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What Do Simple Investing Mistakes Cost? Try 75% of Your Wealth

Everybody makes mistakes with their 401(k). You already know that. Everyone knows that. Fidelity recently made the persistent errors of 401(k) savers the theme of their quarterly report on the 17,500 plans they administer. And on his last visit to the MoneyWatch office, T. Rowe Price PR director Ed Giltenan dropped off a serious-looking power point slide called "Four Deadly Sins of Plan Participants" (also available online here), all about the things 401(k) investors continually do wrong.

[Fyi, Price's deadly sins: Saving too little, withdrawing too much, improper asset allocation, and inertia. Fidelity's "potential pitfalls": People in their 20s save too little; people in their 30s borrow too much from their plans; older workers take too much or too little investment risk.]

But neither Fidelity nor T.Rowe tried to estimate what these errors might actually cost. Not to worry: The estimating has been done by Alicia Munnell, director of the Center for Retirement Research at Boston College, aided by a couple research assistants. They simulated how much a non-brilliant, non-rich, no more than ordinarily frugal median middle-class worker could have saved simply by doing what he or she is supposed to do in managing a 401(k), without making those persistent mistakes. They then compared that with what the median real person in their age cohort actually had in retirement savings, as measured in the Federal Reserve's 2004 and 2007 Survey of Consumer Finance. Here are the results:

It's pretty shocking. According to CRR's estimate, for real people aged between 55 and 64, median actual retirement plan balances come to just $78,000, compared to $320,000 for the simulated 55-64 year-old. That's not a misprint; elementary, avoidable investment mistakes for an average worker add up to a 75% penalty over the course of a career.

I'll let the CRR team speak for themselves:

In theory, a typical worker who ends up at retirement with earn­ings of about $50,000 and who contributed 6 percent steadily with an employer match of 3 percent should have about $320,000...In 2004, the typical individual approaching retirement had only $73,000, far short of the simulated amount. (Note that the reported amounts include holdings in IRAs because these balances consist mostly of rollovers from 401(k) plans.) By 2007, the picture had im­proved somewhat..[but] actual holdings of $78,000 for those 55-64 are dramatically lower than those simulated for the hypothetical worker. Moreover...those at younger ages do not appear to be on track in their accumulations either.
(And by the way, CRR estimated estimated that the crash brought that real median sum down to just $56,000 at the bottom this spring.)

To be sure, the CRR study isn't reality. It assumes that its hypothetical employee enjoys an uninterrupted, steady, recession-proof career, and that the employee had access to a 401(k) the whole time. Many real people have neither.

Still, for policy makers, the point is that there's a vast gulf between how well ordinary people ought to be able to do as investors and how well they really do. Maybe the 401(k) could use some help.

For the rest of us, the point is how important it is not to commit those elementary, avoidable "deadly sins." Save at least as much as the company will match. Start now. Don't borrow from your 401(k) and don't pull out money when you change jobs. Have a reasonable asset allocation plan and stick to it. The upside can be great, as the CRR simulation shows. But the cost of mistakes can be, well, deadly.