Most of us have lived through economic downturns before, and many remember the Great Recession’s impact. When you’re young, recessions can be difficult, but you have decades to recover. When you’re already retired, however, it’s a different ball game. Recessions can create near-constant worries if you’re not adequately prepared. Fortunately, there are retirement planning strategies that can help you prepare for a recession when you’re retired so that you can feel secure about your personal finances.
Why Recessions Matter When You’re Retiring
A recession is a natural part of the economic cycle. Like the seasons, we can expect them periodically. In recent decades, interventions by the Federal Reserve may have influenced the process, but natural forces eventually prevail. It’s then when a recession normally starts.
What Does a Recession Look Like?
While politicians debate the current definition, there are some common signs: spending slows, people lose jobs, and credit card debt grows. The traditional definition is a period of temporary economic decline generally identified by two quarters of falling Gross Domestic Product (GDP). Bear markets usually accompany recessions, which means the stock market drops in value and often stays low for a while. According to data from the National Bureau of Economic Research, the United States has had about 35 recessions, each lasting an average of 17 months.
Of course, recessions are not predictable. Some, like the Covid recession of 2020, was short, lasting only two months. The longest recession in U.S. history was the Great Depression. While it technically only lasted four years, its impact lingered until World War II.
If you find yourself losing your job, obviously, a recession can hit you particularly hard. But if you’re retired or preparing to retire during a recession, it can also throw your plans into disarray. With most investments dropping in value, it can require you to cut back. In many cases, people end up delaying retirement or even going back to work.
Fortunately, that doesn’t have to happen. With the proper financial planning, you can prepare for a resilient retirement that can withstand most anything…even a recession.
How Much Should You Hold in Stocks and Bonds When You Retire?
According to an old rule of thumb that many still follow, you should hold 100 minus your age in stocks, then the remainder in bonds. Another popular guideline was the 60/40 portfolio for retirement accounts, where you held 60% in stocks for growth and 40% in bonds for stability.
Here’s the problem: bonds aren’t necessarily behaving like the safe haven they used to represent in past decades. With today’s low interest rates, these investments yield dramatically less than the inflation rate. As interest rates rise, existing bonds will fall in value because you can get higher interest rates elsewhere. So retirees with bond-heavy portfolios following these old rules may not find the ride a smooth one.
Your other options for fixed income are equally slim. Money market funds, certificates of deposit (CDs) and savings accounts pay a minimal interest rate compared to inflation. So you’re essentially losing money monthly since most of your expenses likely continue to grow with inflation.
The Paradigm Shift
When retirees make the transition into retirement, we believe they must focus on income rather than account values. This is hard to do. We’ve been trained for years to look at account values in our retirement portfolios equating to some number that we’ll have saved for retirement. Now that number needs to take a back seat to consistent, reliable income.
Does performance still matter? Absolutely. But, once the income problem is resolved, a whole world of opportunity opens up. One with greater tax efficiency, wealth accumulation potential, and overall retirement enjoyment.
Are there Alternatives to Bonds?
Fortunately there are. One alternative is the annuity, which is an insurance product. Before we dive into details, let’s compare the basics of bonds with annuities.
Bonds are debt instruments. When you buy a bond, you essentially loan a certain amount of money (“principal”) to a debt issuer in exchange for a stated amount of interest. For example, you may buy a $10,000 bond that pays you 3% interest per year for 20 years. This is referred to as “fixed income” because you know the amount you’ll get. You’ll get your money back unless the issuer “defaults”, which is very rare, so bonds have significantly less risk than stocks. But their risk is not zero, because if you need to sell, you may have to accept less than the face value of the bond if interest rates have risen. And that is happening now as the Federal Reserve has been recently increasing interest rates.
Annuities, on the other hand, are not debt. Instead, they are an insurance product that is designed to pay predictable income. You enter into an insurance contract with the company, then the company promises to pay you either a steady amount, or some type of assured amount starting on a specific date. When specified in the annuity contract, these products can pay “lifetime income” which means you will receive this every month as long as you live, no matter what happens in the stock market or with interest rates. Annuity types and contracts vary so it might simply guarantee you a minimum, or you may get a specific amount.
Build up Your Recession Defense with Guaranteed Income
This guaranteed income aspect of annuities can help you reduce the uncertainty in your retirement life. We find these especially helpful now since bonds have more risk and lower yields. At our firm, we have created our 4 Buckets framework to help clients create guaranteed income with annuities as an alternative to the traditional 60/40 bond allocation.
Typically, clients view all that they’ve saved as a single bucket for income and investment allocation purposes. Instead, we focus on the client’s income need first. This income need is the money required each year for the remainder of their lives, whether in the throes of a recession or at the heights of a bull market. It’s the amount you need to pay your basic monthly bills so you won’t feel financial uncertainty. We feel strongly that your income in retirement should not fluctuate with the movements of the market. Instead, we focus on meeting income needs with consistent, pension-like buckets. Then, growth or income from your other assets can supplement this base amount.
How We Use Annuities to Help Reduce Uncertainty in Retirement
We understand that the mere suggestion of annuities can ruffle some feathers and there are strong opinions of annuities on either side of the argument. Annuities suffered from a bad public image in the past, primarily due to deceptive sales practices. Still, annuities were developed by the insurance industry with a goal to meet a very specific need: providing a consistent income that you can count on in retirement. Previous generations received annuities from their companies in the form of pensions as a retirement benefit. Even social security has annuity-like components to its structure.
The biggest knock against annuities is their cost – they aren’t your 0.05% index fund. Instead, these can often cost in the range of 3-4% a year. Yes, this is a high cost, and that’s why we use these financial products strategically. That cost will only impact those assets we use to generate this portion of your retirement income.
The remainder of your savings can and should stay in higher growth, lower cost, lower turnover buckets.
Is the High Cost of Annuities Worth It?
Everyone must answer this for their own situation, but here’s another way to look at it. Ask yourself why you own bonds in your portfolio? Lower volatility and interest income are some reasons that come to mind, but the real answer is usually so that you lose LESS money when markets go down. If you agree with this statement, then you would likely also agree that by owning more bonds in your portfolio you are making a decision for lower profit potential on your money.
This is an opportunity cost. While this is invisible, it is still a very real cost. It’s just not one that investors think about a lot. If we were to compare two portfolios – one with 100% stock exposure and our 60/40 traditional portfolio over the last 10 years we would see this cost in black and white. The opportunity cost of holding bonds actually would have exceeded the direct cost of owning an annuity.
Can More Consistent Income Make You Feel Young Again?
As the saying goes, it’s not a matter if we’ll have another recession, it’s when. For young savvy investors, recessions represent an opportunity to buy investments at bargain prices. Why can’t that be the case for older investors as well? It is possible, it just requires an openness to change and a different way of viewing retirement. If you have predictable income coming in, it is far easier to be a disciplined investor who is able to stay in the market long-term….and continue to seize opportunities to scoop up bargains.
Of course, the key is to determine if annuities are right for you. Then, you need to buy annuities very carefully. They are not like buying a stock. They are a significant and long-term purchase, more like a house. You should investigate every feature you’re paying for and make sure you know exactly what you are buying. You can’t easily back out of the purchase, so it will cost you if you change your mind.
That’s why we recommend buying from an independent firm, not an insurance company. You need a financial advisor who can sit with you and evaluate pricing and options from many companies, not just pitch you based on their company’s offerings. So it’s wise to look for financial advisors with no ties to insurance companies.
Timing is Everything
As in many aspects of life, timing is everything. The key is to start financial planning as soon as possible, so you have time to implement these retirement strategies. We often find that people in or near retirement have not saved enough and haven’t adequately prepared for how long they may need their money to last. By starting the conversation early, you have time to make up ground and get prepared.
Bottom line…if you’re retired or close to it, don’t wait to start preparing for a potential recession. It’s wise to do your research now to see how you can make your retirement income as recession-proof as possible.