Has Your Ship Come In?

Here’s a quick rule of thumb:  at retirement, your nest egg should be roughly 20-25 times your annual withdrawal rate.  So, $40,000 of additional income a year implies a fund balance of $1 million, or $80,000 a balance of $2 million.  Lots of footnotes, but that’s the rough number.  There’s about $5 trillion invested in 401(k) plans today.  Sounds like a lot, but the average account is worth only $85,000.  What’s the problem?

The elephant in the room is the so-called “self-direction” of modern retirement assets — “self-direction” just means you become your own money manager.  You’re on your own. That’s the part that doesn’t work.

After 15 years of volatile markets and the subtle drag of hidden internal product costs, many participants have become reluctant to commit enthusiastically to their 401(k) programs.  They tell us that they “keep adding money but the balance sort-of stays the same.”  And yes, it is hard. In an environment where professional managers struggle to match the performance of their benchmarks, how can we expect individuals (who do something else for a living) to understand and manage their “self-directed” plan choices? It’s as if the swimming teacher just threw everyone into the deep end.

The results tell the story:

160325 WEK - Mutual Funds_0001

So, we come to the reality that the US 401(k) system is way underfunded — by a factor of at least 5 or 6.  Even we we allow for other sources of retirement income, most folks are in trouble. It’s a slow-moving $5 trillion disaster.

Participants are never told that 90% of their portfolio’s performance depends on their asset allocation decision, not on their individual fund choices. Secondly, they are never adequately warned that financial markets are subject to highly violent, yet quite frequent, disruptions (2002, 2008, 2011) that can completely derail the return assumptions of their financial plan, especially if their performance is likely to have been below average in the good years. Finally, individuals – more so than professionals – are vulnerable to “behavioral errors,” all of which tend to reduce their investment returns, some quite dramatically. Our friends and neighbors bring terribly counterproductive instincts to the management (“self-direction”) of their retirement savings.  The selection and timing of their investment choices tends to be awful, contributing to the performance gap in the chart above.

Many folks participate in their 401(k) plans only because they are told by everyone that they have to, but they do it reluctantly. We all yearn to go back to the days when employers routinely offered defined-benefit pension plans, managed by professionals.  Today, the dark side of capitalism has taken us to a very different place.

It is still possible to to be successful at saving for retirement, but you will need to be more involved.   Keller Partners offers guidance for the most important decision — when to be committed to the market — and offers this advice without charge.  However, a successful final outcome will require a completely new way of thinking about at how we manage these self-directed retirement accounts and a lot of commitment and discipline by the individual investor.