I've blogged before about something interesting that my 401(k) plan does. Once a year, they send you a sheet detailing your 401(k) performance and comparing you to your peers. There are all kinds of problems doing this, and I take it with an extremely large grain of salt given that we have three other 401(k)s, Roth IRAs, and a taxable account. But I admit it is kind of fun to look at. Let's take a look.
Now, we have a great 401(k). It's spectacular for our full-time advance practice provider employees. We offer a 200% match on their first 6% of salary contributed. But it's a great plan even for the partners. Look at all the great investments in it! You've got a TSM fund, a developed markets fund, an EM fund, a small value fund, a REIT fund, a short-term bond index fund, a total bond market fund, and even a gold ETF. All have very low costs and, unsurprisingly, excellent long-term returns when compared to other funds in their asset classes. The fees are low at something like 0.2% a year (plus fund ERs) but you can actually even avoid that if you are willing to trade some ETFs yourself through the Schwab PCRA option. The PCRA option does cost me $200 extra a year (plus commissions if I don't use Schwab ETFs), but that works out to be less than the 0.2% for me. As you can see, my total fees (not counting ERs) in the last five years are less than $1,000. Not bad for what is now a $401K 401(k). See what I did there? Pretty cool huh. Let's hope it doesn't become a $201K anytime soon.
The Comparison: Why Did My 401(k) Outperform My Peers?
However, what I wanted to focus on today was the comparison numbers. If you look at the top few lines, you'll see that my 5 year performance of 8.52% per year outperformed 56% of my peers in the plan, 61% in the last year. At the bottom, we see that the average participant had a return of 7.47%.
Now, I don't care all that much about my personal return in this plan as this is a relatively small part of my retirement assets. I have all those other accounts. But there are plenty of people in this plan for whom this is either all of their retirement money or the vast majority of it. Is 7.47% good? Is it going to be adequate to meet their goals? If those blokes had just chosen to go 100% Small Value, they would have had returns of 16.40%. At 16.40%, your money doubles in a little over 4 years. Even if they had just gone 100% US stocks, their return would have been 14.58%. If they diversified internationally (50% US, 50% Developed), their return would have been 10.25%. The fact that their returns were 7.47% suggests a much less aggressive asset allocation. But even 50% Total Stock Index and 50% Total Bond Index would have given you 8.29% or so. The average performance was almost 1% below that. What gives?
Well, there are a few things that could have happened (and almost surely did.)
- People paid 401(k) fees. Those fund returns don't include 401(k) fees.
- People paid advisory fees. If you're paying 1% of your assets a year, that's exactly equivalent to earning 1% less on your investments.
- Many asset managers, both pros and amateurs, made asset allocation changes that hurt their long-term return.
- People aren't taking enough risk with their retirement assets.
After thinking about all this, I became curious as to what my actual retirement account returns were for the last 5 years, including all my 401(k)s, defined benefit/cash balance plan, and Roth IRAs. Luckily, I keep excellent records and could put that information together very quickly for my 75/25 portfolio.
- 2012 13.87%
- 2013 19.71%
- 2014 6.27%
- 2015 -0.29%
- 2016 10.72%
- Overall 8.91%
Why was my 401(k) return a little lower than my overall retirement return? Well, over the last five years I've had a larger percentage of my bonds in this account than in other accounts. Plus the 401(k) fees provide a bit of a drag. As good as this 401(k) is, it's also the most expensive of our four!
There are a few lessons you can take from this exercise.
# 1 How Much You Save Matters Most
I've got a $401K 401(k). But the sheet says it has only earned $61,558 over the last 5 years. How did it get to be $401K? Apparently, because I contributed almost $340K to it over the last 6 years. Want to get wealthy? Save a big chunk of your income and max out your 401(k)/profit-sharing plan and similar accounts.
# 2 Risk Taking Is Rewarded
While there are no guarantees about the future, especially the near-term future, over the long-term both historical precedent and investing theory suggest you will be better off for taking a substantial risk with your investments. The truth is that most of us cannot meet our financial goals without using a relatively aggressive portfolio, whether we prefer to take that risk or not. If your investments only keep up with inflation, you hope to replace just 40% of your pre-retirement income with your portfolio, and you save for 25 years, you will need to save 40% of your gross income each year. Very few of us will do that.
# 3 Fees Matter
The vast majority of my partners use a financial advisor of some type and most of them charge an AUM fee. Even in a good 401(k), your 401(k) fees, fund expenses, and advisory fees add up fast. If keeping fees low isn't a major part of your investing strategy, you will almost surely have lower returns than what you hope. The problem with that is it means you either have to work longer than you might hope or you will have a less comfortable retirement than you might hope.
# 4 You're Not Competing With Peers
Finally, while it is fun and interesting to see how your returns compare against benchmarks and against your peers, the truth of the matter is that you are not competing against your peers. You are competing against inflation. You are competing against Uncle Sam. You are competing against the financial services industry. And most importantly, you are competing against your own financial goals. It really doesn't matter whether you outperform your partners especially when you're comparing apples to oranges. Some partners have advisors. Some partners are just starting out and others are about to retire. Some partners have their stocks in this 401(k) while others put bonds in there.
# 5 You're Not Going To Get 10-12% Returns
The last five years have been great for investors. The S&P 500 return was 12.23%. Dave Ramsey runs all his calculations with 12%. But you know what? You're not going to get 12%. You're not even going to get 10%. If you're like a bunch of other docs using a great 401(k), you're going to get 7.47%, and you can knock 2% off that for inflation. It would be even worse in a taxable account. If you count on higher returns, you're likely to be disappointed.
# 6 A Simple Portfolio Is Fine
You don't need a complex portfolio to have good investment performance. A simple combination of 50% TSM and 50% TBM would have outperformed more than half of your peers. 33% TSM/TISM/TBM would have given you about 7.5% returns. Basically average. While the differences in 1-year returns was remarkable, basically any US stock fund would have provided double-digit returns (12-16%) over the five year period. If you want to add complexity and take some more risk in hopes of boosting performance, a small value stock allocation is a reasonable way to do it.
What do you think? Were you surprised to see what actual physician investment performance looks like? Was it higher or lower than you expected? What are the keys to investing successfully? Comment below!