Super Secret of 401k Success: Contribute to the Damned Thing.
(N.B: Even though the title of this post refers to 401k plans, the info is relevant for most any kind of long-term investment portfolio (IRA, Roth IRA, 403b, taxable account, etc.)
A famous study first published in 1986, with a follow-up in 1991, by Brinson, Hood, and Beebower, shows that asset allocation accounts for over 90 percent of a portfolio's return. In other words, the mix of asset classes (stocks, bonds, commodities, etc.) a hypothical investor chose to invest in (for a period of 10 years, in the original study) ultimately accounted for a far greater share of that investor's portfolio performance than other factors, such as the selection of specific stocks in a portfolio.
But it turns out that asset allocation is not the end-all in portfolio performance. There is an even greater factor impacting the ultimate outcome of retirement investments: contributions.
One item that hit my email inbox this week was an article by AP business writer Meg Richards emphasises the contribution imperative forcefully:
Countless studies underscore the fact that successful investors don't wait for the market to inspire them — including a September survey of 401(k) balances conducted by ICI and the Employee Benefit Research Institute. It found that Americans who continuously maintained 401(k) accounts from 1999 to 2004 saw their balances rise by an average 36 percent, despite enduring one of the worst bear markets since the Great Depression. In 2004 alone, the average account balance increased by 15 percent. A big reason for this success was consistent participation, said Jack Van Derhei, EBRI's research director and co-author of the study.
Another EBRI-ICI study, released this summer, offered even more compelling evidence that sticking with your investment plan through thick and thin is the best way to come out ahead. Using simulation models, the researchers tracked 401(k) accounts over much longer periods, and through all kinds of scenarios — such as the worst 50 years, the best 50 years, with a bear market in the middle and at the end.
No matter what scenarios were used, "It was absolutely, without a doubt, the case that the most important thing was people just continue to participate in 401(k) plans year over year," Van Derhei said. "Doing that is much more important than just being lucky or being born in the right year."
A summary of a differently constructed study (by Putnam), highlighed on page 38 of the October 3, 2005 Pensions and Investments magazine reached, in a quite ho-hum coincidence, my actual real inbox this week:
Participant contributions to 401k plans have a far greater impact on retirement wealth than mutual fund performance and asset allocation . . . The study, which compared those three components of defined contribution savings over a 15-year period, found that mutual fund performance had the least impact.
If investors were able to accurately predict which mutual funds would perform in the top quartile and invested in them, the investors' retirement wealth would be 6% higher . . . than if they had selected bottom quartile funds.
[And] changing the allocation from a conservative to a more aggressive portfolio increased overall asset size by roughly 20%.
However, increasing participant contribution to 4% from 2% of salary had 90 times the impact of changing to top-quartile funds from bottom-quartile, over 15 years.
So one more time: far more important than the individual stock or bonds or funds or whatever one picks for a portfolio, even far more imporant than the asset allocation strategy of a portfolio, the most important factor in a portfolio's success, according to these studies, is consistent participation, steady contribution, year after year, of new investment funds to the portfolio. Saving and investing. That seems to be the boring old truth of the matter.