Coronavirus market could make dreams of retirement more distant

Retirement plan investors didn’t panic as global stock markets suffered their swiftest descent on record, and it doesn’t appear they jumped out after a historic rebound. They have held on tight in the face of who knows what comes next.

“As we move out of a period of unprecedented volatility we saw that, for the most part, retirement investors did not give over to emotional selling. The American retirement investor has shown great fortitude and tremendous resolve in the face of historic market volatility,” Edmund Murphy, president and CEO of Empower Retirement in Greenwood Village, said in an email.

Empower studied how the 9.5 million participants in the retirement plans and IRAs it manages reacted after U.S. stock indices went from record highs in mid-February to wiping out more than three years of gains by March 23.

Of that group, 99.3% had made no changes to their retirement investments as of March 30 and only 16% even logged in to check on balances. About 2.1% boosted their contribution rate, while 1.4% lowered it.

Maybe things happened so fast retirement investors didn’t have time to react or maybe they were much more worried about protecting their health and preserving their jobs and businesses that any concerns about the 401(k) balance took a back seat.

“We have to be fairly honest. Retirement plans are not the top priority at the moment. The No. 1 priority is all about health,” said Neil Lloyd, head of U.S. DC & Financial Wellness Research at Mercer, during a webinar hosted by the Employee Benefit Research Institute on Tuesday.

Once things settle people will need to assess the damage done to their retirement portfolios and recalibrate how much they need to set aside to achieve their goals.

EBRI has a database of 27 million retirement plans and regularly looks at how likely participants are to fund their retirement needs under a variety of scenarios. At the start of the year, about six in 10 of plans held by households age 35 to 64 were on track to adequately fund retirement, but four in 10 were behind to the tune of $3.68 trillion, said Jack VanDerhei, research director at EBRI.

Market declines through March add about $136.4 billion to the deficit retirement investors face, according to the simulation. That’s about 3.5% of the existing shortfall, VanDerhei said. That isn’t huge, but the drop in the market has also cut into the surplus that investors on track had, especially those with larger balances in their retirement plans.

Several other trends are in play that could hurt the retirement readiness of workers, especially younger ones. Business failures will result in fewer small retirement plans, meaning fewer employees covered. Some employers, in an effort to conserve cash, will likely eliminate matching contributions in the short-term, which reduces a key incentive to participate.

Workers who have lost income are also more likely to borrow against their plans or spend some of the balances outright, something that the CARES Act makes easier to do without penalties. Money used to cover living expenses won’t be around to compound.

“We believe that difficult economic circumstances will likely lead to increased demand for short-term cash on the part of some participants,” Murphy said. “Empower recently announced that we are waiving fees on all new retirement plan loans and hardship withdrawals. We believe that there will be high interest in loans and hardships.”

Lloyd also expects some employers may shift more of their benefits focus to an area known as financial wellness, in particular helping employees develop emergency savings, which the crisis has exposed as woefully inadequate.

A different downturn

Data on the flows in and out of mutual funds and exchange-traded funds reveals investors at large were on the move in March, but in some surprising ways, according to numbers from Morningstar.

Fixed income investments are usually considered a haven when equities are falling in value, but that wasn’t the case this time around. Taxable-bond funds suffered record outflows of $240 billion, dwarfing the prior outflow record of $54 billion set in June 2013. Investors also pulled a record $45 billion out of municipal bond funds, fearful that state and local governments would default because of reduced tax revenues, Morningstar said.

Investors actually poured $10.4 billion into U.S. equity funds last month, although they pulled $12.6 billion out of international equity funds. And the big winner was cash. Money market funds added a record $684.6 billion in March.

Joe Vietri, branch network leader at Charles Schwab, said the current downturn is often compared to the dot-com bubble bursting in 2000 and the financial crisis of 2008 and 2009.

But he said an external shock, a health crisis, caused this downturn, rather than excesses and imbalances that built up over years. Clients, as a result, are behaving differently.

“They aren’t reacting as much to the volatility as in the past. Health and wealth are both being impacted. Health issues are more front and center,” he said.

Some people are spending the long hours at home reviewing their financial situation and deciding they need to save more and plan better. Schwab has seen an uptick in new accounts, especially from young investors, which wasn’t the case during the last bear market, Vietri said.

Schwab and other financial advisers suggest retirees or those nearing retirement keep at least a year in living expenses in easily accessible savings. They should also keep another two to four years of expenses in more stable investments such as money market funds and short-term bonds.

The “bucketing” approach, as it is called, keeps investors from selling stock positions while they are depressed in value. A young investor can afford to wait for a portfolio to recover, but those near or in retirement will be hard-pressed to restore what was lost if they sell holdings to meet income needs.

“That has made a lot of our clients feel more comfortable with a market downturn,” said Rob Williams, vice president of financial planning at the Schwab Center for Financial Research.

For older investors who haven’t built a cash cushion to draw on until the market recovers, Williams suggests clearing out investments that they would no longer buy now, or the “garbage.” But clear out just enough to provide the cash reserves that should have been there in the first place, and do so strategically, not in a panic.

Prepare for anything

Some forecasts predict the economy will zoom back quickly once stay-at-home orders lift and the massive stimulus money takes hold. That seems to be the scenario investors have considered most likely in the past few weeks, judging by how much they have pushed up equity prices.

“The only thing I have a strong conviction about right now is that nobody should have a strong conviction about anything right now,” tweeted Walter Deemer, a Wall Street veteran and technical analyst.

Nicholas Bloom, a professor of economics at Stanford Graduate School of Business, has studied economic shocks and urges caution regarding an easy rebound. Bloom, in a blog post, doesn’t disagree with forecasts that predict the U.S. economy will be off to the races by the end of the year, given all the pent-up demand.

But he predicts it could take five years before U.S. GDP is back to where it was in 2019, because of a series of what he calls “second moment” shocks. The U.S. has entered a depression, not a recession, he warns.

Jobless claims in the U.S. have topped 22 million in just one month. Households and businesses alike will have a strong incentive to build financial reserves, meaning less spending and more savings. Banks are preparing to write-off huge amounts of bad loans, making them less inclined to lend.

Supply chains will need to be rebuilt and businesses will be less productive as they bring back workers and retrain new ones. Innovation won’t be as robust. Also, the bill will eventually come due for the trillions of dollars spent on stimulus. That likely means higher taxes in the years ahead, especially on corporations and high net worth households.

“As recently as the middle of March, I thought we would probably experience a V-shaped recovery and bounce back relatively quickly,” Bloom wrote. “I don’t think that now.”

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