By Gary Brooks, CFP®
Survey data is regularly publicized by a wide variety of financial firms and research entities. It often is used to make a particular point about savings, investing, views on the economy, etc. It seems that frequently these surveys are based on responses from a relatively small group of people, something close to 1,000. While the survey sponsors suggest that this is a large enough sample size to correlate to a broader audience and be representative of broadly held views, it seems a little light.
So when analysis is published that represents actual activity of millions of people it naturally should carry more weight.
Vanguard is a popular employer retirement plan administrator, providing the platform for 3.9 million employees to save and invest for retirement. With the opportunity to evaluate this statistically significant sample size, Vanguard provides some interesting observations in How America Saves 2015.
One that is counterintuitive represents unintended consequences of encouraging more people to contribute to their retirement accounts. Automatic enrollment has become commonplace over the past several years. But Vanguard attributes this very good trend to harming another important element of retirement savings.
With the rise of auto enrollment, the average salary deferral of Vanguard retirement plan participants has actually come down. The problem is that when people accept auto enrollment they are more likely to accept the default contribution rate which in many cases is just 3% of salary. Without the automated nature of enrollment, people choose higher contribution rates. It’s almost as if people assume the default contribution rate comes with some sort of endorsement that the 3% is enough for people to save.
Using 2014 data, the participation rate in plans administered by Vanguard was 77%. The average salary deferral was 6.9% but this number is down from 7.3% when auto enrollment features become more common.
Of course, identifying how much of someone’s salary needs to be saved and invested as an important resource to withdraw income from in retirement is a challenge that requires financial planning and an understanding of personal goals.
When adding employer matching funds to employee contributions, the average contribution rate rises to 10.4%. This is getting closer to the territory most frequently required to maintain preferences for standard of living in retirement. But knowing how much is preferable requires an understanding of how much income Social Security will provide, what your other income resources might be, and a sense of the preferred level of spending.
Other findings include:
• The average stock market portfolio weight for the 3.9 million participants was 72%. Knowing that this includes a wide mix of participant ages and tolerances for risk, this emphasis on stocks is surprising. A 72% stock portfolio goes beyond the typical definition of a balanced approach and into the beginnings of aggressive territory.
• There is clearly a set-it-and-forget-it mentality among 401(k) participants. Only 10% of participants traded within their accounts, shifting balances from one fund to another or changing their investment allocation in some way. This is partly due to the emergence of target date retirement funds that automatically rebalance and are intended to be an all-in-one investment solution.
• Many employer retirement plans offer the option of investing in company stock. This can lead to dangerous concentration. Not only is the participant’s salary tied to the company’s performance, but so is their retirement balance. In 2014, 28% of participants held more than 20% of their 401(k) in the stock of their employer. This weight increases risk but it is trending down slightly over time. Any single stock position larger than 10% of a portfolio could be considered a concentrated risk.
• The stock market recovery of 2009-2014 provided a healthy lift in account balances. For continuous participants through the five-year period, the median account balance rose by 137%. This figure includes additional contributions and investment returns.
• Roth 401(k) features are used by only 14% of plan participants. Understanding the long-term tax benefits of the Roth apparently requires more education. “We anticipate steady growth in Roth adoption rates, given the feature’s tax diversification benefits” the Vanguard report notes.
On the whole, more people are participating in employer retirement plans and the costs of investment selections within these plans has declined.
Now, it’s important to get people to think more strategically about how much they should be saving in the context of their retirement income goals, their spouse’s savings rate and the many other needs that they will ultimately want to put this deferred income to work toward.
~ Brooks, Hughes & Jones Wealth Advisors — Gig Harbor, Washington