Preparing for Recession During Retirement
The Fed raised interest rates again yesterday and expressed some concern over the direction of the economy after nearly a decade of market recovery and growth. The VIX, the volatility index, has doubled to 25 in the last three months reflecting uncertainty and increasing trading activity. Retirees, Late-Term investors, and those on fixed withdrawals from investment portfolios all run the serious risk of permanent impairment of sustainable withdrawals. For these investors market growth is required for sustainability.
Flat markets or declining markets will result in the dissipation of income producing assets from which recovery is frequently impossible. A recession may be coming, or at least a slow down in growth. For growth stocks trading at a high multiple of earnings, a slowdown or recession will force market prices lower even if the economy realizes some or marginal growth.
There are two broad avenues to manage economic stability, Fiscal policy that primarily addresses taxation and spending, and Monetary Policy controlled by an Independent Federal Reserve, that adjusts the money supply through interest rates to banks. Both tax cuts and lower interest rates are tools to manage the economy, but with a massive tax cut in 2017, that tool is off the table unless Fiscal Policy makers choose to explode the deficit and national debt further. With Interest rates near zero for years, (Quantitative Easing) the Fed too found itself unable to implement policy. Consequently the Fed must raise rates to the point where it again can impact inflation, money supply, through interest rate reductions, and so they raise rates to build a cushion for future expected actions.
As I have said in previous posts, a decline in portfolio value should trigger a halt to distributions should the decline reduce portfolio value -10% below contributions. Continuing distributions in flat or declining markets in the expectation of market recovery may significantly impair future distributions and threaten retirement sustainability. Retirees and Late-term investors taking distribution must prepare for the eventuality of recession by building a reserve equal to at least 1 year's distribution in the event the portfolio stagnates or declines.
Furthermore, take money off the table until the volatility abates and stability and growth return. For example, if you think the market could decline -20% and your risk limit is -10%, paring 50% of your holdings limits losses to -10% yet still provides the opportunity for market participation should markets rebound. Never leave yourself in a position where you are compelled to continue taking distributions from equity portfolios during market declines and particularly if account value falls -10% below contribution.
Finally, You should consider United States Saving Bonds as one vehicle for holding funds tax deferred with liquidity and US guarantees. TIPs, treasury inflation protected securities currently yield 2.3%-2.6%. Savings bonds come in many denominations with limitations on purchases to $10,000/yr per category per social security number both for "EE" bonds and "I" Bonds (inflation adjusted). "I" bonds have averaged between 2.5% and 3% over the past 10 years and currently stand at 2.83% with rates currently rising with inflation. In past periods of high inflation, yields have exceeded 5%. TIPs and Savings Bonds are competitive with any short-term rate or CD. I encourage all investors to max out their I Bonds every year and consider TIPs to round out portfolio allocations.