Falling Stocks: How the Bear Market Affects Pension Plans

No investor likes to see stocks fall. But this year’s market downturn is particularly bad news for the cohort of retirees and near-retirees who have much of their portfolio tied up in stocks.

With the S&P 500 officially entering a bear market in June (down more than 20% from its previous all-time high), young investors probably have no reason to panic. Rather, they now have the ability to buy stocks cheaply and let their portfolios grow over decades as the market recovers.

The picture is bleaker for investors who are retired or planning to retire soon – and whose stock-heavy portfolios have been hit hard lately.

For years, investors have become accustomed to reliable and attractive returns in the stock market. A long-running bull market was briefly interrupted at the start of the pandemic, only to be followed by another surge in stock prices.

So it’s understandable that many investors have kept a large portion of their portfolios in stocks, especially now that 401(k) accounts are gradually replacing fixed income pensions as the default retirement planning option for private sector workers. Nearly three-quarters of assets in 401(k) plans managed by Vanguard were invested in stocks in 2021, according to a recent report of the company, up from two-thirds of assets invested in equities in 2012.

Now that we’re in a bear market and facing a possible recession, however, retirees who remain heavily invested in stocks through their 401(k) accounts face “uncharted waters,” says program director Richard Johnson at the retirement policy at the Urban Institute.

401(k) accounts are not foolproof

As 401(k)s become more popular and pensions slowly fade, workers are taking on more risk when it comes to their nest egg.

“To the extent that the money in these private sector accounts is invested in stocks, workers bear the entire risk of stock market fluctuations,” Alicia Munnell, director of Boston College’s Center for Retirement Research, wrote in a statement. recent article. column.

Americans have accumulated more than $3 trillion in retirement savings since stocks began to slide earlier this year, Munnell calculated. Pension plans and social security are not subject to this type of risk (although both are vulnerable to inflation).

There’s also the fact that a market downturn hits mature portfolios harder than the smaller portfolios of younger investors. A 30% impact on a portfolio worth $20,000 means a loss (on paper) of $6,000, while the same percentage drop on a portfolio worth $800,000 would wipe out $240,000 .

When your account balance is bigger because you’ve been saving money for decades of your working life, “even minor market fluctuations will overwhelm…. the effects of any additional input,” says Monique Morrissey, an economist at the Economic Policy Institute, a left-wing think tank. In other words, it’s much harder to catch up on that $240,000 portfolio with short-term contributions, especially if the market remains volatile.

Of course, all this market angst comes with a major caveat. “It’s an upper-middle-class problem,” Morrissey says. Only half of American families own stocks, according to the Federal Reserve Consumer Finance Survey. Social Security is the most common form of retirement income, received by 78% of all retirees, according to Data of the Fed, while 30% of American households still receive a pension, according to a report from JPMorgan.

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Target date funds can also be risky

Target date funds, which hold both riskier assets like stocks and safer assets like bonds and rebalance to a more conservative allocation near a set retirement date, have become 401(k) options. (k) increasingly popular. They are widely seen as a way to minimize risk due to the way they are structured.

Yet the automated diversification of target date funds doesn’t make them a completely safe choice. They are always vulnerable to volatility and the unpredictable nature of the stock market. On top of that, they can”[lull] people into complacency because a lot of these target date funds are actually quite aggressive,” says Morrissey.

The most popular target date funds have lost between 10% and 22% of their assets this year (due to equity losses as well as withdrawals), according to Morningstar data. reported by CBS News. Between the last quarter of 2021 and the first quarter of this year, target maturity mutual fund assets fell by more than $100 billion, according to Data of the Institute of Investment Companies.

The fixed income assets of these target maturity funds are also not without liabilities. “There are a lot of bond funds that are also risky,” says Johnson of the Urban Institute, “particularly in a time of rising interest rates. Interest rates go up and the value of your bond fund will fall.

In addition, like other retirement investment vehicles, target date funds are subject to timing risks. More on that below.

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When to retire? Timing is everything

While it is true that the stock market tends to rise over the long term, investors should not take this as a guarantee that their portfolio will grow in any given period.

“Stock returns don’t even out over time,” says Morrissey, and when you retire has a huge impact on the value of your portfolio and how long that money will last.

The vanguard provides this example: Two investors entered the market at the same time with the same assets, the same portfolio allocation and the same withdrawal strategy. He retired in 1973, during a severe bear market. The other retires a year later in 1974, when stocks began to recover. According to Vanguard’s calculations, the 1973 retiree is running out of money after 23 years. The 1974 retiree maintains a large portfolio balance and finds himself with money to leave in a will.

What to do if you need retirement money in a bear market

While it’s disconcerting to see the value of your investment portfolio plummet in a matter of months, it’s worth remembering that the market remains positive over the long term. The huge gains in the early days of the pandemic mean that the market’s three-year annualized return, “even including this recent drop, is still over 8% per year,” says Anqi Chen, deputy director of market research. savings at Boston College’s Center of Retirement Research, “which is pretty good.”

Although stock market fluctuations are out of your control, there is one obvious proactive step you can take to make sure your money lasts longer. “If you’re worried about retirement finances,” says Morrissey, “every year that you can keep working without undue stress is a good thing.”

Delaying your retirement for even a year or two could make a big difference to the value of your portfolio (not to mention the value of your Social Security benefits, if you can wait until age 70). ). This is true at all times, not just during a bear market.

If working longer isn’t an option (and it isn’t for many older Americans), it’s best to have a plan B to earn money in retirement. Chen suggests prioritizing non-stock assets like bonds and cash if you need to dip into your retirement savings during a downturn, rather than selling stocks that have lost value in recent months. .

Taking out a home equity loan can also be an option, as can downsizing your home, although sky-high house prices have made this strategy less effective in recent months. Wealth manager Schwab recommended withdraw interest and dividends from your investment accounts rather than selling the original investment.

“Stay diversified,” Johnson advises, and remember that stocks will eventually rally. “Don’t completely give up on the stock market when you retire.”

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