We hate to drag out that old, on-the-fence phrase, "it depends." But it does. Your 401(k) plan's rate of return is directly correlated to the investment portfolio you create with your contributions, as well as the current market environment. 

That being said, although each 401(k) plan is different, contributions accumulated within your plan, which are diversified among stock, bond, and cash investments, can provide an average annual return ranging from 3% to 8%, depending how you allocate your funds to each of those investment options.

How 401(k) Plans Work

Let's review the basics. An employer-sponsored retirement plan such as a 401(k) can be a valuable tool in accumulating savings for the long-term. Each company that offers a 401(k) plan provides an opportunity for employees to contribute money—a percentage of their wages—on a pretax basis [or after-tax basis for Roth 401(k)s], through paycheck deferrals. Often, employers provide a match on employee contributions, up to a certain percentage, creating an even greater incentive to save.

While they vary according to the company and the plan provider, each 401(k) offers a number of investment options to which individuals can allocate their contributions—usually, mutual funds and exchange-traded funds (ETFs). Employees benefit not only from systematic savings and reinvestment, their investments' tax-free growth, and employer matching contributions, but also from the economies-of-scale nature of 401(k) plans and the variety of their investment options.

It's All About the Asset Allocation

How your 401(k) account performs depends entirely on your asset allocation: that is, the type of funds you invest in, the combination of funds, and how much money you've allocated to each.

Investors experience different results, depending on the investment options and allocations available within their specific plans—and how they take advantage of them. Two employees at the same company could be participating in the same 401(k) plan, but experience different rates of return, based on the type of investments they select.

Different assets perform differently and meet different needs. Debt instruments, like bonds and CDs, provide generally safe income but not much growth—hence, not as much of a return. Real estate (available to investors in a real estate investment trust (REIT) or real estate mutual fund or ETF) offers income and often capital appreciation as well. Corporate stock, aka equities, have the highest potential return.

However, the equities universe is a huge one, and within it, returns vary tremendously. Some stocks offer good income through their rich dividends, but little appreciation. Blue-chip and large-cap stocks—those of well-established, major corporations—offer returns that are steady, though on the lower side. Smaller, fast-moving firms are often pegged as "growth stocks," and as the name implies, they have the potential to offer a high rate of return.

But of course, what goes up can go down: the greater a stock's potential for aggressive growth, usually the greater its chances of big tumbles, too. It's called the risk-return tradeoff.

Your asset allocation should be determined based on your specific appetite for risk, also known as your risk tolerance, as well as the length of time you have until you need to begin withdrawals from your retirement account. Investors with a low appetite for risk are better served by placing investments in less volatile allocations that could result in lower rates of return over time.

Conversely, investors with a greater risk tolerance are more likely to choose investments with more potential for higher returns but with greater volatility.

Balancing Risk and Returns

Now, it's time to return to that 5% to 8% range we quoted up top. It's an average rate of return, based on the common moderately aggressive allocation among investors participating in 401(k) plans that consists of 60% equities and 40% debt/cash. A 60/40 portfolio allocation is designed to achieve long-term growth through stock holdings while mitigating volatility with bond and cash positions.

On the risk/reward spectrum, the 60/40 portfolio is about in the middle. For instance, if you invest in a more aggressive portfolio—say 70% equities, 25% debt, and only 5% cash you may expect higher, double-digit returns over time. However, the volatility within your account may also be much greater.

Conversely, if you went more conservative—75% debt/fixed-income instruments, 15% equities, 10% cash—your portfolio would have a pretty smooth ride, but returns of only 2% to 3% (depending on what prevailing interest rates were).

Typically, an individual with a long time horizon takes on more risk within a portfolio than one who is near retirement. And it's common, and prudent, for investors to gradually shift the assets within the portfolio as they get closer to retirement.

As a one-stop-shopping way to accomplish this metamorphosis, target-date funds have become a popular choice among 401(k) plan participants. These mutual funds allow investors to select a date near their projected retirement year, such as 2025 or 2050.

Funds with a further-out target date focus investment allocations in a more aggressive manner than funds with a near-term target date. Rates of return on target-date funds vary from company to company, but these one-fund allocations offer a hands-off approach to asset allocation within a 401(k).

How Is Your 401(k) Doing?

Allocate your assets as you will, you can't ever be 100% certain of the returns your 401(k) will generate—that's why it's called investing, not saving. But if you want a sense of how your portfolio is performing, you can, and should, make comparisons.

Specifically, you can compare the investments in your account to other mutual funds or ETFs that invest in similar assets (corporate bonds, small-cap stocks, etc.), or have similar investment objectives (aggressive growth, balanced income, appreciation, etc.). You can also see how a particular fund is doing compared to an overall index of its asset class, sector, or security type.

For example, if you owned a real estate fund, you might want to see whether it is underperforming or outperforming Dow Jones U.S. Real Estate Index (DJUSRE), which tracks over 100 REITs and real estate companies. If you own broad-based equity funds, you can even compare them to the stock market itself.

Don't be surprised, though, if your actual return lags the index by 1% to 2%. The cause is, in a nutshell, the annual fees charged by both your individual funds and by the 401(k) plan itself. Unfortunately, this sort of expense is pretty much beyond your control, and to be expected. However, if the index is up and your fund is down, be afraid, be very afraid.

The Bottom Line

It is not possible to predict your rate of return within your 401(k), but you can use the basics of asset allocation and risk tolerance, in conjunction with your time horizon, to create a portfolio to help you reach your retirement goals.

Also, look carefully at the fees different choices entail. Each of these factors influences the overall rate of return within your 401(k) account and should be reviewed regularly to ensure that your account meets your investment preferences and nest-egg accumulation needs.

There’s no one return that's "right" to expect from a 401(k). But it's not like it's some situation or event outside your control—like watching the weather and making vacation plans accordingly. It works the other way around: You pinpoint what you’ll need in retirement and your time frame until you retire, and determine what you expect from your 401(k) from that.