We’re sorry to bring up that dated, ambiguous statement, “it depends.” ” But it does. The rate of return on your 401(k) plan is directly related to the investment portfolio you build with your contributions and the state of the market.
That being said, contributions accumulated within your plan, which are diversified among stock, bond, and cash investments, can provide an average annual return ranging from 3% to 8%, depending on how you allocate your funds to each of those investment options. This is true even though each 401(k) plan is unique.
What is a good rate of return on a 401(k)? This is a question that plagues many investors, especially as they near retirement and their financial goals become more pressing. While there’s no one-size-fits-all answer, understanding the factors that influence 401(k) returns can help you set realistic expectations and make informed decisions to maximize your retirement savings.
Average 401(k) Returns: A Starting Point, Not a Guarantee
Financial planners often cite an average annual return of 5% to 8% for a typical 401(k) portfolio. However, this is just a general guideline based on historical market performance and doesn’t account for individual circumstances. Your actual return will depend on several factors, including:
- Contributions: The more you contribute, the faster your 401(k) will grow. Aim to contribute as much as you can afford, at least up to your employer’s matching limit.
- Investment Selection: The mix of investments in your 401(k) portfolio plays a crucial role in determining your returns. A diversified portfolio with a mix of stocks, bonds, and other assets can help mitigate risk and potentially boost returns.
- Fees: Hidden fees can eat into your returns over time. Be mindful of administrative fees, expense ratios, and other charges associated with your 401(k) plan and individual investments.
Beyond Averages: Understanding the Impact of Market Volatility
Market conditions can significantly impact your 401(k) returns. In volatile markets, like the one experienced in 2022, even well-diversified portfolios can experience significant losses. Therefore, it’s crucial to understand your risk tolerance and adjust your investment strategy accordingly.
Optimizing Your 401(k) Returns: A Multi-Pronged Approach
Maximizing your 401(k) returns requires a multi-pronged approach:
- Maximize Contributions: Aim to contribute as much as you can afford, at least up to the annual limit set by the IRS.
- Choose the Right Asset Allocation: Align your portfolio’s asset allocation with your risk tolerance and time horizon. Consider consulting a financial advisor for personalized guidance.
- Minimize Fees: Opt for low-fee funds and be mindful of administrative and other charges associated with your 401(k) plan.
- Rebalance Regularly: Regularly rebalance your portfolio to maintain your desired asset allocation and mitigate risk.
- Seek Professional Guidance: Consider working with a financial advisor who can help you create a personalized retirement plan and navigate the complexities of investing.
Additional Strategies for Boosting Your Retirement Savings
Beyond optimizing your 401(k), consider these additional strategies to maximize your retirement savings:
- Take Advantage of Employer Matching: Contribute enough to take full advantage of your employer’s matching contributions. It’s essentially free money that can significantly boost your retirement savings.
- Explore Other Retirement Savings Options: Consider supplementing your 401(k) with an IRA or Roth IRA to diversify your investments and potentially access additional tax benefits.
- Reduce Expenses and Increase Savings: Look for ways to reduce your expenses and increase your savings rate. Even small changes can make a significant difference over time.
Understanding the factors that influence 401(k) returns and implementing strategies to maximize your savings can empower you to take control of your retirement future. Remember, there’s no one-size-fits-all approach, and seeking professional guidance can be invaluable in navigating the complexities of retirement planning. By actively managing your 401(k) and exploring other savings options, you can work towards achieving your retirement goals and securing a comfortable future.
Balancing Risk and Returns
Now, it’s time to go back to that 5% to 8% range that we quoted at the top. It is an average rate of return that is determined by the common, somewhat aggressive allocation made by investors in 401(k) plans, which are comprised of 20%600% cash and 20%600% stocks. A 60/40 portfolio allocation is intended to reduce volatility with bond and cash holdings while promoting long-term growth through stock holdings.
Approximately in the middle of the risk/reward spectrum is the 60/40 portfolio. For example, if you allocate your investments to a more aggressive portfolio, say consisting of 25% debt, 75% cash, and 10% stocks, you may anticipate double-digit returns over time. But there’s also a chance that your account’s volatility will be far higher.
Alternatively, your portfolio would have a smooth ride if you were more conservative and invested in debt/fixed-income instruments, stocks, 2010% cash, and debt/fixed-income instruments. However, the returns would only range from 2% to 3%, depending on the current interest rates.
Long-term investors typically take on greater risk in their portfolios than do those who are close to retirement. Additionally, when investors approach retirement, it is customary and wise for them to gradually rotate the assets in their portfolio.
Participants in 401(k) plans are increasingly choosing target-date funds as a one-stop shop to complete this transformation. Investors can choose a date close to their anticipated retirement year, like 2025 or 2050, with these mutual funds.
Compared to funds with a near-term target date, funds with a further-out target date focus investment allocations more aggressively. Target-date fund rates of return differ from business to business, but these one-fund allocations provide a laissez-faire attitude to 401(k) asset allocation.
The average balance in a 401(k) plan as of Q3 2020 at Fidelity Investments, which serves as the administrator and provider for more than 30 million such accounts .
It’s All About the Asset Allocation
Your asset allocation, or the kinds of funds you invest in, the combinations of funds you choose, and the amount of money you allocate to each, determines how well your 401(k) account performs.
Depending on the investment options and allocations available within their particular plans—and how they take advantage of them—investors experience varying outcomes. Depending on the kinds of investments they choose, two employees of the same company may participate in the same 401(k) plan but receive different rates of return.
Different assets perform differently and meet different needs. Debt instruments, such as CDs and bonds, offer a relatively safe income but little growth and, consequently, a lower return. Real estate offers income and frequently capital appreciation to investors who can purchase it through a real estate investment trust (REIT), real estate mutual fund, or exchange-traded fund (ETF). Corporate stock, aka equities, have the highest potential return.
But the universe of stocks is vast, and returns vary greatly within it. Certain stocks provide substantial dividend income, but they don’t appreciate as much. Large-cap and blue-chip stocks, which are held by reputable, well-established companies, provide consistent returns, albeit somewhat lower ones. Smaller, more dynamic companies are frequently classified as “growth stocks,” and as the name suggests, they may provide a high rate of return.
Of course, though, anything that rises can also fall: a stock’s likelihood of experiencing significant declines is typically correlated with its potential for rapid growth. Its called the risk-return tradeoff.
Even though it sounds like a cliche from advertising, it’s important to reiterate: past performance of funds in a 401(k) plan does not guarantee future results.
Your individual appetite for risk, or risk tolerance, and the amount of time you have left before you need to start taking withdrawals from your retirement account should be taken into consideration when allocating your assets. Investing in less volatile allocations, which may eventually yield lower rates of return, is better for those with a low tolerance for risk.
On the other hand, investors who can tolerate more risk are more likely to select investments that have higher potential returns but also higher volatility.
How Is a 401(k) Rate of Return Calculated?
FAQ
Is 7% return on 401K good?
What is the average return on 401K over 20 years?
Why is my 401K rate of return so low?
Does 401K double every 7 years?
What is the average return on a 401(k)?
Based on a standard portfolio mix of 60% stocks and 40% bonds, the average rate of return for a 401 (k) generally ranges from 5% to 8%. What is the most common type of investment in a 401 (k)? Mutual funds are the most popular kind of investment in a 401 (k).
What is the average 401(k) balance?
According to research from Transamerica, this is the median age at which Americans retire. Current 401 (k) Balance: $0. Hopefully you have more than this saved for retirement already, but for the purposes of this calculator, we set our default to represent someone starting from scratch. Annual Rate of Return: 9%.
How do I get the best 401(k) rate of return?
You’ll get the best 401 (k) rate of return by being consistent and not changing your contributions based on short-term stock market performance. An investing strategy involving regular fixed investments, buying more shares when prices are low and fewer when high.
How much money can you make with a 401(k)?
Suppose you earn $50,000 annually and set aside 10% of your wages each year. Your salary increases by 10% annually, and you are currently 45 years old with a 401 (k) balance of $1,000. With an annual rate of return of 7%, you could expect to have $497,444 by the time you retire at 65.