Families face more and more economic uncertainty in their daily lives with jobs quickly disappearing in some communities, pay at the whims of ever more powerful employers, contingent jobs and the gig economy taking on a larger role in everyday life, to name just some of the most common risks. Preparing for retirement is no exception. Workers increasingly save for what is typically their largest expense with do-it-yourself retirement accounts such as 401(k)s and Individual Retirement Accounts (IRAs). How much money will be in these accounts is highly unpredictable as this value can widely swing over short periods of time. Ultimately, families could end up with a lot less retirement income than they had hoped and planned for if they make unlucky or unwise decisions.
There are lots of chances for making decisions that are detrimental to families’ future well-being in retirement savings accounts. Workers could decide, for instance, not to take advantage of an employer’s retirement benefit, possibly because they have other more immediate economic concerns such as paying for childcare. Workers could also decide to put only a little money in their retirement accounts, potentially because they receive very little tax benefits for saving. Workers would also have to invest their savings, which could lead them to take on too much financial risks. For instance, a worker may decide to invest half of their money in the stock market and the other half in the bond market when they start saving. But when stock prices rise quickly, workers often forget to move money out of stocks and invest that money in bonds to keep the balance at 50-50. As a result, they end up with too much stock market risk. A drop in stock prices could result in workers’ stress as retirement account balances fall more than they find acceptable. Finally, workers make decisions on their retirement accounts in isolation, ignoring the economic risks they face in other parts of their lives. They may, for example, invest heavily in the stock market, even though they owe a lot of debt. They have fixed costs that they need to pay for even in retirement no matter what happens to their savings and retirement incomes.
Many of these risks are apparent in the latest data on household savings from the Federal Reserve covering the period through the first three months of 2019. Assets in 401(k)s and IRAs have swung more widely than assets in defined benefit (DB pensions over the past three business cycles (see Figure below).
The swings in retirement accounts in large part follows stock market volatility. That is, families do not rebalance their savings accounts when the market sharply goes up or down. The result are wide swings in people’s exposure to financial market risks from the stock market in particular (see Figure below). Their savings are just along for the ride and their economic future is then dependent on external influences such as CEOs and other managers manipulating stock prices, the Fed raising interest rates and, more recently, President Trump waging trade wars against allies and adversaries alike.
People tend to react to such swings in their savings, especially when their portfolios go down. Psychologists and economists have studied this phenomenon known as loss aversion, whereby people feel worse in absolute magnitude about losing something than they are about gaining the same thing. That is, drops in people’s portfolios have a larger negative psychological effect than could be offset by a similarly sized gain their portfolio. People then react to drops in their 401(k) and IRA savings by quickly moving money into liquid savings (see Figure below). But this could mean that they are not buying stocks when they are relatively inexpensive. They then forego some returns and their retirement savings and future incomes are smaller than they otherwise would be.
Worse, all of this financial risk in retirement accounts occurs against the backdrop of continued high debt. On average, household debt amounts to about one hundred percent of after-tax income (see Figure below). Worse, after-tax income has gone up somewhat in the wake of the 2017 and debt has become more costly as families have fewer mortgages and more student and auto loans. Increasingly, people retire while still owing debt, including student loans. They still need to pay back their debts, even when their retirement savings go down. High debt then exacerbates the financial risks in retirement accounts.
Families face a lot of economic risks in their jobs, making their income increasingly unpredictable. Saving for retirement has also become more volatile, leading to an uncertain economic future for millions of hardworking Americans.