In most cases, retirement is something that most people don’t think that much of at an early age. As a result, you’re probably putting yourself and your family into a less favorable financial situation. Because of a lack of funds, you’re not able to enjoy the kind of retirement lifestyle you wish for yourself.
In order to avoid this unfortunate situation, it’s best to plan your retirement by getting a 401(k) plan. However, just like other retirement plans out there, you might not know how much the average return of your plan is.
If you’re interested in putting up your 401(k) plan, keep reading this article to learn everything about it, including your expectations about its average rate of return.
401(k) Retirement Plan: An Overview
If you’re unfamiliar with the concept, 401(k) refers to an employer-sponsored retirement plan which can be used to accumulate long-term savings. With this type of plan, the employer gives their employees an excellent opportunity to contribute a portion of their salary based on a pretax arrangement. This means that if you set aside $5,000 to your 401(k) plan, you’re not required to pay income tax on your $5,000 in the year you’ve earned it.
Also, it’s essential to remember that a 401(k) retirement plan might vary depending on the person’s employer and plan provider. But despite the variations, it can provide a variety of investment options in which a person can distribute their contributions. These options might include mutual funds, exchange-traded funds (ETFs), and even small business financing.
401(k) Plan: Expectations On Its Average Rate Of Return
Generally, people who have started to plan their retirement suggest that the average return on investment of 401(k) plan is approximately between 5% and 8% according to the market conditions. However, it’s crucial to understand that the average return might vary depending on many factors such as your savings, years you have until retirement, fees, and the choice of investment. Because of this, your expectations on the return might also vary based on different factors.
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But, to give you a better understanding, here’s what you can expect about your 401(k) retirement plan’s average return on investment.
Regular Savings Can Increase Your Average Returns
As mentioned, the 401(k) plan allows you to put aside a percentage of your salary for your retirement savings under such a plan. That’s why if you save some money from your paycheck and allocate it to your 401(k) on a regular basis, you can probably increase the returns in the long run. This is also true if you still have many years before your actual retirement date when you can save a lot more for your retirement.
So, if you’re consistent in putting some funds into your 401(k), then you can expect a higher return on investment until you reach your retirement. To help you plan your retirement well, make sure you know how much you should have in your 401(k) at your age now. But, just like the statutory contributions, the amount of money you can contribute to your retirement plan also comes with limitations. To see the most recent contribution limits for 2020, click here.
The Performance Of Your 401(k) And Potential Returns Depend On Your Asset Allocation
Despite the 5% to 8% average return of a 401(k) plan, the results can significantly vary depending on how you allocate your assets. This means the type of investment you choose and the amount of money you’ve invested in each. Typically, most retirement planners get various returns based on how they take advantage of their investment options and allocations.
For example, you can invest your 401(k) funds into different assets to generate ROI (return on
investment). If you decide to allocate your funds into debt instruments like bonds and CDs, then you can expect a safe income but not that much. If you’re looking for the highest possible return, you can also use some of your funds to buy corporate stocks. But if you want to build and finance your own business, using your 401(k) funds can also be a good idea.
Given these circumstances, it’s best to assume that your 401(k) returns will vary depending on how you choose and allocate your funds into various valuable assets.
Your Degree Of Risk Tolerance Can Affect Your Returns
When it comes to investing your 401(k) funds, your risk tolerance is something that you should consider as it can impact your rate of return. For instance, if you’re not afraid to invest in high-risk investments, then you’ll more likely get a higher rate of return. But, if you’re a conservative investor, considering low-risk investments can give you a good return in the long run.
Because of these conditions, no doubt your degree of risk tolerance towards different assets can influence the amount of ROI you expect from your plan. The more you’re fearful of the market, the more you forcibly choose the wrong investment assets and make unnecessary decisions. As a result, your average 401(k) returns have underperformed the market.
Given the economic uncertainties these days, planning your retirement through a plan such as 401(k) can be the best decision you can make for yourself and your family’s financial future. But, just like other plans in the market, it’s essential to keep in mind that your returns might experience an increase or decrease due to many factors mentioned above, and this is something that you should expect from your 401(k) returns from the very beginning.
Diane Knibbs is an experienced financial advisor who works with clients in helping them achieve their short and long-term financial goals. Diane looks at the current financial health of her clients, come up with a financial plan, and help them decide on the best investments to make. Diane usually works with individuals and business owners. When Diane is not busy at work, she loves to spend time with her children and write articles on financial literacy.