How to boost your 401(k) by 25%

The study, which is titled “Financial Knowledge and 401(k) Performance” and was published by the National Bureau of Economic Research, found that people with more knowledge about stocks and investing tend to achieve higher returns in their retirement accounts. By a lot. Of the individuals the study examined, those who knew something about investing were on track to have 25% more in their 401(k) at retirement than those who didn’t.

This may sound obvious, but it goes against much of what has become conventional wisdom about investing. Professional money managers presumably know more than the Average Joe. Yet mutual funds — and even hedge funds — regularly trail the market. Indeed, the widely cited advice to go with a passive index fund, rather than trying to pick individual stocks or go with someone who will pick them for you, is based on the belief that knowledge, when it comes to the market, doesn’t get you anywhere.

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And 401(k)s, too, haven’t worked out as planned. The average account has just $89,300 in it. Not quite enough for retirement. And handing over control to individuals, the switch to 401(k)s from defined pension plans, hasn’t been so great, either. Numerous studies show the more you trade, the worse you do. And in the financial crisis, the accounts of the people who were closest to retirement did the worst. Not exactly how it is supposed to work.

I wrote a story a few years back looking at a company, the first I believe, that ditched its pension plan for a 401(k). The results were near universally terrible.

But this recent study seems to offer hope. The authors, which include Annamarie Lusardi of George Washington University, Olivia Mitchell of University of Pennsylvania’s Wharton School, and Robert Clark of North Carolina State University, know their stuff. Lusardi is an expert on financial literacy. Mitchell is one of the go-to academics on retirement and 401(k)s.

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So, what do you need to learn about finance to boost your 401(k) by 25%? Not much. Stocks perform better than bonds or cash. That’s it. The study found that people with higher levels of financial literacy tended to invest more of their 401(k) money in stocks. That’s what generated nearly all of the extra returns.

And that was about it. Any more knowledge didn’t seem to get investors very far.

During the period the authors examined, stocks did indeed outperform bonds and cash. You would expect that to always be the case, but it’s not.

What’s more, the study found that the portfolios of those who knew more about finance tended to be more volatile, because stocks are riskier than bonds or cash.

So where does that leave you? To improve the performance of your 401(k) account, put more of your money in stocks. How much? All would have been the right answer in the period that the professors studied, but let’s go with a majority, or most. Unless, of course, you hit a year in which stocks do worse than bonds or cash, like 2008, then you will do worse, and all your financial acumen will really have not helped you much.

Good luck.