The latest economic guessing game these days is predicting when the next recession will occur in the U.S.
Last week, I had the opportunity to attend a mid-year market outlook conference at Charles Schwab headquarters in San Francisco. There were four panelists; two from the equity side and two from the bond side of the investment world. Liz Ann Sonders, the Chief Investment Strategist for Schwab, was on the equity ‘team’. All four panelists agreed on two major themes; the global economy continues to slow down, and that a recession starting in early 2020 is a very likely possibility.So what does this all mean in terms of your retirement income strategy and what should you do, if anything, when our economy does fall into recession?
Below are 5 tips for optimizing your cash flow during a recession, with the likely consequence that a recession will cause a mild or major downturn in the stock market:
1 - Discretionary vs. Fixed Expenses:
It’s been 10 + years since the great recession of 2009 occurred, and with the stock market currently at an all-time high, your cash flow management muscle may have gotten a little flabby. Now is the time to get that muscle back into shape. The first thing you want to do is break down your annual expenses into two categories; fixed expenses and discretionary expenses. Fixed expenses are your mortgage, property taxes, insurance, food, transportation, etc. Discretionary expenses include dining out, travel, gifts, entertainment, etc. If you have to trim spending next year, the discretionary bucket is where you’ll do the trimming.
2 - Adjust your Withdrawal Rate:
If you’re a Spiritus client and currently retired, most likely you have a dynamic spending and withdrawal rate plan. Meaning, instead of using the popular 4% safe annual withdrawal rate each and every year, you may have a higher initial withdrawal rate the first 10 years of retirement, with that rate adjusting lower the next 10 years, and lower again the following 10 years. This is often referred to as the go-go years, the slow-go years and the no-go years, with the premise being that the first 10 years of retirement will be your most active, the second 10, less active, etc. With a recession in full force and or simultaneously a major stock market decline happening as well, adjusting your withdrawal rate will be one of your key levers to use when managing cash flow. Being nimble with this lever is the key to success.
3 - Maintaining 1-2 Years of Living Expenses in a Short-Term Bond Fund:
Let’s say your retirement income strategy has you withdrawing $75,000 annually from your portfolio. Now let’s assume a recession does occur at some point next year or the following year and the stock market takes a nose dive. Having that $75,000 you planned to withdraw from your portfolio in a ‘cash bucket’ such as a short-term bond fund will surely help you sleep better at night. Many of my retired clients prefer to play it even safer by keeping two-years worth of annual withdrawals in this same fund. The purpose of this strategy is to avoid having to sell your investments at a low point in the market. Having 1-2 years of cash available helps you ride out a stock market downturn, and lets you sleep easier at night.
4 - Asset Allocation:
If you’re a DIY investor and you started with, say a 60% allocation to the stock market and a 40% allocation to the bond market years ago, AND you haven’t been re-balancing your portfolio at least annually, there’s a good chance you now have a lot more money in the stock portion of your portfolio than you realize. Asset allocation is yet another strong lever to use when managing your overall investment strategy during a recession. Since most economists are predicting the high probability of a recession next year, now is as good a time as any to reevaluate your asset allocation and re-balance your portfolio back to your original asset allocation target.
5 - Risk Tolerance vs. Risk Capacity
If you’re recently retired, the risk tolerance and risk capacity you had while still working is not the same as when you’re retired - not by a long shot. Now, the savings you’ve accumulated need to last the rest of your life. While it seemed easy to ignore the market downturns and corrections while working, dealing with that now while in retirement is a different challenge. Now is a good time to visualize how it would feel if your portfolio dropped by 20% or 30%. Could you tolerate that level of decline in your investments? Can you stay on track with your financial plan with that type of loss or would you do something rash and sell at a low point in the markets? The other question is more fundamental to cash flow. Do you have the capacity to withstand a drop in your portfolio of that magnitude and still be able to maintain your lifestyle? If the answer is no to either question, now, while the markets at all-time highs, it’s a perfect time to align your risk tolerance and risk capacity with reality, your reality that is.
Bottom Line: Whether a recession happens next year or the following year, history tells us that recessions can be pretty brutal to the stock market, depending on the length and severity of the recession. Use these 5 tips above to be proactive not reactive with your cash flow and investments NOW, not when it’s official that the U.S. economy is in recession. You’ll be happy you did and so will your money!
Photo by Pat Chiappa