401(k) – The Next Bubble?

There’s a really large proportion of people who are more-or-less passively “investing” in 401(k) type funds — a large enough proportion that if, in addition to the speculative bubble in mortgages that destroyed all sorts of paper “wealth” over the last 12-24 months, a macro-bubble exists, a lot of people are going to be all sorts of financially FUBAR.

The unintended consequences of government intervention in individual retirement planning is terrifying: it’s so massive and affects so many people. I suggest that, as the working population grew over the last several decades, this process created its own macro bubble, for which there are a few contributing factors:

1. Even if prospects are poor, it seems foolish to turn down “free” and tax-deferred money.
2. The individual has relatively little control over the allocation of his funds, especially he can not “cash & hold”.
3. The individual can’t liquidate his holdings unless he’s unemployed, deqlinquent on your mortgage, or otherwise altogether financially f**ked.
4. There is no opt-out mechanism: even if fund managers think there is nothing worth buying, they have to buy.

For most people making small/minimum contributions, even abstaining from contributing to these plans would only make a barely noticeable difference in their take-home pay. Individuals, faced with the prospect of “free money” via employer-matched funds, as well as tax deferral, have a huge economic incentive to invest in these vehicles. People, faced with severe economic incentives to invest in these vehicles (“matching funds” and tax deferral) will more often than not, put 3% or 6% or 10% into a 401(k) type plan. Corporations get to include matched funds as part of total compensation, which is tax deductible, it’s like health insurance: “We offer this awesome Health Plan/401(k) plan as part of our total compensation package. You don’t have to sign up, but you don’t get any substitutions if you don’t, though.”

So, why wouldn’t someonesign up? Keep in mind that they’re not actually making a trade-off between A and B, they’re making trade-offs between A and nil. Now, the individual has essentially delegated her retirement savings to the fund. And the fund takes care of her retirement, so she doesn’t have to &mash; indeed 60% of working Americans think of their 401(k) as their primary retirement fund! But here’s the rub: The level of control which any individual can exercise over his account is relatively limited, for instance, Vin Suprynowicz tried to convert his holdings to physical gold, gold ETFs, mining shares, and finally to cash — he couldn’t do any of these! There are also strict limits on how and under what circumstances an individual may withdraw from her account, but typically one must be unemployed, delinquent on her mortgage, or have suffered the death of an immediate family member.

The bottom line is that people are contributing to these funds because they really don’t have another meaningful option. This is interesting, and terribly frightening, because I don’t think we’ve seen the tip of the iceberg yet.

The “value” of these funds have previously been buoyed by (essentially) forced contributions burgeoned by a growing workforce. Funds were being bought because money was coming in, and managers had no other option but to buy.

As the growth of the workforce slows or potentially declines, what happens to the values of all these funds? Or, to make mattes even worse, when the baby-boomers begin drawing down these funds (i.e., selling them) in order to draw a retirement income, what happens to their value when there’s nobody buying them on the other end?

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(H/T: Vin Suprynowicz’s recent editorial.)