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The Price of Uncertainty: Target-Date Funds and Stock Volatility
What a prolonged debt ceiling fight could cost retirement investors.
The countdown to a federal fiscal crisis got a bit more frantic last week, when the nonpartisan Congressional Budget Office projected that if the federal debt limit is not raised, “there is a significant risk that at some point in the first two weeks of June, the government will no longer be able to pay all of its obligations.”
President Joe Biden and congressional Republican leaders have met to discuss solutions but plans to resolve the problem are still pending.
Uncertainty about a possible U.S. default on its debts is injecting volatility into global financial markets, and while the exact outcomes are uncertain, history offers some sense of what could happen.
The U.S. has had some form of a debt cap since 1917, and since World War II, the ceiling has been raised or suspended 102 times—the last in 2021. The federal debt limit is $31.4 trillion.
In 2011, Congress raised the borrowing limit two days before the Treasury was projected to run out of money, agreeing on July 31 to the terms of the Budget Control Act of 2011, which passed the next day. Despite meeting the deadline, the crisis prompted Standard & Poor’s to downgrade the U.S. credit rating to AA+ from AAA on August 5.
In the run-up to that move, the dollar’s value dropped, and U.S. stocks fell: The S&P 500 Index fell 17% between late July and mid-August.
For investors in 401(k) and 403(b) plans, sinking stocks mean lower retirement plan balances, which can be particularly tough on retirees or near-retirees who had plans for a larger nest egg.
Using data from ISS Market Intelligence’s Simfund, PLANSPONSOR created a few scenarios showing the drawdowns investors in different vintages of target-date funds could face if stocks behave similarly in the coming weeks if a deal is not reached.
The data show that at the end of the first quarter of 2023, more than $1.5 trillion invested in target-date funds, and of that, $861.7 billion was allocated to U.S. equities.
A 10% equity-market drop would result in $85.2 billion lost from those retirement accounts. With a 15% drop, the damage would be a loss of $127.8 billion. If stocks dropped 20%, $170.3 billion could be wiped out.
ISS Market Intelligence Simfund, like PLANSPONSOR, is owned by Institutional Shareholder Services Inc.You Might Also Like:
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