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Why Rising 401(k)s Are No Cause to Celebrate

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There's no better friend to retirement savers than a rising market. Yet even as most investors have seen the balances in their 401(k) retirement plan accounts go up over the past year, the question they ought to be asking themselves is why those balances didn't go up more.

The latest quarterly look from Fidelity Investments revealed that its clients' average 401(k) balances rose to a record $77,300 as of the end of 2012, rising from $75,900 in the third quarter of 2012 and from $69,100 at the beginning of the year. Those figures correspond to strong performance in the financial markets, but what they reveal is that investors aren't doing nearly enough to take advantage of unusually favorable conditions.

Breaking down the numbers
As the report presents the figures, Fidelity is fairly optimistic about the state of retirement savings. According to its figures, participants are saving about 8% of their salaries in their 401(k)s, with another 4% or so coming from employer matching contributions and profit-sharing. Although only 1 in 11 participants changed their savings rate during the quarter, nearly twice as many raised it as lowered it.

According to the report, gains in the market accounted for two-thirds of the increase for the full year, while contributions represented the remaining one-third. That implies an investment return of about 8% on their invested money, while less than $3,000 of the $8,200 rise came from contributions.

Spoiling the party
Obviously, whenever retirement balances go up, it's good news. But in a year in which the basic vanilla Vanguard Total Market ETF (NYSEMKT: VTI  ) rose more than 16% and the Vanguard Emerging Market ETF (NYSEMKT: VWO  ) jumped almost 20%, it's clear that 401(k) balances are underinvested in growth assets.

Moreover, even bonds didn't do as badly as their low yields might suggest. The iShares Core Aggregate Bond ETF (NYSEMKT: AGG  ) rose almost 4%, besting the yield to maturity on most of the bonds it holds as bond prices rose overall. Corporate bonds did even better, with the iShares Investment-Grade Corporate ETF (NYSEMKT: LQD  ) rising more than 10% on the year.

With stocks well into double-digit returns and certain bonds providing decent gains, a rise of only 8% from 401(k) investments suggests that investors have a whole lot of cash in their accounts earning next to nothing. Given the fact that the vast majority of 401(k)s are invested for long-term goals, the level of cash that would lead to such modest returns in a very strong year for the markets is far too high.

Falling behind
Moreover, when it comes to amassing a sufficient retirement nest egg to survive throughout their retired years, near-retirees are still coming up short. The average balance of $143,300 for those age 55 or older translates to less than $500 per month in supplemental retirement income using the 4% rule -- and that rule has come into question lately due to low interest rates.

Moreover, most investors have their retirement plan balances in traditional 401(k)s, and so withdrawals will be subject to income tax, further reducing its purchasing power. The report pointed to a substantial increase in the adoption and use of Roth 401(k) plans, but assets in such plans remains only a tiny fraction of overall retirement assets.

What to do now
In order to keep from falling behind, long-term retirement investors need to understand that it takes a combination of ambitious saving and what may feel like overly aggressive investment strategies in order to reach their financial goals. As difficult as it may be to set aside 8% of your salary, finding ways to boost that level to 10% or even 15% will leave you in much better shape to withstand the ups and downs of the market.

Meanwhile, with stocks near all-time highs and bond prices still holding up well, it may seem ill-advised to get more aggressive with your retirement portfolio. For those who have decades to go before they actually need their retirement money, though, adding to better-performing asset classes has a high probability of long-term success even if it brings more volatility along the way.

Most 401(k) plans don't offer ETFs, but the right ones in an IRA or other brokerage account can make your nest egg a lot bigger. To learn more about a few ETFs that have great promise for delivering profits to shareholders in a recovering global economy, check out The Motley Fool's special free report, "3 ETFs Set to Soar During the Recovery." Just click here to access it now.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 22, 2013, at 4:46 PM, Erbjl wrote:

    I think this article ignores several facts of retiree investment. I am a 69 year old retiree, and while my case may be a little unusual, I think it points out the fallicy of drawing too many conclusions from the numbers quoted in this article.

    1) I currently hold 2 IRA's and 2- 401k plans. (one of which is managed by Fidelity).

    2) If you look at any one of my plans you will say that I am underinvested and woefully undiversified. If you look at the whole group you will come to quite a different conclusion.

    3,) With the ongoing fiscal financial crises which keep coming at us, even my financial advisors are uncertain what the best move is right now.

    4.) Right now, my decisions are being effected by plans for major purchases that I am about to make.

    Consequently, I think the conclusions that you draw from looking at individual plans can be rather misleading.

  • Report this Comment On February 24, 2013, at 2:17 AM, linmarman wrote:

    One reason 401(k) investors are receiving lower than market returns is because many (like me) are not fully invested. In about August, I pulled back significantly being 90% invested in stocks and funds, to about 50%. Since then, I've probably bought and sold enough to stay right about there. We had the looming election, the 'fiscal cliff', now the 'sequestration' and that will be kicked down the road to the next Congressionally mandated crisis. Up until about Jan 1, I was ahead. Now, I'm behind where I'd be had I stayed invested. But clearly, although my 401(k) largely reflects the market, my returns don't. Could be a significant contributor to the statistics noted in the article.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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