Study: Retirement Savers Keep Plugging Away

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This comes as no surprise: Employees’ 401(k) plans were hammered in 2008, with the stock-market collapse trimming the average account balance by 24.3%.

But a new report by the nonprofit Employee Benefit Research Institute offers some encouraging news as well, and sheds light on ways employees might boost their prospects of retiring comfortably.

Rather than panicking and pulling their money out, or switching to holdings that were super-safe but unlikely to grow substantially, the typical employee stayed the course, maintaining a healthy mix of stocks and bonds.

As a result, the average account actually increased at an annual rate of 7.2% for the five years ended 2008, ending the period at $86,513.

Growth in account size is not the same as investment return, because it includes new contributions by workers and their employers. The growth means employees kept plugging away, putting money in every week or month.

That’s good news, because 401(k)s and similar workplace investment plans have replaced traditional pensions as the key way to fund retirement, aside from Social Security.

Still, the EBRI report reveals a few things the typical 401(k) participant could do better.

About 56% of employees’ assets were invested in stocks. That’s close to the 60% rule of thumb. Although stocks obviously carry a risk of loss, they’ve traditionally provided bigger returns than bonds or cash over long periods. Investors need those bigger returns to get real growth after accounting for inflation.

But many 401(k) participants had a sizeable portion of their stock holdings in shares of their own company. About 10% of the typical account was in “company stock.” That’s a lot of eggs in one basket.

Fortunately, that number has dropped by nearly half from the 19% level of 1999, probably because of regulations passed after the 2001 Enron collapse giving 401(k) participants new rights to sell company stock.

As a general rule it’s best to avoid having both your income and retirement investments dependent on your company’s fortunes.

In another troublesome sign, 18% of employees who had the option of taking out loans against their 401(k)s had done so. The average loan balance was about $7,200.

Many employees feel this is a good way to borrow, because interest payments go into the account rather than to a credit card issuer or other lender. But a loan reduces the assets in the account, stunting growth until it is paid back. It’s an option best reserved for a real emergency, not used as a convenience.

Among the best news in the EBRI study was the growing use of life-cycle or target-date funds, which automatically make the allocation of stocks, bonds and cash more conservative as the employee ages. About three-quarters of plans offered these funds at the end of 2008, and nearly a third of employees had some money in them.

(If your plan does not offer these funds, think about investing in them through an IRA or taxable account. Most of the big fund companies such as T.Rowe Price (Stock Quote: TROW), Vanguard and Fidelity offer them, and you can search on the site of Morningstar Inc. (Stock Quote: MORN), the market-data firm.)

The EBRI study did not break down participants’ contributions to their plans, but other studies have shown that most employees kept putting money in even when their stock holdings were losing value.

On the other hand, many studies have shown that few employees contribute the maximum allowed, which for 2009 is $16,500, or $22,000 for workers aged 50 an older.

At a minimum, employees should contribute enough to get the largest matching contribution offered by the employer. Use the Retirement Planner to see if you’re putting aside enough.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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