Stock Market Fluctuations and Retiree Income: An Update


The recent plunge in home values and even bigger dive in stock prices offer painful reminders of why Social Security seemed like such a good idea in the 1930s. Benefits are predictable, are guaranteed by the government, and are adjusted every year to keep their purchasing power stable. In contrast, workers who count on the stock market to fund their retirement have seen their savings shrink more than 40% over the past year. The question is: what kind of retirement plan offers the best guarantee workers will receive a predictable and comfortable income when they grow old?

Luckily for most older Americans, the cornerstone of their retirement income is still a Social Security check. Social Security plays a crucial role in maintaining the incomes of Americans past the age of 65. Last year it accounted for 39% of the total income received by the elderly. It is a particularly important source of income for low-income seniors. For aged Americans in the bottom one-fifth of the income distribution, it accounts for nearly $9 out of every $10 they receive. The benefits and returns are more secure than incomes from private saving accounts, and they are indexed to inflation, which is rarely the case for private pensions or annuities.

Financial planners often recommend that workers aim to replace 75% to 85% of the wages they earn before retirement. Suppose workers set aside 4% of their salaries to meet this goal. How much would their retirement incomes fluctuate, depending on the start and end dates of their careers and the investment strategies they choose? Between 1999 and 2002 both the stock market and the yield on bonds declined. Wage earners who worked for 40 years and invested all their retirement savings in stocks would have seen their wage replacement rates fall 53 percentage points. Workers who followed a more conservative investing philosophy and placed half their retirement savings in bonds would have seen their replacement rates fall 18 percentage points. The latest market turmoil has delivered another jolt to workers who count on their stock investments to pay for retirement. Between October 31, 2007, and October 24, 2008, the drop in stock prices has reduced the expected retirement income flow from a stock-invested savings account by 46%.

The Great Depression and the stagflation years from 1974-1983 were the most recent periods of great economic uncertainty. Few people in those years suffered under the illusion that a private savings account offers a secure foundation for a comfortable retirement. Big selloffs in the stock and bond markets persuaded most Americans that government-guaranteed pensions were valuable and well worth preserving. The recent market selloff may have the same salutary effect on voters’ opinions. Social Security’s problems still need fixing. But it is hard to argue that the most sensible fix will involve scaling back Social Security’s basic promises in order to make room for a bigger private savings system.