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Why Rising 401(k)s Are No Cause to Celebrate: Vanguard MSCI Emerging Markets ETF (VMO)

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There’s no better friend to retirement savers than a rising market. Yet even as most investors have seen the balances in their 401(k) retirement plan accounts go up over the past year, the question they ought to be asking themselves is why those balances didn’t go up more.

The latest quarterly look from Fidelity Investments revealed that its clients’ average 401(k) balances rose to a record $77,300 as of the end of 2012, rising from $75,900 in the third quarter of 2012 and from $69,100 at the beginning of the year. Those figures correspond to strong performance in the financial markets, but what they reveal is that investors aren’t doing nearly enough to take advantage of unusually favorable conditions.

Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO)Breaking down the numbers
As the report presents the figures, Fidelity is fairly optimistic about the state of retirement savings. According to its figures, participants are saving about 8% of their salaries in their 401(k)s, with another 4% or so coming from employer matching contributions and profit-sharing. Although only 1 in 11 participants changed their savings rate during the quarter, nearly twice as many raised it as lowered it.

According to the report, gains in the market accounted for two-thirds of the increase for the full year, while contributions represented the remaining one-third. That implies an investment return of about 8% on their invested money, while less than $3,000 of the $8,200 rise came from contributions.

Spoiling the party
Obviously, whenever retirement balances go up, it’s good news. But in a year in which the basic vanilla Vanguard Total Stock Market ETF (NYSEMKT: VTI) rose more than 16% and the Vanguard MSCI Emerging Markets ETF (NYSEMKT: VWO) jumped almost 20%, it’s clear that 401(k) balances are underinvested in growth assets.

Moreover, even bonds didn’t do as badly as their low yields might suggest. The iShares Barclays Aggregate Bond Fund rose almost 4%, besting the yield to maturity on most of the bonds it holds as bond prices rose overall. Corporate bonds did even better, with the iShares IBoxx $ Invest Grade Corp Bd Fd rising more than 10% on the year.

With stocks well into double-digit returns and certain bonds providing decent gains, a rise of only 8% from 401(k) investments suggests that investors have a whole lot of cash in their accounts earning next to nothing. Given the fact that the vast majority of 401(k)s are invested for long-term goals, the level of cash that would lead to such modest returns in a very strong year for the markets is far too high.

Falling behind
Moreover, when it comes to amassing a sufficient retirement nest egg to survive throughout their retired years, near-retirees are still coming up short. The average balance of $143,300 for those age 55 or older translates to less than $500 per month in supplemental retirement income using the 4% rule — and that rule has come into question lately due to low interest rates.

Moreover, most investors have their retirement plan balances in traditional 401(k)s, and so withdrawals will be subject to income tax, further reducing its purchasing power. The report pointed to a substantial increase in the adoption and use of Roth 401(k) plans, but assets in such plans remains only a tiny fraction of overall retirement assets.

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