I elicited some grief from certain Vanguard Blog readers by talking about a recovery in 401(k) accounts earlier this year. Allow me to provide an update on the issue.

Recall my basic premise: As a result of ongoing contributions, as well as portfolio diversification, the wealth level of many 401(k) participants had not fallen as dramatically as commonly perceived. In fact, some workers had experienced growing 401(k) account balances even during falling markets. These were, admittedly, mostly employees starting out their savings careers, where contributions are large relative to balances.

We’ve updated our analysis, looking at participants beginning on September 30, 2007 (just before the early October 2007 market peak), and ending two years later, on September 30, 2009. As of that date, the median 401(k) account holder at Vanguard had more in retirement savings, despite the market decline, than two years ago. The reasons are the same: ongoing contributions and diversification. (Read the full report)

As expected, younger people (whose contributions are large relative to their balances) are doing much better than older people (whose contributions are small relative to balances). Still, over half of those in those critical preretirement years, ages 55–64, were ahead of where they stood two years ago. And most of those with large losses were participants with ultra-aggressive portfolios invested largely in stocks.

In the report, my coauthor Jean Young and I discuss the criticisms of this perspective—echoed by some of you—that we are conflating investment returns with contributions. But retirement wealth is a combination of contributions and returns. Moreover, to anchor your retirement perceptions at the high-water mark of fall 2007 is just as much a mistake as to set expectations at the low-water mark of March 2009.

In any event, to me these findings underscore the fact that the risks of 401(k) savings are misunderstood. For participants who are regularly saving even in the face of large market losses, the road to recovery is rocky, but still manageable. And, for the median 401(k) participant at Vanguard, the road to recovery was relatively short—two years, in fact.

The real risk to 401(k) savings stems not from market risks, but from a toxic combination of market decline and job loss, and the ensuing pressure to access retirement savings. I’ll return to that perspective on 401(k) risk in a future post.

Note: Diversification does not ensure a profit or protect against a loss in a declining market.