Here’s a number that should get your attention: American households owned $74 trillion worth of stocks as of June 30, compared with $49.8 trillion worth of homes, according to the Federal Reserve’s latest report on household balance sheets.
It wasn’t always this way. As recently as the end of 2022, homes were the bigger pile: $41.9 trillion versus $38.6 trillion in stocks. Then stocks took off. In just the three months ending June 30, household stock holdings jumped $10.7 trillion.
Feeling richer? Plenty of people are. Household net worth just hit a record 8.28 times after-tax income, the Fed says, topping the previous high set in early 2022.
Now, here’s the problem: Stocks and houses don’t behave the same way.
From the fall of 2007 to early 2009, the stocks American households owned lost about half their value, falling from $17.9 trillion to $8.8 trillion in roughly 18 months.
Home values took more than five years to drop about a quarter, from $24.1 trillion at the end of 2006 to $17.9 trillion in early 2012.
The housing bust was painful, no question. But stocks fall faster and harder. In the first three months of 2020, household stock holdings lost $7.7 trillion. Home values actually rose by nearly $1 trillion.
I was working on Wall Street as an investment advisor on Black Monday in 1987, and I’ve been writing about money since 1991. Here’s what I’ve learned: The damage never stays inside brokerage accounts.
This also isn’t the first time stocks have outgrown houses. A Federal Reserve governor noted in 2001 that stocks passed homes in household portfolios as share prices soared in the 1990s.
Then the dot-com bubble burst, and household stock holdings shrank by about a third from the end of 2000 to the fall of 2002.
So what happens to the rest of us when stocks tumble? Here are five things — and you don’t need to own a single share to feel them.
1. The big spenders close their wallets
Economists call it the wealth effect. When people feel richer, they spend more. When they feel poorer, they pull back.
How big is it? Most studies suggest each extra dollar of household wealth eventually leads to a lasting rise in spending of 3 to 5 cents, said Edward Gramlich, then a Federal Reserve governor, in a 2001 speech.
Now run that in reverse. If stocks fell 30%, households would lose about $22 trillion on paper. At 3 to 5 cents on the dollar, that eventually works out to roughly $670 billion to $1.1 trillion a year in lost spending, by that rule of thumb.
And that money isn’t spread evenly. The richest 1% of households own about half of the stocks and stock funds households hold, according to the Fed’s distributional data. The bottom half of households owns less than 1%.
Exactly how much of the economy rides on the well-off is a hot debate. Moody’s Analytics says the top 10% of earners account for more than 45% of consumer spending. The government’s own spending survey puts it at 23%, according to a March review by the Minneapolis Fed.
Either way, when the people doing a big chunk of the buying get scared, everybody feels it. You can read about how high-income Americans keep spending in a shaky economy. A stock crash is how that spending stops.
2. Pink slips follow
One person’s spending is another person’s paycheck. When well-off shoppers skip the cruise, the kitchen remodel and the new SUV, the people who sell those things lose hours, then jobs.
Gramlich watched it happen after the dot-com peak. In that same 2001 speech, he pointed to slowing business investment and a wealth effect that had flipped from positive to negative as big reasons demand had cooled.
The 2008 financial crisis was worse. The unemployment rate was 5% in December 2007. It peaked at 10% in October 2009, according to the Bureau of Labor Statistics.
What to do: If your paycheck depends on other people’s spending — restaurants, travel, retail, real estate, home improvement — build your cash cushion now, while you’re still working. Six months of bare-bones expenses is a reasonable target.
3. Retirement plans get torn up
In the 2008-09 crash, 401(k) and similar plans lost about a third of their value, according to Boston College’s Center for Retirement Research.
In a 2009 survey, the center found that about 40% of workers ages 45 to 59 said they’d now quit working later than they’d figured before the downturn. Most of them were pushing retirement back four years or more.
Think about that: Four more years of alarm clocks and commutes because the market cratered at the wrong moment.
It’s not just how much you lose. It’s when. A big drop right before or just after you retire can do lasting damage, as we explain in “Same Returns, $239,000 Apart: The Retirement Risk Your Statement Won’t Show.”
What to do: If you’re within five years of retirement, consider keeping two to three years of spending money out of the stock market. That way, you’re never forced to sell stocks when they’re down.
Quick aside — most internet financial advice comes from people who weren’t alive during the last recession. I’ve been writing about money for more than 35 years. Want rock-solid advice? Sign up for the free Money Talks Newsletter. Takes 10 seconds. No fluff. No spam.
4. State budgets crack
States that lean on income taxes feel a stock crash fast. When investors stop booking profits on stock sales, the tax checks on those profits shrink, too.
California learned this the hard way after the dot-com bust. In late 2001, the state’s nonpartisan Legislative Analyst’s Office projected income tax receipts would drop more than 18% that fiscal year. The No. 1 culprit: a plunge in profits from stock sales and stock options.
When a state’s revenue drops, somebody pays. That can mean service cuts, new fees or higher taxes on everybody else. Schools, roads and programs for seniors don’t get any cheaper because the market fell.
What to do: If you count on a state program, don’t assume it’s untouchable. And if your state is talking about tax cuts during a bull market, ask what happens when the bull runs out of steam.
5. Your savings account stops paying
When the economy weakens, the Federal Reserve typically cuts interest rates to prop it up. That’s good news for borrowers. It’s bad news for anyone living on interest.
By late November 2001, the Fed had cut its benchmark rate by 4.5 percentage points since January, Gramlich noted. In December 2008, it cut that rate to between zero and 0.25%.
Right now, rates are moving the other way. In September, the Fed raised its benchmark rate to a range of 3.75% to 4%. Even so, your savings account may be losing ground to inflation.
What to do: If you have cash you won’t need for a year or more, consider locking in today’s rates with a CD. If a crash comes, rates on new CDs are likely to fall with it. You can compare savings and CD rates in our Solutions Center.
How to brace yourself
I’ve lived through Black Monday, the dot-com bust, the 2008 meltdown and the COVID crash. Here’s what I’d do now:
- Don’t spend paper profits. Until you sell, a stock gain is just a number on a screen. As I explain in “Ray Dalio Says a Billion Dollars on Paper Is Hard to Spend,” your account balance isn’t the same as cash.
- Rebalance. If stocks have grown into a bigger slice of your investments than you intended, trim them back. Selling inside a 401(k) or IRA generally doesn’t trigger a tax bill.
- Keep real cash on hand. Emergency money belongs in an insured savings account, not in stocks you might have to sell at the bottom.
- Get a second opinion. If you’re not sure your mix is right, you can find a financial advisor here.
Nobody can tell you when stocks will fall. I certainly can’t. But after 45 years of watching markets, I can tell you they will.
When it happens, the people who prepared won’t panic. Be one of them.
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