There's good news and there's bad news when it comes to the retirement readiness of the average investor. The good news is that the average 401(k) balance recently reached a new record. The bad news is that record amount of savings isn't exactly enough to fund a lush retirement for even the most frugal of retirees.
Taking the slow boat
Fidelity Investments, currently the largest retirement plan administrator in the business, recently reported that the average 401(k) account in the U.S. hit a record of $74,900 at the end of March. According to Fidelity, roughly two-thirds of the rise in balances over the past year was from market gains, while the remaining one-third came from employee contributions. While it's good to see those balances rising, retiring on $75,000 is a tough prospect for anyone.
Of course, there are a few other things we need to take into account here. This number is just the average account balance, meaning some investors have saved less and some have saved more. Most likely, investors who are closer to retirement have quite a bit more saved, given that they have had more years to sock money away and generally earn more than their younger counterparts. In addition, investors may have other sources of retirement income available to them including pensions from prior or current jobs and Social Security.
However, for increasing numbers of young investors, pensions are fast becoming a thing of the past, and odds are good that younger generations will face lower payouts from Social Security along with a higher retirement age. That means more and more of us will end up relying on our 401(k) savings as our primary source of retirement funds down the road. That means we've got some work cut out for us to push that $75,000 average up. Fortunately, there are a few steps that investors can take to maximize their 401(k) or other retirement plan investments.
1) Stop trying to time the market
Trying to time the market is a tough game, even for the Wall Street folks who have nearly unlimited resources and brain power on their side. That means it's pretty near impossible for mere mortals like us. A study by DALBAR shows that while stocks returned an average of 11.8% from 1988 to 2007, the average mutual fund investor only saw a 4.5% gain.
Why the disparity? Investors tend to buy and sell funds at exactly the wrong times, selling after the market drops and only getting back in after a meaningful run-up, when they think the market is "safe." That's the exact opposite of buying low and selling high. My advice is to not try and avoid every short-term dip in the market but rather invest for the long run. Ride out the temporary bumps without heading for the hills and you'll end up with greater gains over the long-term.
2) Don't chase fads and hot performance
It's hard to ignore that sector of the market that has been on an absolute tear recently, while you are stuck with your boring old long-term asset allocation. After all, you want a piece of the action, too!
The problem with jumping into hot sectors or countries is that if investors are being drawn in by a hot performance record, the biggest gains are likely already behind you. You're more likely to get burned than you are to make huge profits. Investors probably already know which sector qualifies as today's hot new thing: commodities. While I can't argue with the logic of holding a small commodities allocation for the long run, investors buying into the sector now expecting to make millions are probably going to be disappointed. Prices are already high in this sector, which means there's a lot more risk involved than there was just a few years ago.
3) Diversify, diversify, diversify
It's been said that there is no free lunch in the economic scheme of things, and that also holds true when it comes to investing. However, maintaining an adequate level of diversification in your portfolio is the closest thing there is to a free lunch. Spreading your bets across sectors, market capitalizations, and countries may seem like a safe, boring approach, but it's the key to successful long-term investing.
And make sure you're not making the mistake a great percentage of 401(k) investors are making: being too heavily invested in your company's stock. You're already pretty dependent on this company for your well-being since they employ you, so don't add to that risk by betting your retirement assets on the company's future fortunes. If you've got a large percentage of your assets in company stock, seriously think about reallocating some of that money to more diversified options.
You will, of course, be somewhat restricted to the investment options available in your employer-sponsored 401(k) or other retirement plan, but you should still take care to examine the fund options to identify the best investments. If you're not sure which funds you should pick, a safe bet is to go with index funds across various asset classes. These funds obviously won't blow the market away, but they are typically inexpensive, making it hard to go wrong here. Exchange-traded funds typically represent an even cheaper option, but they aren't usually readily available within retirement plans. However, many retirement plans are gradually moving to include ETFs, so you may see these funds in your plan down the road.
For example, if you're lucky enough to have access to Vanguard funds, you'll have quite a few options for index funds, ETFs, or both. Here are some of the shop's better offerings in this area:
Exchange-Traded Fund Version
|Vanguard Total Stock Market Index (VTSMX)||
Vanguard Total Stock Market ETF
|Vanguard Small Cap Index (NAESX)||
Vanguard Small Cap ETF
|Vanguard Total International Stock (VGTSX)||
Vanguard Total International Stock ETF
|Vanguard Emerging Markets Stock Index (VEIEX)||
Vanguard MSCI Emerging Markets ETF
|Vanguard Total Bond Market Index (VBMFX)||
Vanguard Total Bond Market ETF
So if you've got more than $75,000 in your 401(k) account, congratulations -- and keep up the good work. If not, you've got some ground to make up. But no matter where you fall on the spectrum, you're probably going to need to save a whole lot more to live out your dreams in retirement. It's not an impossible task, but you will need discipline, a long-term focus, and an ability to shut out the day-to-day noise that surrounds us all.