Rekenthaler Report

What Are Realistic 401(k) Expectations?

John Rekenthaler

What Was
Yesterday’s column was a history test. If somebody joined the workforce in 1948, held an ordinary job for the next 67 years, put about 10% of her salary into U.S. stock each year, and held tight, what would be the result? Might she accumulate a fortune so large as to attract the attention of The New York Times?

She might, and she did. Sylvia Bloom, a longtime legal secretary, amassed $9.2 million by putting her spare cash into stocks, and then holding ... for decades. As yesterday’s column demonstrated, her gains required no financial wizardry. The U.S. stock market has been so strong for so long that a steady, persistent buyer such as Bloom couldn’t help but make several millions.

While instructive about the power of compounding, as well as the fact that most investment wealth is created by time rather than brilliance, that homily only goes so far. Few people work for 67 years, and only those with a Time Stone will be able to invest in previous stock markets. Ordinary mortals will have less time for compounding to occur and will almost certainly receive lower equity returns.

What May Be
With that in mind, let’s see what current 401(k)s might bring to middle-class investors who share Bloom’s commitment but can claim neither her employment life span nor her excellent stock market luck. Below are my inputs for the spreadsheet.

1)     Salary that begins at $45,000 and peaks at $70,000 (in real terms)

2)     10% 401(k) contribution rate (no match)

3)     A diversified U.S. stock portfolio

4)     Contributions that begin at age 25 and conclude at age 65

5)     An average annual real stock market return of 4%

The first three items emulate Bloom’s situation. There were no 401(k) plans during half of her working years, and the other items are approximately rather than exactly a match, but never mind that. All precision from this type of exercise is false; thus, there is no point in sweating the details. The best that we can do when probing this hypothetical is get a rough idea of how the future might look.

The fourth proviso, that the working career will be 40 years, differs from Bloom’s case but describes the typical employee.

Stock Assumptions
The fifth and final stipulation is the most problematic. The key assumption--the figure that dramatically affects the results--is also the hardest forecast. Whether stocks will return 2% per year in after-inflation terms over the long haul, or 4%, or 6%, makes an enormous difference in the results. And that knowledge cannot be had. We can reasonably state that U.S. stocks will not match their 150-year average of almost 7% because some of the risk has been squeezed out of equities (and thus some of the expected return), but after that we can say no more.

For me, 4% is the Baby Bear’s chair. An estimate of 4% lands squarely in the middle of current long-term forecasts for real equity returns. In this instance, the crowd may not prove wise, but it is the best available indicator. Bloom, of course, was better treated; real stock returns averaged 7.5% during her investment lifetime. Ah, for that Time Stone!

You may have a question: Who invests solely in stocks until age 65? The flip answer is, my spreadsheet does. The less-flip response is that Sylvia Bloom also seems to have done so (although we don’t know for certain), and this column aims to measure what a modern-day Sylvia Bloom could accomplish. Besides, as previously stated, this entire castle is constructed on the sand of an equity market forecast. If we improve that estimate slightly, say to 5%, and managed the portfolio with a glide path, the final result would be similar.  

Thus, while the all-equity assumption looks aggressive, I don’t think it greatly affects the results. Not in the grand scheme of things, considering other uncertainties. Nor, I must confess, does my decision not to shape the annual stock market returns as a straight line. Instead, I created a random series, centered around that 4% average and assuming a 15% standard deviation. Doing so makes for a fancier model and for a smug designer. It does not, however, meaningful improve the spreadsheet’s accuracy.

Enough preamble. Here is the result: $760,000, at age 65. Not Sylvia Bloom wealth, to be sure. Nonetheless, that sum will yield $30,000 per year in income for those who choose to retain those assets, and more income yet for those who use them to purchase an immediate lifetime annuity. A handsome addition to Social Security payments; doubly handsome should the investor be married to a spouse who invested similarly.

If that amount seems insufficient, we can goose it in a couple of ways.

The first approach, sadly, is purely cosmetic--to present that final amount in nominal terms. The reports of Bloom’s fortune, after all, were not stated in the 1948 dollars with which she began her investments, but instead in 2016 dollars, when she completed the process. Inflation averaged 3.9% annually during that period. Inflating the spreadsheet’s totals by that same rate, over the 40-year period, balloons that $760,000 to $3.5 million.

That appears a tidy sum! The $3.5 million in 2058 dollars doesn’t purchase more than the $760,000 in today’s terms, but it does rate style points.

The other, more meaningful way to grow that 401(k) balance--while also behaving somewhat more like Bloom--is to recall that money also serves those who only stand and wait. Let that account ride. Unfortunately, for those who have the patience, health, and outside assets to adopt such a strategy, a 401(k) plan’s minimum-withdrawal rules don’t permit one to accumulate until age 96, as Bloom did. But even waiting a modest 4.5 years, until withdrawals become mandated, would boost the sum to $900,000--just shy of becoming a middle-class millionaire.

This projection strikes me as plausible. Obviously, high-salaried employees can (and will) achieve larger balances. Just as obviously, tens of millions of Americans won’t come close to the mark because they work at companies that lack retirement plans, or are low-income, or are not consistently in the workforce. However, for those who land in the broad economic middle, building a high six-figure 401(k) balance should be achievable.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.