Are Your Retirement Investments Ready for a Recession?
With the world economic forum just completed in Davos, many economists have made a stark forecast — that there will be a major stock market correction in the next 13 months, with extended losses into early 2020. What Can a Severe Correction Do to Your Investments? Whether or not Rogers is right, you need to know what a possible recession will do to your retirement portfolio. To help you make sure your money is safe, let me show you what will happen to a $200,000 retirement account in some of the most common investment methods. For these illustrations, we’re going to use the average 12 months drop in stock price for recessions, which is around -1.5% monthly. Remember, many recessions will last longer than a single year, which is why the stock market lost half its value during the recession that began in 2008.
If the Investment is in a Mutual Fund A 2014 study found that mutual funds generally underperform the market by -0.5% every month during a recession. So if the market drops 1.5% over the course of a year, then you’re losing 2% every month. In a single year, $200,000 can become $160,146. By the way, this doesn’t include the advisor fees, individual fund expense ratios, or transaction costs that apply. If the Investment is in a 401(k) 401(k) accounts are generally thought of as a safe investment approach (perhaps because all your coworkers are in the same plan), but remember that they’re basically a managed mutual fund portfolio for a large group of people. Where the mutual funds go, so, too, goes your 401(k). That means the -2% drop every month would also make $200,000 into $160,146. And 401(k)s are heavily invested in mutual funds, they also incur the same fees as mutual funds. If you’re retired, you’ll inevitably magnify the problem by creating guaranteed losses as you take withdrawals every year for income purposes. If the Investment is in a Stock Portfolio It might seem like investing directly in the stock market might be better. After all, the -1.5%/mo would make $200,000 into $169,367. But remember that number is only the average. As anyone with a stock portfolio during the 2000s can tell you, it’s easy to do a lot worse than that. Also, every stock trade comes with fees upon fees, which add up quickly.
If the Investment is in Bonds Bonds, generally viewed as the “safest” asset class, are far from it. Bonds are inversely correlated with equities. To simplify, remember that as equities (stocks, mutual funds, etc.) drop in price, bonds go up, and as equities go up, bonds go down. Let’s look at the Barclay’s US Aggregate Bond Index. In 2008, a single quarter saw a 5.2% drop, while 2013 saw a quarter that dropped 2.2%. In 2013, $200,000 would have dropped to $195,600 in a 3 months, while it would have dropped from $200,000 to $189,600 in a single quarter in 2008. Remember, bonds are also subject to fees. And if the company that holds the bond cancels the debt, then the bond is suddenly useless, which was sadly very common during the 2008 recession (most notably with MBS or mortgage-backed securities). If the Investment is in Annuities During a recession, fixed or fixed-indexed annuities are your best options. In either of these options, your principal is guaranteed by the issuing insurer, meaning your deposit is safe from any market fluctuations. In a Fixed-indexed annuity, if the linked index (like the S&P 500) goes up, you get that interest in your account without having to pay taxes on it. The thing that makes your investment recession-proof is that the value of your annuity can never go down. Even if the S&P 500 takes a -37% hit like it did in 2008, your annuity stays the same. So if you had invested in 4.5% fixed interest rate annuities in 2007, your $200,000 would have been worth $249,236 in 2011, even though the market crashed in 2008. Make Sure You’re Protected There’s no way to guarantee that you’ll make a certain amount of money on an investment, but there are choices you can make to prevent losing your money. When you’re thinking about retirement, you need to remember that you’re thinking long-term. It’s much more important to protect your savings than it is to chase the big returns and risk losing it all. *The best thing you can do is talk to a financial advisor who will be honest with you about your investment options—one who has your best interests in mind, not their commissions or fees.