Many people save and invest in a 401(k) plan with the hope that they can accumulate enough to eventually pay for retirement.
In addition to your savings rate and employer contributions, your 401(k) investment returns have a big impact on your final account balance.
The average 401(k) return can vary, depending on:
- How consistently you save.
- The number of years until retirement.
- How comfortable you are with risk.
- The ups and downs of the market.
To make the most of your 401(k) plan and increase your chances of a high rate of return, “your portfolio has to be right for you,” says Emmet Savage, chief investor and co-founder of MyWallSt, an investing education app. “Taking a small amount of time to understand your options and make adjustments can reap massive benefits.” Consider the following factors to determine the return you might get on your 401(k) plan.
Saving Regularly Can Increase Returns
If you have funds taken from your paycheck and put into a 401(k) every month, over the years the continuity could pay off. The average 401(k) plan account balance for consistent participants grew every year from 2010 to 2016, according to a November 2018 report by the Employee Benefit Research Institute. Overall, the average account balance increased at a compound annual average growth rate of 14.2 percent from 2010 to 2016. (The report points out that account balances are influenced by three factors: new contributions to the account; investment return, which is tied to the performance of the financial markets and the mix of assets in the 401(k); and withdrawals from the account.)
“Automatic payroll deductions keep you investing at regular intervals, reaping the benefits of dollar-cost averaging and preventing you from making emotional decisions,” Savage says. Dollar-cost averaging refers to the strategy of purchasing the same amount of an investment or group of investments at set intervals.
Some companies automatically enroll eligible employees in a 401(k) plan. They might also increase the contribution percentage periodically, which participants can also do on their own. “If you do these two things, you’ll save much more than a person who only does one or neither of these,” says Jake Sensiba, an investment advisor at CRG Financial Services in Brookfield, Wisconsin.
Your Retirement Date Can Impact Your 401(k) Rate of Return
If you have several decades left before retirement, you might opt to invest in mutual funds that offer a potentially higher rate of return but also carry more risk. For those close to retirement, funds that offer a lower return in exchange for less risk might have more appeal.
Target-date mutual funds are set up to help align your investments with your estimated retirement date. You might choose a target-date fund focused on the year you plan to retire. The rate of return can fluctuate, as funds might initially be allocated more heavily toward higher-risk investments like stocks and over time shift to more lower-risk investments like bonds. Regarding the rate of return in a target-date fund, “For a 2050 fund, it’ll probably be somewhere between 6% and 10%,” Sensiba says. “For a 2025 fund, it’ll be mostly in bonds, so that rate of return would probably be between 2% and 5%. These figures are also at the mercy of the market.”
Your Risk Tolerance Can Impact Your Rate of Return
If you tend to be a conservative investor, you might consider low-risk investments like certificates of deposit and bonds. The average rate of return for a 60-month CD at the beginning of April 2019 was 1.27%, according to the Federal Deposit Insurance Corporation. The rate for a 30-year U.S. Treasury bond was 2.89% at the beginning of April 2019, according to the U.S. Department of the Treasury.
If you opt for higher-risk investments like stocks, you might receive a higher potential rate of return. The one-year return of the Dow Jones Industrial Average, an index of 30 large, publicly traded U.S. companies, was 8.74% at the beginning of April 2019. Individual stocks can fluctuate significantly from month to month and year over year. “In the early stages of your career, you may want a more aggressive portfolio, switching to a more conservative one as you approach retirement,” Savage says.
The Past Doesn’t Reflect the Future
From 1926 to 2017, government bonds returned 5.5% compounded annually, according to historical data from Ibbotson Associates. Large stocks returned 10.2% compounded annually during that same time, while small stocks returned 12.1%.
Focusing on the past doesn’t always help predict the future. “It is common for investors to want to adjust 401(k) allocations to be more aggressive after periods of positive performance and more conservative following periods of negative performance,” says Kurt Rossi, president and wealth advisor at Independent Wealth Management in Wall, New Jersey. “Be careful when using the rear-view mirror approach when determining your strategy, as market timing is not advisable for a long-term 401(k) strategy.”
Consulting a financial advisor can help you make investment decisions. “Consider basing your 401(k) allocation on your personal financial goals, risk tolerance and time horizon,” Rossi says. Ask a professional about portfolio stress testing, which allows you to see how your investments might perform if a recession hits and the stock market drops sharply. After evaluating the scenarios, you’ll be able to decide what mix of assets you’re comfortable with during both up and down markets.
Source: U.S. & World Report News
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