According to a Charles Schwab study reported in The Washington Post, 401(k) participants who used an independent investment advisor (made available to them) had an average return of 14.1%. Those who didn't seek advice averaged only an 11.1% return.
Now, three percentage points may not seem like a significant amount, but compounded over time, it can make a huge difference in your retirement nest egg. Take a look at the difference in compounded return rate using an initial investment of $10,000:
|
Years |
11.1% Return |
14.1% Return |
|---|---|---|
|
10 |
$28,651 |
$37,399 |
|
20 |
$82,088 |
$139,866 |
|
30 |
$235,192 |
$523,081 |
|
40 |
$673,849 |
$1.9 million |
The 11.1% return yields less than half that of the 14.1% return. In other words, those three measly percentage points translate to a difference of $1.3 million!
I'd rather be the millionaire ...
So what million-dollar wisdom are these investment advisors dispensing?
Robert Brokamp, advisor of the Fool's Rule Your Retirement service, says that the key factors to help determine higher returns for investors include:
- Diversification
- Asset allocation
- Asset location
Specifically, he points out that asset location is commonly overlooked, but can have a major effect on your portfolio. Simply determining in which account your investments are located (taxed or untaxed) can mean a 15% difference in after-tax wealth, according to a study by Robert Dammon, Chester Spatt, and Harold Zhang.
For example, you want your most tax-inefficient investments in tax-advantaged accounts such as an IRA or 401(k). Such investments could include high-turnover stock funds (which generate capital gains), taxable bonds, or stocks with better-than-average dividend yields, such as Johnson & Johnson
Once you've maxed out your retirement accounts, additional investments in low-turnover stock funds, index funds, or low- to no-yield individual stocks (like Jones Soda
No more excuses
In many cases, as the article mentions, the advice offered through 401(k) plans is free -- because the service is wrapped in overall expenses of the fund.
What kind of questions should investors ask? The Schwab study found that the difference in returns was most pronounced in young investors, who can afford to be a little more aggressive. Robert suggests the following guidelines:
- If you need the money in the next year, it should be in cash.
- If you need the money in the next one to seven years, choose safe, income-producing investments such as Treasuries, CDs, or bonds.
- Any money you don't need for more than seven years is a candidate for the stock market.
The Foolish bottom line
It's well known that by not contributing to a 401(k), you're leaving money on the table. But simply seeking advice can boost your returns and leave you with a significantly larger nest egg.
Have an informed discussion with your investment advisor -- with the help of the Fool's retirement newsletter, Rule Your Retirement. Robert Brokamp guides investors through the fundamentals of appropriate diversification, asset allocation, and asset location. He also covers tax-deferring strategies, expense planning, model portfolios, and more.
You can try the service free of charge for 30 days, giving you access to all back issues, as well as the subscriber-only discussion boards. Click here for all the details -- without obligation to subscribe.
Claire Stephanic does not own any of the stocks mentioned. Johnson & Johnson and Pfizer are Income Investor recommendations. Pfizer is also an Inside Value pick. Jones Soda and Baidu.com are Rule Breakers recommendations. The Fool has a disclosure policy.
