Households lost trillions in wealth in the last three months of 2018, most recent data from the Federal Reserve show.
These losses starkly illustrate the risks that people face when they need to make retirement and savings decisions mainly on their own.
Many people save for retirement with mutual funds and retirement savings accounts which are fraught with pitfalls. People need to make a variety of consequential decisions, often without having the necessary information and resources. They then end up with too much risk, as a rather large drop in household wealth at the end of 2018 highlighted.
Investing in financial assets for retirement in retirement accounts such as 401(k)s and IRAs is fraught with risks. The main challenge is to manage one’s own money amid the ups and downs of the stock market. People can incur too much and too little risks and lose money both ways. For one, those who save in retirement accounts regularly forget to rebalance their accounts to match their exposure to the market to what they actually want. Say somebody wants to have half of their savings in stocks, typically invested through mutual funds. They then would put $20,000 of a hypothetical balance of $40,000, for instance, into a stock market mutual fund and the other half into a bond fund, when they start. If the stock market does better than the bond fund, over time people will actually have more than 50% of their money in stocks. The risk here is that, when the market tumbles, people will have too much risk for their own taste and they will lose more than they are comfortable with. Such unwanted losses can then lead people to go in the opposite direction and invest too little in the stock market and hold more cash, which means that their money is not earning enough in returns for their retirement. People’s savings will not grow fast enough because first they lose more than they wanted to in the stock market and then they invest with too little risk as they become more worried about losing money in the market.
The most recent three month period highlighted that risk as the share of financial assets invested in stocks fell to 23.8% in December 2018 from 26.3% in September 2018. This meant a loss of $4.4 trillion in just three months. In all likelihood, people incurred more financial risk than they probably were comfortable with during the market upswing that preceded the downturn.
The data also show that, yet again, when people lose money in the stock market, they will move into safer investments such as checking accounts and money market mutual funds that pay little interest. Since the early 1970s, people have moved gradually back into the stock market, often foregoing cheap buying opportunities. The result then are lower-than-expected returns on their investments. And retirement income grows also more slowly than would be possible with other investment strategies.
Household financial data show that people can face massive risks when they need to make long-term financial decisions on their own. Right now, a significant number of people have built up a lot of financial risk in their savings, especially their retirement accounts, which makes them particularly vulnerable to the kind of sharp drops the market experienced in the past three months of 2018.
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