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A Warning For Boomers: What Will Happen to Retirement Savings in the Next Market Crash?


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Ron Surz   Ron@PPCA-Inc.com   949/488-8339  Originator of Age Sage

  • Recent stock market losses have refocused investor attention from wealth building to wealth protection: Retirement savers win by not losing.
  • Based on previous market crashes, investors in stocks could lose as much as 80%, but not many are 100% invested in stocks.
  • We examine the risk exposures of target date funds (TDFs) and Individual Retirement Accounts (IRAs) in the face of various market crashes that could repeat.

Sometimes you get, and sometimes you get got -- Old Farmer’s Saying.

As shown in the following table and graph, market losses occur fairly frequently and last pretty long, although not forever:

Based on the U.S. history of previous market crashes, investors who are currently entirely in stocks could lose as much as 80% of their savings if the 1929 or 2001 crashes repeat. If we have a repeat of the 2008 crash, the loss would be “only” 56%.

But most investors are not 100% invested, and the next crash might not be as bad as 1929, 2001 or 2008, so in the following we look at all the previous U.S. market crashes and at asset allocations of 55% equities, which is the typical allocation for target date funds (TDFs), the most popular investment in 401(k) plans, at $2 trillion.  55% equity is also the common allocation for IRAs, regardless of age. Some will recover from the next crash but many will not. Those near retirement will probably not recover, including many of our 75 million Baby Boomers, and it’s a shame.

Target date fund and IRA allocations

Until now, most of us had forgotten the devastation of 2008 when the typical IRA and 2010 TDF lost more than 30%. Target date funds are not all built alike. There is a wide range of risk at the target date among TDFs, ranging from 10% equity to 70% equity, with a cluster near 55% equity. In the following we examine the average TDF and the safest TDF to provide a range of potential losses.  Although it went unnoticed, the SMART TDF Index, which is the safest, defended quite well in 2008, with only a single digit loss. The following graph summarizes this TDF and the industry.

The average TDF is about 55% in equities near the target date while the SMART Fund is less than 20%. Also most of the balance in the typical TDF is in long term (risky) bonds while SMART is in T-bills and TIPS. Note that these differences are all about risk management rather than timing.

Possible losses in 2020 target date funds and IRAs

It’s worth noting that when the 2010 TDFs lost more than 30% in 2008 they were 2 years away from the target date; beneficiaries in these funds were expected to retire in 2 years. That’s precisely where the 2020 funds are today – 2 years away from the target date.

The following table shows the history of U.S. stock market crashes and how much investors in 2020 funds and IRAs stand to lose if history repeats itself.

How much will 2020 TDFs and IRAs lose if a market crash repeats?

As you can see, potential losses on the typical 2020 TDF are at least 16% and could be as high as 50%, but the maximum loss on the low risk 2020 SMART fund is capped at 16%.

The following chart puts these losses into perspective by showing the return that it takes to recover from a specific loss. For example, you’ll need to earn 100% to recover from a 50% loss.

So you’ve been alerted. Some will recover but many will not. Those near retirement will not recover.  Let’s take a look at how long your remaining savings might last following a market crash.

How long will post-crash leftovers last?

We’ve run analyses on the 4 worst market crashes, hypothetically investing in the two different TDFs: Average TDF (also IRA) and SMART (SLGP) TDF.  The perspective is that a beneficiary with a $1 million TDF or IRA account is retiring when the crash occurs and then withdraws, investing in Treasury bills. This beneficiary uses the 4% Spending Rule designed to make his savings last. The following table and graphs summarize the fate of this beneficiary.

The length of time that remaining savings last is a function of the amount lost and the subsequent return on safe investments, namely Treasury bills.

Even if you stay in the market, it takes decades to recover, as shown in the following exhibit:

Conclusion

There is a well-documented Risk Zone that spans the transition from working life to retirement. Losses in the Risk Zone are devastating because account balances are at their highest and “Sequence of Return Risk” reduces the length of time that savings will last. There are currently 75 million Baby Boomers in the Risk Zone. Many are invested in target funds and Individual Retirement Accounts (IRAs) that are 55% in equities with the balance in risky long term bonds. The next market crash will be exceptionally ugly in its impact on so many people. It may take a while -- like 15 years or so after the next crash -- for these people to run out of money, but they will eventually become society’s burden. 

The current Baby Boomer demographic bubble exacerbates the repercussions of the next market crash, and this bubble will last 20 years so the odds of a crash in that timeframe are high. Boomers really should get out of the way and move to safety. There are tools that can help, including a computer resource called Age Sage that I’ve developed based on my many decades of investment consulting experience to $trillions in assets.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.






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