Key Takeaways:
– Many investors mistakenly leave their money in cash when rolling over from a 401(k) plan to an individual retirement account (IRA).
– Approximately 68% of rollover investors are unaware of how their assets are invested.
– Holding long-term savings in cash can cause potential losses to inflation and fail to generate an adequate nest egg for retirement.
– Investors are encouraged to question the necessity of rolling money from a 401(k) plan to an IRA, as it brings its own set of advantages and disadvantages.
The Unforeseen Cost of Cash in Rollovers
Rollover from a workplace retirement plan to an individual retirement account (IRA) is common among investors, particularly after reaching certain milestones like job changing or retirement. The latest IRS data shows that about 5.7 million people rolled a total of $618 billion to IRAs in 2020. However, a worrying trend is revealing that many investors are inadvertently costing themselves when leaving their money in cash.
A recent Vanguard report indicates that substantial amounts of these rollover funds remain in cash for extended periods instead of being invested. This leaves their savings in stagnation and leads to what Vanguard termed as the “billion-dollar blind spot.”
Unintentional Cash Holding Results from Misunderstanding
The majority of rollover investors hold cash unintentionally. A startling 68% don’t realize how their assets are invested, compared to 35% who deliberately choose a cash-like investment. This conclusion was drawn from a Vanguard survey of 556 investors who transferred to a Vanguard IRA in 2023 and kept those assets in a money market fund through June 2024.
The Reality of Retirement System
Interestingly, the retirement system itself might be causing this misunderstanding. When a 401(k) investor, whose funds are, let’s say, in an S&P 500 stock index fund, decides to roll their money into an IRA, the financial institution receiving the money doesn’t automatically invest the savings in the same or similar fund. The onus of moving the money out of cash is on the account owner. Unfortunately, about 48% of people erroneously think their rollovers are automatically invested.
The Pitfalls of Long-Term Cash Holding
Retirement experts advise against holding excessive amounts of cash in the long term. Investors may believe that by saving in cash, they are protecting themselves from the unpredictable nature of the stock and bond markets. However, they inadvertently risk underperforming against inflation and potentially jeopardizing the growth of their retirement nest egg.
Financial consultant Philip Chao explains that using cash as a temporary placeholder during the decision-making period is acceptable. But, this often leads to the fund being forgotten and remaining in cash for extended periods, which he described as “absolutely crazy.”
Adapting to Changing Financial Trends
The attractive cash returns of 5% and higher from the past two years may have lulled investors into a sense of security. But market analysts predict that these returns are unlikely to last due to forthcoming interest rate cuts from the U.S. Federal Reserve.
Tony Miano, an investment strategy analyst at Wells Fargo Investment Institute, suggests investors should “start repositioning excess cash”. It’s also worth assessing the necessity of transferring money from a 401(k) to an IRA, as it has its own merits and downsides.
Meticulous awareness and careful planning can help investors avoid the costly mistake of unnecessary cash holdings in their rollover accounts.