401(k)s Don't Work, Or Do They?

by: Roger Nusbaum

Someone tweeted out this link that notes by one study that 401k balances almost doubled from the 2008 low average balance of $49,932 to $94,482 at the end of 2011. The implication is that balances grew with the equity market but not mentioned in the article was how much of the "growth" came from payroll contributions.

The average numbers seem to be all over the place with these studies. Both figures seem to be high but the percentage increase captured in those averages makes sense. Equity markets went up a lot and people reasonably speaking kept putting money in.

401k plans drew a lot of negative attention when jokes of 201ks were prevalent at what turned out to be the lows a few years ago. For many people, their only attachment to the capital markets is their 401k, so when the markets went down a lot so did 401k balances and there was blame directed at the 401k wrapper.

They are flawed from the standpoint that they often have poor choices selected by someone in HR who very likely lacks the knowledge to decide which funds to include. Invariably there is a salesperson involved somewhere in the process and so available funds tend to be expensive. Fidelity is a huge player here and while I would not say their funds make for poor choices necessarily, a suite of actively managed funds might be expensive. From what I have seen from clients' plans, the index funds tend to not be insanely expensive even if they are more expensive than the 0.17% charged by VFINX.

More and more plans are providing a brokerage option that will allow for trading anything in some instances or maybe just ETFs in other instances. This sort of evolution will move along at some pace that some will be pleased with and others think is too slow but either way it will improve.

The point though is that 401ks do work but they may not be very efficient. If the only choice for an S&P 500 Index fund charges 1% (there used to be ones that did, not sure if that is the case anymore) then the fee will certainly be a drag that compounds but that fund's chart is still going to look virtually identical to the actual index.

Note that I am not condoning charging 1% for an SPX fund just pointing out that a fund with that expense will go up a lot when the index goes up a lot and it will go down a lot when the index goes down a lot.

Similar to IRAs and other vehicles, a 401k will give people that have reasonable savings rates appropriate asset allocations and who don't panic sell a fair chance of having enough when they need it even if it is not the most efficient vehicle. And for as inefficient as they might be, the employer match (if there is one) might help offset that inefficiency.