Hello there! I am trying to become financially literate this year. I have listened to a bunch of people refer to the 2008 economic downturn, and how it set back their retirement savings.
I was 8 at the time, so I don’t have much life experience in economic recessions beyond COVID.
I understand that if you have retirement savings (401k or IRA), the money is invested in the stock market. When there is a downturn, those assets are worth less. But retirement accounts are long-term, so wouldn’t the assets just regain their value after an economic recovery? Why would it set you back permanently? Can’t you just wait?
Thank you! 🙌
In: Economics
Some of it is people misunderstanding…
There was a time when the recession caused the stock market to fall about 50% from it’s highs and that can be scary to see. Some people did panic sell and realized big losses. But if those people didn’t panic sell, and kept their 401k contributions in place, they actually probably came out better in the long run. Their holdings that lost value eventually bounced back, and any investment money invested at the bottom saw substantial gains.
Much of it is in investments that were expected to grow at a higher rate than they actually are, resulting in less retirement money overall.
Retirement accounts are long term for those still working. If you are not and actively using that money or about to, you don’t have the time necessary to wait until those losses are recouped.
Relative to a world where that downturn never happened, the account certainly has less value given that we live in a world where markets did fall. However, this is somewhat wishful thinking – the values of the stocks were artificially too high prior to the downturn. If the market were perfect, we likely would have gotten to the same place we’re at now, just with both less down *and* less up.
But there are a few other ways that an acute economic downturn can have a lasting impact on retirement savings. First, a loss or reduction of income usually translates to less retirement savings. You can’t put money into your 401k when you don’t have a job or need your entire paycheck. Some people may have even dipped into their retirement accounts to make ends meet – something you *can* do but suffer heavy penalties for.
Second, not everyone is a position to wait for retirement. If you were intending to retire in 2008 and start drawing from your savings, that would mean locking in those deep losses – at least for a few years. This drove at least some older people to work for longer than they were intending or have a more modest retirement. This is most obvious for people who were just about to retire, but it also had a smaller effect on people intending to retire in the next 5-10 years.
> But retirement accounts are long-term, so wouldn’t the assets just regain their value after an economic recovery? Why would it set you back permanently? Can’t you just wait?
Someone’s retiring every day. If the stock market wipes out their retirement today, they can’t retire. Or they can, but they won’t have enough savings and are going to have to find employment. If the recession’s recovery takes 5 years, that means everyone who was going to retire for 5 years either has to wait or find post-retirement employment. If the recession’s recovery doesn’t quite make it back to 100% of where it was, they have permanently lost retirement money.
You also have to reckon that once you start taking money *out* of retirement and not putting money *in*, you have a problem. It *was* growing because money only went in. But now in addition to the returns from investments, you are taking money out. If the market isn’t doing well enough, you’ll be taking more out than the investments are making. That means you start slowly losing money, and every withdrawal makes you lose money a little more quickly until suddenly you aren’t sure if the money will last the rest of your life anymore.
Imagine you had like, 30 years of money saved up and a recession destroys it down to 3 years. Maybe the recovery happens in 2 years. But you have to figure if the “bad part” took 1 year, you lost 1/3 of your remaining savings before recovery started happening. So even if it was a perfect, instantaneous recovery, in 1 year you lost 10 years of retirement savings, and you’re in the sort of financial condition you were hoping it would take at least 10 years to reach. If another recession happens you’re broke. And they’re happening about every 5-10 years now.
And if you’re 65 in a highly skilled position, you can’t just ask your boss to let you work 8 more years while the economy sorts itself out. If you start showing diminished productivity because of aging, they’re going to have to fire you.
Worse, if you can stay, odds are someone was going to be promoted to your position after you retire. But now you aren’t retiring. Now that person’s making less money without the promotion, which means they’re putting less in THEIR retirement, so now they’re kind of getting double screwed.
Further, every company I’ve worked for has had as a benefit a “match”, some percentage where if I put that much into my retirement they’d put in that much too. It’s free money. It’s also one of the first benefits every company I’ve worked for has cut when a recession starts, because it doesn’t hit people as hard as a salary cut.
And you have to figure if people can’t stay, and have to find post-retirement work, now they are taking jobs OTHER people could be taking. Those people need those jobs so they can save for retirement. But if they can’t find a job because too many retirees are competing with them, they’re both unemployed and not saving for retirement…
## Really short answer:
“Long-term” doesn’t help you if you are retiring this year and your savings has been hit so hard you realistically only have 2-3 years of savings left. You’re 24 right now so you’ve still got 8 or 9 recessions before retirement. Imagine you’re 64, already planning the retirement party, and already worried things are going to get financially rough when you’re 75.
The big issue was for the people who were retiring in the window of the downturn. Their retirement fund evaporated at the time when they went to cash out.
Once you retire, you live on the interest accrued on your retirement account **and by taking money out of that retirement account**. If the interest you earn is low (or even negative when you account for the market crash), then you have to withdraw more to cover your costs, and withdrawing money means permanently reducing the interest you can earn the following year.
Okay real numbers. You need $50,000/yr to live comfortably and go on vacation sometimes with your grandchildren. You’ve got $1,000,000 in your retirement account. Awesome. That’s 20 years of expenses covered even without interest. You’re 70 years old. This is good.
Fast forward. $850,000 in the account. 73 years old. Cool cool.
Market crash! $425,000 in the account. Jesus fuck. 73 years old.
You skip vacation and cut other expenses. $390,000 at 74.
$360,000 at 75
$330,000 at 76
Miracle market recovery! $660,000 in the account. 76.
Even though the market halved in the crash and doubled in the recovery, you’ve lost almost $200,000 in 3 years. Living like crap and skipping vacation and missing out on theme parks with your grandkids, and at the same time, your bank balance looks like you’ve been spending $66,000/year.
And if the market didn’t recover, you’d live like crap and run out of money at 87.
And if you spend like you’re used to, you’ll run out of money at 82.
I used big numbers to make the math easier. Most people don’t have $1,000,000 in the retirement account.
Run the same exercise with a starting balance of … 401k and you’ll see just how devastating this could be.
In 2007 the Dow Jones Industrial Average peaked in October, and then the stock market took a tumble and the value of that average basically dropped in half over the next 16 months. The Dow didn’t get back to its October 2007 level until January 2013. So basically that was 5 years wiped out.
If you’re young, losing 5 years of progress on retirement savings is something you can manage. If you were, say, 60 in 2007, and expecting to retire in 2012… losing that 5 years would have been pretty significant to you.
You actually have a pretty good understanding, and a lot of people did bounce back.
* A lot of people lost jobs, or took lower salaries, or didn’t get bonuses for a few years, or something. They made less money, and couldn’t contribute much for retirement.
* Some people panicked, and sold their stocks, and didn’t benefit when stock prices went to.
* Some people needed to pull money out of investments/retirement funds to get by, and pulled out at lower prices and never got that money back.
* Lots of people didn’t have diverse retirement funds in index funds, they might have had stock from their company, or they might have invested in stocks they picked. Many of these stocks did poorly.
* For lots of people, retirement savings isn’t a 401K, it’s a small business they run, and some of these went broke.
* For some people- their retirement wasn’t a stock fund, it was an expensive home they bought with a low adjustable mortgage. They started with a low interest rate- but it adjusted/jumped up after a promotional period, and they couldn’t pay the higher rate. They tried to refinance, but they couldn’t- even though mortgage rates were low- because they were out of a job, or because their house value went down, or because they’d missed payments and their credit score was low. So they couldn’t get a new loan. So they defaulted on the loan and lost the house and their savings. A lot of people treat their house as their retirement savings.
* Some people already were retired and were taking money out of their retirement fund every month. They never saw the rebound.
You have a lot of the right ideas already. What happened in ’08 was people panicked, were worried it was going to keep getting worse or not bounce back, and stopped their losses by getting their money out of the assets that did badly. We now know that if you left your account alone it would have bounced back, but people at the time had doubts and didn’t want to wait it out.
Latest Answers