How Much Damage Did the Market Crash Do to Retirement Security?
The stock market collapse of 2007-2009 was the worst since the 1930s, and rivaled in modern times only by the crash of 1973-74. But the real question for those counting on equities to help fund their retirement security is: “What are my long-term prospects in the wake of the carnage?”
In a new paper, TPC’s Eric Toder, along with the Urban Institute’s Karen Smith and Barbara Butrica, look at how investors would fare under three post-crash market scenarios. And what they found may surprise you a bit. Under one, your portfolio gets back to where it would have been, absent the crash, by 2017. That would take large, but not unprecedented, stock gains over the next decade. If equities merely revert to their historic annual returns from the market’s December 2008 level, you’ll permanently remain far behind where you would have been if there had been no collapse. And if stocks respond as they did in the decade after the 1970s crash—well, you don’t want to know.
Now for the numbers. First, the researchers used the S&P 500 Index. Based on historical data, they assumed a real, inflation-adjusted, average growth rate in the index of 3.5 percent. Add in reinvested dividends and subtract 1 percent in administrative costs, and stock portfolios “normally” increase by 5.5 percent. You should also know they measured future returns from December 31, 2008, and not from the March, 2009 market bottom that was 27 percent lower.
If you had invested $100 in December, 2007 and the market hadn’t crashed, you’d have had $171 (in 2008 dollars) by 2017. The authors figure you still can get there, but it would take an implied average real annual growth rate of 9.4 percent in the index until 2017. That’s less than the 13 percent we saw in the 90s and the 12 percent from 1955 to 1964, but it is awfully robust.
If instead, the S&P index had simply resumed its historical 3.5 percent real growth rate after 2008 as if nothing had happened, you’d have just $100 in 2017—exactly where you started in December, 2007. But it could be worse. If we get a repeat of 1974-82, when the S&P grew at an average annual rate of minus 4 percent, your 2007 nest egg of $100 will turn into a whopping $60 by 2017. Ouch.
Aha, you say, all these scenarios are far too pessimistic. After all, the market has recovered about half of its losses since it bottomed last spring. But remember the 1930s. The market lost 86 percent of its value between 1930 and 1932, rebounded strongly until 1937 but crashed again. In the end, it took nearly three decades for the Dow to find its 1929 high. What matters to future retirees is the long-term trend, not a nine-month rebound.
Keep in mind that there will be big differences in how the crash affects individuals’ retirement prospects, depending on their age and income. Older people are likely to lose more because they had more invested before the crash and have less time to recover their losses before they retire. But younger people may benefit because they’ll have the chance to buy stocks at bargain prices. Because the wealthy are likely to own more stocks, they’ll lose more if the market does not bounce back, but gain more if it recovers. In contrast, low and middle-income individuals own few stocks and rely mostly on Social Security for their retirement. They are little affected by the market crash and most can recover their losses by working for an additional year.
There is, of course, no way to predict the future. But this paper will give you a sense of just how bad the last couple of years were for our retirement savings.