401(k) Failures: Over Last 20 Years, The Average Investor Did Worse Than Cash

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These days, not too many people are singing the praises of their 401(k) plans. They have been called failures, with many having hidden fees and poor investment choices. But I was reading a Scott Burns article that had an different take on things: 401(k) plans are a miserable failure because most of us make bad choices.

Here the evidence: For the 20-year period from 1988-2007, the S&P 500 had annualized returns of 11.81%, while investment-grade bonds returned 7.56%. But what did the average mutual fund investor return? Only 4.48 percent. That’s worse than super-safe Treasury bills, which managed 4.53% annually!

This data is actually pulled from the “DALBAR study”, which I have seen referenced before. DALBAR is a research firm that provides research for financial professionals about investor behavior. Each year, they publish a report called the Quantitative Analysis of Investor Behavior where it compares the returns from average individual investors to various benchmarks. The news is not encouraging…

For years, mutual fund companies have been marketing their products using the long-term results of a lump-sum investment. The results typically show that the funds’ annualized returns have outpaced their designated benchmarks and inflation, implying that if investors purchase fund shares and hold them for similar time periods, they may achieve similar results.

Reality, however, is quite different from this scenario – and it’s not the fault of the fund companies. In this year’s Quantitative Analysis of Investor Behavior, DALBAR illustrates how investors are often their own worst enemies. By examining actual fund inflows and outflows during the 20-year period ended December 31, 2007, the analysis finds that investors often buy and sell at the worst possible times – and achieve commensurate returns.

As Burns quips, investors as a whole do seem have a great skill for “methodically buying equities when they were up and selling when they were down.” 🙁 This sentence summarizes it best:

Investment return is far more dependent on investor behavior than on fund performance. Mutual fund investors who hold their investments typically earn higher returns over time than those who time the market.

Added: I’m not really trying to bag on 401ks, I’m trying to focus on the fact that tying to time the market has been very destructive for investors. For a related parable, read their story of Quincy and Caroline.

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  1. This is not surprising. Many of my co-workers look at their quarterly 401k statements and move all of their $$ into the fund that had the highest return over the prior 3 months. I think this approach is used by many people who self-manage their 401ks. In an attempt to “actively manage” their 401ks, they are effectively buying high and selling low, which would explain the under performance.

  2. I don’t know that it is fair to say they are “Failures.” Poor investment choices are going to hit you whether it is in your 401k or an IRA. The 401k provides the added benefits of being pre-tax as well as employer matching. So while the market and my choices may hurt me, I am still getting the extra money from my employers matching contributions.

  3. OK pet peeve of mine… who invests their 401k in a lump sum in one year? Somebody publish a number that represents monthly investing over 20 years and let me know how our 401k performance is relative to that!

    We’re buy and hold 100% and our returns are HORRIBLE… a product of starting into such plans during the .com boom. Maybe there’s also a fundamental problem in that booms tend to have high employment (so you’re contributing to your plan) and busts have lower employment (so you can’t contribute to a plan, or you contribute less.)

  4. Does not tell all sides of the story…

    Does the article take into account the different types of Mutual Funds? Mutual Funds have many different styles and and risk tolerances. Some Mutual Funds are by definition more conservative, where lower risk/reward is the goal.

  5. I have said this for over 15 years. 401k’s are a bad idea for many reasons.

  6. So true. People have emotional and financial needs and typically, the emotional needs for safety lead the investor to over-ride their financial best interests. Nice post. Thanks!

  7. All of the increase in my 401K comes from employer contribution. As long as I contribute only to the level my employer matches and I invest in the most secure investment possible then I am guaranteed a 100% return. Right? 🙂

  8. That’s because every dude with a 401K plan out there thinks he is the one that can time the market with his 401K. Do you need to revise your investment strategy over time. Sure. Do you need to move everything from stock funds to cash and back every time the market spikes up or down. Your numbers above probably indicate no.

    I’ve been fighting this battle with my mother for years. Every time the market goes up or down all her buddies get worried and move their money and get my mom all freaked out.

  9. Just curious, since the market hasn’t done well — what has done really well in the last 20 years, oil, gold, bonds?, real estate, what does all of this say about the economy? Scarcity seems to be implied in value. Maybe the market is just too large. Maybe it should have been cut into pieces, so people would care more.

  10. Everyday Finance says

    This is lousy news, but not unexpected. Great article and thanks for highlighting this so people reconsider their allocation and perhaps focus on low fees/indexing first, then actively managed funds will fall to the wayside.

    I had done a post recently on 401K asset allocation for US workers. The aggregate results indicated that employees hold way too much company stock. In reality, they should probably hold 0% since they’re taking on multiple risks from a personal income/job security standpoint + investment standpoint, plus, what are the odds your company will do any better than the index? 50%. Might as well roll the dice!

  11. As much as I personally enjoy financial DIY and debating the finer points of asset allocation, it’s plainly obvious that a system that tries to turn workers into portfolio managers for their retirement funds is doomed to fail. It’s inappropriate for 95% of people.

    I don’t think defined-benefit pensions are about to make a comeback anytime soon, but auto-enrollment and target date funds are probably a step in the right direction. Maybe workers should be shown the results of the above study before they’re allowed to opt out of the automatic asset allocation.

  12. I started thinking since I get a match that I really do not have to take the risk investing in the market and still get a nice return when I consider the employer match and the tax savings. Granted it is a great way to dollar cost average but sometimes you have to be looking to just get a return of your money rather then reaching for returns. I think this economy and market still has room to the downside, the percentage of falling is lower now then last year but co.s are still laying off and the country is still cluelessly printing money to cope with a problem they do not know how to solve.

  13. William Bernstein, author of Four Pillars of Investing, wrote an excellent piece on this:


    He says, “I’ve come to the sad conclusion that only a tiny minority, at most one percent, are capable of pulling it off.”

  14. What I have learned from pass 15 years…
    1. Buy and hold doesn’t mean to hold something forever. If you hold something long you are bound to lose (Companies or even empires will eventually disappear). Hold long to me means just over 1 year.
    2. There is nothing wrong with investing 100% into a money market fund in your 401(k). I have been doing it for pass 2 years. While most portfolios loss 40-50%, I am up 3%. Which gives me a virtual gain of 40-50%.
    3. Buy low, sell high. Set objective with each investment: What % are you willing to lose? What % would you like to gain?

    It takes time to manage your 401(k), but fact is we all don’t have 20 years to waste.

  15. What about company matches though??? If you’re doubling your money you invest from the start, that has GOT to be better than investing it anywhere else no matter how awesome (or not) you are at investing…

    I don’t care what people say, I’m all about the 401(k)s 😉

  16. I will let you know in 30 years how I do.
    At the risk of making a big error, I ran the monthly open for GE, bought $100 in shares per month, reinvested dividends, and counted in the 5 splits since the 80’s.
    Since 1962, that would be an investment of $56,600. Value on 2/2/09 is $370,130.
    Someone may want to check my math, but I know GE has tracked up or down with the DJIA every year except ’94.
    Based on my poor math skills and this relationship, if you are smart enough to hold, you would make a profit.
    Oh, at 4% annual return, you would have $167,000.
    Sorry if this is all wrong… if it is, let me know.
    I did not include any fees or company matches. If you get match, you should be further ahead even after fees. (note in Sept 2007 you had $1.1 mil).

  17. These numbers do not take into account the tax shelter aspect of a 401k. Factor in any rational tax rate (and compound over 20 years) and the 401k clobbers bonds and treasuries in taxable accounts. Stocks might stay ahead – if you buy tax-efficient equities/funds and never incur capital gains.

    It is meaningless to say that 401k’s are failures because individual investors are foolish. This is true regardless of investment vehicle. The overwhelming benefits to the 401k are the tax shelter and the (usual) company match. The only 401k “failures” are plans with poor fund choice and high fees.

    On the other hand, the usually suggested alternatives (pensions and SS) are unmitigated disasters.

  18. A good article!

    While investor behavior may count for the low return on investment, the primary reason may be how the investment industry as a whole is marketed and how much control one has over the investment. When you hear the word “investment”, nine of ten times people will link it to the stock market, but keep in mind that there are many other investment vehicles out there. With the stock market, how many average investors really have control over a company’s stocks? One screte that made Warren Buffet successful is that he wants to have control over a business he buys!

    The mutual fund industry is even worse. We lose our control to those highly paid fund managers who may not performan better than any monkeys (about two years ago, I saw news on TV that a monkey was used to pick that year’s investment…).

    Many companies/organizations offer limited investment options to their employees’ 401k/403b retirement plan. One good example is TIAA-CREF, the nation’s largest mutual funds for educators. So many hard working educators’ retirement plans have been locked into limited options and high management fees.

  19. TIAA-CREF has limited options, but very low fees.

  20. Tyrone Biggums says

    This just goes to show the Bogleheads are right. Set an asset allocation and stick with it no matter how well or poorly your funds are doing. And invest most of your money in low-cost index funds.

  21. @mimi: …what has done really well in the last 20 years…?
    I’d have to go with people. Quality of living for the average human being is well up over the last 20 years. Commodities, Equities and all variety of IOUs have been in and out of greatness over the last 20 years.

    But it turns out that highly educated people or people who produce large amounts of value for the world are definitely doing better for themselves.

    @Chris: Oh, at 4% annual return, you would have $167,000.

    It was a noble effort, but any calculation like this is always fraught with issues. This sentence is pretty much problem #1. People in the 80s could lock in government bonds at 16%+ for 10+ years. So 4% annualized seems like pretty wrong number.

    Plus, you’re not accounting for inflation, so the numbers are really deceptive. To do this calculation correctly you would need to “normalize” to a standard number (say years of income) and then work out from there.

    Of course my method is significantly more complicated (which is why it’s left as an exercise 🙂

  22. Gates: Very true. I did not take into account any taxes (401K vs roth, etc) or employer match.
    I think it still gives an income gap that you can’t completely ignore.

  23. I’m wondering how long it will take until people’s 401k’s are back to their 2007 highs. Sad indeed. My parents lost a lot of money. Buy and hold is a mantra that doesn’t work in today’s market.

  24. I just love the fact people are out there saying buy and hold is dead. That indicates to me that it has probably never been more alive and well!

    financePHI – Sorry about your parents, but maybe they should have had their portfolio allocated more inline with their age/risk profile?

  25. I moved all to cash/MM in Sept 07. Still have no reason to get back in. I’m up oh 3-4%. Beats down 40-50% like my now-horrified work buddies who only started paying attention well after the bear market asserted itself. Occasional chart-watching and some basic TA will determine when I get back in for another long haul in cheap index funds. That’s not happening anytime soon.

    You can very broadly “time” the market, but you can’t do it more than twice in a given bear/bull scenario, and you will miss the highest highs and lowest lows. I missed the Oct ’07 high. I’m sure I’ll miss the late-09/early-10 lows. I’m cool with that. Anyone who thinks they can actually call a top or bottom is delusional.

  26. @42:Anyone who thinks they can actually call a top or bottom is delusional.

    The irony here is the belief that you even need to call a bottom or top. It seems that financially-minded people have this min/max mentality that drives them. There’s a feeling that you can’t “time” the market b/c you can’t hit the peaks, while ignoring that you don’t actually need to hit the peaks.

    But underneath all of this is the belief that “timing” is somehow bad. When in reality, everyone has to “time” the markets at least once when they plan to “get out” (either by retirement or death or other circumstances).

    I think it’s far more lucid to understand that some form of timing is reasonable. Market investing involves leveraging a lot of volatile moving parts. But hey, maybe we all just need to read Taleb’s Black Swan.

  27. If this isn’t enough to get people to take index funds seriously, I don’t know what is.

  28. Stocks-Young-Money-Get says

    Well, it’s not even about index funds or mutual funds. It’s just that people buy at the wrong time and sell at the wrong time.

    Warren Buffet said it once that I read–somebody asked him how he does what he does and he said “We simply attempt to be fearful when others are greedy and greedy when others are fearful”

    If somebody’s able to follow that advice succesfully, they don’t even have to worry about when to buy and sell, right?

  29. So is it the 401k manager that is making these poor choices (buying/selling at the wrong times) or the investor who funds his 401k?

  30. It’s the investors. Probably the fund managers are doing some of that too.

    The whole problem is caused by a “herd” mentality with regard to investing & the dynamics of the public market.

    Some news comes out (may not necessarily be that bad), investors get spooked, start selling, prices go down, other investors see the price going down, remember the news, get spooked, start selling, price goes down more, more investors see, get spooked, start selling, price goes down even more.

    In the meanwhile, there may or may not be anything actually fundamentally wrong with the business.

    It happened to Google. Google was selling at $700 before the whole financial crisis. Now it’s under $400. Nothing really fundamentally went wrong. Sure, their earnings and growth slowed, but that’s expected in a recession and as a business matures.

    Sorry, got off on a bit of a tangent. But to answer your question, mostly it’s the individual investors making mistakes. The fund managers are surely guilty of the same mistakes to some degree. But the whole inefficiency boils down to the “herd” mentality inherent in the markets.

    When one investor moves, it provokes others to move in the same direction.

  31. What type of mutual funds were these, was that information available from the place you got your graph from?

    I moved to cash over a year ago now, and I’m pleased with my decision. Managing your 401k isn’t an easy job, after all.

  32. 401k’s are a hoax. I managed to get out in 1999 by luck because I walked away from a job, took out the money and bought land in Central Texas so I could raise my own food. It was dumb luck, but I am sure glad I did.

  33. not all that many people have been IN 401k plans for 20 yrs.
    I only started in one in 2003. Earnings-wise – my pre-crash peak was in Aug 2007 [+$2100]. My lowest point was Feb 2009 [-$4600]. By Sept 2009, I had regained ALL that I had lost in that 18 month crash [+2600]. and a year later, I’m up $5700 since the beginning.

    and that’s in addition to >80% FREE company match money I have received on my contributions. my earnings represent a return of about 39% based on my avg monthly balance. @9/8/2010 the S&P500 is only about 9% higher (in 7 yrs) than it was when I started my 401k plan

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