As aptly explained in “The Consequences of a Market Correction,” stock markets will correct because they routinely crash. Just look at the following graph created by Morningstar researcher Paul D. Kaplan in 2020:
It’s not an issue of “if” because there’s no doubt that there will be market corrections in the future, and it really doesn’t matter much what causes them, although there are currently reasons to be concerned about the economy as discussed below.
What matters most is where you are in your investment lifecycle “when” the correction occurs. It’s an individual exposure; some investors are currently in harm’s way while others are not. A very large group of investors—78 million baby boomers—could be irreparably harmed by a correction that occurs in this decade. The “when” for them to be seriously harmed is within this decade. That’s why I wrote the book “Baby Boomer Investing in the Perilous Decade of the 2020s.” Most other investors will feel the correction but will recover.
Baby boomers might never recover, and their misery will ripple throughout the economy. Current baby boomers’ wealth is $60 trillion.
As discussed below, the tectonic plates of the economy are shifting. Baby boomers are near the epicenter of the next quake because they are in what is called the Risk Zone when sequence of return risk transforms “risk of loss “ into “risk of ruin.” Baby boomers will be devastated the most.
Target-date fund providers, regulators, employers fail retirement savers
They do so by not acknowledging and quantifying major target date fund risks.
Even though retirement researchers have identified and written extensively about the Risk Zone, it remains a virtual secret. Most retirement savers are unaware of the threat they face during the 5-10 years before and after retirement. But the next market correction will wake the sleeping baby boomer giant and slap it silly.
There have never before been so many people simultaneously in the Risk Zone. Most baby boomers will spend much of this decade in the Risk Zone,
As explained in this recent article, and many others like it, losses sustained in the Risk Zone can reduce the standard of living and radically reduce the length of time that savings last. It’s the “luck of the draw” that very few recognize but should.
What’s worse is that the very popular target-date fund (TDF) investment in 401k savings plans does not defend in the Risk Zone. TDFs lost more than 30% in 2008 and they have become riskier since then because bonds have become risky.
This fact recently prompted a Congressional inquiry that asks why most TDFs are so risky at their target retirement date while the Federal Thrift Savings Plan (TSP), the world’s largest savings plan, is so safe.
As shown in the following graph, the typical TDF is 90% in risky assets — 55% equities plus 35% risky bonds — while TSP is only 30% risky at the retirement target date with the 70% balance in very safe government-guaranteed bonds (Fund G).
A reprehensible breach of responsibility
The TSP target date fund design should be the standard. TSP is not alone. Similarly, safe glidepaths are followed by the SMART Target Date Fund Index and the Office Professional Employees International Union (OPEIU), one of the largest AFL-CIO unions.
It is arguably unconscionable that sequence of returns risk, with its ability to derail a participant’s dignified retirement, is not addressed and quantified by regulators and plan fiduciaries.
According to surveys like this recent State Street survey, most beneficiaries in TDFs do not understand them because they did not choose them, rather they have been defaulted into them.
Fiduciaries choose TDFs on behalf of defaulted beneficiaries, and they have chosen to ignore sequence of return risk, a reprehensible breach of the duty of care. The duty of care is like our responsibility to protect our young children from harm. Like the excessive fee debacle, it will probably take lawsuits to remedy this breach of responsibility.
Regulators now require disclosure of projected annuity income, but this disclosure ignores the possibility of losses as the baton is passed at retirement from 401(k) savings to the purchase of an annuity. Sequence of return risk is the risk of dropping the and game over.
401(k)s can be an asset or liability for small business owners
Small business owners have a more personal relationship with their employees than large corporations. They sincerely want happy employees, and they want to protect defaulted beneficiaries, so they need to use safe TDFs in their 401(k)s. Happy employees create a happy work environment. Investment losses make people unhappy.
If the 401(k) uses a safe TDF, the plan is an asset. If it does not use a safe TDF, the plan can become a liability when the next market correction occurs because defaulted employees will blame their employer for their losses and seek reparation.
This applies to single-employer plans as well as the newly popular Pooled Employer Plans (PEPs).
The SECURE Act of 2019 has provisions that make employer-sponsored retirement plans available to more workers to help solve the retirement savings crisis. The Act creates Pooled Employer Plans. Adopting employers need to recognize that PEPs can be an asset or a liability depending on the TDF used as the Qualified Default Investment Alternative (QDIA): safe is an asset, risky is a liability. Please see this short video.
Employers don’t need the morale problems and distractions caused by 401(k) default investment losses. They simply want to run their businesses.
Will a correction happen this decade?
And will it happen when baby boomers are in their Risk Zones?
No one knows the answer to this question, but there are four major threats that make a correction highly likely—things that are just plain out of whack. It is different this time because:
- Bond yields have never been lower, so bond risk has never been higher. Interest rate risk, as measured by duration, has never been higher
- Stock prices have never been higher. Yes, I know this is subject to debate, so chime in. If you say it’s OK because interest rates are so low, see item 1 above.
- The US government has never printed more money. M1 money supply has quintupled in 2 years from $4 trillion to $20 trillion. It’s hard to imagine that this is not inflationary although some think “slow velocity” will save the day. There’s a likely $4.5 trillion more on the way for infrastructure and social policy.
- The wealth divide has never been wider, creating havoc in Seattle, Portland, Chicago…Social unrest is at its pinnacle, compounded by a pandemic.
Conclusion
There will certainly be market corrections—no “if” about it. As for the “when,” will baby boomers get through the Risk Zone this decade without a market correction? I wouldn’t bet on it. But the unfortunate reality is that most baby boomers are unwittingly making this bet, especially those defaulted into target-date funds because they’ve relied on their employers to protect them. I sincerely hope they’re lucky because there are no do-overs.
Ron Surz is President of Target Date Solutions and CEO of GlidePath Wealth Management. He is also the author of Baby Boomer Investing in the Perilous Decade of the 2020s. He can be reached at Ron@TargetDateSolutions.com.