How Will the Stock Market Collapse Affect Retirement Incomes?

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Abstract

Urban Institute projections suggest the stock market collapse will have small effects on most Americans' retirement incomes. It's estimated that 37 percent of Americans born between 1941 and 1965 owned no stocks when the market crashed in 2008 and that income from assets will account for a small share of retirement income, even for those with stocks. For most retirees, Social Security provides the majority of income. Had Social Security been invested in private accounts with equities, the impact of the crash would have been much larger—positive or negative, depending on one's birth cohort and on future market performance.

Introduction

Between December 2007 and December 2008, the S&P 500 index fell by over one-third. As a result, retirement accounts lost about $2.8 trillion, or 32 percent of their value (Soto 2008). Individual investors also lost substantial wealth in equities outside of retirement accounts. Urban Institute simulations show that the long-term effects of the 2008 stock market crash on retirement incomes will depend on the stock market’s future performance, as well as investors’ market exposure at the time of the crash, the amount and composition of their future contributions, the proportion of their retirement income coming from assets, and how many years they have to rebuild their assets.

Scenarios to Assess the Long-Term Effects of the Stock Market Collapse

This brief assesses the impact of the current financial crisis on individuals’ retirement resources using projections from the Urban Institute’s Dynamic Simulation of Income Model (DYNASIM3). DYNASIM3 is a dynamic microsimulation model that projects retirement income, including Social Security, private pensions, and financial assets, accounting for many of the demographic and economic changes expected to impact the aged population. (See Favreault and Smith [2004] for a more complete discussion of DYNASIM3.)

The analysis uses DYNASIM3 to compare outcomes under a scenario in which the stock market did not crash with outcomes under alternative recovery scenarios. The no-crash scenario assumes the stock market had not collapsed in 2008 but instead continued to increase at its long-term historical rate. The three alternative scenarios capture the market decline in 2008 and then consider different patterns of recovery.

1. Under the no-recovery scenario, the stock market does not rebound but instead resumes its longterm historical rate after 2008.
2. Under the full-recovery scenario, the stock market fully rebounds over 10 years to its projected no-crash level.
3. Under the partial-recovery scenario, the stock market rebounds to halfway between the 2017 levels projected under the no-recovery and fullrecovery scenarios.

The simulations assume that investors rebalance their portfolios to maintain the target allocation for their ages, and that they therefore purchase more equities as prices fall. But the simulations also assume that people will continue making the same contributions to retirement accounts, working at the same jobs for the same pay, and retiring at the same ages predicted under the no-crash scenario. The alternative simulations only change retirement accounts and financial assets. They assume that other income sources are unaffected by the stock market collapse. Further, they do not account for the effects of recent declines in bond and housing values or the effects of the current recession on employment, earnings, or employer-sponsored pension benefits. Therefore, the simulations only partly reveal the potential impact of recent economic events on total retirement income.

The brief describes what household incomes will be when individuals born between 1941 and 1965 reach age 67. It reports results separately for those born from 1941 to 1945 (pre-boomers), 1951 to 1955 (middle boomers), and 1961 to 1965 (late boomers). When the stock market crashed in 2008, the pre-boomers were 63 to 67, the middle boomers were 53 to 57, and the late boomers were 43 to 47.

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