People’s responses to the stock market collapse — and their decisions about whether to save or spend — are much affected by their perceptions of their own wealth.
Like most people, I have seen the value of some of my retirement funds drop over the past 15 months. But I never was particularly aggressive when choosing the specific funds that my 403(b) or 401(k) money went into. So while some of them have dropped in value since October 2007, I am not particularly daunted.
I sensed that, considering the 26 years I have contributed to such plans, I am doing OK. But just to be sure, I devoted an evening to a spreadsheet detailing yearly contributions to these funds since 1982. It calculates the average annual return represented by my balances at the end of January 2009. It came to 8.5 percent per year over a period in which inflation averaged 3 percent.
A real return of 5.5 percent a year is low compared to growth of the Nasdaq in the 1990s, for example, but I feel no reason to don sackcloth and ashes. These are better returns than anything to which my dad ever had access. I won’t be living under a bridge in my retirement.
A friend has a similar career and income. He, however, always chose the “aggressive growth” funds that I avoided. By October 2007, his retirement account balances were markedly above mine. Now they are slightly below. Over time, his returns are probably about the same as mine, but he perceives he has lost a huge chunk of wealth.
My wife and I didn’t increase our spending much when these funds were growing. Nor did we go on a spending spree a couple of years ago, when the tax-appraised values of our St. Paul house and a small farm in southwest Minnesota each increased by more than my annual earned income. And we are not cutting back a great deal now.
My friend never spent recklessly either, but he certainly has cut back in recent months and frequently frets about his retirement.
Younger acquaintances, in their early 30s, who have had jobs with 401(k) benefits for only a few years, also suffered sharp drops over the past 15 months. They had followed advice that younger people should put most of their money into growth stocks.
For them, it is not just a matter of a lower return on investment than previously thought. Instead, it was an actual loss of much of the principal they contributed. They feel particularly bruised by the ongoing financial crisis.
If history is any guide, their fortunes eventually will recover along with the economy. They probably will have a lifetime income and living standard as good as me or my contemporary. But seeing more than a third of the dollars they chose to save over the past five years swirl down the toilet has been wrenching. They are living very austerely right now and their attitudes toward investment risk probably are changed for life.
Aggregate such differences across 120 million households and you get an idea of the uncertainty of how our collective saving and spending patterns will adjust to a debacle that continues to unfold.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.