The Trusty 401(k) Is One of the Best Ways to Invest. This Chart Shows Why

A photo to accompany a story about the average 401(k) return RedBarnStudio/Getty Images
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Don’t sleep on the 401(k). 

This pre-tax investing account can offer an average return of 10% per year, if you choose the right funds to put your money in. And as the chart below shows, a 401(k) is the perfect vehicle to get you all the advantages of compound interest.

A 401(k)’s average rate of return depends on what you’re invested in. Depending on the investments, you can expect to see returns of 3% or up to 10%. If you’re looking for the latter, consider investing your 401(k) in funds that track the S&P 500, which is the 500 biggest publicly traded companies in the U.S. 

The S&P 500 makes up about 80% of the entire value of the market, and that makes it a useful way to track the market’s overall performance. Between 1926 and 2022, the average return for the S&P 500 and its precursor has been about  10%. 

While that’s the average, some years have been much higher, and others — like this year — have been lower. But overall, you can reasonably expect around a 10% return in your retirement account, depending on a variety of factors. 

It’s important to note that a 401(k) is the shell that you can put money in to be protected from taxes. And then from there, you choose how to invest it. Most 401(k) plans have a few options that should get you close to the average annual return. 

Let’s take a closer look at 401(k) accounts and the returns you can expect. 

What Is a 401(k)?

A 401(k) is a vehicle to invest your money that gets you more tax benefits than opening a brokerage account on your own.

“It’s a tax-preferred retirement savings account you can have access to through your employer,” explains Amy Ouellette, VP, Product at Vestwell, an investment firm. “It’s a way to avoid taxes either now in the future, or some combination of the two,” depending if you choose the traditional or Roth option (if available). 

Most employers offer company matches, or free money, if you contribute to a 401(k) up to the required limit.

What Is a Good 401(k) Return Rate?

The rate of return from your 401(k) depends on your asset allocation: which investments you’ve chosen, how long of an investment timeline you have, how much you’ve contributed, and what kind of fees you’re paying in your account. 

There are two ways experts think about returns, says Vanessa N. Martinez, former financial advisor and founder of Em-Powered Network, a consulting firm. Those on the conservative side believe your average 401(k) return will range between 5% and 8%. Others say you can expect between a 7% and 10% return. The difference comes down to which investments you choose, and what your asset allocation is for each fund. 

In general, you want your returns to outpace inflation. If your returns “underpace inflation, then you’re losing money in the long run,” Ouellette says. That’s why experts recommend low-cost, broad-market index funds for long-term investing.

Typically, there are at least a few good options to invest with your 401(k), even though you’re most likely limited to the options your plan provider offers. If you can find one that tracks the S&P 500 or total market, or at least a broad portion of the overall market, you can expect somewhere around a 10% annualized return, which would both match the historical average and outpace inflation. This is the most ideal situation for your investments.

How Do You Calculate a 401(k) Annual Return?

To run the annualized return calculation yourself, take your ending balance for a specified period – usually a year – and subtract your beginning balance. That’s your total dollars of growth. Then, divide that by the beginning balance to find the percentage your balance grew for the period of time. For example, if your ending balance is $120,000 at year-end and your balance was $100,000 at the beginning of the year, you’d subtract $100,000 from $120,000. Then, divide $20,000 by $100,000 to find a 20% return for that time period. 

“First and foremost,” Ouellette says, “make sure you’re comparing it to the right benchmarks.” 

That means you shouldn’t compare, say, an S&P 500 index fund with a bond fund. This will let you know if your returns are performing compared to the index it’s meant to track. If there isn’t one, “people often compare to the S&P 500,” because it’s an easy proxy for the overall market. 

If you made any contributions, you’ll want to subtract those from your calculations. And if you made several deposits or had any withdrawals, the math can get more complicated. It’s also harder to review your returns for multi-year periods, although the method above should give you a reasonably close estimate. 

That said, most online brokerages have an option to view your annualized returns and will even calculate your return over a custom period of time,  so you don’t have to break out the pen and calculator. 

What Factors Affect Your 401(k) Returns?

It’s very important to look at the expense ratio, or fees, associated with your investments which can eat away invisibly at your earnings. You won’t always see these fees. Instead, you’ll just get a lower return, which can amount to thousands of dollars over the lifetime of your investments. That’s why it’s important to choose investments with low expense ratios.

Diversification is also key. Diversification means spreading out your investments among hundreds or thousands of companies instead of a select few. “Think about diversification,” says Ouellette. “Certain types of investments or certain companies can be volatile.” 

Age is also a big factor that affects your returns. You can also think of this as time in the market. The younger you start, the longer compound interest gets to work its magic on your balance. Starting even a few years later can mean losing thousands of dollars down the line, so getting started as soon as you can is the single factor that can produce the best returns. 

401(k) Savings Potential by Age

Here’s the power of compound interest over time. 

These calculations assume the average 10% return with various amounts invested at age 20, and without ever adding another cent. All of the gains are purely from compound interest.  This is why investing early and often is so important. It gives your money the time to grow on itself.

Age 20Age 25Age 30Age 40Age 50Age 60

If you put $1,000 into your retirement account at age 20, you’d have $45,259 at age 60 without any extra effort on your part. If you add $100 per month, that jumps to a staggering $576,370. 

The more you can contribute, the more dramatic the returns. If you can start with $50,000 and leave it invested for 40 years, you’d have over $2.2 million dollars. And even if you can’t start with that amount, adding regular contributions to your account is the next best thing you can do.

How to Get a Better 401(k) Return

Putting a portion of your check into a 401(k) is the first part of investing. The next “important step is to go back in and allocate those funds,” Martinez says. That means assigning your dollars to the funds you want to invest in. You don’t want your money to just sit there. You have to invest it.

Pro Tip

To get the average 10% return, consider an index fund that tracks the S&P 500 or total market in your investment account, if available. Regardless of what you choose, keep an eye on fund fees, which can eat into your returns over time.

Many 401(k) plans have funds that are all stocks, all bonds, or a blend of the two – one example of these blended funds are the common target date funds. Target date funds take the guesswork out of investing. They automatically allocate from riskier to more conservative investments depending on your age. 

Finally, your savings rate and consistency are huge factors. It’s important to keep contributing at regular intervals to dollar-cost average your investments. That way, you buy the market through all the various peaks and valleys, because no one can time the market. And adding as much as your budget allows will also be a big boost to your returns over time.