It has been hard to ignore the recession chatter among government officials and financial media outlets over the past 12-16 months. While the risk of a recession exists, it is essential to understand that a recession is a natural business cycle phenomenon. The business cycle consists of four distinct phases:
Therefore, it is natural and healthy for an economy (and the stock market) to experience both upswings and downswings. However, we understand that recessions can be uncomfortable and difficult for all investors, but more so for those in retirement or close to retirement. Retirement is supposed to be a time of enjoyment and less stress. But a recession can impede enjoyment and cause more stress for those not prepared. If the current economic and market environment is making you uncomfortable, there are a few strategies you can implement to help alleviate some of the stress and uncertainty. Before we discuss those strategies, I think it would be helpful to provide some historical information as it relates to recessions in the US economy.
According to the Oxford Dictionary, a recession is a temporary period during which trade and industrial activity are reduced, generally identified by a fall in GDP in two consecutive quarters. Typically, recessions are characterized by a reduction in consumer demand, falling corporate earnings, an increase in unemployment, and a falling stock market.
While recessions can be a scary time for investors, we can take solace in knowing that a recession is temporary. If we look at history, we will see that the US economy has experienced 13 recessions since the end of the Great Depression. This averages out to be a recession about every 6 years. While the severity of these recessions has been different (some were mild while others were more severe), they all have one thing in common – they came to an end. Other than the Great Recession from 2007-2009 (which lasted 18 months), on average recession typically lasts 11 months.
It is also important to understand how the stock market tries to predict a looming economic storm or the start of an economic expansion. Traditionally, the stock market has been viewed as a leading economic indicator. In other words, the stock market is always looking into the future, trying to understand where the economy is headed. If a recession is on the horizon, stock prices will decrease to reflect the potential for reduced corporate earnings due to a decrease in consumer demand for goods and services. The opposite is also true: during an economic contraction, stock prices will begin to increase as the potential for stronger consumer demand will push corporate earnings higher. Therefore, it is not uncommon for the stock market to bottom out in the middle of a recession before it begins to rally, even before the economy is out of recession.
While we do not know if a recession is on the horizon, it seems as though the stock market is predicting one. If this is the case, what strategies can you implement to help cushion the blow that a recession may have on your financial situation? Below are five strategies we feel may help you comfortably survive a future economic contraction:
Review your Budget
Now is a great time to review your budget for retired people and take distributions from their investment portfolio to help supplement their retirement income. Using your portfolio to supplement retirement income can be a double-edged sword, especially during stock market declines. Not only is the portfolio losing value due to a slumping stock market, but also losing value given the distributions. We understand it may be difficult to reduce spending given the high inflationary environment. Still, you may be surprised to find areas of your discretionary expenses that can be reduced or even eliminated in the short term. Reducing your expenses may allow you to reduce the amount you are taking from your portfolio, leaving more for when the market recovers. The same thing is true for those who are close to retirement. Making short-term adjustments to your retirement budget can positively impact your retirement security. When the portfolio begins to recover, you can return to your normal spending pattern with more confidence that your money will last throughout retirement.
Rethink Social Security
For retirees who have decided to use their investment portfolio as a bridge to delay collecting Social Security retirement benefits, perhaps it makes financial sense to start collecting Social Security sooner than expected, instead of taking the funds from their portfolio. While we always encourage people to delay collecting Social Security, where appropriate, there may be situations where it would be more beneficial to delay taking distributions from the portfolio until it has time to recover.
Pay down Variable Interest Rate Debt
The Federal Reserve has aggressively raised its benchmark interest rate to combat high inflation. This has increased interest rates associated with mortgages, car loans, credit cards, and other types of loans. While the Fed’s future interest rate increases may not be as aggressive as it has been over their last few meetings, they have indicated that rates will continue to move higher and may even remain at a high level for a longer period of time than they originally expected. Therefore, now is a great time to review your debt and begin to reduce, or even eliminate, your variable interest rate loans (e.g., credit cards, lines of credit, etc.) As interest rates increase, so will the interest rate associated with the variable rate loan. Paying off this debt will reduce the interest you pay over the life of the loan, but once the debt is eliminated, the money used to service that debt can be applied to your other expenses. Even better, eliminating the debt could reduce your portfolio distributions, as you will no longer need the money to service the debt.
Have an Emergency Fund
An emergency fund is a foundation for a solid financial plan. This cash cushion can help protect against unforeseen emergencies and supplement your retirement income when your portfolio is down. Instead of taking distributions from your investment portfolio, you could use a portion of your emergency fund to help fund your lifestyle expenses. This will allow your money to stay invested until such time as it recovers its losses. We wouldn’t recommend completely depleting your emergency fund to help fund your lifestyle, but a portion could be used in the short term to help cushion the declines in your portfolio.
Stay the Course with Your Investments
It can be difficult to watch your portfolio lose value, especially in retirement. However, we also know what happens when investors have hit their breaking point and push the panic button – they liquidate their portfolio and put the money in the bank. While this may help them feel safe and secure, it is not a good long-term strategy. Not only will they have locked in their losses, but they will never recoup those losses by having the money sit at the bank. In addition,the money will lose ground to inflation each year, causing the balance to deplete over the course of retirement. So how do you avoid pushing the panic button? First, you want to ensure that your asset allocation aligns with your risk tolerance. While this may not protect your portfolio from declines, it should help keep those declines within your comfort zone. Second, make sure that your portfolio is diversified. The more you spread the risk, the better you can protect yourself from large portfolio losses. Third, turn off the financial news. In my experience, the financial news tends to report the day’s flavor. Since the markets change daily, this can cause confusion for investors. In addition, many financial pundits featured tend to be traders, not investors. As traders, they are looking to take advantage of short-term market movements to make a quick profit. However, investors are looking to make money over the long term. What may be a good move for a trader may not be a smart decision for an investor. Therefore, it is always best practice to avoid getting caught up in the financial media frenzy because it could lead you down the wrong path.
Contact Zynergy Retirement Planners
While we know that recessions will happen many times over the course of our lives, we are never prepared for them. However, we can arm ourselves with the necessary tools to deal with them when they occur. The strategies above are just ways to protect ourselves when the inevitable happens. Before implementing any of the strategies above, it is essential to speak with a financial professional who can provide you with a clear picture of how your decision(s) will impact your financial situation.