Retirement Plans May Feed This Bull for a While

Small investors are pouring into stock and bond mutual funds in record numbers, which in turn is keeping the stock market up and bond yields down. On Wall Street, however, there is less celebration of this phenomenon than there is concern about what horror will follow it.

If this tsunami of cash reverses, the logical fear is that stock prices will plunge and interest rates will jump.

But here’s a question hardly ever asked today: What if this money flow doesn’t reverse soon--or doesn’t reverse substantially, or for long?

Usually, the most dangerous line uttered in defense of a bull market is “This time it’s different.” But this time something is different: the large sum of money finding its way into stock and bond markets each month via small investors’ retirement savings plans.

Think about how employer-sponsored 401(k) retirement plans work. Each paycheck, employees have money taken automatically from their earnings and deposited in an investment account (or accounts) of their choice. Most employees tend to decide on an investment mix and then leave it alone. It is, after all, retirement money--you’re not supposed to worry about it on a day-to-day basis.

For a stock fund manager, 401(k) money is like an annuity: It just keeps rolling in, month after month. And once in, “that money doesn’t move, it doesn’t turn over,” says Neal Litvack, executive vice president at fund giant Fidelity Investments in Boston. “It provides a very steady asset base.”

That makes it easier for a fund manager to make long-term investment decisions, and to avoid being frightened into selling stocks at the first sign of a setback in the market. Indeed, if you want to keep a bull market alive for an extended period, retirement money may be the best fodder.

Now, consider that there was far less of that particular fodder around during the 1980s bull market than there is today.

The number of businesses offering 401(k) plans has rocketed over the past 10 years, reflecting corporate America’s recognition of aging baby boomers’ dire need to save for the future. A survey of major companies by benefits consultant Hewitt Associates showed that 58% of the firms offered 401(k) plans in 1984. Today, 96% do.

The Investment Company Institute, trade group for the mutual fund industry, figures that the funds now hold $60 billion in 401(k) assets, up from virtually nothing in the mid-1980s.

Combined with annual contributions to IRAs and retirement accounts for the self-employed, the sum of money committed by individuals to long-term investments is mushrooming.

In fact, Fidelity’s Litvack estimates that retirement accounts now make up fully half of his firm’s $210-billion asset base, and that 50% of the money Fidelity takes in each month is via retirement vehicles. Other major fund companies say their retirement flows are smaller--but still very significant. The Vanguard Group of funds in Valley Forge, Pa., estimates that one-third of its monthly cash inflow now is retirement money.

More important for the stock market, in particular, is that while stock mutual funds are getting a good chunk of retirement monies, their share still is a small compared with total retirement savings.

Hewitt estimates that 33% of employees’ 401(k) assets are invested in so-called GICs, or guaranteed investment contracts, conservative accounts that offer a fixed annual yield similar to a bank savings certificate. Another 25% of assets are invested in the shares of the companies sponsoring the 401(k) plans (i.e., employees invest directly in their business by buying the employer’s stock).

Meanwhile, just 19% of employees’ 401(k) assets are in stock funds, and 11% are in bond funds.

But experts say the trend is in the mutual funds’ favor, specifically stock funds. Pressured by the federal government to give employees more savings options, more businesses are offering a wider assortment of 401(k) investments. “Many companies are convinced that it’s in the best interest of the employees to diversify” their nest eggs, says Jack Marsteller, partner in Hewitt Associates’ Los Angeles office.

And because history shows that diversified stock portfolios provide by far the best returns over long periods, many companies are encouraging their employees to rethink the current concentration of 401(k) assets in GICs and other conservative accounts, Marsteller says. When looking 20 years or so into the future, he says, “There’s a realization that there’s a cost associated with being too conservative in investing.”

All of this points to a sustained--and increasing--flow of money from small investors into financial markets, one that may surprise the market’s bears, who may be forgetting how much investing now is automatic: People don’t have to think about writing that check.

Won’t people be frightened away at the first sign of market turmoil? Some will, of course. But it’s important to remember that millions of Americans have convinced themselves that they’re long-term investors. That’s why 401(k) plans and other retirement accounts exist. It will take much more than a short-term setback on Wall Street to reverse that mind-set and stop this money flow.

401(k) Plan Assests How assets of 401(k) retirement plans are allocated, according to a survey of large corporate plans. These figures represent the employees’ investment choices (not counting employer contributions). GICs are guaranteed investment contracts, which are similar to bank CDs.

GICs: 33%

Employer stock: 25%

U.S. stock funds: 19%

Bond funds: 11%

Money market: 4%

Balanced funds: 3%

Foreign stock funds: 1%

Other: 4% Note: Some figures are rounded Source: Hewitt Associates