What kind of return can we expect from a 401(k)?

Five golden eggs, expecting a return on their 401(k)

How much can we realistically expect our 401(k) retirement plans to earn each year.

We asked Christine Benz, director of personal finance for Morningstar, a respected provider of independent investment research.

She said 5% a year is a good conservative estimate to use for planning purposes.

Of course, your actual return depends on the plan you have, the fees you pay and performance of the stock and bond markets. (And that means how well the markets do over many months, not a few very good — or very bad — days or weeks.)

But 5% is not unrealistic, and it's a good figure to use in judging how well your account is doing.

It's easy to get dazzled by the good years and think you should be doing better.

From 2009 to 2014, mutual funds that were heavily invested in stocks — a common component of 401(k) plans — did much better than that.

Although stocks have subjected investors to several headline-grabbing declines over the past year, prices were essentially flat for 2015.

That's why it's costly to panic and sell when markets fall. You'll just lock in your losses.

"You want to avoid getting too caught up in the short term and think about what you're trying to achieve," Benz says. "Think of it as a multiyear process and not a short-term endeavor."


Building Financial Security



Over the years, a 401(k) plan is one of the best options you have to save and build financial security.

First, it allows you to make pretax contributions to a savings plan and grow your money. Second, if your employer offers matching contributions, that's free money to add to the pot.

"What you don't want to do is not contribute or let money sit in a savings account earning nothing," Benz says.

Brightscope, a financial information company that provides analytics on investments and retirement plans, provided us with this list of mutual funds, and Morningstar provided the performance data as of Sept. 30, 2015.


Returns and Expenses

The Biggest Mutual Funds Commonly Found In 401(k) Plans

Mutual Fund Ticker Symbol Description Average Annual 5-Year Return Management Expenses
PIMCO Total Return PTTRX World's largest fund holds intermediate-term investment-grade bonds 3.23% 0.46%
Vanguard Institutional Index VINIX Large-blend domestic stock fund that tracks performance of the S&P 500 13.31% 0.04%
American Funds EuroPacific Growth AEPGX Foreign large-cap blend fund with stocks in European and Pacific Rim companies. 4.19% 0.83%
Fidelity Contrafund FCNTX Large-cap growth fund that seeks capital appreciation 13.34% 0.64%
Vanguard Total Bond Market Index VBMFX Intermediate-term bond fund 2.87% 0.20%
Fidelity Spartan 500 Index FUSEX Low-cost large-blend fund with 80% of assets tracking the S&P 500 13.24% 0.09%
Vanguard 500 Index VFIAX Very low-cost index fund that tracks the performance of the S&P 500 13.30% 0.05%
Fidelity Growth Company FDGRX Large-cap growth fund that seeks capital appreciation 15.65% 0.82%
Vanguard Wellington VWELX Moderate allocation fund with 60% of assets in dividend-paying stocks 9.33% 0.26%
American Funds Growth Fund of America RGAEX Large-growth fund with $145 billion in assets. 12.57% 0.68%
5-year returns as of Sept. 30, 2015



Mari Adam, president of Adam Financial Associates in Boca Raton, Florida, says what you can expect to earn is also highly dependent on how you invest.

Ideally, you'll want a mix of stocks and bonds in your plan. You'll generally want to be invested up to 90% in equities when you're in your 30s, then move more into bonds as you get closer to retirement.

"I think 6% is a reasonable expectation for retirement planning purposes if you're investing properly for your age," says Adam.

You can get a good asset allocation through a balanced fund or target-date fund.


Thinking about bonds



While stocks have the potential for rapid gains when the market is going strong, bonds are also essential to provide some stability when stocks are down.

One of the most common balanced funds found in 401(k) plans is the Vanguard Wellington, which holds about 65% in stocks and the other 35% in bonds.

Wellington owns a lot of large-cap stocks, such as Verizon, Wells Fargo & Co., Microsoft and Merck, and a variety of government and corporate bonds.

It's a decent pick for a single-fund 401(k) plan. Its expense ratio is a mere 0.26%, and over the past 10 years, it's averaged nearly 7% in returns.

The PIMCO Total Return (PTTRX) is another fund you're likely to find in your 401(k) plan.

It holds intermediate-term investment-grade bonds, seeks to maximize total return while preserving capital and has produced an annualized return of 5.62% over the past decade.

Because it's strictly a bond fund, you'll want to pair it with an equities fund.


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Creating a balanced fund



Benz says you can easily create your own balanced fund in most 401(k) plans.

If you wanted a traditional 60/40 mix, you would simply direct 60% of your contributions to a stock fund and 40% to a bond fund. Or you could be more aggressive and use a 70/30 mix or even more in equities.

"It's not very difficult to create a diversified and balanced portfolio with the funds in most plans," Benz says. "It could be the next-best option for someone trying to find their way in a 401(k) plan without a lot of information."

A couple of solid equities funds you may find in your plan include the Vanguard Institutional Index Fund (VINIX) and the Fidelity Spartan 500 Index (FXISIX).

investing_stocks_sm

Both of these are low-cost funds designed to track the performance of the S&P 500 and provide exposure to the broad stock market.

Over the past five years, the Vanguard fund has averaged almost 11%, while the Fidelity fund has averaged about 10%.

Other popular bond and equities funds, including the Fidelity Contrafund, Vanguard Total Bond Market Index and Vanguard 500 Index, have all produced solid returns in recent years.

It's important to note that past performance should never be seen as an indicator of future returns. As this year makes clear, the markets will fluctuate, and run-ups will inevitably be followed by periods when the market is flat or falling.

But if you place your 401(k) in funds with an established track record with reputable companies, you should do OK over the long run.

When making that decision, one of the most important factors to consider is expenses.


Considering expenses



Choosing mutual funds with the lowest management fees can make a big difference in how much you wind up with.

And seemingly small fees can add up to big amounts of money over the course of a career.

chart glasses nest egg

Consider that if you invested $5,000 annually for 30 years and averaged a 6% return with a 1% management fee, you'd pay $71,000 in fees during that time.

But if you managed to earn the same return from a fund with a 0.25% management fee, you'd only have paid $19,000 in fees.

That 0.75% difference could mean an extra $50,000 in your account when you retire.

As you can see from the chart, there are lots of funds that earned healthy average annual returns over the past five years, despite 2015's mixed record, with expenses well under 1% a year.

That's the combination you want to look for — a history of solid returns with low expenses.

Those are the mutual funds that can help your retirement account grow.

But Adams notes that the single biggest boost to your 401(k) comes from employer matching contributions.

"People get focused on how much they're making on investments," she says. "But if your employer is matching up to a certain amount, that's a 100% gain on that money right there. That's why you need to take full advantage of matching contributions if you have them."

  • Tony Edwards

    Where are you getting AA or AAA bonds paying 6%? Puerto Rico bonds pay that much but they are low rated and higher risk. Plus don't expect annual return on stocks to be 10 %. More like 7-8. Overshooting expectations will drive you to sock away less money. 401k avg 5% return nationally.

    • John Richards

      So, I think the key here is short term vs long term. I'm thinking 20 years, but you appear to be looking at 5-10 years? Over the past 50 years, 10 year Treasuries have returned about 7%... but I think you're focused on the current environment: I agree, it'll be tough to find current issuance at historical rates in this environment without assume significant credit risk.

      As you note, we're currently in a low interest rate environment. Also, on the equities side, the US market is expected to provide sub-par returns over the next decade (but Int'l markets are expected to do well, especially emerging markets.) I suspect the next ten years we'll see returns that are low relative to long term rates, perhaps more like 6-7% for a diversified 50/50 portfolio, or even 5% if you are US-centric in your investing and the worst case scenario comes to pass. I suspect that the decade after that will see some rebound, such that Long Term returns continue to be about 7-8% for a diversified portfolio. Best guess.

      Average 401k returns lose a couple points a year because the investor has no real plan and moves their money based on emotion. Buy and Hold (& rebalance) would serve them better in the long run. Secondly, small 401k plans often have excessive fees in the plan and/or the funds. I think it wise to adjust expected returns down by the combined fee structure if you are in a high-fee environment.

  • Joshua Flowers

    I don't see down years as a major issue when your still 20-30 years away from retirement. The way I see it is that your are investing in cheap funds because the market is low.
    Personally I have been ultra aggressive with my portfolio. I am heavily into the S&P even knowing how risky that is. The way I see it is that I am buying the shares at their low. Hopefully it pays off.

    • etplante

      Late 30s here and I manage the family retirement portfolio.

      100% invested in ultra low cost equities index funds:
      55% US large cap
      10% US small cap
      5% US REITs
      25% foreign developed
      5% foreign emerging

      Fees on that mix runs about 0.10% per year
      Annual return for 2015 was +0.80%.
      Annual return for previous 10 years was 10.2%.

      The dog in that mix has been the emerging marks index fund which returned -0.10% over the last 10 years. I must be a masochist to stick with it at this point but I tell myself I'm playing the long game.

      Recently opened a brokerage account and will be putting non-emergency savings into a leveraged muni bond fund that pays a 5.5% dividend.