Saving for the future, especially retirement, involves some critical choices. When to kick off saving, how much to stash away, and where to put those savings can all impact your financial well-being. Recently, the focus on where to invest has intensified, particularly with regulators looking to allow 401(k) plans to include various alternative assets, such as private market investments.
Let’s take a look at two hypothetical savers and how their paths might unfold.
A tale of two savers
Laura and JR, both 25 and newly employed in similar positions at the same company, are just starting out on their financial journeys.
Step 1: Choosing to save
On her first day, Laura decided to contribute 10% of her $75,000 salary to her 401(k). That gave her a 3% company match for a total of 13%. With that, she still had plenty of room in her budget for weekend plans.
Meanwhile, JR was feeling a bit more anxious. He was more focused on enjoying his salary than on funding a 401(k), which he hadn’t touched in years. After five years, he finally decided to step things up, opting to contribute the minimum percentage needed to access the company match—6% with a 3% match.
Step 2: Investment choices
Both Laura and JR had access to various investment options through their employer, including target-date funds. Some of these invested solely in public stocks and bonds, while others allocated 15% to private equity and credit along the glide path.
Laura went with the public-only target-date fund because she appreciated its straightforwardness. JR, on the other hand, felt drawn to the private market fund, believing it could yield better returns, especially since he had time to make up for his earlier delay in saving. He figured, with 35 years until retirement, he could recover from those lost five years.
From earning years to retirement
Both Laura and JR gradually climbed the corporate ladder, with their pay scaling up accordingly. By the time they hit 65 and were gearing up for retirement, each was earning $178,620 a year. They hadn’t changed their 401(k) contribution rates or the matching policy during their careers. As they approached retirement, they took another look at their 401(k).
JR’s private market-focused target-date fund proved to be a winner, achieving an annualized return of 8.9% over the 35 years, while typical consumer options returned 8.4%. This left him with around $2 million saved. With Social Security benefits, he felt confident about enjoying his retirement without financial stress.
Laura’s public-only fund didn’t perform as well as JR’s private market option, but she was unbothered. Her steady investing over 40 years led her 401(k) to accumulate over $3 million. Starting early and contributing more had clearly amplified the benefits of compounding interest for her, far more effectively than it had for JR.
Ultimately, JR’s private market advantage gave him a slight head start, but Laura’s earlier and larger contributions were the game-changer. Compound interest played a significant role in her larger savings when all was said and done.
The takeaway: prioritizing how much to save and when to start is often more crucial than the specific market types you choose to invest in.
Behind the scenes
To illustrate the significance of starting early and saving more, some assumptions were made. Both Laura and JR were assumed to have consistent salaries, remain with the same employer throughout, and avoid job interruptions. It was also posited that stocks, bonds, and private investments would deliver on long-term return expectations as outlined by investment analysts. Notably, a target-date fund with a 15% private market allocation outperformed its public-only counterpart, especially when ignoring fees.
There’s ongoing conversation about whether private equity funds genuinely outperform public options. Analysis suggests that private equity should be viewed as a type of active management, where a few funds may outperform significantly, even though average returns might be on par with or below public funds.
Moreover, in private markets, the variety of underlying investments adds a layer of complexity to making predictions. This analysis represents a best-case scenario for target-date funds including private market elements.
