Vanguard: 401(k) to IRA rollovers have ‘billion dollar blind spot’

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Many investors unknowingly make a costly mistake when transferring funds from a 401(k) plan to an IRA: keeping the funds as cash.

It’s common to switch from a workplace retirement plan to an Individual Retirement Account (IRA) after reaching certain milestones, such as changing jobs or retiring. About 5.7 million people rolled up According to the latest data from the IRS, IRAs totaled $618 billion in 2020.

However, many investors who transfer funds to IRAs keep those funds in cash for months or years rather than investing them — a move that causes their savings to “dry up,” according to a recent report from Vanguard Group. analyze.

About two-thirds of rollover investors are unintentionally holding cash, according to Vanguard: 68% don’t know how their assets are invested, compared with 35% who prefer cash-type investments.

The asset manager surveyed 556 investors who completed rollovers to Vanguard IRAs in 2023 and left those assets in money market funds through June 2024. There are several reasons for rolling over cash holdings.

“IRA cash is a multi-billion dollar blind spot,” Andy Reid, director of investor behavioral research at Vanguard Group, said in an analysis.

“It always turns into cash”

Retirement experts say the retirement system itself may be causing this blind spot.

Suppose a 401(k) investor holds his money in an S&P 500 stock index fund. Technically, the investor would liquidate the position when transferring funds to the IRA. The financial institution that receives the funds does not automatically invest the savings in an S&P 500 index fund; the account owner must make an active decision to move the funds out of cash.

“That’s one of the challenges: It always turns into cash,” says Philip Chao, a certified financial planner and founder of Experience Wealth in Cabin John, Maryland. “Before you do something, it’s going to be in cash.”

According to the Vanguard Group survey, approximately 48% of people (incorrectly) believe that their rollover funds will be invested automatically.

When holding cash can be a ‘mistake’

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It often makes sense for people to hold cash—perhaps in a high-yield savings account, certificate of deposit, or money market fund Build an emergency fund or for those saving for short-term needs, such as a home down payment.

But financial advisers say saving large amounts of cash over the long term can be problematic.

Investors may feel they are protecting their retirement savings from stock and bond market swings by setting aside cash, but they could be doing themselves a disservice, advisers warn.

The interest earned on holding cash may be too negligible to keep up with inflation over the years, or it may not be enough to provide adequate savings for retirement.

“Ninety-nine percent of the time, unless you’re ready to retire, putting any meaningful money in cash long-term is a mistake,” Zhao said. “History has proven this.”

“If you invest for 20, 30, 40 years, (cash) doesn’t make sense because the return is too small,” Zhao said.

Zhao Chao explained that using cash as a “temporary parking space” in the short term—perhaps a month or so while making rollover investment decisions—is OK.

“The problem is, most people will eventually forget about it and it will sit in cash for years, decades, which is absolutely crazy,” he said.

Certain types of cash accounts have had relatively high returns on cash over the past year or two (perhaps around 5% or more), which may lull investors into a false sense of security.

However, investors are “unlikely to sustain these returns over the long term,” Wells Fargo Investment Institute investment strategist Tony Miano wrote on Monday.

This is because the Federal Reserve is expected to launch a new round of interest rate cuts this week. Miano said investors should “start reallocating excess cash.”

Chao said investors should also question whether it’s necessary to move funds from a 401(k) to an IRA, as there are pros and cons to doing so.