The stock market crash is undermining retirement savings

With the S&P 500 SPX,
down roughly 20% from early 2022, it’s helpful to consider how it affects retirement savings for today’s workers.

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The shift from defined benefit (DB) plans to defined contribution (DC) plans in the private sector means non-government workers have most of their retirement savings in 401(k)-type plans or individual retirement accounts (IRA) (see Figure 1). It’s important to include IRAs in the calculation because they are mostly 401(k) rollovers. (Most state and local workers continue to be covered primarily by defined benefit plans.) To the extent that the money in these private sector accounts is invested in stocks, the workers bear all the risk of stock market fluctuations.

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Vanguard reports that 72% of the 401(k) plan assets the company manages were invested in stocks in 2020. Given the COVID-19 stock market boom, the percentage could be slightly higher by the end of 2021 My best guess is that the asset allocation for IRAs would be about the same. Therefore, a significant portion of retirement assets are at risk.

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One question is, who owns these assets? Again, the data comes from Vanguard. In terms of income, it used to be that high-income participants took more market risk, that is, invested more in stocks, than their low-income counterparts. However, with the increased use of target date funds and automatic adjustment, low-income participants actually have a slightly higher proportion of their assets in stocks (see Table 1).

It is also important to understand which age groups are exposed to fluctuations in stock values. If younger employees own the majority of the shares, they would have time to recover and recoup losses before they retire. In terms of age, stock holdings decline as participants age, but those over 65 continue to hold almost half of their portfolio in stocks (see Figure 2). To the extent that these seniors are forced to withdraw their retirement assets, they will not have a chance to recover.

So how much have people lost in their retirement plans during this market downturn? Let’s assume the markets are down about 20% since January. Participants would have lost 20% of $6.8 billion ($9.5 billion x 72%) or $1.4 billion in their 401(k); and IRA owners would have lost 20% of $10.0 billion ($13.9 billion x 72%) or $2.0 billion in these accounts. Remember that IRAs are mostly 401(k) rollovers and therefore should be counted in the total.

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One could argue that these recent losses are simply wiping out windfall gains from COVID-19, so participants are no worse off than they were before the pandemic. But it’s human nature for people to feel like past gains are theirs to keep, so recent losses are painful.

People, mostly the wealthiest, also have stocks outside of retirement accounts. In 2021, these holdings amounted to $32.2 trillion. Applying the 20% decline means people have lost an additional $6.4 trillion in direct holdings. However, these people are much less likely to be forced to sell and can wait for the decline to pass to recoup their losses.

We all know that the shift from defined benefit to defined contribution retirement plans has shifted longevity and investment risk from employers to workers. It’s easy to forget this fact when the market is booming; hard to ignore when the market crashes.

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