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Recession-Proofing Your Clients’ Retirement Portfolios

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What You Need to Know

  • It is practically guaranteed that a given retiree will have to navigate a downturn at some point during their golden years.
  • Advanced planning is the only real way to mitigate the pain of a market downturn and recession for retirees.
  • A sizable cash reserve may feel like a performance drag during times of very strong returns in the markets, but it will pay dividends during a downturn.

Speaking during a recent ThinkAdvisor webinar on the topic of “Recession Proofing Your Clients’ Portfolios,” Rob Brown, chief investment officer at Integrated Financial Partners, offered a stark analysis of the situation facing investors heading into late 2022.

To begin with, inflation rates are the highest since the early 1980s, and most economists expect the economy to fall into a recession by 2024. Stocks are officially in a bear market, with the benchmark Standard & Poor’s 500 Index declining more than 20% from its peak in early  January. Bonds, too, are in a bear market, which Brown sees as perhaps even more troubling than what has happened with equities.

“Stock bear markets tend to be more severe on a percentage loss basis than bond bear markets, but stock bear markets tend to play out much faster and recover more quickly,” Brown said. “This makes sense because stocks are far more attuned to the basic facts about whether an economy is seen as growing or shrinking.”

The picture with bonds is much more complex, Brown warned, noting that bonds are generically a lower-return asset category in the long term. A blended portfolio of quality bonds returns something in the ballpark of 1.6% above inflation from a long-term historical perspective, he said. That’s not much to work with when it comes to the downside.

The ThinkAdvisor webinar also featured David Blanchett, managing director and head of retirement research, PGIM DC Solutions; Mike Kurz, director of programs, Investments & Wealth Institute; and Marcia Mantell, owner of Mantell Retirement Consulting. According to the panelists, there is strong evidence to believe that interest rates will continue to climb in the near- and mid-term futures and that both stock and bond portfolio values may continue to decline.

Opportunities Abound

One silver lining, according to the group, is that income investors now have more attractive opportunities to secure higher yields. It is a great time to begin building bond ladders and to think about ways to take advantage of the rate environment, perhaps by considering CDs or annuity types that benefit from higher rates. And, there are attractive opportunities to purchase Series I Savings Bonds, which pay a 6.89% interest rate through April 2023.

“This is just an extraordinary moment,” Brown said. “Essentially, every single asset category on the planet is down. While it is an extremely rare outcome, it is not an irrational or unexpected outcome given what are we facing economically in the U.S. and around the world.”

As the group pointed out, thanks to the soaring inflation, essentially all of the central banks around the world are simultaneously tightening their monetary policies. During the course of 2021, many investment professionals expected that higher inflation would be transitory and would disappear.

It’s All About Timing

However, with the passage of time, advisors and their clients have had to adjust to the reality that the current wave of higher inflation is not transitory. The global markets are doing the same, and investors are feeling the pinch.

As the panel discussed, those people who are still working and closing in on retirement seem to be the ones facing the most crucial decisions. Younger people have time on their side for financial markets and the economy to improve, while those who have been retired for a while have probably already made many of their big decisions. Those in the middle remain in a precarious position.

According to the panelists, to navigate this environment, investors must be very cognizant of their time horizon and plan accordingly. There are obvious rules of thumb to follow, they noted. For example, if a person is planning to retire within the next five years, any non-discretionary wealth that is likely to be needed in the short term shouldn’t be heavily invested in stocks.

But if investors have more time, the panel agreed, they can take heart and stay invested. Stocks may be down, but that means they are cheaper. If past recession-bear market combos are any guide, it will take anywhere from two to five years for the stock market to recover.

As Blanchett pointed out, research clearly suggests that investors, especially older investors, can reduce the odds of making ill-timed trades by effectively hiring someone else to manage their investment portfolio for them. This probably is going to mean selecting a target date fund or a retirement managed accounts program inside a 401(k) plan, while outside the defined contribution space, this is typically going to mean hiring an advisor.

Strategic Planning Starts Early

Brown and Kurz suggested the current environment has raised the profile of alternative investment opportunities, as traditional 60/40 portfolios consisting of publicly traded stocks and bonds have failed to hold up to expectations.

However, as the pair warned, there is a vast range of investment products that are both rightly and wrongly described as alternative investments available on the marketplace today. Thus, advisors can deliver a lot of value to concerned clients by helping them to filter through and navigate a very dynamic marketplace.

“I’m one of the greatest advocates and the greatest critics of alternatives,” Brown said. “We have seen so much product development, but a lot of it has not been great, frankly. Wealth management advisors looking for opportunities in this environment should be warned: It is really hard to do alternatives outside of the institutional arena and have it work out well.”

In the end, the panel agreed, this moment shows just how critical it is for advisors and their near-retiree clients to confront sequence of returns risk in a meaningful way. This can be accomplished in many ways, for example by strategically utilizing guaranteed income annuities or by embracing what is commonly referred to as a bucket strategy.

Critically, such strategies must be put in place early and be maintained with discipline, even when markets are soaring. Ideally, clients in this moment will have already set aside substantial resources to cover their living expenses without having to sell equity holdings at a dramatic loss. They can spend from the liquid bucket at a moment like this without having to sell mid-term or long-term investments at a significant loss.

The panel said advisors should counsel clients, during the core of their working years, to set aside at least six months of living expenses that can be used in case of an emergency, such as a job loss or health crisis that keeps the person from working. When people begin to approach and actively plan for retirement — assuming they have adequate resources to do so — they should carry up to 36 months of liquid living expenses. Those with less means may have to attempt to work longer or cut expenses.

A sizable cash reserve may feel like a performance drag during times of very strong returns in the markets, but that type of sentiment misses the point. The safety bucket is there to protect the client in case of a rainy day, the panel agreed, and it is practically guaranteed that a given retiree will have to navigate a downturn at some point during their life after work.


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