The Dow suffers another triple-digit loss, real estate values plunge another 4 percent, more banks fail, credit tightens further and the value of the dollar is dropping. If it seems bad for most Americans, it is only worse for those who have already retired or were getting ready to leave the workplace for good.
By early October 2008, the Congressional Budget Office revealed, stock market turmoil had wiped out roughly $2 trillion of American’s retirement savings over the previous 15 months. According to an Employee Benefit Research Institute analysis of 2.2 million participants, individual 401(k) losses ranged from 7.2 percent to 11.2 percent in the first nine months of 2008 before the big losses even hit.
While the recent plunges in the stock market have affected 401(k)s and IRAs, it is only one part of a wave of attacks that are eating away at retirement funds and plans. Throw in the downward spiral of home values, higher inflation and a declining dollar, the credit crunch and banking crisis, and retirement may be nothing more than a mirage for many.
Sinking stock market
For those at or near retirement, it’s been downright terrifying. On Oct. 10, Wall Street ended one of its worst weeks ever with a loss of $2.4 trillion in just five days. From its highs exactly one year before in 2007, the Dow Jones and S&P 500 each lost more than 40 percent of their value. Investors have suffered staggering losses and those near retirement may not have time to wait out the market. Tom Rogers, principal and Certified Financial Counselor with Portland Financial Planning Group in Portland, Maine, has seen a number of clients postpone retirement and stay in the workforce.
“It is pretty remarkable how quick and painless the 1987 crash was in hindsight. No one is expecting that to happen this time around. It has got to be highly stressful for someone who is on the verge of retiring or worse yet, has retired,” says Rogers.
History has shown that those who wait out bear markets not only can recover their losses but profit handsomely. On average, investors have come out even two years after bear markets. But with multiple financial and economic problems unfolding at the same time, some investors are worried just how low the market may go or how long it may take to rebound. Near retirees are faced with the options of cashing out and locking in their losses or holding on for a turnaround that may not come in time. Chris Miles, a financial coach and mentor with Engenuity Financial in Salt Lake City says that fear can perpetuate and make market declines worse.
“I think you are going to see a lot worse in the future because you have Baby Boomers that may soon start pulling their money out of their 401(k)s and IRAs like crazy,” says Miles.
Declining real estate values
Recent trends in real estate have given many homeowners the idea that investing in their homes can serve as a standalone retirement plan. During the run-up, some people “invested” more money in their bathrooms than they did in their retirement accounts. For those who didn’t get out before the bubble burst, the pain is growing more intense as the real estate market continues its downward spiral.
Mari Adam of Adam Financial Associates in Boca Raton, Fla., says counting on a primary residence as a retirement plan was a recipe for disaster. Many who were riding the wave in the real estate bonanza and were planning to sell their homes at high prices have been hit with a rude awakening. According to First American CoreLogic, a data firm in Santa Ana, Calif., home prices peaked in mid-2006 after rising 86 percent since January 2000. Since then, that index has fallen 13 percent, while home values in some markets such as Las Vegas, Los Angeles, San Diego, Miami and Phoenix have sunk nearly 30 percent.
“(Your primary residence) is not a retirement asset” says Adam. “It does no good until you sell it and then you still have to live somewhere. We have clients with considerable assets in real estate and it is a problem because they can’t get their money out,” says Adam.
According to Moody’s Economy.com, the declining real estate values have created a perfect storm causing more homeowners to fall into the realm of negative equity. An estimated 12 million households, or 16 percent of all homeowners in the United States, owe more than their homes are worth. That compares to 6 percent last year and 4 percent in 2006. Having so many homes in negative equity will eventually lead to more foreclosures, which will bring real estate values even lower.
Higher inflation and a declining dollar
The risk of higher inflation in the coming years also has a big impact on retirement planning. As the Federal Reserve pumps more money into the system, it will only further erode the relative value of the dollar, decreasing purchasing power. Most importantly, retirees are often hit harder with inflation because many of their major products and services — such as health care, food and travel — often increase at far faster rates. As of Oct. 8, the Federal Reserve reduced the federal funds rate again to 1.5 percent. While that move was intended to help spark more lending, it will also increase inflationary pressures.
The government officially uses the consumer price index to measure inflation but Miles says real inflation figures are likely much higher. Miles agrees inflation can hit retirees harder and even if it subsides, increased taxes to pay for entitlement programs such as Social Security and Medicare will likely have the same effect on their purchasing power.
“The dollar has been cut in half in the past six or seven years and even if inflation becomes less of an issue, there will likely be an increase in taxes in coming years,” says Miles.
The banking crisis and credit crunch
With high profile bank failures a weekly occurrence, many Americans have been thinking twice about their bank deposits. Created by the Glass-Steagall Act of 1933, the Federal Deposit Insurance Corporation guarantees the safety of checking and savings account deposits. The $100,000 limit was recently increased to $250,000. While no one has ever lost money on an FDIC-insured account due to a bank failure, the recent news of doom and gloom is enough to scare some into running for cover.
Adam hasn’t seen many clients running out to the banks to withdraw their cash but she says the problems in the financial sector have a hard impact on retirees because many of them own financial stocks. Some of those stocks that were once considered conservative investments have lost half their value in recent months.
“For someone keeping cash in the bank, I don’t think it is a problem, but the financial components have been hit very hard and investors have really taken a hit.”
While the credit crunch will have a minimal impact on most retirees, it can be extremely damaging to those who may be upside down in their mortgages or to those who took out an adjustable rate mortgage. Those who were planning to downsize may also have to settle for selling their house for much less than they expected, not just because the housing market is declining but because it is harder for prospective homebuyers to get loans.
Fear of the unknown
Most financial planners agree that it isn’t necessarily the financial crisis that can do the most damage, but a person’s drastic moves based on emotion and fear instead of careful planning. Adam says that as people see banks failing, stocks tanking and corrupt business executives slashing pensions while lining their own pockets, they begin to lose faith in the system. And when they lose faith in the system, they want to hold on to their cash and invest less.
“It is confidence in the system that is the most profound price we are paying. People have a hard time believing in their elected officials and the people running companies and when they lose faith, they don’t want to participate anymore,” says Adam.
Christine Fahlund, a senior financial planner with T. Rowe Price, says there could be a silver lining in the fear that the doom and gloom is creating. Considering that most Americans don’t even save adequately for retirement, Fahlund says that the constant news make awaken some people from their debt-laden, cash-strapped slumbers.
“People are starting to wake up and realize that they aren’t doing enough. If you are in your 40s, this is a real blessing and might be the wake up call that you needed,” says Fahlund.