.
Plus there is the withdrawal timing problem. In 2008 my return looked miserable, but I’ve about doubled since then (counting additional investments, of course.)
Plus as you move towards retirement you will want to change the investment mix to a less volatile but lower yielding mix.
I believe I got this site from another poster last year, but I find it quite fun in calculating the range of possible outcomes: http://www.firecalc.com/
Be sure to tweak the settings to your liking. I think the default uses history since 1871, which strikes me as too broad; I usually adjust that to be 1950 (under the Your Portfolio tab).
No, no, no, no, no… Market Timing is a loser’s game. Even thinking about timing your investments is folly. No one can predict when a bull or bear market is going to start or end. Trying to is going to greatly reduce your returns.
Put your money in a low-cost S&P 500 index fund, and forget it. Don’t try to move money in or out. Just leave it in there. Put more money in as you get it (on a schedule, like your paycheck dates). Look up “Dollar Cost Averaging” for why.
Trying to time a market is indeed folly, but portfolio rebalancing is an accepted technique for reducing risk over the long term. It works like this:
invest your wealth in two or more uncorrelated assets. (reality: it’s impossible to find assets that are completely uncorrelated, but you can shoot for poorly correlated assets. A simple binary portfolio would be stocks and bonds.)
Select a target allocation at the outset, e.g. invest 10% in bonds, 90% in stocks.
Once per year, on the same date every year, you reexamine your portfolio and buy or sell assets as needed in order to restore your chosen allocation.
This is a technique that forces you to buy low and sell high. In a normal year (or a bull market), the stocks will do considerably better than bonds. So on January 2, you would sell some of these stocks and put that money into bonds, restoring your 90:10 allocation. In a bear year, stocks would do worse than bonds; this time, you sell bonds and use the money to buy stocks, again restoring your 90:10 allocation.
Having a portion of your portfolio in bonds lowers your long-term average rate of return, but more importantly, it reduces the variability of your long-term outcome. In other words, if your projected final nest egg is $1M, you’re less likely to end up with $3M, but you’re also likely to only end up with only $300K. For most folks, the value of avoiding a shoestring-budget retirement is worth sacrificing the potential of being a gray-haired multimillionaire, so this is a technique that’s worth applying.
The challenge lies in sticking to the technique. When January 2 rolls around (or whatever your chosen rebalance date is), it can be emotionally difficult to sell off any of your stocks when they’re up 30% from a year earlier - or to buy them when they’re down 50%.
An alternative to rebalancing yearly is to use a fund that does it for you - as long as you choose one with low fees.
Two that I like are Fidelity Four in One Index FFNOX (85/15 stock/bond) and Vanguard Wellington VWELX (65/35). My 30 year old daughter owns the first and my 60 year old wife the second. (Wellington is one of the first mutual funds and is a staple in what I think of as ‘Little old lady trust funds’. It survived the Great Depression without impoverishing those who held it.)
You can squeeze the expense a bit lower with separate index fund, but these are each about .2%.
I agree about the Vanguard Wellington. I’ve told my wife that when I die she should sell my carefully accumulated portfolio of dividend growth stocks and put everything into the Wellington. She lacks the temperment for investing and doesn’t enjoy it. Should she predecease me I’m spending her deferred compensation on 40-year old scotch and 20 year old hookers, so we’ve both got a plan.
FYI, Warren Buffett has a slightly different plan for the money his wife would inherit upon his death, “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P
500 index fund. (I suggest Vanguard’s.)”