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!
Lessons Learned
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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
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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!
Is there a cash option in your 401(k)? Perhaps many physicians have started to move more money to cash as the stock market has risen to “higher valuations.” Certainly, that is what many hedge funds have tried to do (or short the market). Some famous hedge fund managers (e.g. David Tepper) have been calling a market top for several years now. Thus far, those that have been following these predictions have been punished with below-market returns.
You can get anything publicly traded that you want through a PCRA option, but there is no cash option in the 401(k) itself. What you see is what is there.
I love that you think my partners actually pay enough attention to the markets or what’s in the 401(k) to be doing some sort of dynamic asset allocation. If they are worried about the market, chances are they simply didn’t contribute to the 401(k) at all. You might be surprised to learn that only ~5% of partners max out their defined benefit/cash balance plan.
Really great post. My portfolio is even more messy. I own several of the same funds. Curious about the rational about the Pimco total return? I have had 8.2% total return over the last 3 years with a 65/35 portfolio. I would recommend ignoring what your peers tell you they are making because they likely are not talking about their losses. I think if you polled WCI investors they are stock heavy and bond light. However I think there is a large group of docs who are so risk averse they sit in CDs and MMFs.
I was going to mention that, too. If WCI ran a poll on the forum, or even the email list, response bias would lead to the returns being significantly higher than the actual market returns. The great thing about this data is that it includes all physicians, not just those who choose to report their returns.
I recently added a widget to my blog with my 401 k asset allocation. I left my IRA’s out of the widget but you can see that I am mainly in BTC US Equity Market. Figure it is a little more aggressive.
I still imagine savings rates are the best predictors of FI. The other stuff becomes important, but not as important.
I think I’d say it a different way- FI depends far more on what you spend than what you make or have. You can be FI with $500K and you can be not FI with $5M.
You really want the rationale? It’s about past performance. I’d dump it but the fund choices are made by a committee which is heavily influenced by past performance.
Excellent post!
The question I bring up yearly both at home and with our investment advisor after seeing the S&P listed along side our returns is why we aren’t using that alone.
The answer is always ‘it’s not a diversified portfolio’ when using a single index ETF. In my simple view, diversification is necessary to protect against the downside, yet I have not seen convincing data that it does such. In our own portfolio, our ‘diversified’ portfolio took as big of a hit (if not a little bigger hit) than the S&P did in the downturn in 2008.
You are making 7.5%. The S&P has made 12%. You can cheaply buy the S&P and you don’t. What am I missing?
I can see going into bonds when closer to retirement age (we are not) but doesn’t the S&P (pick the index if your choice) provide a ‘diversified’ bucket of stocks? And does diversification really matter?
Thanks in advance! Your site and book are part of the non-hand surgery curriculum for the fellows and residents I teach.
There are plenty of years when a “diversified portfolio” makes 7.5% and the S&P 500 makes 1% or -5% or whatever. Sometimes small stocks, value stocks, international stocks, real estate, or bonds outperform. I think you would really benefit from this:
https://www.callan.com/wp-content/uploads/2017/01/Callan-PeriodicTbl_KeyInd_2017.pdf
That explains as well as anything why I’m not 100% S&P 500. That said, I do know at least one physician couple who did just that and it worked out fine.
https://www.whitecoatinvestor.com/150-portfolios-better-than-yours/
Thanks Jim. Super helpful!
Yup. #1 is the big deal. How much you save is the one factor we have the most control over and it drives your wealth the most. This seems like an obvious fact, but I didn’t really get it until I read your book. I had always been fascinated by lowering costs, managing risks, security selection etc. Tinkering on the edges of complex theory won’t build your wealth massively or quickly. You have to pile up the Benjamins out of your earnings.
Indeed, savings rate is extremely important until you hit some critical mass and compounding growth becomes an even bigger force. 8% growth on $200k is very different when compared to even 5% growth on $2 million.
Bonds in the 401(k), eh? What happened to “bonds go in taxable!”? FWIW, my bond allocation exists entirely in my 401(k), so I would rank pretty low on the percentile scale with about 70% bonds. But it wouldn’t be a fair comparison, because my 401(k) represents about 1/8 of my portfolio.
Overall, with a 90 / 10 stock / bond allocation, the past 5 years has been quite good to my overall portfolio. Yesterday wasn’t so great, but day-to-day is just noise.
Cheers!
-PoF
Since there is much discussion on some controversy on where bonds go regarding taxable vs tax advantaged I decided to split it 50/50
Total bond fund in my 401k and tax exempt intermediate term in my taxable.
Honestly, it’s probably fine for now. But if interest rates rise significantly, rethink moving bonds into tax-protected.
You keep forgetting that until recently there was no taxable. EVERYTHING should go into tax-protected if it can.
Wish my employer would do something similar. Would be fascinating and reflective of US population. Out of curiosity WCI, did you (your and employer match) actually contribute $340k over 6 years? Given, the sheet you showed has returns over 5 years, it appears possible that you have additional ‘cumulative earnings’ that may not be reflected on the sheet for the additional year. Reason I ask, is though I track percentage returns, I am a much larger fan of understanding cash flow contributions (how much did I/employer put in) versus a point in time valuation.
Ha ha. Employer match. That’s funny. I’ve actually never received an employer match from any employer. I do “self-match” as the employer into my current 401(k)s though.
I can’t quite tell what you’re asking. Are you seriously interested in what the cash flows into one of my 401(k)s is? I can’t tell why that would matter to anyone, although I suppose I could find that information from old statements if I really wanted it. Suffice to say I have maxed it out each year, but may not be able to at some point in 2018 or 2019 if I keep dropping shifts from my schedule.
past performance is fine to look at but truly means little to each of us personally. Each investor allocates assets within their comfort level. When we are in a bull mkt there is lots of NOISE; when shit hits the fan many panic out of the stock mkt and remain there; probably the last crisis made docs forget about retirement. Save plenty, invest conservatively in stocks/bonds, and time will create wealth more than anything else. Those axioms will remain forever
Thank you for this post-
Remind me – How do you get 4 401(K)s? – my wife and I are both hospital employees, hence we get one each – Are the other two coming from having your own business?
1) 401(k) from previous employer (US Military TSP)
2) 401(k) from physician partnership
3) Individual 401(k) from WCI for me
4) Individual 401(k) from WCI for my wife (who owns 50% of WCI)
Thanks-
So you put 18k on each 401 every year?
Even for the TSP?
No, I put $54K into my partnership 401(k)/profit-sharing plan, $54K into my WCI individual 401(k), and $54K into my wife’s WCI Individual 401(k). I can’t contribute anything to the TSP any more.
I’d say that mine are also around a 7-8% return, with most of the investments in a taxable account (ouch). Great point about comparing apples–one doc I spoke to in his 70’s was very proud of his long-term Wall Street advisor who gave him 9% returns over the years. I wouldn’t be getting those same returns if I put my eggs in his firm now.
It’s all about front loading your savings and accounting for unexpected expenses in the long run.
AS an aside- I would not want to see these numbers on my portfolio. After a decade of percentile rankings in the 90s on all the exams we have had to take (and now for me and others with kids that age, for our kids) it might demoralize me to be at the 50th or 30th (50 or 70 in your 401K’s ranking) percentile. Don’t recall other places where the concept is used outside of growth charts.
Everyone should keep in mind as well that the numbers used to show the growth of indexes like the S&P 500 are time-weighted, whereas the returns you actually experience are dollar-weighted. If you are contributing to (or withdrawing from) a fund, this difference will virtually always exist.
For instance, if you put $1,000 every year into a fund (starting at year 1), and the fund instantly doubled in value at the end of year 5, then remained flat until year 10, your personal return would have been 8.7%, but the fund’s return would have been 7.2% (one doubling in 10 years). In some situations, the difference can be extreme. For instance, because of this difference, DALBAR’s study which concluded that most investors vastly underperform the market was fundamentally flawed and came to the completely wrong conclusion.
Investors need to realize that their returns will almost certainly differ from those shown for the funds or ETFs they are purchasing.
I agree the Dalbar study has serious methodological flaws that limit its use. You point out the most serious one.
Jim-
Love the website, just bought the book. As a practicing physician now 10 years removed from residency, I espouse many of the principles your adhere to, and surpassed the million dollar net worth number a short time ago. My question is, how is it possible to contribute $340K to your 401k over 6 years? 2017 maximum contribution per IRS regulations is $18,000, right? If you are over-contributing with post-tax dollars, aren’t you setting yourself up for double taxation (i.e. on the monies deposited and eventually again on the withdrawals)? Not to mention the enormous tax prep headaches that likely causes?
18,000 a year for an employee, plus the 200% employer match, is $54,000 a year
Joe,
You’ve come to the right place if you had no idea after 10 years as a practicing physician that many people have options to sock away far more than 18k/yr in tax advantaged accounts. I’d encourage you to invest your weekend in reading the book you bought and consume as many of the ‘start here’ greatest hits old posts on this site as you can.
As others noted, I can put $54K into my partnership 401(k)/Profit-sharing plan per year. So 6 years x 50K = $300K. The rest is earnings.
The DFA 80/20 Balanced Strategy did +12.6% in 2016, +5.4% per year from 2014-2016, and +10.5% per year from 2012-2016. Time and time again, we see that a well-designed portfolio consistently held far outweighs small differences in expenses.
Weird that DFA is still losing the head to head competition in the only place the funds are available to me without hiring an advisor. 🙂
I stopped to look at my 5 year return. Almost all stocks, invest an average of 3k a month in investments, return per year is 11.51% to Aug 1 2017. That does not take into account that I was paying over 2% in fees on about half the investments before I started reading WCI, looked hard at the fee structure the financial advisors were charging me, and moved to a much lower fee investment strategy after having a pity party for myself. Hindsight is 20/20.
Sounds like you’ve been investing pretty aggressively. Your example is a good one that demonstrates that asset allocation matters even more than fees, particularly in the short-term.
Some great comments
As a 50 yr old cardiologist who reached FI a few years back now with net worth approaching 8 figures in today’s market. l lived through the tech bubble, 2008 and the most recent bull market. A word of warning. It is easy to judge or feel good about a portfolio when the market is in the green. Not as easy when all that frugal saving evaporates (maybe only temporarily) in a bear market. That is the power and importance of rebalancing even when you know you are shifting money from hot markets to boring bonds. Hopefully twci will show us his charts when this incredible run up pulls back.
I continue to rebalance my 60/40 knowing I may be leaving some gains on the table.
I agree that trees don’t grow to the sky.