Slow and Steady Saving Still Pays
uesday, January 4, 2011
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The path toward having enough money to enjoy a comfortable retirement is a long one. And as the recent decade in the U.S. stock market shows, it's one where patience pays off.
For younger retirement savers who diligently put money away, that long march of time also provides a crucial ally: the ability to recover from inevitable losses. That's especially the case for 401(k) investors who don't pass up the essentially free money that comes by taking full advantage of any matching contributions provided by their employers.
There's no reason to sugar-coat the miserable experience most stock investors have had since the collapse of the technology-stock bubble beginning in March 2000. The Standard & Poor's 500-stock index, the most commonly used market barometer, has risen an average of just 1.4% per year over the past 10 years, a 3.6% gain once dividends are included.
It was only last month that the Dow Jones Industrial Average pushed above where it stood in mid-September 2008 when giant brokerage house Lehman Brothers collapsed.
But let's look at how steady savings and the passage of time can benefit younger 401(k) investors. Consider a person making $40,000 per year in 2000 who contributed 6% of her salary — $200 per month — in the first year with a company match of 3%, or $100 to start.
Beginning back in January 2000, that money goes into the Vanguard 500 Index mutual fund, which tracks the S&P 500.
Over time that person gets a 3% raise per year, with her contributions rising accordingly. That would mean in the second year, the investor contributes $206 per month out of her pocket and gets an additional $103 put in the account by the employer.
When it comes to timing, starting off as an investor in January 2000 would have been especially dispiriting. Within three months, stocks entered a bear market that would last nearly three years.
By March 2001, that investor and her employer would have made contributions of $4,527 but would have had only $3,833 in her account — more than a 15% loss — thanks to the stock market's decline, according to data compiled by Financial Engines.
But an investor sticking with the program would have seen her fortunes rebound nicely. By June 2007, our investor opening her 401(k) statement would have had $40,736 in her account, of which only $19,866 was her contributions. Some $10,000 would have been company contributions, and returns on the investment would have approached 37%, according to Financial Engines.
Of course, the roller coaster dipped again with the financial crisis, wiping out those gains and more. At the end of February 2009, the account would have been down to $25,449, a loss of nearly 32%.
Fast forward to today, however, and the numbers are once again looking better. As of the end of November 2010, there would be almost $52,000 in that account, with just $30,470 of that money coming from the saver's own pocket. The rest would have come from the company match and a nearly 14% gain in the S&P 500 fund from January 2000.
Skeptics would point out that there would have been a lot more money in that account if the investor has pulled out of stocks before the late-2008 market collapse or even invested entirely in bonds. The most widely used benchmark for the bond market, the Barclays Aggregate, is up 95% in the past 11 years.
While it's true both would have been good strategies, it's hard enough for professional investors to time the markets' ups and downs, never mind individual investors.
And as for bonds, there's basically nowhere for interest rates to go but up; because bond prices move in the opposite direction from rates, the result could end up being losses on bond investments, as seen in the last month in 2010.
For younger retirement investors, the long-run part of the equation is what matters. Despite the stomach-churning ups and downs of the stock market during the past decade, an investor who started with $300 in an account 11 years ago, and who has nearly $52,000 socked away today, is much further down the path toward a comfortable retirement.
