Those who don’t invest in the stock market would like to pretend stock market crashes don’t concern them, but the truth is that they do. It’s not only those who actively trade who lose money. The average person loses money and opportunities as well. To show how, 24/7 Wall St. put together a list of eight ways market collapses affect people’s lives.
In the last stock market crash, between the spring of 2008 and the spring of 2009, the Dow dropped by more than half of its value. The crash ruined individual retirement accounts, pension funds, corporate balance sheets, as well as the overall confidence of companies and individuals. It also led to the question of whether the recession caused the market drop, or the market drop caused the recession as so many trillions of dollars of wealth were destroyed in the sell-off.
The markets have become choppy again, and their overall direction has been down in the past month — sharply down in some days. Many investors have already fled the market for the safety of gold, Treasuries, or AAA-rated corporate bonds. That trend has put a huge portion of the institutional and individual investor communities on the sidelines. A market sell-off always leaves people wanting to know if they should flee the market to avoid future drops, or remain in the market in the hope that it recovers.
24/7 Wall St has put together a list of the major effects a market sell-off has on personal finances. The current drop is fairly similar to the last one, insofar as the economy is weakening quickly, joblessness has become a problem again, and most corporate spending has ground to a halt. The dual anchors of a possible new recession and extended drop in equities will have an unpleasant effect on many people’s lives.
These are the eight ways the market collapse will drain your bank account.
1. Employee benefits cut
Stock market collapses hurt employee benefits in several ways. Initially, when the market is soft, companies tend to pull back on retirement benefits, eliminating pensions and matching 401(k)s. Motivated by the same concern, they also reduce other types of benefits, like health care and dental plans. The 2008 Employee Benefits study by the U.S. Chamber of Commerce showed that “employers began scaling back on employee benefits as the economy slowed down in 2007, even before last fall’s economic tailspin partly unleashed by the constriction of the credit markets,” according to The Wall Street Journal. “The average dollar amount of employee benefits fell 14% to $18,496 in 2007 from $21,527 the year before.”
2. Retirement deferred
Nothing kills retirement like a cratering 401(k) — when the value of savings meant to fund life after people stop working plummets. The difference between a $1 million portfolio and a $500,000 portfolio can be the difference between retiring at 65 or working until 70 — as large numbers of people found out when the market collapsed in 2009. According to USA Today, a 2009 AARP study found that “35% of those ages 45 to 54 have stopped putting money into their 401(k), IRA or other retirement accounts, 25% said they have prematurely withdrawn funds from their retirement accounts.”
3. Home sale
Are the stock markets and home markets tied to one another? Absolutely. Over 20% of home loans in the U.S. are underwater. To sell those homes, owners have to come up with the difference between what they can sell the house for and what they owe the bank. That difference can certainly be well into the tens of thousands of dollars. If the money needed to bridge that difference is tied to the stock market, owners will have a hard time selling.
4. Home purchase
It has become difficult to get a mortgage even though rates are at historic lows. Banks are leery of lending when house prices continue their free fall. A down market makes the banks even more cautious: they tend to tighten lending standards, require higher credit scores, shrink credit limits, raise minimum payments and make it generally more difficult to qualify for a loan. On top of it, any assets potential home owners set aside for down payments are often partially in equities.
5. Education deferred
College funds, kept by many parents for their children’s higher education, are generally comprised in part of equities. A correction in the stock market drags the value of these funds down, and as a result makes paying for tuition harder. During the middle of the last recession, enrollment in low-cost colleges, and public community colleges increased an average 16 percent in 2009, according the U.S. News & World Report. “One reason: ‘reverse transfers.’ Students at expensive four-year universities are switching to lower-cost two-year schools to get their basics completed inexpensively.”
Businesses feel the ripple effects of a market collapse fairly fast. Some hold the money on their balance sheets in cash, but that is often mixed in with equities. A rapid and sharp drop in the markets can erode a company’s assets. This, in turn, makes it more cautious about expenditures, which includes payroll. The other reason companies review employment levels when the markets sell off is that the drop is likely to be the precursor of an economic slowdown. If a company sees a recession in its business coming it may lay off workers preemptively.
7. Car purchase
One thing that car companies found out three years ago is that consumer confidence is harder to come by when the market corrects by 30% or 40%. The psychological effect is only part of it. People with a part of their net worth in the stock market usually curtail their spending on anything more than the essentials until they see a rebound in value. And, after a huge correction, a rebound can take years. Added to that, much like a home loan, getting financing becomes much more challenging. J.D. Power & Associates lowered its estimate for U.S. auto sales in 2011 by 300,000 light vehicles to 12.6 million.
8. Small business start-up
Small business start-ups are not funded by venture capital money. People use their own savings or borrow from friends and family the seed capital needed to start a new company. A market sell-off hurts start-ups in two ways. First, it shrinks the nest eggs people might use to begin a new enterprise. Second, it makes it hard for the start-up to flourish as business and consumer confidence are low. The Wall Street Journal reports that according to the Census Bureau, the number of new companies that were started in the 12 months ended March 2009 was down 17.3% from a prior year — the fewest since 1977, when the Census Bureau began keeping records.
Douglas A. McIntyre