The Difference Between Gain and Return

One of my Nash Institute colleagues was exploring 401(k) retirement plan returns. He learned from the retirement analysis chief at the Government Accounting Office that they “don’t maintain that information”, but directed him to Vanguard’s latest annual report, “How America Saves”. That document is full of detailed data on a large population of plan participants.

It presents the CAGR (Compound Annual Growth Rate) for the past five years, as of December 2018. Remember, average return, as advertised by many funds, is misleading. Recall the first chapter of my book Stop Being Poor and the previously linked article. They compare their funds to the S&P benchmark of 8.5%. The theoretical returns of the plans chosen by their participants were 5.2%. The real dollar-weighted return was 4.8%. That difference is due to the real, non-theoretical, investment timings, withdrawals, and exchanges that occur. The difference is 3.7% from what you may see on CNBC or Bloomberg (did I mention my segment on Privatized Banking was just on Bloomberg TV?). My friend also extrapolated back to the ten-year point, and that yield was 8.8%. No, that did NOT include 2008 (guess what happens then). Timing is everything.

Let’s talk real gains now. I did a search of the report, and nowhere did I find whether or not the return figures were net of fees. You think they would mention that. Vanguard does have many funds that are advertised with no load. I guess they are making money somehow. Snarky comments aside, there are always fees. This is vitally important: even a 1% net fee, deducted every year, will result in around a 10% loss of the total gain in 10 years. But let’s give them the benefit of the doubt.

Wiping out a lot of that edge is the sad realization that this gain is taxable. Since it is in a 401(k)—or an IRA or other tax-deferred program—it is taxable on withdrawal. Yes, you saved on taxes in the year you didn’t take the money as salary, but it is all taxable when you are on a fixed income, at your marginal tax rate. What will that rate be? Who knows. Don’t assume it is less, you may be sadly surprised.

If we compare that to a privatized banking strategy, the “return” in may appear to be close or less, based on the highly stable and conservative methods used by our folks. Let’s compare the true “gain”. We never worried about the market going up and down, so we are happier (and probably healthier). We have access to funds at all times. Yes, 401(k) has loan programs, but I don’t see much difference in having a credit card balance—and don’t forget the loan origination fees. Our loans, by contrast, have the best and most flexible terms and no qualification.

Above all, our growth is tax deferred as long as we keep our system in good order.

Let’s add it up. Yes, it is certainly possible that for short term (10 year), Wall Street can produce superior returns. The booms and busts of the last forty years should give you pause. But to understand actual gain, we should take the long view of access to cash, fees, and taxation. There are far better true investments than Wall Street, but no better warehouse of wealth than in Privatized Banking.