Preparing for the Worst: Retirement During a Recession

Every retirement story is different, but they all share a common theme of preparing for the unknown.

My parents worked for decades in the domestic auto industry at what were then stable jobs at well-run companies. They were on track toward a happy retirement with long-term benefits locked up, complemented by ample tax-deferred savings.

What could possibly go wrong?

Enter the financial crisis

I began my career in wealth management on the eve of the Great Recession of 2007-09, and by the time it was all said and done, my parents’ world had been flipped on its head.

My dad lost his job, while my mom had to watch as the business she worked at slowly shut down, essentially turning the lights out on her office. Their retirement accounts were ravaged by the performance of their investments.

Adding insult to injury, their once-guaranteed retirement benefits were gone. It was a devastating experience for them and for us as a family.

Time for a new plan

At the time, I had the great fortune of working for a fantastic financial adviser who, shortly before the crisis, began helping my parents. He was an early adopter of financial planning software for all his clients back in ’07 and took the advising part of the job to heart.

He diligently guided them during the crisis and worked with them to craft a plan to match their new reality.

In the end, their retirement accounts recovered, and while some of the benefits they lost were gone forever, it all worked out. They both found rewarding “second act” careers after their forced retirement. They’re both now fully retired and have set themselves up for success for decades to come.

This very personal experience left an indelible mark on me and how I have conducted my career.

Look at the dark side

One of the most important things this experience taught me was that a retirement plan needs to be prepared for the worst.

You must build in a scenario where your portfolio experiences a bear market on Day One of retirement. This helps model out what’s known as “sequence of return risk,” where taking withdrawals during an early down market can permanently damage your ability to meet goals later.

That’s because when you sell out to meet distributions at the bottom, there are less funds to bounce back when markets recover.

Incorporating this simple change into your retirement plan assumptions can flip a good plan into a bad plan instantly.

When I meet with clients to discuss their plans and I turn on a simulation with a large bear market drop, it helps drive the conversation. It provides something to think about as it relates to their goals.

This type of analysis fits times like now — when markets are volatile and there is a high degree of uncertainty — by showing the impact if the worst happens at the most critical moment.

Prepare for the unexpected

Recessions often bring pain for both markets and employment. The threat of layoffs can be an especially daunting risk for pre-retirees in the last few working years of their career.

One of the most important things you can do to help prepare for a recession is to gauge your readiness for retirement with a plan that includes several ideal and less-than-ideal scenarios, such as the following:

• What if I’m forced to retire early and miss out on income and savings accumulation?
• What if I planned to have part-time income for five years in retirement and can’t find work?
• What if I’m forced to cover my health care costs out of pocket for several years?
• What happens to my asset base if I need to start drawing down assets early?

Start with a safety net

So how do you adapt your plan to a poor economic environment?

If you are in the last five working years of your career, one planning strategy to consider is to make sure you have at least 18 months of expenses saved in liquid accounts. That can be a combination of checking, high-yield savings and CDs or treasuries.

Wherever you decide to stash your money, the funds should be readily accessible and not require selling your portfolio to access. This helps reduce the risk of being forced to draw down your assets at the worst possible time.

As an added bonus, while lower than a few months ago, interest rates are still the highest that they’ve been in years.

Not everyone has the ability to stockpile cash, and even those who do may be faced with unforeseen circumstances. But remember, every plan has four levers that can be pulled to improve your outcome:

• Increase your return
• Shorten the amount of time in retirement by working longer
• Increase your income
• Decrease your expenses

Among these levers, some are better to pull than others.

I tell clients all the time if you push your risk level up to hit a sufficient return to meet your goals, we have a bad plan. One of the worst things you can do is overreach on risk, because you tend to find out you were too aggressive with your investments at the worst possible time.

No amount of good planning can fix selling at the bottom.

This really leaves us with time in retirement, expenses and income, but changing those variables isn’t easy. I haven’t met anyone who wants to take a long walk off a short pier if they’re at 82 and their plan says they will run out of money at 83.

Yes, you could go back to the workforce, for example becoming a store greeter, which provides income and shortens your time in retirement — but most people want to enjoy their golden years.

Similarly, inflation can make it hard to control expenses, and sometimes the biggest expenses are ones that you cannot cut, such as health care or mortgage payments.

The bottom line

That doesn’t mean you can’t retire during a recession. It’s just that a complicated problem usually requires a multifaceted solution.

Markets eventually recover, and sometimes that recovery brings deflation with it, easing expenses. Many of my clients, particularly those who retire early, have often found great second careers in fields they may have previously avoided due to lower pay or the fear of starting over.

If you are concerned about the possibility of a recession in the near-term future, the single best thing you can do is gauge how it might affect your long-term goals today.