In good economic conditions, it’s easy to feel optimistic about your retirement and long-term future. But if an economic recession hits as you approach retirement or in your early retirement, you might begin to feel concerned about your ability to live the rest of your life without working.
How are you supposed to deal with economic recessions and volatility in retirement?
The Impact of an Economic Recession on Your Retirement
Economic recessions can be defined in different ways, but they always have a significant and negative impact on economic conditions, often stifling investments, business transactions, employment, and more.
These are just some of the ways that an economic recession could impact your retirement:
Market Declines
One of the hallmark signals of a recession is a decline in market value across the board. While some recessions may have more of an impact on some markets than others, most markets experience at least some kind of damage. Notably, recessions put downward pressure on the stock market, often wiping out trillions of dollars of value from equities. They may also wreak havoc in the real estate market, causing prices to decline.
Income Decreases
Similarly, an economic recession could impact your income, and in multiple ways. Some forms of retirement income are well insulated from recessionary pressure; for example, if you have a fixed income from a pension plan or Social Security, you probably don’t have to worry about it being disrupted by a routine recession. However, the recession may impact dividend payments from stocks, income from your rental properties, and other sources of income you may have.
Fewer Job Opportunities
If you plan on working part-time or engaging in various gigs throughout your retirement, you should know that a recession may impact your opportunities as well. There may be fewer clients or businesses willing to work with you, and they may be willing to pay less for your services due to the increased economic pressure.
Less Liquidity
You may also have less liquidity within the context of your investment portfolio. Because people are usually risk-averse and pessimistic during recessions, there will be fewer buyers for your assets. This may force you to sell at a loss if you are indeed forced to sell anything during this time.
Higher Risks Overall
Generally, economic recessions are times of higher risk overall. There are more ways that things can go wrong and more potential damages associated with bad financial planning.
The Good News
There is some good news to go over, however.
Recessions don’t last forever.
The first bit of good news is that recessions don’t last forever. As a country, we’ve experienced many recessions, some of which have lasted for years. It’s common to feel pessimistic while the recession is still unfolding, but you should know there’s a light at the end of the tunnel.
There are strategies to insulate you from recessions.
There are many strategies that can protect you and your investment portfolio from recessions. We may not be able to stop recessions from occurring, and we have little control over how they develop, but we can prepare ourselves and our assets for these tumultuous times.
Investment opportunities abound during a recession.
It’s also important to recognize that recessions hold valuable investment opportunities. Certain markets predictably decline and suffer during economic recessions, but other markets flourish. Additionally, you may be able to find new assets to add to your portfolio for a significant discount.
Building a Resilient Portfolio
The first and most important way to prepare for a recession is to build a resilient portfolio. In other words, you want to develop an investment portfolio that can stand up to an economic recession without much trouble. The most straightforward way to do this is to diversify your portfolio, holding many different types of assets so that no single crash or stretch of hard time can disrupt your long-term investment goals.
It’s also worth considering specific types of assets that are known to stand up well in the face of a recession, such as:
Different types of stocks/index funds
Broadly, the stock market tends to dip during a recession, but there are some types of stocks and funds that can help you weather the storm. For example, utility companies tend to perform well during a recession, since no matter what else is happening in the market, people will still need utilities. It’s also worth allocating at least some of your assets to foreign stocks, as not every recession is a global one. Even if the United States is going through a hard time, developing countries may be flourishing.
Real estate
The real estate market can be hit hard by economic recessions, but real estate is also a valuable source of stable income if you can manage your portfolio wisely. Economic recessions are also an excellent opportunity to look for real estate at lower than typical prices.
Bonds
Many investors consider bonds to be excellent hedges against economic recessions, as bonds are stable, predictable, and relatively low in risk. They may not have the high long-term returns of their stock counterparts, but they can function as a backbone of your investment portfolio.
Crypto
For some retirees, it’s worth considering investing in cryptocurrency. Once you learn the basics, you can invest in crypto, much like you would invest in any other asset, through online trading apps. You can also stay plugged into crypto news to get the latest about how your favorite currencies are performing. For example, a quick conversion of USD to ETH can tell you whether it makes sense to buy, sell, or hold, based on your goals and investment strategy. Crypto sometimes performs well during recessions, as people see it as an independent, decentralized currency that functions separately from the broader economy.
Precious metals
Precious metals like gold and silver are also common safe havens during economic recessions. Even if you don’t have much faith in mainstream fiat currency or assets like stocks, you’ll likely have faith in these materials that have been valuable for thousands of years.
Commodities
Similarly, commodities markets tend to perform well during economic recessions. Commodities are often essential goods that people continue to need despite economic hard times.
Options
It’s possible to succeed during an economic recession by placing bets against the market. By trading options, you can make money when the market goes down. Options are complicated and somewhat risky investments, so make sure you do your due diligence before you consider investing in them.
Annuities
Annuities are rightfully praised for their ability to stand up to recessionary pressure. In many cases, you’ll continue receiving payments as prescribed by your annuity plan. However, there are some extra risks and caveats that you’ll need to keep in mind, which vary depending on the type of annuity you’ve bought.
Other assets
There are other types of assets that can perform well during a recession as well, but the preceding items are some of the best and most common examples.
Keep in mind that no asset is guaranteed to perform well during a recession, and even common hedging assets can suffer losses during this period of volatility.
Anticipating Recessions
You can sometimes reallocate assets and make different financial plans if you anticipate a recession coming. Economic recessions are notoriously hard to predict, such that even our best economists can’t say with confidence when the next recession will be or what it will look like. However, there are some signals that can potentially clue you in to a recession on the horizon:
Economic bubbles
Many recessions start when an economic bubble pops. Economic bubbles form when functional prices for a given asset rise far higher than is rational. It’s not always easy to spot a bubble forming, but absurdly high prices in a given sector are an important clue.
The yield curve
Economists frequently look to the bond yield curve as a signal that a recession is coming. Ordinarily, the interest rate for long-term bonds is higher than the interest rate for short-term bonds. When this inverts, or becomes reversed, it could be a signal that a recession is coming.
Federal Reserve interest rates
Federal Reserve interest rates play a complicated economic role. The Fed often increases rates during good economic times and decreases rates during bad economic times. However, high interest rates for prolonged stretches can cause economic distress, making recessions more likely if not adequately managed.
International politics
Recessions are sometimes sparked by political developments. Wars, controversial elections, and general political uncertainty can all trigger recessions.
Recent economic cycles and performance
You can also reasonably deduce a higher likelihood of a recession by paying attention to recent economic cycles and performance. Our economy tends to ebb and flow in cycles, so a long period of growth unmitigated by recessions could be a sign that a recession is on the horizon. Similarly, if you see a wave of wage stagnation and unemployment, it could be the first sign of a recession.
“Cash Is King”
The phrase “cash is king” is likely a familiar one to you if you have any experience in business or investing. Essentially, it means that having cash on hand gives you the greatest amount of flexibility, at least financially. If you want to make sure you continue thriving during a recession, it’s a good idea to have plenty of cash on hand. At a minimum, you should have at least six months of expenses set aside in a cash account, so you don’t have to worry about selling any assets or replanning your income distributions just because of a relatively short recession. If you want to be even more conservative and risk-averse, consider hoarding more than a year of cash.
Building a Resilient Mindset
If you want to thrive during economic recessions in your retirement, you’ll also need to build a resilient mindset.
Understand that recessions are temporary.
In economic recessions, people have a tendency to freak out. But it’s important for your own sanity and for the preservation of sound decision-making that you understand recessions are temporary. The next recession may last a few months, or even a few years, but it will eventually make way for better economic times.
Expect recessions.
Similarly, recessions are inevitable. There might be short or long stretches between them, but it’s only a matter of time before another recession rears its ugly head. If you expect and embrace recessions as a part of your financial life, they become much easier to deal with.
Accept off years.
Your portfolio isn’t going to be thriving all the time. There are going to be hard years and you’ll be faced with some difficult decisions. Accepting this as a reality can help you plan more carefully.
Save more than you think you need.
This is a good maxim for retirement planning in general, but always save more than you think you need. If you have, say, 20 percent more assets than you truly need, a sudden 20 percent drop in the stock market isn’t going to rattle you.
Exercise frugality without panic.
During economic recessions, it’s often a good idea to cut back on spending. There’s nothing wrong with exercising frugality during stretches of economic tumult. However, it’s important to avoid panicking. Your financial decisions should be conservative, calculated, and deliberate; they shouldn’t be emotionally reactive.
Take advantage of discounts when you can.
Finally, pay attention to potential investment opportunities that arise because of the recession. Remember that recessions aren’t always a bad thing; they’re often associated with deeply discounted assets, like stocks and real estate, which can help you grow your portfolio significantly once the market rebounds.
Recessions aren’t fun to talk about or plan for, but they won’t go away by ignoring them. If you want your retirement portfolio to survive, or even thrive during inevitable economic recessions, it’s imperative that you plan and work proactively to make your financial position more resilient.
