It turns out my clients and family members weren\u2019t far from the norm of Americans. The average 401(k) balance has been increasing year over year. This is mainly due to the market\u2019s returns over the past few years and larger contributions from employers and employees contributing to 401(k). Additionally, around 55 million workers were actively participating in 401(k) plans<\/a> as of 2016. So plenty people are participating in their 401(k) plans.<\/p>\n Fidelity suggests the average worker has\u00a0saved 8x their salary<\/a> by the time they retire, yet a study done on 401(k) balances for the typical middle class worker found that pre-retirees, those aged 55-65, had an average balance of only $100,000 saved.<\/a> If your ending salary is $90,000, your 401(k) should have $720,000 based on Fidelity\u2019s general rule. Your 401(k) balance, based on the 4 percent rule, provides you with $28,800 in withdrawals each year in retirement.<\/p>\n Related:<\/strong> You Should NOT Bank on Your 401k For Retirement. Here\u2019s the Superior Alternative.<\/a><\/em><\/p>\n Why the big discrepancy? I think there are many reasons; however, I am going to discuss the two that I believe to be among the most critical: failure to rebalance and high fees. I\u2019m also going to attempt to quantify the 401(k) investment vehicle as a whole and show you what the typical 401(k) must earn in order to make the contributions worthwhile, rather than simply forgoing the 401(k) and investing that money in the market.<\/p>\n It blows my mind how many people invest in 401(k)s blindly. By that I mean they don\u2019t really understand what they are buying with their money, they don\u2019t understand how the funds operate, they typically don\u2019t know the 401(k) rules, and they certainly don\u2019t rebalance their portfolio. In fact, only 15 percent of 401(k) participants rebalanced their 401(k) in 2014.<\/a><\/em> This statistic alone shows me that many people truly “invest and forget” with their 401(k)s. Do you think financial advisors\/money managers rebalance their client\u2019s portfolios every year? You bet they do. And if they don\u2019t, they have a really good reason not to.<\/p>\n The problem here is that 401(k) participants aren\u2019t adapting their portfolios to new market trends. The argument can be made that personal investors tend to do worse than the market as a whole, as they make poor, emotional decisions \u2013 in fact, in 30 years, the average investor has returned a measly 1.9 percent.<\/em><\/a> But does this mean the plan participant should never<\/em> rebalance their portfolio? Absolutely not.<\/p>\n A 401(k) is not something to \u201cset and forget,\u201d as your returns will drastically suffer. By not rebalancing your portfolio, you become overexposed to certain asset classes. Maybe you are a 25-year-old and overweight in bonds, which slows your portfolio\u2019s growth. Or you are 65 and overexposed to equities or emerging markets because you haven\u2019t rebalanced in years and the next market crash wipes you out.<\/p>\n You should rebalance at least once per year. Make it a New Year\u2019s activity. Read about the market and events that are expected to occur in the next year. Use retirement calculators and asset allocation calculators to determine your ideal asset allocations. Pay a financial advisor $80 for an hour of his\/her time and have them review your 401(k) balances. It will be worth it in the end.<\/p>\n There are typically high fees involved with 401(k) plans. The employer is required by law to shop around in order to get the lowest fees for their employees, but at the end of the day, the employer has the luxury of passing the plan fees on to the employees.<\/p>\n Fees range from plan administration (usually low) to fund management (usually high). The fund management fees are what plan participants can and should zero in on. Even though the participant has a limited selection option of funds to invest in, the participants can still pick funds with lower fees involved. Ideally, the participant would not invest in a fund charging more than 0.1 percent on assets. Sadly, I see many people paying 1 percent or more on investable assets, and those are only the front end fees.<\/p>\n Be sure to look at each of your plan\u2019s fund choices carefully. Sometimes funds will have posted large returns in years past, but will charge an exorbitant fee. Be careful investing in these funds, as historic performance is not an indicator of future success, but the fees are for certain.<\/p>\n The big question is: Should I invest in my 401(k) or use the post-tax funds to invest in the market or alternative asset classes, such as real estate? The answer is quite complicated, as there are many variables involved.<\/p>\n My modeling was based on the assumption that tax brackets will never change, which of course is laughable. But it\u2019s all I have to go on since literally no one can predict the tax or political environment in 30 years. So take my model with a big grain of salt.<\/p>\n Using the model I have uploaded<\/a> into the BiggerPockets Fileplace, I have assumed that the average 401(k) return is 6 percent<\/a>\u00a0and that the geometric mean of the market since 1965 is 9.84 percent.<\/a> I have two scenarios: the 401(k) contribution scenario and the non-401(k) scenario, which assumes that you have forgone the contribution and instead invested the post-tax money in a low cost index fund. My model only looks at the money you contribute or forgo to contribute.<\/p>\n Assuming a starting salary of $60,000, an annual raise of 5 percent, an annual contribution of 6 percent and a 50 percent employer match, at the end of 30 years, the 401(k) will have a higher balance than the \u201cnon-401(k)\u201d option: $767,636 vs. $670,532, respectively. At 30 years I assumed we retire and begin withdrawing 4 percent for each scenario. After an additional 20 years (at the end of 50 total years), the 401(k) ending balance is $1,088,172, while the \u201cnon-401(k)\u201d ending balance is $1,936,667. The big eye opener was that the 401(k) will generally outperform your post-tax money until you retire and no longer receive employer contributions. <\/em>At that point, the \u201cnon-401(k)\u201d portfolio drastically outperforms the 401(k) portfolio.<\/p>\n I also found that taxes are a moot point. Assuming a 4 percent withdrawal rate in both scenarios, the tax rate will be the same (15 percent) until the 401(k) withdrawals push the owner into the 25 percent tax bracket, as you will be paying 15 percent on the \u201cnon-401(k)\u201d gains in the form of capital gains. Total taxes paid are going to be higher for the \u201cnon-401(k)\u201d scenario, but the portfolio ends up with a significantly higher value than the 401(k) portfolio, which effectively makes the tax argument invalid.<\/p>\n Related:<\/strong> 7 Things to Do NOW to Get Your Financial House in Order<\/a> The good news is that I found if your 401(k) earns only 7.72 percent annually, assuming all the variables above, your 401(k) portfolio will have value equal to the \u201cnon-401(k)\u201d scenario at the end of 50 years. This means that the answer to the \u201cshould I invest in my 401(k) or not\u201d question comes in the form of another question: Will your money earn at least 7.72 percent annually in your 401(k), and if not, will you invest your post-tax foregone contribution, and will that money earn 9.84 percent annually?<\/p>\n An employer match is a big component of a successful 401(k) plan, and unfortunately, my employer will only match 25 percent up to 6 percent. Because of this, I have decided not to participate in my employer\u2019s 401(k). I\u2019m sure it may make sense in the future, but I need to earn more and see a higher employer match first.<\/p>\n One thing I didn\u2019t mention in this article was solo-401(k)s for self-employed individuals and business owners. Due to the significantly higher contribution limits for solo-401(k)s, I can\u2019t think of a time where it wouldn\u2019t make sense to max out this investment option, financially speaking.<\/p>\nFailing to Rebalance Your 401(k) Will Sink You<\/h2>\n
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<\/p>\n401(k) Plan Participants Don\u2019t Understand Fees\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 <\/strong><\/h2>\n
What Does the Typical 401(k) Plan Need to Return to Make it Worthwhile?<\/h2>\n
\n<\/em><\/p>\n![\"401(k)](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2015\/08\/401k-pic-1.png\" "\\"\\"")
<\/a><\/p>\n![\"401(k)](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2015\/08\/401k-pic-21.png\" "\\"\\"")
<\/a><\/h2>\nWhat Am I Doing?<\/h2>\n
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