How Much Have Pension Pots Dropped & Why?

In 2022, many individuals grew concerned as their retirement savings appeared to shrink. This article explores the magnitude of these drops and the economic factors that contributed to them, examining how different pension structures were affected.

Quantifying the Drop in Pension Values

Pension values experienced notable declines across the board in 2022, reflecting a challenging year for global financial markets. Overall, global pension assets, measured in U.S. dollar terms, saw a decrease of 16.7%. This represented the largest drop since 2008, bringing asset levels back to those last observed in 2019. The world’s 300 largest pension funds collectively shed 12.9% of their value.

In the United States, public pension funds recorded preliminary average investment returns of -10.4% in 2022. The median investment return for state pension systems was -5.2%, falling below their typical assumed rates of return, which average around 7%. This led to an estimated 6.6% decline in the national average funded ratio for U.S. state and local public pension plans, moving from 83.9% in 2021 to 77.3% in 2022.

The broader market indices also underscore the challenging environment for investments. The S&P 500 Index, a common benchmark for U.S. equities, finished 2022 down 18.1%. The NASDAQ Composite, which includes many technology stocks, experienced an even steeper decline of 33%. The bond market, as measured by the Bloomberg U.S. Aggregate Bond Index, also saw a significant downturn, dropping 13%. This resulted in a traditional 60% stock and 40% bond portfolio losing 16% of its value, marking one of the worst years for this diversified strategy.

Economic Factors Contributing to Declines

Several interconnected macroeconomic factors contributed to the widespread decline in pension values in 2022. A primary concern was the surge in inflation, which reached its highest levels in decades. High inflation erodes the purchasing power of money, impacting both current and future investment returns. This prompted central banks globally to take decisive action to stabilize prices.

To combat persistent inflation, central banks, including the U.S. Federal Reserve, aggressively raised interest rates throughout 2022. This rapid increase in borrowing costs had a direct and negative impact on bond prices. Bond prices and interest rates share an inverse relationship, meaning as interest rates rise, the market value of existing bonds with lower fixed interest payments typically falls.

The rising interest rates and inflation also significantly affected equity markets. Higher interest rates make it more expensive for companies to borrow money for expansion and operations, potentially reducing future earnings and making stocks less attractive relative to fixed-income investments. This combination of factors contributed to a broad downturn and increased volatility across global equity markets. For the first time in several decades, both stock and bond markets experienced simultaneous declines, creating a particularly challenging environment for diversified portfolios.

Impact on Different Pension Structures

The economic shifts of 2022 affected various pension structures in distinct ways, primarily influencing how investment losses or gains were realized and managed. Defined Contribution (DC) plans, such as 401(k)s, saw a direct reflection of market performance in individual account balances. These plans are funded by contributions from employees and often employers, with the accumulated value dependent on the investment performance of the chosen funds.

The downturn in equity markets and bond values directly reduced DC plan balances. Participants in these plans bore the direct impact of market volatility, as their retirement savings are held in individual accounts that fluctuate with asset prices.

Defined Benefit (DB) plans, which promise a specific income stream in retirement, experienced a more nuanced impact. While these plans also hold assets that saw declines in 2022, particularly in their bond portfolios, the rising interest rates had a significant and often positive effect on their liabilities. Higher interest rates reduce the present value of future pension obligations, meaning the cost of fulfilling those promises becomes lower. This reduction in liabilities often offset, or even outweighed, the asset losses, leading to an improvement in the plan’s funded status. For instance, corporate DB pension plans in the aggregate reached an estimated 100% funded status in 2023, up from 98% in 2022, partly due to the liability reduction effect of higher rates.