The Market’s Crashed! How Much Can I Spend?

“Some of the people I know lost millions,” he later wrote. “I was luckier. All I lost was two hundred and forty thousand dollars. I would have lost more, but that was all the money I had.”
—Groucho Marx, 1929

The crash of 2008 has been a horrible experience for investors. Although the stock market has rebounded of late, it’s still roughly 40 percent below its peak in October 2007. House prices have also dropped—on average, by about 29 percent. But those who can keep up with their mortgage payments and intend to remain in their homes, a lower house price doesn’t require cutting spending.

The stock market losses, on the other hand, do necessitate spending cuts. But how large should those spending cuts be?

There is no simple rule of thumb to use to scale back your annual spending. There are too many variables to provide a one-size-fits-all answer. So we’ve used ESPlanner to illustrate how much a 40 percent market loss of financial assets should alter the discretionary spending of three married couples ages 30, 45, and 60 years old.

The couples have the following characteristics. All amounts are present in today’s dollars.

• Earnings: $75,000 per spouse in annual household earnings at age 30 rising through age 45 to $100,000 per spouse and remaining fixed through retirement at age 65.
• Children: Two children with annual college expenses of $45,000.
• Mortgage: $450,000, mortgage that runs through age 65.
• Retirement Assets: At age 30, each spouse has $100,000 in tax-deferred 401(k) accounts. Each contributes 4 percent of earnings and receives a 4 percent employer matching contribution. By age 45 each spouse has a $300K account, and by age 65, each has a $750,000 account.
• Regular Assets: We assume a good saving pattern: Age 30, 50K; age 45, 150K; and at age 65 they have 300K.
• Rate of Return: 6 percent before inflation, and 3 percent after inflation.
• Social Security: Projected retirement, spousal, and survivor benefits are based on each spouses’ earnings history. Spouses are assumed to start benefit collection at age 65.
• Taxes: Married filing joint return using state of Michigan tax tables.

ESPlanner differs from other planning tools in its ability to determine households’ sustainable spending power—how much they can spend each year, on a discretionary basis without going into debt and without suffering a drop in living standard.

According to ESPlanner, a 40 percent decline in asset values necessitates a 1 to 2 percentage point cut in discretionary spending by the 30 year-old couple through age 56. After age 56, they reduce their spending by 6.3 percent.

ESPlanner tells the age-45 couple to reduce spending by 6 percent through age 56 and by 11.5 percent thereafter.

And ESPlanner tells the age-60 couple to reduce its spending by 20.3 percent in each future year. This is, without question, a very big hit.

Clearly, younger couples take a smaller hit with respect to their requisite reduction in discretionary spending. The reason is that younger couples have fewer assets to lose as a proportion of their total lifetime economic resources, which includes their future earnings and Social Security benefits. For the 60-year old couple, in contrast, financial assets represent roughly half of remaining lifetime resources.

The other interesting point is that the younger couples take more of their spending reduction out of their future spending than out of their current spending. The reason is that the couples have relatively more of their assets in retirement accounts, which they can’t spend until they start withdrawing at our assumed age 65.

So how should households react to major capital losses in their financial assets? The answer depends critically on their age and the relative size of their financial assets.