Benchmarking Your 401(k) Accumulation

The finance and investment sector can be daunting when it comes to planning for one's financial future. Every day, CNBC features experts who analyze the latest economic indicators, such as inflation rates and GDP growth, and predict market trends. For those without a background in investing, this barrage of technical terms can be confusing. All the while, many have become de facto portfolio managers through their 401(k)s. This raises some important questions:

• How effectively am I managing my 401(k)?
• What types of investments should be in my portfolio given my age?
• Will my retirement savings be sufficient when I need them?
• What financial changes can I expect over the next 10, 20, or 30 years?

While there are various ways to address this, I'd like to share one method that I've found useful both personally and professionally.

Always pay yourself first

Possibly without exception, one of the best personal finance strategies is to “pay yourself first”, which means automatically routing a specified contribution from each paycheck into a savings or investment account. Traditional 401(k) participants receive the added tax benefits of pre-tax contributions and tax-deferred growth inside their 401(k) accounts.

I recently engaged in a thought experiment guessing how many years of contributions a 401(k) participant would have needed to have accumulated $500K in their 401(k) account today assuming they contributed the IRS-specified annual limit each year for those under age 50 and simply invested in an S&P 500 Total Return Index fund. My raw guess was 15 years of contributions to accumulate $500K as of year-end 2023. I ran the numbers and was surprised to find that the actual answer is 12 years of contributions. A 401(k) participant who started in 2012 accumulated over $531K as of year-end 2023. It turns out a 401(k) participant who started in 2009 (the person I imagined with 15 years of contributions) accumulated over $822K as of year-end 2023.

How am I doing?

I compiled the 401(k) historical accumulation balances by starting year and years of contributions for the last 20 years in the table below.

401(k) Accumulation by Starting Year Assuming Maximum Annual Contributions and Annual S&P 500 Total Returns

The fact that the accumulated balances increase monotonically with each additional year of contributions is a testament to the power of investing consistently and staying invested during one’s asset accumulation phase. This is despite S&P 500 Total Return losses of -37.0% in 2008 and -18.1% in 2022.

Why would my balance be different?

Let’s examine factors that would explain the difference between your actual 401(k) balance and the benchmark balance in the table.

Factors that would increase your accumulated 401(k) balance:

• Investment returns that consistently outperformed the annual S&P 500 Total Returns
• Employer-matching contributions
• Dollar-cost averaging (for simplicity my calculations assumed annual contributions and returns; bi-weekly or semi-monthly contributions should produce a marginal dollar-cost averaging benefit due to volatile market prices)

Factors that would decrease your accumulated 401(k) balance:

• A more conservative asset allocation than the S&P 500 (which is 100% large cap US stocks)
• Fees and expenses associated with your 401(k) plan and within your fund options
• Having contributed less than the annual limits each year
• Any gap periods in your 401(k) participation or eligibility
• Early withdrawals

Ultimately, there is no universal benchmark for what your accumulated 401(k) balance should be. That is determined by your risk tolerance and is constrained by the investment options available in your 401(k) plan. The example above illustrates the concept of the Most Efficient Investable Product (MEIP) assuming the S&P 500 is an appropriate benchmark for our hypothetical, maximum contribution 401(k) participant. Ideally, your appropriate benchmark can be constructed as a composite of MEIPs by asset class that corresponds to your optimal asset allocation, which should be a function of your investment objectives and risk tolerance.