The Stock Market Faces Headwinds From Falling 401K Contributions

There a relatively new correlation between the stock market and employment, 401K contributions, that isn't receiving the attention that it deserves. Over the last 20 years, the stock market has enjoyed the benefit of a positive inflow of cash from 401Ks and retirement plans. It is likely that you will see this tailwind become as headwind for the market as more people draw on 401Ks and fewer people contribute. While there may be a net positive inflow in different sectors, inflows will be significantly lower than in the past.

There are three factors driving increased use of retirement savings. First, people are getting older and need income to live. Second, the unemployed will need a way to live and retirement savings is much cheaper than consumer debt. Third, even those that keep their job will need to need to paydown debt. Borrowing against a retirement plan will be attractive to many. In short, people are going to start using retirement accounts more and more.

This capital drain will cause some headwind for the market. This drain is going to occur at the exact same time as people reduce their commitment to retirement savings. There are three factors which will make people realize that saving for retirement makes no sense when they face insolvency in the present.

First, many of the unemployed have lost access to 401K plans which will constrain the inflow of capital into the market. They can't contribute a portion of a salary even if they have found a parttime job. Beyond the loss of employee contributions, the market is going to lose capital committed by employers as a match. In the net, the capital inflows from retirement plans will be growing more slowly over the next few years.

Second, companies are looking for ways to cut costs. As part of this initiative, employee benefits are under constant scrutiny. This scrutiny may play out in 1 of 3 ways. Companies may eliminate the benefit outright. Even if they keep the benefit, they may reduce or alter the matching payments. Even if the companies keep the benefit with the same matching terms, the market will still feel the loss of inflows if the company changes the match from cash to restricted stock. Given the labor market, it is difficult to image many companies increasing the capital allocated to matching retirement savings for employees.

Third, the most likely factor in reducing retirement savings will be the deleveraging of America. It is very difficult to justify saving for the future when the present is insolvent. Americans will shift resources currently set-aside for retirement to paydown debt. This process will be exacerbated by banks which are increasing interest rates and fees on access to credit. The basic problem is that consumer debt isn't tax deductible where retirement income is.

To give you some idea of how unfavorable retirement saving is vs consumer debt. If an employee puts away $1,000 with a $1,000 employer match, it will be worth almost $300,000 when the employee retires after 30 years (assuming an 8% return). After taxes, it will be worth something less. $1,000 of consumer debt at 14% will be almost 5 million dollars after 30 years. It isn't going to take a CFA for people to figure out that retirement savings simply makes no sense when they owe any consumer debt much less 2 trillion dollars of it.