How Long Is the Way Out of the Hole?

Often observers will look at how long it took a stock price index after past crises to recover its previous nominal level. This approach has several problems, though. It understates the speed of recovery since it tends to ignore the fact that stock holders will also earn a dividend on their stocks and generally reinvest that dividend, especially if the money is invested in an index fund in a retirement account, such as a 401(k). It also tends to understate the speed of financial recovery for families since most families hold bonds in addition to stocks. So, the drop in stock prices overstates the actual drop in people's portfolios. Looking just at stock prices will, however, overstate the speed of recovery in financial security since it ignores that incomes also rise at the same time—after all wealth exists primarily as an income replacement measure.

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This article was originally published in Credit Slips.