Thursday, May 26, 2011

401(k) Plans May Not Be a Good Investment

Recently, I was doing some research into risk and perceived risk, as well as the other side of the coin: reward. I wondered if the lottery was more risky and has more reward than investing through 401(k) plan. I ended up comparing the S&P 500 to growth in the average 401(k) participant's account. I didn't like what I found.

From 1990 to 2003, the S&P 500 went up 340%. The average 401(k) account went up 127%. So I considered that new people were joining their company's 401(k) plans with low balances. I also considered that with matching and continual contributions, the average account probably added 4.5% per year.*

When I modify the results for the ongoing contributions, I found that 401(k) plans are horrible investment growth vehicles quantitatively. Growth was only 44% over the 13 years.
I'm a big believer in 401(k) programs when they have a matching portion. It's sometimes the only way I can make money in my investments. At least with the match, I'm less likely to lose any of MY principle.

*As to modifying the results with the 4.5% annual contribution: In year two for new participants, their account balances will increase by 100% because they're continuing to contribute and the matching contributions are being added (assuming no change in contribution rate and changes in wages). For those that have been in the plan for 10 years, their account additions are 10% of their balances without any growth. Besides new people participating, some leave. The total number of participants more than doubled. Therefore, the average length of time in a plan couldn't be much over 5 years or 20% additional contributions every year.

 I figured on average the participant is adding 3% of their wages. The company is adding another 1.5%. Combining these into 4.5% additional contributions per year is probably pretty conservative.

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