Written by Is your 401k not growing the way you expected? Are you concerned about whether you’re keeping up with benchmarks and how other people’s 401ks are performing? If so, this is the video for you. Today, we answer the question: Is your 401k underperforming, and what should I do about it?
Why Optimizing Your 401k Matters
The majority of Americans fund their retirement plans with a 401k, 403b, or other pre-tax plans. It’s essential to know if your 401k is optimized to help you achieve a wealthy retirement. Today, I’ll show you how I review a 401k and how you can follow the same process if it works for you.
The main takeaway today is that you need to check your 401k regularly. You should review your fees, performance, and asset allocation. We’ll go over why this is important and how often you should do these reviews.
The Impact of an Underperforming 401k
If we leave our money in an underperforming asset for five, 10, or 25 years, we really hurt our retirement. We’re talking about leaving hundreds of thousands of dollars on the table. A quick log-in, checking fees and allocations, and making a couple of small tweaks can make a huge difference.
By optimizing your 401k, you can take advantage of time. Time can work for or against us. For example, if we invest for 30 years and have a certain performance, we don’t have to invest as much money.
I’ll share a chart that shows different ways to create a million-dollar portfolio. You’ll notice that if you start early, you can invest as little as $5 a day. But if you start late, you’ll have to contribute more. The most crucial point is that by optimizing your 401k, you could contribute $50,000 to $80,000 and still reach a million-dollar retirement.
However, if your 401k isn’t optimized, you might need to contribute $500,000, $600,000, or even $800,000 to achieve the same goal. I don’t want that for you. I believe your money should work for you more than you work for it.
Tracking Your Progress
As you get closer to retirement, you’ll know you’re on track because you’ll see the shift: in the beginning, 100% of your income is generated by your time. By the halfway point to retirement, ideally, 50% of your income will come from your money, with the other 50% from your time.
Even if you don’t withdraw from your investments, having the ability to generate 50% of your income from your savings is key. Compounding interest, what Albert Einstein called the eighth wonder of the world, starts to accelerate your growth. This is why optimizing your 401k is essential.
Three Common Reasons Your 401k Might Be Underperforming
1. Higher Fees
There are obvious fees and hidden fees, and unfortunately, they are often hidden. I’m going to walk through the types of fees I look at when deciding if they’re too high and negatively affecting stock performance.
The reason you need to keep track of fees is that even 1% adds up. Here’s a chart showing an estimate of someone’s 401k fees. It’s a simple example, but it illustrates the impact well.
Imagine someone is 25 years old, planning to retire at 65, with $25,000 in their 401k. They contribute $5,000 annually and expect a 7% return. Without fees, their portfolio would grow to $1.5 million. But just a quarter-percent fee would reduce that by over $100,000. A half-percent fee would reduce it by another $100,000. And with a 1% fee, they’d lose nearly $400,000.
The question isn’t whether we pay fees; we understand there are costs to managing investments. But it’s vital to know if these fees are being justified by your investment strategy. Is your advisor doing enough to make the fees worthwhile?
Since 2012, the government has required 401k plans to disclose their fees. Start by asking your HR department for your 401k’s fee disclosure document. Also, ask if there are hidden fees. While they might not know, it doesn’t hurt to ask.
Fees generally fall into three categories:
- Administrative fees: These cover basic services, such as record-keeping and customer support (like that 1-800 number you call). The company passes these costs on to you.
- Investment management fees: These are often the most significant, typically ranging from 0.5% to 1.5% of your assets. Actively managed accounts usually charge around 1%. Passive accounts charge less, around 0.5% or lower.
- Individual service fees: These are unique to you, like fees for loans against your 401k. Sometimes employers add special arrangements, and the costs are spread across all employees’ investments.
Hidden fees could also come from the custodian in the form of trading or plan-specific fees. Sometimes, you pay extra to access a “special” fund, but it’s essential to know what you’re getting in return.
2. Poor Asset Allocation
Next, I examine your asset allocation. Don’t chase last year’s top performer—stocks that did well last year often underperform the following year due to market rebalancing.
For instance, if a portfolio averages a 10% return and generated 50% last year, it’s likely to produce negative returns the following year to balance out the average. Don’t fall into the trap of investing based on past performance alone.
It’s also important to avoid being too conservative or too aggressive. If you’re nearing retirement, you should lock in your gains to feel more secure. If retirement is 10, 20, or 30 years away, you have time to allow your portfolio to grow.
One idea is to subtract your age from 100. For example, at age 40, 60% of your portfolio should be in aggressive investments, while 40% should be more conservative. This isn’t an exact science, but it helps frame how you should be thinking about risk as you near retirement.
3. Market Volatility and Rebalancing
If you’re not rebalancing your portfolio, market shifts could expose you to unnecessary risk. Rebalancing ensures that you buy low and sell high, removing emotional decisions from investing. If your portfolio is meant to be 60% stocks and one stock grows to 70%, you sell that extra 10% to buy the underperforming assets at a lower price.
Rebalancing prevents buying high and selling low, a common mistake many make when they chase trends and fear missing out.
When you have an investment strategy in place and stick to it, rebalancing ensures your portfolio performs well across different market conditions. It also allows you to buy great investments on sale during market downturns.
Performance Review and Benchmarks
I also review your 401k’s performance by comparing it to benchmarks like the S&P 500, NASDAQ, Russell 2000, and more. Based on your asset allocation, you should expect similar performance to these benchmarks. For instance, if 60% of your portfolio is in large-cap stocks, you should aim for 60% of the S&P 500’s return.
If your portfolio is underperforming, this might be the time to explore passive investments. Index funds, for example, often charge significantly lower fees (around 0.1% to 0.3%) compared to actively managed funds.
By switching to a lower-fee passive fund, you can increase your returns by paying less in fees.
Final Thoughts
If your 401k is underperforming, start by comparing it to benchmarks. Then review your asset allocation—are you too aggressive or conservative? Lastly, check your fees—are they reasonable, or can you reduce them? If everything checks out, you might need to increase your contributions.
Keep in mind that your 401k is a pre-tax account, so you’ll pay taxes at retirement. It’s important to consider whether you want to pay regular income tax in retirement or explore options like tax-free income or capital gains taxes.
Remember, 65% of self-made millionaires have at least three streams of income. Diversifying your income streams increases the likelihood of a wealthy retirement.
Your 401k is a critical part of your financial future. With the right steps, you can ensure it’s working for you. If you feel overwhelmed, I’m here to help create a Wealthy Retirement plan tailored to your goals.
Thanks for joining me. If you found this helpful, please like and subscribe for more valuable insights on building your own wealthy retirement system.
Until next time, stay safe and enjoy life!
Image from: Freepik.com
Employee Fiduciary: Retire Richer by Lowering Your 401k Fees