Vanguard claims that 60 percent of 401(k) participants are back to even from two years ago. They’re right, but the devil’s in the details.

I love it when big companies tell us a little about their customer base. After all, the market as a whole is made up of so many different kinds of participants that just looking at performance and flow numbers can be deceiving. After all, how do we know whether those UNG inflows Matt’s lamenting in his last blog really matter? Maybe it’s all institutional hedgers. Maybe it’s all hedge funds speculating.

But when someone like Vanguard talks about their client base, I feel comfortable making some assumptions. The typical Vanguard customer, I assume, is a watered-down die-hard customer—the infamous Bogleheads. These are people sold on the notion of buy-and-hold investing. They’re convinced that active management is generally a bad idea, and they value economy over flash. To be blunt, they’re my kind of people.

So Vanguard’s latest research note (available here) is required reading if you want to know what’s going on with real investors—at least retirement investors.

First, here’s the set of numbers that drive the big headline. These are the median account balances across Vanguard’s 1.7 million 401(k) accounts:

Sept. 30, 2007: $33,417

Sept. 30, 2008: $32,806

Sept. 30, 2009: $41,027

On the surface, that looks like great news. The typical Vanguard defined contribution (DC) customer has 22 percent more money in 2009 than they did in 2007. But to really understand the headline, you need to dig a layer deeper. Here’s how those overall medians are broken out, based on the investors account-balance experience in the two-year period.

Even, or ahead:

This seems much more sensible to me, and while yes, it does indeed show what the headline suggests—that 60 percent of Vanguard’s accounts are in the black, I get something else out of these headlines:

1. Younger investors are better diversified, and thus recovered faster. In fact, 87 percent of Vanguard’s clients under the age of 25 are back above water, vs. 52 percent of their clients over 65. This is a phenomenally hopeful sign for me. It means that the education programs put in place by DC plan sponsors are getting the job done.

 

2. Wealthier investors got hit harder than less-wealthy investors, in general. This makes sense to me. I expect the novice investor with a small account balance to be cautious. I expect folks who think they understand the markets and have been around the block a few times to be more comfortable with long-term risk. That’s why I think you see the wealthiest block being down 1-10 percent.

But the big caveat to all of this is that these are account balances, not returns. We know that the average contribution rate for the average 401(k) plan is in the 5-7 percent range, and with company matches, the actual contributed amount in most accounts is around 9.5 percent. Those are squishy numbers, because the people who do the best work on this, the Employee Benefits Research Institute, haven’t updated the numbers since 2001. But let’s just pretend 9 percent is a good number, and that the average salary level for a covered employee is about what it was way back then when they did the last survey, or $44,000 per year.

That means the average account should have gone up just about $4,000 a year, with no market performance. Vanguard’s average (not median) 401(k) balance, across all its demographics, is about $92,000, of which we assume some $8,000, or just under 10 percent, was contributed just in the last 2 years.

Vanguard’s rosy “60% are whole” headline takes these contributions into account as if they were performance—a fairly hefty 10 percent add-on over the last few years that came out of investors’ pockets, not the markets.

Vanguard knows they’re counting these contributions, and it explicitly says “that’s OK” in their report:

“In fairness, many participants may still perceive that they have lost two years—two years in which they had to save in order to simply maintain retirement wealth, rather than have it grow substantially higher. Again, we feel that this belief is based on a misperception that a given high point in retirement wealth is somehow fixed or guaranteed and not subject to some level of risk. A better way to understand retirement saving is as the accumulation of assets over market cycles, and not as a value fixed (with exuberance) at market peaks or locked in (with despair) at market troughs.”

While I commend the prose, I think the very headlines of their press releases on the report encourage precisely the wrong message—that the market will take care of investors. If anything, the report highlights the fact that there is in fact no free lunch, and that retirement savings is ultimately an act of will and discipline—earn and save—with the only smart move to diversify, diversify, diversify.