Average 401(k) Rate of Return: What to Expect and How to Maximize It
9 MIN READ
Published September 29, 2023 | Updated October 27, 2023
Every 401(k) plan is different. The contributions you accumulate in your plan, the diversification of your portfolio, and the market environment will affect the returns on your investment. The average 401(k) rate of return depends on all of these factors, but in most cases, you can expect a return of 3% to 8%. Generally speaking, a moderately aggressive portfolio will earn higher returns, but it is also a riskier approach that is best suited for someone who has a longer time horizon.
What Is the Average Rate of Return on a 401(k)?
You understand why money management is important and have been trying to save as much as you can for your retirement. Just as you’d monitor your other assets, it’s also important to monitor the performance of your 401(k) account. This can help you evaluate how your investments are performing and if you need to make any adjustments.
To calculate the average rate of return on your 401(k) investments, you’ll need to follow a simple formula:
- Look for the beginning balance of your account. For example, the balance of your account was $20,000 at the start of the year. You’ve contributed $10,000 to the account during the year, and the year-end balance is $31,500. This means that beyond your contributions, your investment gains are $1,500.
- Once you have that number, you can calculate your annual rate of return: (Gains/ending balance) x 100.
- For this example, it will be $1,500/$31,500) x 100 = 4.76%.
Once you know the rate of return of your 401(k) account, you can compare it against benchmarks or similar funds to determine how it is performing.
“If you have an employer that matches some portion of your contributions, this is a great way to maximize your investment,” explains Teresa Dodson, founder of Greenbacks Consulting. “Also, understanding your portfolio is very important in understanding risk and return,” Dodson adds.
The Last 30 Years
The average rate of return on 401(k) for the last 30 years ranges from 5% to 8% for portfolios that have 60% stocks and 40% bonds. This is just an average that can be used to estimate returns. Your returns can be higher if you have invested a higher percentage of your funds in stocks. When you invest conservatively and allocate more towards bonds, your returns can be lower, but it also reduces your risk.
An important thing to remember here is that the returns for a single year shouldn’t worry you too much because short-term market fluctuations are normal. The best way to maximize your returns is by contributing consistently and taking benefit of your employer’s 401(k) match.
6 Tips To Maximize Your 401(k) Returns
Most Americans don’t have a traditional pension today. This is why it is important to maximize your 401(k) returns so you can have financial freedom and security during your retirement. Here are six tips on making the most of your retirement plan.
1. Contribution Limits
If you’re several years away from retirement and struggling between paying off debt or saving for retirement, you may think retirement isn’t a priority. But you should at least contribute the amount that qualifies you for the maximum employer match and the maximum yearly employee contributions that allow you to enjoy full tax savings.
As you get closer to retirement, strive to save more of your pre-tax income. The contribution limit for 401(k) accounts in 2023 is $22,500. Those who are over the age of 50 can contribute an additional $7,500 in a year. Most importantly, be consistent and continue to put aside a predetermined amount from each paycheck.
2. Choosing the Right Investment
Diversifying your 401(k) balance is a good investment strategy because it helps you get returns from a mix of stocks, bonds, and more. It also protects your investment against losses in case an asset class experiences a downturn. Generally, you won’t be able to invest in individual stocks through your employer-sponsored 401(k). Instead, you’ll be able to select from exchange-traded funds (ETFs), index funds, or mutual funds. Your company’s plan provider or brokerage may offer you a selection of bond and stock funds to choose from for your investment account.
When choosing investment products, take a long-term view of past performance. Look at the five-year returns to get a better idea of how a fund has performed. You should also pay attention to the expense ratio of the fund, which should ideally be less than 1%. You can also speak to a financial advisor or a personal finance expert to determine the right investment options.
3. Use 401(k) Calculator
A 401(k) calculator can estimate what your account balance will be at retirement based on your contributions, employer match, growth of investments, and retirement age. Use the calculator to determine how much you should save each month to reach your target savings by the time you reach retirement. If you’re not sure how much you should put aside each month, this is a good tool to use.
4. Watch Out for Market Volatility
It’s normal for short-term volatility in the market performance, and even though you may be worried when you see you are losing value in your retirement plan, remember to have a long-term view. There are several things you can do to protect your investments from market volatility.
Diversify your investment portfolio and mitigate risk. This is the single most important thing you can do to protect your investments. Shift to conservative investments as you get older so they can weather volatility. Have more cash on hand and be diligent with your contributions. Don't panic and cancel your 401(k) and cash out, especially before you reach retirement age, because you’ll have to pay an early withdrawal penalty. Speak to an experienced financial planner if you’re worried about market volatility and what it may mean for your nest egg.
5. Protect Your 401(k) Against Inflation
While there’s not much you can do about inflation, you can take several steps to insulate your retirement account against it. Continue maintaining your contributions, even when it seems difficult to stretch your paycheck too far. If you can, increase your contributions so your 401(k) can continue to grow.
Spread your investment across different types of investments to minimize risks and reduce the impact of inflation. For example, short-term bonds may be safer during times of higher inflation. Some real estate stocks may also be suitable during inflation. Try to find ways to minimize your investment fees, especially during inflation. The less fees you pay, the higher your average 401(k) rate of return can be.
6. Keep an Eye on Fees
Some investments may have high costs, and they can negatively impact the performance of your 401(k) balance over time. Pick investments with the lowest fees that still match your risk tolerance. Federal laws require 401(k) plans to send an annual fee disclosure statement to each participant. You’ll be able to find the costs of each fund in the plan. Review the statement to see if the fees are too high, and talk to your HR department to see if you can change your plan.
Plan for Retirement Income from Your 401(k)
Your 401(k) is not a retirement income plan on its own, but it’s a vital source of income for retirees. Your retirement income plan should take into consideration your 401(k) along with other sources such as cash reserves in savings accounts, investments, IRAs, income from pensions and annuities, and Social Security benefits. Having multiple income streams will allow you to efficiently generate a higher retirement income.
Once you turn 59 ½ years old, you no longer have to pay the early withdrawal penalty, but you still have to pay taxes to the IRS because 401(k) withdrawals are not tax-free. You can begin taking withdrawals at this point, but it doesn’t mean you should. If you don’t need an income, it may be worth it to let the funds grow. The exact amount you should withdraw from your 401(k) account will vary based on your individual circumstances. One popular retirement withdrawal strategy is the 4% rule, which states that you can safely withdraw up to 4% of your savings when you retire and adjust for inflation for each year for 30 years. Consider your retirement financial goals to determine the right withdrawal amount for you.
The Bottom Line on Average 401(k) Rate of Return
Careful retirement savings and consistent contributions can help you ensure a pleasant and comfortable retirement. With an average 3% to 8% rate of return on 401(k) accounts, ensure you contribute enough to take full advantage of your company match. Avoid withdrawing before you turn 59 ½, and educate yourself about different retirement withdrawal strategies so you can stretch your retirement funds further. Talk to a money management professional and seek investment advice to ensure you are on track to achieve your retirement goals.