If you’re curious how you stack up, to everyone else, it helps to look at the average 401k balance by age. But if you want to know if you’re on track to never have to work again, you might need to compare yourself to a stricter standard. As we’re about to see, the typical person’s 401k balance leaves much to be desired.
Here’s the average 401k balance by age according to the most recent annual study from the investment firm Vanguard:
|Age||Average Balance||Median Balance|
There’s a few things we need to keep in mind as we break this down.
There’s No Such Thing As an Average Person
I know statistics are boring, but we need a basic refresher of the first week of Stats 101:
- Median: A number where half the observations are higher, and half are lower
- Mean (or average): Add up all the observations, divide by the number of observations
- In the normal distribution (a.k.a. “the bell curve”), the median and mean are the same
I bring this up because we often use “average” to mean “typical.” But that’s not what it means, and it doesn’t usually work when talking about money. Imagine a neighborhood of 25 families where every family has a net worth of about $50k. Then Bill Gates moves in. The median net worth of the neighborhood doesn’t change much. But the average net worth goes through the roof. It’s not because the typical person is wealthier, it’s because Bill Gates is so absurdly wealthy that his net worth has a gravitational pull on the averages.
While Bill Gates might be an extreme example, there’s a similar effect everywhere money is involved. The people who do well do so well that they skew the averages.
So when you look at the data in the tables above and see that in every single category the average is higher than the median, that tells you that the average is really just an indicator that super successful people are super successful. Which I think we already knew.
The number that far better represents the “typical” person is the median. Although depending on how much variance there is in the distribution, this might be too much of a simplification as well. Even if there isn’t a lot of variance, remember that there are a whole heck of a lot of people doing worse than the median (specifically, half of people).
In the full report, Vanguard mentioned that the average balance represented about the 75th percentile. This means that about a quarter of people have more than the average listed and about three quarters of people had less.
All of that to say, this next point is especially concerning:
The Average Person is in Bad Shape. The Median Person is Screwed
Granted, these charts only show assets in retirement accounts. We don’t know what other assets (or debts) people have outside of retirement accounts.
But I have a hard time imagining that the average person is not overly worried about their 401k balance because they have a hefty company pension and a real estate portfolio with enormous monthly cash flow.
If you’re using the 4% rule, it means that in retirement you’ll start withdrawing 4% of your investment balance each year to live off of. So if you have $1,000,000 invested, you’ll withdraw $40,000 your first year of retirement. If you have $2,000,000, you’ll withdraw $80,000. We saw that the median 401k balance for someone in the 55-65 age bucket is $89,716. That calculates to the impossibly meager annual withdrawal of $3,589 a year. The average balance of $256,244 would get you an annual withdrawal of just $10,249.76.
That’s not going to get it done.
The Two Stages of Investing
If you look at the median numbers, you’ll notice that they decline in the 65+ age bracket for both tables.
This is because in general people under 65 are putting money in to their retirement accounts, and people over the age of 65 are taking money out.
These are the two stages of investing, which I call the “wealth accumulation” phase and the “wealth preservation” stage. You start out by putting money into the market hoping it will grow. Eventually, the goal is to stop making deposits, and start making withdrawals. Instead of funding your account, your account funds you.
In a perfect world, you could just live off of the earnings of your nest egg without ever touching the principal. If you had predictable 8% annual returns, you could just withdraw a little less every year (let’s say 6 or 7%), and your money would just keep growing (making your annual 6% withdrawal a little bigger each year).
So why doesn’t this usually work out in practice? One major issue is that it’s hard to get predictable returns. Even though the market tends to go up over time, some years it loses money. Here’s how the S&P 500, a decent benchmark of the stock market, has fared over the last decade plus:
Things have been outrageously good overall, although last year was quite bad.
Where this can come to bite you is what is known as sequence of returns risk. Here’s the super simple version: Imagine you retire with a million bucks in your retirement account. In your first year of retirement, you take out some money to cover your bills, but the market has a down year. The second year you take more money out and the market goes up…but not enough to cover two withdrawals and last year’s downturn. This starts a downward spiral that results in your portfolio quickly becoming depleted.
If you want the bigger, far nerdier version, you can read this post:
But the other reason why it’s hard to pull off is because you need enough money in your portfolio to be able to withstand your withdrawals. In other words, even with a sensible asset allocation, there will be some ups and downs.
You need to have enough put away that you can withdraw an amount that doesn’t threaten to deplete your portfolio. A good rule of thumb is that if you have a good asset allocation, a 4% yearly withdrawal is fairly sensible. I go into more detail here:
Under most circumstances, we would expect people using the 4% rule to see their balances go up in the years after they start withdrawing, so the fact that we see the median retirement account start to decline is potentially concerning. Especially given the fact that the market has been so good over the last decade.
On the other hand, the average 401k balance goes up when people cross into the typical retirement age of 65+. This basically confirms what we already knew: there’s a small percentage of people in really good shape, but most people are in bad shape.
The Best Time To Start is Today
One of the most important factors in investing is the length of your investing career. The market won’t work magic for you in the short term, but you can build real wealth over time, Simply put, the more time your money stays in the market, the more magical the power of compounding becomes.
It might not seem like you can make a difference, but contributing what you can today will be much better than doing nothing.
The typical person is in trouble. Even the “average” person, who in this case is better off than about 75% of people, isn’t in great shape. Comparing yourself against other people isn’t going to be enough to retire. You’ll have to run the numbers and make a plan for yourself.
Having other assets helps. It also helps if you plan on having any active source of income in retirement. But for most people, the best bet is to get started today with whatever they can contribute. It doesn’t have to be complicated, just find a nice index fund to help your money grow.