Planning for Retirement in a Slowing Economy

Planning for retirement is always tricky, but when the economy slows down, things can get even more complicated.
Planning for Retirement in a Slowing Economy

Even with consumer optimism, stock market highs, and low unemployment rate, signals like an inverted yield curve for Treasury Bills and Federal Reserve moves like reducing short-term interest rates can signal trouble ahead in terms of the long-term health of the economy. The recent Black Swan event known as the Novel Coronavirus, or COVID-19, has shifted the Federal Reserve and other policymakers to prepare for an economic slowdown. When the pace of growth appears to slow, those in and approaching retirement may want to revise their plans in order to take these realities into account. 1,2

A market downturn early in retirement is much more damaging than one a decade or so in. It’s called Sequence of Returns Risk — markets don’t move in averages. They can fall a few years in a row, then be up a few years, and so on. When the market falls early in retirement, just as retirees are withdrawing to fund their lifestyle, it can be a problem. The math is simple: If your portfolio drops 20%, you need a 25% gain just to get back to where you were. If you’ve withdrawn money to live on, your balance is even lower and requires an even greater upswing to recover.3

Analysis by Michael Fiske and David Blanchette in Advisor Perspectives shows that historically, when dividend yields were low, bond yields were high, but in 2021 both are well below long-term averages. Their calculations show a tripling of principle is needed to achieve equivalent yields from just a few years ago, which may require retirees withdraw from their principal in order to maintain their lifestyle, rather than living solely off interest. Rather than chasing risky yields, one focus they recommend is maximizing the after-tax return from the portfolio.7,8

Below are some of the hallmark signs that indicate a weakening economy:
• Yields on long-term Treasury bonds falling below shorter-term ones. An inverted yield curve along with Federal Reserve tinkering in the bond market have historically indicated that an economic slow-down is on the horizon. 1
• Slowdowns in manufacturing - the ISM manufacturing index fell to 52.1 in May 2019 from 52.8 in April. Around the same time period, Empire State Manufacturing Index posted a steep one-month drop, the largest on record, in fact. Tariff trade wars with China and a supply-chain disruption are the biggest culprits behind these manufacturing slow-down indicators. 1
• In 2017, the Tax Cuts and Jobs Act gave companies in the U.S. a profit boost by reducing the corporate tax rate. But these tax rates can’t last forever. So experts are concerned about the development of an earnings recession (defined as two or more quarters of diminished corporate profits). The last quarter of 2018 saw notably weak profits which resulted in the Dow’s lowest December since the 1930’s, but the earnings recovered a bit during the first quarter of 2019. Experts warn that earnings could continue to languish. 1
• Slowing real estate markets - 2019 has also seen real estate at the slowest it’s been in seven years. A housing downturn has historically preceded every U.S. recession since the 1950’s.
• Drops in the index of consumer sentiment can also indicate a weakening economy. The Conference Board reported that the index of consumer sentiment dropped to 121.5 in the summer of 2019, it’s lowest level in about two years, possibly due to poorer than expected job growth - in May of 2019, the U.S. added only 75,000 jobs versus the average of 212,000 over the previous 12 months, indicating a softening job market. 1
• In 2018, major investment firms like Morgan Stanley, Vanguard and Charles Schwab are increasingly cautious about stocks over the next 10 years. We may not experience a “lost decade,” as we did in the 2000s, but subpar returns—and another bear market—appear highly likely. The average bear market lasts 15 months and its average decline in stocks is 32%.4

Despite the many indicators, consumer confidence remained high in 2019 with about 75% of Americans believing they’ll be financially better off in 2020 - however the recent coronavirus outbreak is creating new disruptions and volatility. Below are some important financial strategies to consider while the consumer outlook is in flux. Americans who stay ahead of the slowing economy are likely to see better results than those who deny the likelihood of an imminent downturn:
• Low-risk investments may be a good choice in a slowing economy. Certificates of Deposit and money market mutual funds have failed to wow consumers with interest rates over the last few years, but yields have recently risen. So pay close attention to your liquid holdings. They may provide a buttress during a slowing economy. 2
• Changes in tax withholding rules may lead to some uncomfortable surprises for retirees. A number of Americans experienced tax breaks last year, so estimated tax withholdings are likely to be on the low side this year. That means a lot of Americans will have a higher-than-expected tax bill next year if they don’t plan ahead for the new rules. 2
• While stocks and stock mutual funds may still provide some safety, during a downturn experts recommend that investors re-think their investment mix. A recession can cause losses in high-yield bonds and even some investment-grade bonds, so fixed annuities and fixed indexed annuities offer the advantages of guaranteeing the value of your principal and earning interest, while maintaining the diversification benefits. 2,4
• Build a cushion of cash to avoid living paycheck-to-paycheck. Consider setting up a special savings account or a 401(k) retirement plan and have payroll deductions taken automatically. 2
• Review your money habits and exercise best practices such as getting a handle on debt, reducing unnecessary spending, and maintaining an adequate amount of cash to handle emergencies. 2

It may be best to buy stocks when the economy is slow because you can buy at a lower price, but only invest in the stock market what you can afford to lose and plan to hold them for five or ten years or more. Those nearing or in retirement may want to look for guratantees of principal and interest in vehicles like the Multi-Year Guaranteed Annuity (MYGA), which locks in a fixed rate for the term you select, usually five to 10 years. The principle is guaranteed and the interest you earn grows and compounds tax-deferred within the annuity, providing a stated predictable return. 5,6

With news of a downturn, play it safe.
• Increase your available cash in the year or two leading up to retirement. Instead of an emergency fund with a few months or a year of living expenses, consider keeping three years’ worth of available cash in retirement. Having cash means you don’t need to sell stocks in a falling market and allows you to live the lifestyle you’ve budgeted for. 3
• Minimize debt - for example, if you’re investing in real estate, buy in cash rather than carrying a mortgage that you may not be able to afford should the economy slow down.
• If market turmoil increases as you near retirement, consider working a little longer. Another year of living off your salary rather than your savings can benefit you for decades; you might be able to save a bit more, and your Social Security benefit will increase. In fact, according to the National Bureau of Economic Research, working three to six months longer can have the same effect on your retirement income as increasing your retirement contributions by one percentage point over 30 years of employment. 3
• Talk to your financial adviser about your investment portfolio and look to diversify. With a wise investment strategy in place, an economic downturn can actually benefit you financially, even as you near retirement. 5


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