Image: Wikimedia Commons, courtesy LadyofHats.
After a long bull market, investors have recently started to get nervous, with the summer months bringing the first market correction to the Dow Jones Industrials (^DJI +1.79%) and the S&P 500 (^GSPC +1.20%) in years. Many investors are now bracing for the next bear market, and that has brought back fears from the market's plunge in 2008 and early 2009.
Yet one thing that many people don't fully realize is that the average American can fare quite well over the long run by following a simple strategy: contributing toward your retirement savings either through an employer-sponsored retirement plan like a 401(k) or by using an independent IRA provider. As a new study shows, the typical person following this strategy produced impressive market gains even when you measure returns from before the market meltdown.
Staying the course is the key
A recent study from the Employee Benefit Research Institute shows just how successful the average American has been over time in building up retirement savings. The EBRI looked at the workers in its database who had access to 401(k) plans at work and who had consistently participated in their plans between 2007 and 2013.
The findings were encouraging for savers. As you'd expect, the average participant's 401(k) balance plunged during the bear market in 2008, losing more than a quarter of its value. Yet gains from 2009 to 2013 more than made up for those losses, and by the end of 2013, the average participant had a balance of about $148,400. That balance rose at a rate of 11% per year when you consider the full six-year period, including the 2008 bear market.
Even looking beyond averages, typical Americans who participated consistently in their 401(k) plans saw even bigger gains. Many see the median balance as a more accurate figure in reflecting a typical person's experience. Although the midpoint of 401(k) balances was lower at about $75,350, that figure was up an even more dramatic 16% per year -- even though it included that massive market drop along the way.
Think long-term and keep adding money
Three main factors led to this long-term success. First, most of those who consistently had 401(k) plan accounts during the period regularly contributed additional money, which of course helped to boost account balances. Moreover, the vast majority of employers that the EBRI looked at add their own contributions on top of money that their employees set aside, pushing overall balances even higher. Finally, participants took advantage the market's big rebound from 2009 and 2013, with substantial allocations to equities even in the aftermath of the losses they had suffered in 2008.
401(k) participants of all ages enjoyed solid gains in their account balances, but younger workers fared the best. The average worker in their 20s saw their 401(k) balance rise nearly tenfold between 2007 and 2013, as the impact of new contributions was highest. For those in their 60s, gains were more modest, but as you can see below, even they saw an overall jump of 45% in their balances over the six-year period.
Source: EBRI.
Keep feeding your piggybank
It's tempting to think that you can do better than the average American by moving your retirement savings out of stocks before a bear market hits. That way, if you can miss out on a big downward move like the 25% hit that the average 401(k) participant suffered during 2008, then you'll have that much more in savings in your retirement plan when you decide to quit working.
Yet two big challenges come into play with that strategy. First, you have to predict accurately when the bear market is going to happen. That can be tough, as many market commentators have expected marked declines for years now even as the bull market has thwarted their predictions.
Second, even if you do accurately predict a bear market, the next question is when to get back into stocks. Throughout the recovery since 2009, countless investors have remained on the sidelines, convinced that another leg downward in the bear market would give them a better opportunity to move their retirement savings back into the stock market. If you're even the slightest bit late to the game, it can eat into or even outweigh any money you saved from selling out of the market.
As simple as it is to have money automatically moved into your 401(k) paycheck after paycheck, the discipline to do that and leave your investments alone can be very hard to maintain. Nevertheless, what these figures show is that the average American can make a lot of progress toward a financially secure retirement by following that simple strategy.
