How to invest your 401K if the U.S. Treasury defaults

People wonder if the U.S. debt ceiling is not raised and the Treasury defaults how will that affect their 401K? They wonder what is the safest place for 401K funds during a Treasury default. The answer is that a 401K is simply a container that holds assets similar to what you could buy outside of the 401K. With a 401K in the account owner’s mind this account value is the quantification of his or her future retirement and thus a decline in its value makes one feel worse than if a taxable account went down in value.

If the Treasury defaults this would cause a panic and presumably corporate bonds, stocks and real estate would be hurt. Professional investors might even buy more Treasuries as a safe haven even though the Treasury was in default! Possibly people will buy gold and silver.

foreign currencyIs foreign currency the answer?

   A Treasury default would create condition of austerity (meaning there would be less government subsidies, welfare, etc.) and this could tip the economy into a recession. So that means high quality bonds would go up. But in a recession poor quality bonds will go down in value because of an increase in default risk. So there would be a panic like the Titanic passengers fighting over a seat in a lifeboat as investors rush to buy AAA rated bonds. A cold, wet, leaky lifeboat is better than drowning. This is called “crowding in” where people pay high prices for AAA quality bonds pushing interest rates to absurdly low levels. The Japanese government’s ten year Treasury bond went down to about 1.5% yield as Japan’s finances became worse because of crowding in.

So it is all about seeking safety and avoiding the hidden risk of poor quality bonds disguised as high quality bonds. That means everyone should be careful that their Money Market Mutual fund does not hold Greek or European bank issued commercial paper, since a Eurozone sovereign default will hurt European banks.

Most 401K’s have a short term government bond or short term high quality bond choice. That might be a place to invest, even under the threat of inflation, so as to avoid losses from another banking crisis. In the near future, the risk of loss of principal in the stock market and real estate market is greater than the risk of loss due to inflation that hurts or may in the future hurt bonds, assuming bond maturities are short term.

I wrote a blog post “Are your funds trapped in a 401K” and “Prepare for a crash”.

Investors should seek independent financial advice.