Question:
Has the advent of the 401K retirement plan impacted the stock market? It seems to me that the massive flow of cash that must be invested immediately would drive up prices. I understand that prior to 401Ks, retirement plans tended to invest in the host company's stock rather than the general market.Answer:
In principle, if most companies offering retirement plans switched to 401(k)'s simultaneously and no new stocks were issued (i.e., no change on the supply side of the stock market), I would expect a substantial increase in the stock prices, as you have described. In practice, the roll-out of 401(k)'s has been gradual and coincident with many IPOs and structural changes in the stock market. As such, the actual impact of 401(k)'s on the stock prices may be challenging to ascertain.
To be clear, a 401(k) is a defined contribution plan. Under it, a company deposits a specified amount in an employee's retirement account, whereas the employee makes all investment decisions, subject to the plan's constraints. Typically, investment options comprise stocks (possibly including the company's stock), bonds, and other financial assets.
Prior to 401(k)'s, companies tended to offer defined benefit plans. Under such a plan, a company promises to make pension payments to an employee upon his or her retirement. These payments are based on a formula that takes into account the employee's salary, years of service, and other factors. Such a plan would not normally involve setting up an account for the employee while he or she is serving for the purpose of investing in financial assets.
