Saving for Retirement in a Recession
If you focus on the headlines, it can be easy to make emotional and possibly costly investment decisions.
The news can fill you with doom and gloom about the recession, high unemployment rates and big stock market swings. When you are saving for retirement, remember to take a long-term view so you can avoid making emotional, knee-jerk investment decisions.
Recessions Come and Go …
The Covid-19 pandemic triggered a recession in the U.S. economy starting in February. A recession simply means the economy shrinks, typically over a period of several months.
Recessions can be scary, especially if you or someone in your family is concerned about losing your job. Yet, they are a normal part of the business cycle. Economies grow, then shrink, then grow again — just like the sun rises and sets. Only the business cycles last much longer.
Fortunately, the good economic cycles last longer than the bad.
Over the past 60 years, U.S. expansions lasted on average 81 months, or about six and a half years. During that time, we experienced eight recessions, which lasted on average 11.6 months.
Recessions, while hard to live through, are simply a part of the natural rhythm of the economy’s business cycle.
The Stock Market Is Not the Economy
When you are investing your hard-earned money for retirement, it can be easy to forget that the stock market is not the economy.
During a recession, big stock market swings are normal, like the ones we’ve seen this year. A bear market, or a stock market decline of 20 percent or more, often occurs during recessions. In fact, during recessions, the stock market typically falls about 32 percent.
It’s no secret the stock market doesn’t like recessions. Here’s why.
When the economy is strong, people spend on everything from dining out and clothes, to cars and new houses, and that helps corporate profits to rise. More profits push stock prices higher. When the economy shrinks, the opposite happens. Businesses and people spend less, which can push corporate profits and stock prices lower.
There is a silver lining.
Typically, the stock market starts recovering about four months before a recession ends.
One reason is that the stock market while the stock market reflects the economy, the market is forward looking, as investors price in future expectations of corporate revenue growth.
The GDP report, which measures how much the U.S. economy grows or shrinks, is a lagging indicator. The GDP report tells us what happened over the last quarter. It’s a backward-looking report versus the stock market, which looks ahead.
Focus on What You Can Control
While you can’t control the stock market or the economy, there is plenty you can control, including how you save for retirement.
Create a plan. Decide how much to contribute to your retirement account and how to invest that money, and make a plan for regular rebalancing.
Block out the news. Ignore the headlines, at least when it comes to your retirement investing decisions. History shows us that recessions will end. And, down markets will turn into rising markets again. After every recession, the stock market has bounced back and climbed to new all-time highs. Going all the way back to 1926, the S&P 500 averaged an average return of 10 percent per year.
Don’t move to cash. It can be tempting to want to shift your retirement funds to cash or a stable fixed-income fund when the stock market nosedives. Selling when the market is down is a mistake made by some investors. Research backs this up. Stock fund investors earned only a 4.1 percent return per year, well below the average 10 percent return seen by the S&P 500 index. Why? One reason is because investors bought and sold and bought and sold during the year. It’s extremely difficult to know when to sell and then when to rebuy. Not only do you have to be right once, but you must be right twice.
Talk with an advisor. Take advantage of your access to an Edelman Financial Engines advisor. Watching the value of your retirement account go down when the stock market tanks is hard, but having a plan can help you gain confidence to weather market storms that may lie ahead. Our advisors are a phone call away and can answer your retirement investing questions.
Continue saving for retirement. Yes, you should continue to contribute to your workplace retirement plan even during a recession. How much? Contribute at least enough to earn your employer match, if your employer offers one. Most people need to save more than that — around 15 percent of their salary year in, year out, to reach their retirement goals. If you started saving late or might have to take some years out of the workforce, you should consider contributing at the maximum level allowed for your age if you can afford it.
Shore Up Your Home Economy
Last but not least, take some time this weekend to review your finances. That plan can be as simple as reviewing what’s coming in every month and what’s going out. Identify areas where you can trim your expenses so you can save more.
To prepare for retirement, you should save and invest through all economic and market cycles. Don’t stop contributing to your retirement plan just because the economy is in a recession. Follow the steps in the checklist below to prepare your investments and finances so you can feel more confident no matter what lies around the corner.
Prepare Now: Your Financial Checklist
- Maintain a Long-Term Focus
- Build an Emergency Savings Fund
- Rebalance Your Portfolio
- Talk With an Edelman Financial Engines Advisor
Recessions are a normal part of the business cycle but typically much shorter than periods of economic growth. There have been eight recessions in the past 60 years.
The stock market typically starts recovering about four months before the end of a recession.
Continue to contribute to your retirement account through all market cycles.
Key Points
It’s official. The U.S. economy is in a recession. In the short term, recessions create big swings in the stock market. Yet, over the long term, the performance of the S&P 500 stock index, a widely used market barometer, has posted an average return of 10 percent per year since 1926, according to Ibbotson Associates. So, even during a recession, you should continue to contribute to your retirement plan.
In this article we explain why recessions are normal, how the economy differs from the market, and how to act now to prepare your finances for whatever lies ahead.
This material was prepared for informational and/or educational purposes only.
An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee future results.
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