I got a question from one of the readers this week: “How can I earn an 8% annual return on my 401k?” This is a great question.
First, I will admit that I do not claim to be an expert and that I made my fair share of mistakes as an investor and learned well from them.
One of those lessons includes trying to actively manage my 401k investments.
I know this is an extremely sensitive subject and there is always a heated debate between active and active. passive portfolio management.
As a common man, if you were given $5000 today and tasked with outperforming the S&P in a given year, would you be able to beat the market? Now it gets even worse when you have $50,000 or more in your 401k. Would you be able to actively manage your account and beat the market?
That is a great self-imposed challenge. According to CNN money, 86% of active money eat poorly in 2014. Now try to beat the S&P year after year.
According to CNNmoney, “Nearly 89% of those fund managers have underperformed their benchmarks over the past five years and 82% have done the same over the past decade.”
Here’s a link to Money Chimp’s S&P Performance Tool: You can see the CAGR of the S&P 500 over a 100-year period. You can see that it is possible to achieve an average return of 8% per year over a long period. For example, S&P 500 CAGR (compound annual growth rate) from 1950 to 2014 was a whopping 11.42%
I am a fan of Warren Buffet and I value your opinions. According to CNN Money, this is what Warren says: 2. Buffett recommends passive: Even legendary stock picker Warren Buffett likes that approach. In his annual letter to shareholders last year, he wrote that he advised the trustee of his estate to place 90% of his assets for his wife in a “very low-cost” S&P 500 index fund, because he believes that the “results to term of this policy will be higher than those achieved by most investors”.
Now back to my story, long story short, I didn’t beat the market by actively managing my 401k account. I learned my lesson early though, this was a decade ago. I just set up my 401k to invest in a target date retirement fund that has a mix of stocks and bonds. It’s worked out pretty well and I’ve never had to sweat trying to manage my 401k since. It has done much better than my active attempt to manage it, yet it has not outperformed the S&P 500.
I understand that everyone’s financial situation is unique. You are the captain of your ship as I am of mine. Do your research and draw your own conclusions.
Finally, to answer the question, yes, it is certainly possible to achieve a return of ~8% over longer investment periods at dollar cost average in the S&P 500 Index. I understand that everyone’s financial situation is unique. You are the captain of your ship as I am of mine. Do your research and draw your own conclusions. I will state the obvious that past performance is no guarantee of future results. As for me, I give my nod to passive investing in the S&P 500 Index.