Retirement is the culmination of an employed person’s hard work over the years. While retirement can come off as scary and daunting—where the thought of your mind stagnating and your physical body weakening because of the lack of motivation to do something on a daily basis—the idea of retiring in the middle of a recession makes things even worse, especially for your retirement savings.
In this article, we will discuss how to make your retirement savings recession-proof and protect your hard-earned money from market volatility.
What is a Recession?
You’ve probably heard of a recession—yes, it is bad. But what exactly is it?
The International Monetary Fund (IMF) describes recession as a ‘period of decline in an economic activity’ that should last months and has effects on production, employment, income, and many more.
One of, if not the most identifiable recession period of recent history is the COVID-19 recession, a deep downturn of economic activity caused by the COVID-19 pandemic. The COVID-19 recession crashed stock markets, severely increased unemployment rates, and halted production lines all over the world. It is easy to say that this has become one of the largest global economic crises in history.
The world’s largest economic downturn, the Great Lockdown, started in most countries in February 2020, which projected global economic growth to fall by -3%, the worst since the Great Depression and even worse the Global Financial Crisis in 2009, according to the IMF.
In relation to COVID-19, here are some hard-hitting effects of the recession and how it has impacted the global economy:
According to Pew Research Center, the level of unemployment during the first three months of the COVID-19 recession came at a high of 13 percent (or even as high as 16 percent) in May 2020—almost 3 percent higher than the highest unemployment rate during the years of the Great Recession at 10 percent in January 2010.
Increased unemployment happens during a recession because business owners may not need too much manpower to supplement the lack of production and demand during an economic downturn.
The loss of employment results in a lower household or individual income. According to the UC Davis Office of Research, when inflation or recession happens, those who lose their jobs as a result of an economic downturn may find themselves in longer unemployment periods thereby resulting in lower income and increased poverty levels, especially for lower-income households.
Aside from individuals, businesses also suffer significant losses and lower profits during a recession due to many factors, like increased raw material prices and a lack of purchasing power from their customers.
Fall in Asset Valuation
Some assets are more vulnerable than others during a recession. This is because assets, like stocks, are highly dependent on economic performance. When income and employment lower—-any economic activity, for that matter—stock performance begins to plummet.
However, not all stocks are affected by market volatility as there are defensive stocks—stocks in industries where products and services are a necessity and are in no way affected by economic performance—that could well worth be maintained despite a recession.
Retirement Planning During a Recession
Planning for retirement is one thing—but retirement and a recession were probably not on anyone’s Bingo card.
The thing about recessions is you can never predict them. Your retirement savings invested in the stock market can be worth as much as 50 percent less than what they’re worth just a few hours ago.
If you are someone who’s retiring soon (or still have your retirement savings handy), here are some things to keep in mind on how to manage your retirement savings even before (and during) a recession to keep your hard-earned retirement money safe from market instability:
Regularly contribute to 401(k) plans—and keep your ground
One’s first exposure to retirement plans and investing, in general, is through your 401(K).
The 401(K) is a special type of retirement contribution plan that is deducted pre-tax from an employees payroll account and directly deposited to your 401(k) retirement savings plan that is usually matched by your employer based on certain percentages (25%, 50% or even 100%).
The best benefit of having a 401(k), among others, is that you get certain tax benefits that you don’t get from other retirement savings plans:
- Because 401(k) contributions are taken pre-tax, it lowers your total taxable income so you have lesser taxes to pay.
- Traditional 401(k) accounts accumulate tax-deferred, which means that your money accumulates tax-free until you decide to withdraw them which then becomes part of your taxable income. You can pre-calculate your tax liability if you ever decide on an early withdrawal.
- Roth 401(k) is the opposite of traditional 401(k) wherein fund contributions are taken after payroll tax—which means that your designated 401(k) contribution is taxed through your payroll but will not be taxed upon withdrawal, subject to certain conditions. These conditions are:
- The account is held for five years or more
- The account holder should be at least 59 and ½ years old
- Withdrawal due to disability
- Withdrawal due to death
In 2023, the IRS implemented an increase to $22,500 as a contribution limit for those participating in 401(k), with an additional $7,500 as a catch-up contribution for those 50 years and older.
Now that I’ve contributed to my 401(k) plan, what exactly happens to it?
A 401(k) plan isn’t your regular savings account because the money you contribute doesn’t just sit down to earn interest.
As the contributor (plus your employer’s additional contributions), you or your plan sponsor (your employer) have the freedom to choose where to put your 401(k) account, depending on the variety of investments that your plan provider or financial firm holds.
Deciding on an investment portfolio for your contributions can be pretty daunting as the performance of your portfolio ultimately decides how your money will grow and how much you’re going to take the moment your retire.
More often than not, many choose to place them in mutual funds, a mixture of mutual funds, or bond funds—you cannot directly invest them in a company as stocks.
This decision mainly relies on your risk tolerance, but many who avail of 401(k) who are beginner investors and are not interested in doing in-depth research about mutual funds and economic performances avail of a target-date fund, a fund class that specifies a target date to meet the desired return by investing in high-risk, high-yield investments at the beginning, and lower risk investments nearing the target date.
What happens to my 401(k) fund during a recession?
Your retirement savings in a 401(k) fund is used as an investment and is therefore not free from the volatility of the economy and market dip resulting from a recession.
It’s easy to get swayed during a period of economic downturn especially when your retirement savings are at stake. If you are caught in between a recession, the best you can do during a recession with your retirement savings is nothing.
Remember that stock market performance is cyclical with its highs and lows. Most of the time, stock markets recover after a recession, so holding down the fort with your investments is the best course of action. You may consider reallocating your investments to recession-proof investment accounts, but you may risk significant losses over the long run.
Invest Your Savings Securely
There are several ways to keep your retirement savings recession-proof, or at least keep the damage minimal. Managing your retirement savings means foreseeing and taking into consideration phenomena that can cause market volatility, including recession and inflation. I If you’re planning to invest your retirement savings and to help protect them even during a recession, keep in mind the following:
Diversify your investments
Diversifying your investments means not pooling your funds and investing in a single account or industry. This does not only apply to your retirement savings but is a golden rule of investment in general.
A dip in the stock price of a company may entice beginner investors to place all their investment funds on it. However, putting all your eggs in one basket is generally not a good idea, especially for those with low-risk tolerance. Diversification lowers the risk and minimizes the impact of losses in the event of recession and inflation during your retirement happens.
According to Catherine Schwartz, Finance Editor at Crediful, “Investing in accounts and funds that distribute your investment portfolio into stocks, bonds, short-term investments or into different industries helps mitigate and lessen the impact of losses brought about by the recession. For example, if a good portion of your funds is invested in a commodity that does not get affected by a recession, like food staples, it recovers some part of the losses from the dip in other investments.”
Invest in those that increase in value
Some assets are more volatile than others (like stocks). While all investments pose their own risks, investing in real estate may give you better security than you do with stocks which makes them a better retirement plan for many people.
When it comes to value appreciation, real estate is at the front line—most especially land and homes. Calculating the return on investment for a real estate investment generally comes from rental income, and there will always be a consistent demand for housing that even when a recession hits, people would still look for homes or apartments.
A typical investor behavior is to wait to buy until prices are low. While this is a tested and proven strategy, it takes a lot of resources, effort, and time to study market behavior and monitor stock prices. If this is not you, you may want to try our dollar-cost averaging.
In dollar-cost averaging, instead of waiting when prices are low, an investor invests a fixed amount regularly into an investment fund. This amount can be worth more in one month, or worth way less in another. Despite the changes in market value, the average cost per share over a period could be lower than if shares were bought altogether at a high price point.
Retirement savings funds like 401(k) are already a form of dollar-cost averaging and are an excellent way to manage your retirement savings.
Know the Difference Between Savings Accounts
There is no exact starting point and deadline on when to start saving for your retirement. If you are in your 20s and 30s and are already planning to set aside funds for retirement, it is recommended to do so after setting aside funds for emergency, education, and other immediate savings.
If you have all other savings plus retirement savings accounts in order and a recession happens, try your best to not touch your retirement savings—this is what your emergency funds are for. Your emergency funds should at least have 6 months to 1 year’s worth of your total monthly expenses.
Keep Debts to a Minimum
Managing your retirement savings can be difficult when you have a constant stream of high-valued debts eating up your finances every month.
Credit accounts and debts cannot be eliminated, but it is a good practice—even before and beyond retirement—to keep debts to a minimum, or at a level, you can pay with your current income stream. This means:
- Constantly paying your dues on time to avoid interest and penalties
- Paying your accounts in full to avoid ballooning debts
- Avail of installment plans for high-value purchases
It is easier to keep up and maintain your retirement savings going to your investment portfolios and other accounts—even during a recession—when you have minimal debts to worry over.
Have a Financial Plan
A financial plan in place even before your retirement helps you assess whether retirement savings, cash reserves, monthly expenses, and outstanding debts are enough to fund your retirement income now, or if you should delay retirement and continue growing your retirement savings. Choosing the best state to retire in is also an important factor to consider in your financial plan as a retiring individual.
According to Jim Pendergast, Senior Vice President at altLINE Sobanco, “Financial management or financial planning isn’t exclusive to companies and businesses only. Individuals who take time to develop an effective financial plan—and stick with it—may find themselves less concerned and worried about market dips and recession because they have already factored in these areas of concern while projecting their financials.”
A recession is not the end-all-be-all of your hard-earned retirement savings. The economy cycles and bounces back as with all recessions that the global economy has experienced for eons.
The important thing in managing your retirement savings is to start planning early, give regular contributions, be consistent, diversify your investments, and have a solid recurring financial plan. Your retirement savings are your comfort blanket at the end of a seemingly unending grind in your career, so making sure you gain more than you lose and that your retirement savings grow in the right hands will help you keep your foothold even if you retire during a recession.