Legislation creating the 401k plan went into effect January 1st 1980. This legislation allowed employees to have a salary reduction from their paycheck and direct deposit the funds into their 401k investment account. Viewed as a way to reduce current taxes and supplement savings and social security for retirement the 401k plan experienced widespread adoption and popularity. Through the 1980’s and 1990’s most investors were generally happy as the U.S. stock market experienced one of the greatest bull runs ever experienced. The new demand from buyers in 401k plans helped drive the value of stocks and bonds into bubble valuations in 2000. Then the bottom fell out. The S&P 500 fell nearly 50% over the next three years and the NASDAQ crashed 80%. Through 2011 the S&P 500 is still struggling to return to the levels of the year 2000 and the NASDAQ is still worth less than half of its year 2000 valuation. As boomers have begun retiring through the 2000’s they’ve been wondering whatever happened to happily ever after. Is the market a casino? Is it the best way to grow my money? Is it the best way to provide an income in retirement?
The stock market has proven a difficult arena for individuals to prepare for retirement. The daily ups and downs have given many an ulcer or two, and most investors haven’t been rewarded for the mental anguish. Studies have indicated for the 20-year period ending in December 31, 2010, average equity (stocks) mutual fund investors have returned a paltry 3.89% compounding return. The results of the average bond fund investor have been even worse at a 1.01% compounding rate. The factors contributing to the poor performance is attributable to factors such as the fear/greed cycle causing investors to jump in and out of the market at the wrong time, and the associated fees.
While it is difficult enough for the average investor to grow their assets and prepare for retirement, distributing a sustainable stream of income in retirement has proven even more treacherous. Studies by T. Rowe Price have indicated if an individual in a 60% stock and 40% bond portfolio begins taking a 5% withdrawal rate and increases the withdrawal 3% annually to adjust for cost of living, the individual has a 68% chance of having money after 30 years. That means 32% of individuals would be broke after implementing the same strategy. Income distribution in retirement is a trickier proposition because money needs to go out every year to pay for expenses whether or not the market is up or down. Withdrawals during down market years exacerbate losses and the greater the loss the more difficult it is to catch back up. If one loses 50% a 50% gain does not get you back to even. A 50% loss must be followed by a 100% gain to get back to even.
If you’re lucky enough to grow your money in the market, is a one-third chance of running out of money in retirement a bet worth taking? Don’t gamble with your financial security.
*Guarantees and Safety are subject to the claims paying ability and financial soundness of the insurance company contracted with.