Vanguard discovers the 'billion-dollar blind spot' of 401(k)-to-IRA rollovers.

• It is common to transfer funds from a workplace retirement plan, such as a 401(k), to an individual retirement account when changing jobs or retiring.
• Frequently, individuals who roll over their 401(k)s to IRAs are unaware that their funds remain in cash by default.
• Holding excess cash is generally a mistake for long-term investors.

Failing to transfer funds from a 401(k) plan to an individual retirement account can result in costly mistakes for many investors, as leaving their money in cash can negatively impact their long-term financial goals.

In 2020, approximately 5.7 million individuals rolled over a total of $618 billion from their workplace retirement plans to IRAs, according to the most recent IRS data.

A recent Vanguard analysis reveals that many investors who transfer their funds to an IRA leave them in cash for extended periods, resulting in their savings not growing.

According to Vanguard, 68% of rollover investors unintentionally hold cash, while 35% prefer a cash-like investment.

In 2023, a survey was conducted by the asset manager on 556 investors who completed a rollover to a Vanguard IRA and kept their assets in a money market fund until June 2024. Respondents were allowed to report multiple reasons for holding their rollover in cash.

Vanguard's head of investor behavior research, Andy Reed, stated in an analysis that IRA cash is a billion-dollar blind spot.

'It always turns into cash'

Retirement experts said that the retirement system may contribute to the blind spot.

When an investor rolls their 401(k) funds into an IRA, they are technically liquidating their position in an S&P 500 stock index fund. However, the financial institution receiving the money does not automatically invest the savings in an S&P 500 fund; the account owner must make an active decision to move the money out of cash.

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"One challenge, according to Philip Chao, a certified financial planner and founder of Experiential Wealth in Cabin John, Maryland, is that money often accumulates and remains in cash until it is actively managed."

According to Vanguard's survey, 48% of people incorrectly believed their rollover was automatically invested.

When holding cash may be a 'mistake'

It is usually wise to keep cash in a high-yield savings account, a certificate of deposit, or a money market fund for individuals saving for an emergency fund or short-term goals such as a down payment for a house.

Financial advisors warn that saving large amounts of money for the future can be challenging.

Advisors caution investors that saving in cash may seem like a safe option for their retirement savings, but it could actually harm them in the long run.

Over many years, the interest earned on cash holdings may not keep pace with inflation, resulting in an inadequate nest egg for retirement.

""Historically, putting any meaningful money in cash for the long term is a mistake, except when you're ready to retire," Chao stated."

Chao stated that if one is investing for a time horizon of 20, 30, or 40 years, cash is not a suitable investment option because the return is insufficient.

It is acceptable to use cash as a temporary parking place for a short period, such as a month, while making a rollover investment decision, according to Chao.

He stated that the issue is that many individuals forget about it and it remains unused for extended periods, ranging from years to decades, in the form of cash, which is utterly irrational.

High returns in certain cash accounts over the past year or two may have given investors a false sense of security.

Tony Miano, an investment strategy analyst at the Wells Fargo Investment Institute, wrote Monday that investors are unlikely to retain those returns in the long term.

Miano advised investors to "reposition excess cash" in anticipation of the U.S. Federal Reserve's interest-rate cuts this week.

As Chao pointed out, investors should consider whether it's necessary to transfer funds from their 401(k) plan to an IRA, as there are both advantages and disadvantages to doing so.