Saturday, November 17, 2018

Better Than Average(s)

Nobody likes to be thought of as “average” – so why do people spend so much time worrying about the “average” 401(k) balance?

These averages are reported with some regularity by any number of providers (based on the records for which they have access), and sometimes by academics drawn from government databases.1

The short (and less cynical) answer to “why” is most likely that the math is “easy.” You simply take the total assets (from whatever recordkeeper/plan balances you have), divide it by the number of participants in that group, and “voila” – you have an average.2

Now, when you stop and think about it (and many don’t), you realize that doing so adds together the balances of individuals in widely different circumstances of age and tenure – everything from those just entering the workforce (and who have relatively negligible 401(k) balances) with those who may have been saving for decades. It can also, in the case of government databases, add together those that have had an opportunity to save with those who haven’t, or who chose not to. That averaging also smushes together the accounts of individuals of vastly different income and financial status, who may (or may not) have other means of support, who may (or may not) be a primary source of retirement preparation in their household, who live (and may retire) in very different places – and, let’s face it, groups together individuals who are not only dealing with very different financial circumstances, but also likely have widely varying retirement security needs.

Moreover – and this generally isn’t highlighted – when you consider results from single provider estimates, all those differences are potentially magnified by the reality that individuals change jobs, and employers change 401(k) providers, and so, those “averages,” of necessity, include the experience not only of different individuals at a time, but different individuals from one year (and reported averages) to another.

As a consequence, while the math is easy, the result is not generally a very accurate barometer when it comes to assessing actual retirement accumulations.

So, how much could an “average” assessment distort things?

Consider the EBRI/ICI database maintained by the Employee Benefit Research Institute. At year-end 2016, the average 401(k) plan account balance was $75,358. On the other hand, the average of individuals who were in that database consistently – meaning that you are at least considering the same group of people during the period 2010 through 2016 – was $167,330. That’s right – twice as large.

However, as I’ve already noted, there are plenty of issues with focusing on averages. But if you take the average of a more homogenous group – say the individuals in this database who have not only been in the database consistently for the specific six-year period, but who have more than 30 years of tenure with their employer – it’s possible to get a much more accurate picture.

Even though some of that group may not have been eligible for, or participated in, a 401(k) throughout their career, it turns out they have accumulated significantly more – $338,735, in fact – an amount that could, even at today’s interest rates, provide an annuity of $1,909 per month (for a male age 65). By comparison, in 2017, the average monthly Social Security benefit for a 65-year-old male was $1,348.70 (for women, $1,076.19).

The math may not be as “easy.” But the answer, certainly in evaluating retirement readiness, is surely more accurate.

- Nevin E. Adams, JD
  1. There are any number of issues with the underlying data, even from otherwise reputable sources. For more insights, see Crisis ‘Management,’ CPS Needs a New GPS, Data ‘Minding’ and Facts and ‘Figures.’
  2. See also Why an Average 401(k) Balance Doesn’t ‘Mean’ Much.

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