Putnam Study Reveals Contribution Rate Important for Successful 401k Investing
If you save more, you can have more in the end. That's not a surprise, but what is surprising is just how big a difference small increases in contributions to a defined contribution plan can mean to retirement wealth. Equally unexpected is the relatively small difference between investing in a top-performing mutual fund versus a poor performer.
A study conducted by Putnam Investments compared three components of defined contribution savings over a 15-year period: mutual fund performance, asset allocation and contribution level. Mutual fund performance had the least impact.
According to the study, if investors had a crystal ball and were able to know in advance which mutual funds would perform in the top quartile and then invested in them, their retirement wealth would only be 6% more over the 15-year period than if they had selected bottom-quartile funds. Changing the allocation from a conservative to a more aggressive portfolio increased results by over 20%.
Increasing contribution rates had the most impact. A 2% point increase (from 2% to 4% of salary, e.g.), which doubled retirement wealth, had 90 times the impact of changing from bottom-quartile to top-quartile funds after 15 years. The study covered the 15-year period of January 1, 1990 to December 31, 2004, and is based on data provided by Lipper, which ranks funds based on total returns and without sales charges, according to similar investment styles or objectives in a given fund category.
"The conclusion of this study is simple, but too often ignored. Saving more is the most powerful way to end up with more. Searching for the perfect mutual fund or allocation is a far less effective approach," said David Tyrie, Director of Retirement Services at Putnam Investments. "Fortunately, many employers have recognized the significant correlation between modest deferral increases and substantial increases in retirement wealth. In addition to ongoing educational programs, DC plan sponsors have begun offering automatic plan enrollment and automatic deferral increases to help participants invest more."