Investment Advice from Jack Bogle

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But while that hypothetical accumulation may look substantial, it would be adequate to replace less than 30% of preretirement income—a help, but hardly a panacea. (The target suggested by most analysts is around 70%, including Social Security.)

Contribute More
One reason for today's modest 401(k) accumulations is inadequate participant and corporate contributions made to the plans. Typically the combined contribution comes to less than 10% of compensation, while most experts consider 15% the appropriate target. Over a working lifetime of, say, 40 years, an average employee contributing 15% of salary, receiving periodic raises, and earning a real market return of 5% per year, would accumulate $630,000. An employee contributing 10% would accumulate just $420,000. If those assumptions are realized, this would represent a handsome accumulation, but substantial obstacles—especially the flexibility given to participants to withdraw capital—are likely to preclude their achievement.

Get Out of Your Own Way
There is excessive flexibility in 401(k) plans. Designed to fund retirement income, they are too often used for purposes that subtract directly from that goal. One such subtraction arises from the ability of employees to borrow from their plans, and nearly 20% of participants do exactly that. Even when and if these loans are repaid, investment returns (assuming they are positive over time) would be reduced during the time that the loans are outstanding, a dead-weight loss in the substantial savings that might otherwise have accumulated by retirement. Even worse is the dead-weight loss—in this case, largely permanent—engendered when participants "cash out" their 401(k) plans when they change jobs. The evidence suggests that 60% of all participants in defined-contribution plans—i.e., a 401(k)—who move from one job to another cash out at least a portion of their plan assets, using that money for purposes other than retirement savings. To understand the baleful effect of borrowings and cash-outs, just imagine in what shape our beleaguered Social Security system would find itself if the contributions of workers and their companies were reduced by borrowings and cash-outs flowing into current consumption rather than into future retirement pay. Bogle wants a new, streamlined, and unified retirement savings system to be stripped of so many confusing options. He says it should be replaced with a handful of conservatively calibrated choices that are clear in their risk profiles and the expectations they can satisfy.

Mandatory Allocation?
One reason that 401(k) investors have accumulated such disappointing balances stems from unfortunate decisions in the allocation of assets between stocks and bonds. While virtually all investment experts recommend a large allocation to stocks for young investors and an increasing bond allocation as participants draw closer to retirement, a large segment of 401(k) participants fails to heed that advice.

The Wrong Mix
Nearly 20% of 401(k) investors in their 20s own zero equities in their retirement plan, instead holding outsized allocations of money-market and stable-value funds—options that are unlikely to keep pace with inflation as the years go by. On the other end of the spectrum, more than 30% of 401(k) investors in their 60s have more than 80% of their assets in equity funds. Such an aggressive allocation likely resulted in a decline of 30% or more in their 401(k) balances during the present bear market, imperiling their retirement funds precisely when members of this age group are preparing to draw on them.

The Under-20% Rule
Company stock is another source of unwise asset allocation decisions, as many investors fail to observe the time-honored principle of diversification. In plans that offer company stock as an investment option, the average participant invests more than 20% of his or her account balance in company stock, an unacceptable concentration of risk. If you feel you must, dabble in company stock with not more than a sliver of fun money. You're already overweighted in your exposure to the company's fate by way of employment and income.

The Old College Try
"Mutual funds can make no claim to superiority over the market averages," argued Bogle in his 1951 Princeton senior thesis, The Economic Role of the Investment Company. In other words, good luck beating the indexes. If anything, his prophecy was understated. Of the 355 equity funds in business in 1970, 223 have since gone bust. Of the 132 that survived, only 24 beat the Standard & Poor's 500-stock index and only seven did so by more than (a statistically significant) 1% per year.

It Runs in the Family
"Gentlemen, lower your costs!" urged Philander Banister Armstrong, Bogle's great-grandfather, in an 1868 speech to fellow insurance executives. In 1917, Armstrong published the book A License to Steal: Life Insurance, the Swindle of Swindles: How Our Laws Rob Our Own People of Billions. "He's my spiritual progenitor," says Bogle.

BusinessWeek Senior Writer Farzad covers Wall Street and international finance.