The Headline Masks the Problem: 401(K) Balances
In the past week, Vanguard and Fidelity have announced record balances for their average 401(K) customer. All they are telling us is that the stock market enjoyed extraordinary gains in 2013. We knew that about six weeks ago. At Vanguard the balance is $101,650, up 18% over the last year. At Fidelity the average balance is $89,300, up 15.5% and nearly double since the stock market’s low in March 2009. According to Fidelity, pre-retirees age 55 and up had an average 401(K) balance of $165,200. The lion’s share of that increase or 78% was due to the stock market, while 22% came from increased contributions. Of course the stock market is up 167% since that period, so it’s not surprising that the balances have rebounded.
Both Vanguard and Fidelity reveal that participation and contribution rates have increased in the past year. Clearly, this is good news for America’s retirement deficit. However, these numbers also reveal a significant problem with the way the 401(K) program operates. In relatively good times (rising stock market and expanding profits), participants and their employees put more money toward 401(K)s. However, when markets are down and corporate profits become pinched, they reduce their contributions. In other words, more money tends to flow into retirement savings when stocks are relatively expensive. This behavior is understandable. When times are tough, companies elect to reduce retirement matches and employees need to leave more money available for current consumption. So when it comes to retirement, we are reverse consumers, meaning that we tend to buy into retirement savings when the price of financial assets are marked up rather than when they are on sale.
Fidelity reveals another major flaw in how we save for retirement. Fully 35% of people who left their jobs in 2013 cashed out their 401(K)s. While many of those folks probably needed to get their hands on the money, the long-term implications are disturbing. This money will no longer compound over time, leading to gaping retirement deficiencies.
During the great recession, it was clear that our reliance on defined contribution plans like the 401(K) to fund retirement was going to leave us well short of retirement security. Even in the good times, it’s clear that the 401(K)/IRA concept is flawed. These programs tend to work for folks who don’t need them: those with a defined benefit plans and/or wealth.