The S&P 500 has shown amazing growth in the past two years — nearly 30% in 2019 followed by about 14% in 2020. To put that in perspective, if you applied those growth rates to a $100,000 balance, it would grow to nearly $150,000 in two short years. And that’s without accounting for your ongoing contributions. That type of growth can give you a nice push toward reaching your retirement savings goals.
If you’re not seeing those strong growth rates in your retirement account, though, it’s time to find out why. Here are three common reasons why your retirement investments could be lagging the stock market.
1. You’re too conservative
Your portfolio might be underperforming because your mix of investments across stocks, bonds, and cash is too conservative. Your age is an important factor here, because what’s too conservative at age 25 might be just right at age 55.
There’s an easy formula to check your allocation, though. Simply subtract your age from 110 — the answer is the percentage of stocks you should have in your portfolio. If you’re 25, for example, it’s appropriate to hold 85% stocks and the remainder in bonds and cash. At 55, you’d have 55% stocks and 55% bonds and cash.
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The beauty of this formula is that it naturally leads you to a lower percentage of stock holdings over time. That allows you to participate in market-level growth when you’re younger, and then move into a more conservative asset mix as you age.
As your portfolio gets more conservative, you’ll see lower growth rates. Consider this an intentional underperformance of the market. It insulates you from volatility, which is harder to manage when you’re taking retirement distributions or you’re about to start taking them.
2. You’re paying high fees
The administrative fees you pay out to mutual funds and to your 401(k) put negative pressure on your returns. If your investments earn 7% returns, but you pay out 2% in fees, your real return is 5%.
Look up the expense ratios on your mutual funds and ask your 401(k) administrator for a breakdown of your plan fees. Mutual fund expense ratios generally range from less than 0.1% to 2.5%. You want to stay below 1% or even 0.5%, if possible. A 401(k) administrative fee of 1% is pretty normal, but 2% or more would be high.
If your 401(k) charges 2% per year and only offers funds with expense ratios of 1% or more, you have some decisions to make. You could start investing your money elsewhere, but that doesn’t always make sense. You get tax-deferred earnings growth in your 401(k), which is a powerful thing. You also might be getting employer-matching contributions. Those two features combined may be worth more than what you’re losing in fees.
To get the best of both worlds, you could contribute enough to the 401(k) to max out your employer match, and then send additional contributions to a traditional or Roth IRA if you qualify. You may not get a tax deduction for the IRA contributions as you do in the 401(k), but IRAs do offer tax-deferred growth.
3. You’re trying to time the market
Even when you have the right mix of assets, trying to time the market can reduce your returns. What often happens is that you’ll sell your retirement investments when share prices are falling — in an effort to cap your losses. But then you won’t buy back in until share prices are rising, so that you’re confident a recovery is underway. Those are normal human reactions, but the result is that you’ve sold for less and bought for more. And that’s not the way to maximize your returns.
A better approach is to stay in the market through good times and bad. That ensures you’ll benefit from recovery gains, which can be steep and unexpected. More importantly, those big growth days are also large drivers of long-term returns. A 2019 J.P. Morgan report found that missing 10 of the best days in the market between 2000 and 2019 would reduce your annual returns from 6.06% to 2.44%.
The takeaway? Stay in the market. It’s too risky to do otherwise.
Returns make a difference
If you can tweak your retirement portfolio or the way you manage it to improve your returns, do it. Even a small change will help. On a $100,000 balance, for example, you’ll earn $35,000 more in 10 years with 7% growth vs. 5%. Increasing your equity holdings, swapping out a pricey mutual fund for a cheaper option, or learning to put blinders on when the market goes haywire are all strategies that can help you reach your retirement goals that much faster.