Protecting your 401(k)

As a record number of Americans are heading into their retirement years with impressive balances in their 401(k) plans, the potential disruption of this long bull market has many people trembling. The prospect of actually losing money just as they need to plan retirement living withdrawals is truly frightening for this generation of amateur investors.

An entire generation has been taught to “ride it out” and “buy the dips.” But what happens when you reach the point where you will no longer be contributing from a weekly paycheck and taking advantage of lower prices? Suddenly you develop a more safety-conscious attitude.

Where can you hide from the ravages of inflation, higher rates and potentially a bear market?

Americans have more than $7 trillion in their 401(k) plans, with $1.8 trillion of that in target-date funds. Those targetdate funds promise to manage allocation by becoming more conservative in their investments as participants reach retirement or remain invested in them during retirement.

But so far this year, the results don’t support that claim. Both bonds and stocks fell sharply in the first quarter — but bond prices fell far more sharply than the S&P 500. Bond prices have fallen dramatically. They always do when interest rates rise. Who wants your old low-yielding bond if they could take cash and buy a new higher-rate bond? Sell, and you take the loss of principal — an ongoing drop in value reported on your statement, even if you don’t sell. Hold, and you suffer with lower yields.

Bonds have traditionally been seen as a safe haven. According to a new report by market analyst Ron Surz of TargetDateSolutions.com, there have been 25 down stock years between 1926 and 2021. In every one of those years, bonds have lost less than stocks, acting as a protective balance. For example, in 2008 a quality bond portfolio returned a positive 9.5% vs the stock market’s 37% loss.

But so far in 2022, Surz said, bonds have lost 9%, while stocks lost 7%. Bonds have been the worst performers, perhaps because we are at a major inflection point in the economy. The Fed is belatedly committed to raising rates higher and faster, potentially causing a recession. And a recession would impact bond prices even more amid rising fears about credit quality.

Now take a look at what’s inside your target-date fund. Likely, it is invested in both bonds and stocks, with very little cash. In other words, your target-date fund is fully invested in the two worst assets so far this year!

Even worse, remember that these targetdate funds are supposed to become more “conservative” as retirement dates near. That means most of the nearby targetdate funds “overweighted” bonds, as the traditionally safer asset. The result is that those “low-risk” 2020 target-date funds have suffered greater losses so far this year than the supposedly more aggressive 2060 target-date funds.

A 401(k) plan is not required to have a money market fund or a conservative stable value fund as an investment choice — and many plans don’t. That’s because these plans are primarily designed for younger investors, who can ride out volatile markets and should stick with long-term future growth reflected in stocks.

Some retirement plans, including the government’s Thrift Savings Plan, do offer a “stable value fund” — basically an insurance contract backed by bonds. Lately those are yielding around 3%, providing a good place to park some of your target-date fund money. If your plan offers a brokerage option, you can move a portion of your retirement funds there, and instead of using it to pick stocks, just use their money-market mutual fund as a temporary place to hide from market risk.

Money in the bank has been out of favor lately. And with good reason. Most banks and money-market funds are paying less than 1%, while inflation is raging at 8%. So, the buying power of cash is being diminished. But the sleeping power of cash is priceless. And that’s The Savage Truth.