Sunday, January 2, 2011

Slow and Steady Savings Still Pays ... If Your Job Has Good Perks

The Wall Street Journal has an article today entitled Slow and Steady Saving Still Pays.  According to the article, you'd have made money over the last 10 years investing in the Vanguard 500 (a low-cost, S&P 500 index fund) in your 401K.  Their example was a person saving 6% of a $40K salary in a 401K with a 3% employer match, and a 3% raise every year, who made about $52,000 on an investment of $30,470, or 170.66%.  Their numbers are correct for their given assumption.

Their assumption, however, is crap.  Do you know anyone who has had a 3% raise every year for the last 10 years?  Heck, do you even know anyone who has had a 3% employer IRA match consistently for the last 10 years?  I don't.  I graduated from college in December 1999, and myself and my contemporaries'  employment experience has been a hodgepodge of jobs, several (mostly) short periods of inadvertent unemployment, few if any raises, and stingy employer IRA matches.  In fact, neither my husband nor I has ever, in our entire working lives, had an employer match of any kind for our IRAs.

In the real world:
(1) Vanguard 500 has and initial minimum of $3K, so it's 15 months before there are enough funds to invest in it.

(2) There's a $20 fee for every purchase (at least at Scottrade, where I am looking), so the original investment is only $2980.  On March 1, 2002 (15 months after you start saving) buy at the opening price of 104.62.

(3)Only an idiot would invest in $200 increments because the $20 fee is 10% of the investment right off the top.  Figure that it sits in the IRA as cash until a reasonable sum accumulates.  Let's say $1000 at a time (every 5 months) at opening price of that month.

(4) Even with 2 recessions, assume a saver dedicated enough to put $200 / month into a 401K every month and lucky enough to have the income to qualify for that for all 10 years.

(5) Today, the account would be worth around $25,838*, of which $23,800 was the original investment.  Gain: $2038 over 10 years.

(6) That's 108.56% above the initial investment, which doesn't sound bad until ...

(7) you realize that most investment guidelines assume an 8% annual return.  Using that model, there should be about $34,767, or 146.08% of your investment.  The account is $8929 short.

Bonus Question for Math Geeks: What post-inflation, after fee rate of return would your $25,838 need to make for the next ten years to have the $70,059 (in 2010 dollars) an average 8% annual rate of return from 2000 - 2020 would predict?  How likely is that in a moderate risk portfolio?

(Answers: approximately 11.25% and not very likely at all)

*I could not find the dividend data for 10 years in Vanguard 500.  I found a website that told me that the average dividend over the past 5 years was 2%, so I used that number for the last 10 years.  Also, the fees are low enough at 18 basis points that I did not bother to calculate them in.


  1. I so love this post because I love thought/math experiments.

    I do get a 6% employer match, my old position got 10%. So that is not so rare. The raises over the last few years have been missing for sure!

    If I remember right from the Fidelity website the minimum was $5000 to invest, but I don't recall an investing fee. $20 is just ridiculous! It should def be less than $10. Even so the assumes that it is an employer set up account so there are no fees and the money is just automatically withdrawn each pay period. Realistic for 401k or 403b accounts, that is how mine is set up, but index funds aren't an option for me in my 401k, just in an IRA.

  2. Ah, the lack of fees is something that I had not realized - since we don't get employer matches, we do self-directed Roth IRAs, which do have those fees.

    I'm glad I know someone who gets matches. I still stand by my belief that they are rare; most of the people I know don't get them. However I am also the first to admit that "everyone I know" is not exactly a random sample, so it may just be that my perception is skewed.

  3. We have an employer match and no fees but our investment options are limited. We also had a salary freeze and 401K match suspended in 2008 and 2009.

    I call it financial planner propaganda. Way to go for calling it for what it is, BS.

  4. More birdcage liner from a large nationwide newspaper. I agree with you on raises? The days of 3% annual raises ended in early 2008. Try *no* raises for the last two years, and perhaps a measly one in 2011. I'm fortunate to have a company match, but many people don't. The WSJ assumptions don't hold water.