How Will Your Retirement Plan Work if We Enter a Recession?
This is the top question I am being asked these days. Clients and others are worried that they will be not able to sustain their retirement lifestyle if we enter a prolonged recession or if inflation eats away at their purchasing power.
After all, you have worked hard to build your nest egg and rightly want to know if you can enjoy the retirement that you worked so hard to earn.
What About Inflation?
These questions are particularly pertinent today as we are looking at economic conditions we haven’t seen in decades.
Inflation has largely been at bay since the early 1980’s and interest rates have been in steady decline from that time until just recently.
Most people in financial services don’t remember how these conditions effected investments, expenses, perception, and our overall comfort level, so it makes sense that folks are nervous.
What are the Risks in a Recession?
There are several definitions and parameters that determine if we have a recession. The most basic is 2 consecutive quarters of shrinking economic activity (GDP).
Officially, recessions are determined by the National Bureau of Economic Research (NBER).
Unfortunately, they usually make the call once the recession is over or mostly passed.
The things they look at are instructive, real income minus transfers, real spending, industrial production and employment.
The result, and what makes this condition a recession, is the shrinking of demand for goods and services, thereby shrinking the overall economy. This tends to reduce the value of things.
Many of those things are what we invest in. Stocks fall as companies do less business and make less profits.
What If You Lose Your Job?
Businesses fail or slow down, with people losing jobs.
When folks lose their jobs, they start selling things off to raise cash for living expenses. This forms a spiral of declining prices as more supply of things are offered for sale.
Some of those things would be stocks, bonds, real estate, collectibles, etc.
Since many of these things are areas that people invested in for making a profit, as those values decline, more people worry about losing value and then they sell, creating even greater downward pressure on prices as the imbalance of sellers to buyers increases.
We saw this happen back in the great recession of 2007-2009. Back then we saw folks losing 50-60 and even 100% of the value of many assets.
If the above were to happen to you and you were about to retire or worse, recently retired, then your financial security could be reduced or even eliminated, depending on where you were invested.
If Asset Prices Are Headed Down, Will Everything Be Losing Value?
In past recessions and depressions, cash emerged as king. When prices fell for investments or other assets, those with cash were able to buy assets for a fraction of their prices prior to the recession.
The buyers then enjoyed the appreciation as those assets. This is the old, “buy low, sell high,” which makes it possible to retire during uncertain times.
After all, it took until 2013 until the S&P500 got back to where it was at the beginning of 200. That’s 13 years before the market broke above where it started the century.
If you were drawing from that portfolio, your risk of running out of money would rise dramatically!
There Are Always Opportunities
What I said was nothing goes up forever in the investment world, but there are always opportunities.
First, what do you do with cash if you want to avoid the asset value reduction that comes with a recession?
There are 4 places (other than your mattress) where you can put cash:
- Savings accounts
- Fixed life insurance
- Fixed annuities.
All other places require you exchange your dollars for something else and we don’t know how the reverse exchange will be when you turn those investments back into dollars to spend.
We can’t spend anything else in today’s economy. So those 4 will eliminate the “exchange rate risk”.
Are There Other Options?
The key is to be selective. As I have said before, there is always something going up in value.
And no economy is bad for everyone.
So, avoid buying entire categories.
This would be things like broad index funds that buy “stocks” without considering the outlook for individual stocks or stock sectors.
Also in real estate, like stocks, look for the stuff that is all weather and still priced right. After all, if the price has doubled or more in the last few years, you are buying high, not low!
Look at trends and decide if the environment is still favorable for the asset class or sector.
Remember, things can change rapidly, so if you are going to fish in these waters, you must pay attention to the general outlook and how that impacts the things you have bought.
What About Inflation?
It has been a long time since we have seen inflation like we have now. Will it last? The Fed is working hard to get it under control, but can it really do much to knock it down?
Only time will tell. But if it continues for a long time, leaving everything in cash will also be a losing deal as your money will not buy as much, so inflation is more of a grinding loss to your wealth.
Keep This in Mind
Following some of the suggestions above will help you grow and keep up with prices, but it can be challenging.
Adding guarantees, as long as you are comfortable with the guarantor, is one way to go. There are lots of alternatives that offer guarantees with upside potential, but the quality of those options can vary greatly.
Now is the time for caution. Do your homework. Know what you are trying to accomplish and how long you have to get there. Now is not the time to ignore your portfolio or your strategy.
Consider Hiring an Adviser
When markets are booming, investing is easy. When I started back in the 80’s, there would be “contests” where people would throw darts at the stock pages of the Wall Street Journal© and those portfolios would routinely beat the so called experts.
That is until October 19, Black Monday when the market dropped by 25% in a single day!
Advisers do more than help you pick stocks. The right one can help you reduce taxes and other costs, leaving you more to spend and enjoy.
They can help you identify other risks you might be expose to without even knowing. They can help you find balance and plan for the most efficient way to utilize resources like taxes and social security.
Your Next Steps
So if you find the current environment to be overwhelming, it might be time to check in with your adviser, or to start working with one. That way you will have the option to enjoy your own happy retirement!
Roger holds the coveted and well-earned designations of Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RIPC®) from the American College. He is also a licensed insurance agent for life and health insurance and a Certified Paralegal for Estate Planning.