What the 2008 Stock Market Crash Means for Retirement Security

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Abstract

The one-third drop in the S&P 500 index between year-end 2007 and 2008 raises concerns about retirement security since Americans now hold more equities through their retirement plans. Those near retirement will fare the worst because they have no time to recoup their losses. Midcareer workers will fare better because they have more time to rebuild their wealth. They may even gain income if they buy stocks at low prices and get above-average rates of return. High-income groups will be the most affected because they are most likely to have financial assets and to be invested in the stock market.

Executive Summary

Between year-end 2007 and 2008, the S&P 500 index fell by over a third—the largest single-year drop in the index since 1974. Any large decline in the stock market is reason for concern, but this one is particularly worrisome because Americans have a much larger share of their retirement assets invested in equities than they did in the past. Over the past 25 years, employment-based pensions have been shifting from traditional defined benefit (DB) plans that require employers to manage retirement savings to defined contribution (DC) plans that place the investment responsibility on workers. Consequently, the share of households holding wealth inside retirement accounts has risen over the past two decades, with the bulk of these retirement assets invested in equities.

This study examines how the 2008 market decline could affect future retirement incomes. We compare alternative recovery scenarios with a "no crash" scenario that assumes the stock market had not collapsed in 2008 but instead had increased at its long-term historical rate from the 2007 level. We simulate three possible recovery scenarios: (1) a "no recovery" scenario in which the stock market does not rebound but instead resumes its long-term historical rate after 2008; (2) a "full recovery" scenario in which the stock market fully rebounds after 10 years to the projected no-crash level in 2017; and (3) a "partial recovery" scenario in which the stock market rebounds to halfway between the levels projected under the no-recovery and fullrecovery scenarios after 10 years.

We examine retirement resources at age 67 before and after the stock market collapse and compare these outcomes by sex, marital status, race/ethnicity, education, and retirement income quintile. We report results separately for those born from 1941 to 1945 (pre-boomers), from 1951 to 1955 (middle boomers), and from 1961 to 1965 (late boomers). When the stock market crashed in 2008, the pre-boomers were between ages 63 and 67, the middle boomers were between ages 53 and 57, and the late boomers were between ages 43 and 47.

The effect of the 2008 stock market crash on future retirement incomes will vary by age, income level, and assumptions about future market performance. Most pre-boomers and boomers will be affected in some way since about 70 percent of them are estimated to have owned stocks in 2008. The effect of the stock market decline on their income at age 67 will depend on the initial share of assets held in equities, the level and composition of future contributions, the number of years they have to rebuild their assets, the relative importance of asset returns as a share of retirement income, and the future performance of the stock market.

• Those farthest from retirement fare better than their older counterparts. Under all the scenarios, late boomers experience smaller income losses at age 67 than other birth cohorts. Because they had fewer years to accrue wealth, late boomers had less wealth (and fewer equities) in 2008 than earlier cohorts and less to lose when the market crashed, even though they were more likely to have DC plans and to invest in equities. They will also have more years to restore their lost wealth from both new stock purchases and future appreciation before retirement.
• For late boomers, average household income per person declines 10.8 percent from $60,300 under the no-crash scenario to $53,800 under the no-recovery scenario but it increases 5.0 percent to $63,300 under the full-recovery scenario.
• Pre-boomers likely will not have enough time to recover all their losses before reaching age 67. Consequently, their average income falls under all scenarios, ranging from a 13.5 percent decline under the no-recovery scenario to a 10.1 percent decline under the full-recovery scenario.
• High socioeconomic groups will be most affected—negatively and positively—by the stock market collapse because they are more likely than low socioeconomic groups to have retirement accounts and financial assets and to be invested in the stock market.
• Middle boomers in the highest income quintile will have only 81 percent of their nocrash income under the no-recovery scenario but 105 percent under the full-recovery scenario.
• In contrast, middle boomers in the lowest income quintile will have 91 percent of their no-crash income under the no-recovery scenario and 101 percent of their nocrash income under the full-recovery scenario.
• The long-term effects of the 2008 stock market crash on retirement incomes will depend on the stock market performance going forward.
• Under the no-recovery scenario, there are no winners. About half of 67-year-olds in each cohort will see their income drop 2 percent or more under this scenario, but many will lose much more. About one in five in each cohort are expected to lose at least 10 percent of their no-crash income at age 67 if the stock market does not recover.
• The full-recovery scenario generates no winners among pre-boomers, but more winners than losers among middle and late boomers. More than two in five preboomers are expected to suffer a loss in their retirement income, and about one in six will experience declines of at least 10 percent. In contrast, more than one-third of late boomers will have higher income at age 67, but only 9 percent can expect gains of 10 percent or more.

Doing everything that financial planners recommend—maximizing contributions to retirement accounts and rebalancing portfolios away from stocks when near retirement age—may be the best strategy for building retirement savings, but it leaves people substantially exposed to market risks. However, timing matters in unpredictable ways, and market swings affect different cohorts differently. Those now furthest from retirement have the best chance of recovering losses from the recent crash and even coming out ahead if the market rebounds. For those at or near retirement, time has almost run out.

As DC pensions continue to replace DB pensions, people are increasingly likely to be directly affected by stock market fluctuations. Many are calling for reforms that expand pension participation among workers. For example, President Obama has proposed requiring employers to offer automatic enrollment in IRAs, which are funded solely through worker contributions. Our results show that most low-income retirees will not be affected by the 2008 stock market crash because they have little, if anything, saved in equities. But research shows that participation, contribution levels, and investment allocations in retirement plans are heavily influenced by employer default rules. Proposals requiring automatic enrollment could lead to much higher participation in DC plans by low-income workers and should be designed in ways that offer some protection from market risks. Sensible default investment strategies that reduce exposure to risk near retirement could improve retirement outcomes for many retirees.

Target maturity or life-cycle default investments that automatically adjust workers' portfolios to reduce stock market exposure as they age can help reduce risks. Other possible solutions include establishing retirement accounts that earn a rate of return guaranteed by the federal government or developing equity products that provide some guarantees, with government backstops and insurance, for low- and moderate-income investors. Beyond the risk of losing their wealth just before retiring, workers also face the risk of depleting their assets after retirement. Options for retirees who wish to minimize both financial and longevity risk should include purchasing annuities that guarantee a stream of lifetime income. Of course, annuitization does nothing to reduce risk while workers are accumulating assets.

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