The Severity Of The Impact Of The Stock Market Crash Of 2008-2009 On The Wealth Of U.S. Workers

KyoungTae Kim

University of Alabama – Department of Consumer Sciences

Sherman D. Hanna

Ohio State University (OSU)

January 10, 2016

Journal of Financial Planning, Forthcoming

Abstract:

  1. This research examines the potential impact of the stock market crash of 2008-2009 on U.S. working households. The Great Recession caused financial problems for many households in terms of unemployment, business losses, and decreases in real estate values, but the broadly based decreases in stock indexes impacted households in all areas of the United States.
  2. Among households age 30 to 70 with a head employed full-time, the ratio of equity assets to total wealth (net worth plus human wealth) had a mean value of 4.2%.
  3. The decreases in stock market indexes between 2007 and 2009 had substantial impacts on the wealth of only a small proportion of working households, with a mean potential loss in wealth due to stock market decreases of only 1.3%.
  4. The relative impact of the stock market declines was highest for the oldest working households, but the mean potential loss in wealth for that group was only 1.9%, and only 5% of households in that age range had a potential loss of 8.0% or more of wealth.
  5. By framing the potential wealth loss from severe stock market decrease as a percent of wealth including human wealth, financial advisors can add another perspective to assist clients in thinking rationally about portfolio choices.

The Severity Of The Impact Of The Stock Market Crash Of 2008-2009 On The Wealth Of U.S. Workers – Introduction

The Great Recession began in December 2007, and officially ended in June 2009 (National Bureau of Economic Research Business Cycle Dating Committee 2010), although high unemployment, substantial drops in housing prices and high foreclosure rates continued for years after 2009. The impact on the stock market was also severe. For instance, the Dow Jones Industrial Average reached a peak before the Great Recession of 14,088 on October 1, 2007 and decreased to 6,547 by March 9, 2009, a decrease of 54%. Bricker, Bucks, Kennickell, Mach, and Moore (2011) reported that the mean net worth of U.S. households fell from $595,000 in 2007 to $481,000 in 2009.

U.S. workers have become more responsible for their own retirement savings because of the replacement of defined benefit pension plans by defined-contribution pension plans, which requires the ability to manage asset allocation. The ability to manage these portfolios efficiently can have an important impact on financial well-being in retirement (Browning and Finke 2015). However, many investors are prone to make financial mistakes due to the lack of market experience for young investors and a decrease in cognitive ability for some older investors. Many investors have fears about investment decision (Budgar 2011), anchoring biases (Astorino 2015), and misperception of risk (Carpenter 2013), especially during periods of economic recession. One role for advisors is to communicate with their clients to overcome their market fears. Vanguard quantified the value of wealth management advice as a total value added ofabout 3%, considering the contributions of an  adviser in the areas of rebalancing, behavioral coaching, access to research, strategy, and income source selection (Astorino 2015). For instance, a financial advisor could inform a client about the history of stock market recoveries after bear markets (Leonard 2009).

Another issue that financial advisors could help clients with is identification of the share of equity investments in the total wealth of the household. For instance, a young worker might have 100% of her financial investments in stock funds, but those investments might represent a small fraction of the total future lifetime earnings, or human wealth. Chen, Ibbotson, Milevsky, and Zhu (2006) discussed the importance of considering portfolio allocations in the context of the total wealth of a household, including human wealth. They noted that human capital (human wealth) is typically worth much more than financial capital for young investors, so the optimal allocation to risk-free financial investments may be initially very low. They also discussed the role of the volatility of human capital in optimal allocation of financial investments, as workers who have volatile earnings should consider a lower level of volatility in the financial portfolio.

stock market crash

stock market crash

Objective of this research

This study has the objective of estimating the impact of the stock market decreases during the 2007 to 2009 period on the total wealth of working households. By providing a human wealth based framework of lifetime wealth shock, this study can help financial planners give their clients better perspectives to prepare for future stock market declines. Using the 2007-2009 Survey of Consumer Finances (SCF) panel dataset, this study also estimates each household’s human wealth, in addition to other forms of wealth. The study is limited to households before retirement, when presumably the focus is on accumulating investments. Only households with a head employed full-time are included, as there may be more uncertainty in projecting the future earnings of other households. This is the first study that analyzes the impact of the stock market crash on the lifetime wealth of U.S. workers with the SCF panel data.

This research provides important insights for financial practitioners regarding rational assessment of portfolio losses of their clients. Put in the context of total wealth, including human wealth, even the severe stock market crash in the 2007 to 2009 period resulted in small potential losses relative to total wealth for all but a small proportion of households.

stock market crash

stock market crash

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