Responding to the RecessionDo you barricade yourself in your home when it rains, to emerge only on a beautifully sunny, 70 degree day? Of course not. Think of what you’d miss. Similarly, while everyone wants to invest in a bull market, in a downturn, it’s a different story. Just as you prepare for bad weather by wearing a raincoat or carrying an umbrella, investing wisely for retirement in a recession requires a little more planning.
According to a recent study by the Washington, DC-based Employee Benefit Research Institute (EBRI), Americans are, in fact, planning carefully in the wake of the recession. Although EBRI’s annual Retirement Confidence Survey (RCS) measured a decline in confidence about the security of retirement (a record-low 13% this year say they are very confident of having enough money to live comfortably in retirement), investors are taking action to gain control. For example, 81% say they have reduced their expenses. Others are changing the way they invest their money (43%), working more hours or a second job (38%), saving more money (25%), and seeking advice from a financial professional (25%). Most notably, among all workers, 75%, one of the highest levels ever measured by the RCS, say they and/or their spouse have saved money for retirement.
The RCS also recorded some lifestyle shifts. For example, 28% of workers say the age at which they expect to retire has changed in the past year, with the vast majority (89%) noting their expected retirement age has increased. Additionally, 72% of workers say they plan to work for pay after they retire, an increase from 66% in 2007.
To position your portfolio to survive the recession:
Review your investment strategy with an emphasis on risk.
You know your investment strategy is a function of your time horizon, goals, and tolerance for risk. While your goals and time horizon are fairly straightforward, risk is often difficult to ascertain in theory. In fact, now facing real portfolio declines, many investors feel the need to make some adjustments.
All investors need protection from three basic risks. First, there’s market risk, the possibility that events in financial markets may lead to a decrease in the value of your investment. Investors in bonds and bond funds are subject to interest rate risk. Interest rates and bond prices generally move in opposite directions: when interest rates go up, bond prices go down, and when interest rates go down, bond prices go up. Finally, in today’s rollercoaster market, it may seem safest to preserve your money with bank certificates of deposit. However, that exposes you to inflation risk. That is, if the rate of inflation outpaces your interest rate, you’ll have diminished purchasing power.
How much risk you decide to take going forward depends on how much volatility you can tolerate. Think of volatility as a change in value of your account. Generally, while stock portfolios experience greater short-term swings in value than do bonds, there is an important tradeoff. Equities reward you with greater potential for long-term gains. Accordingly, a major factor to consider when thinking about your risk tolerance is how long it will be until you expect to tap into your investment account. If you have three decades until retirement, you may be better able to stomach a market downturn. After all, you have plenty of time to recover. Conversely, if you are in or approaching retirement, you have less time to benefit from the market’s eventual upturn and may worry more about a down market.
Re-commit to saving.
History shows that market gains can occur in a few strong, but unpredictable, trading days. Sticking with your retirement savings plan ensures you invest a fixed amount at regular intervals. This “dollar cost averaging” can result in a better average share price than trying to time your purchases because your set contributions buy fewer shares when the market is up and more shares when the markets are down, resulting in an optimal average cost per share over time. Such a plan involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through periods of low price levels. Such a plan does not assure a profit and does not protect against loss in declining markets. Also, check that your assets are spread across stocks, bonds, and short-term investments. The best-performing asset classes vary from year to year and combining investments that respond differently to market conditions helps control risk. Rather than focus on a sector you perceive as safe, continue to make broad-based contributions on a regular basis. You also might consider rolling old retirement plans into an IRA to facilitate monitoring your portfolio.
Work on making rational decisions.
Financial decisions can be difficult even in good times, but the extreme emotions triggered by the recession can impede your ability to think logically. Rather than get upset and react to newspaper headlines or discussions around the water cooler, base your decisions on solid information and careful analysis of your own personal economy. Resist making what you perceive as a quick fix portfolio move, and strive to lengthen your perspective by keeping your long-term goals in mind. When you take the time to run your retirement numbers, you may be surprised. Your diversified portfolio may not have suffered as much as the broader market. What’s more, as with many of the workers responding to the EBRI’s RCS, putting off retirement for a year might not be the worst possible scenario. More importantly, looking at future projections can help you to think more about your current spending, helping you to become a more mindful consumer and make better choices that can further boost your retirement savings.
Although there are certainly some positive signs on the economic horizon, there will be plenty of cloudy days ahead. However, as the economy battles its way out of the recession, anything you can do to feel more in control and focused on your long-term goals will enhance your ability to make sound investment decisions and position your portfolio to benefit from the market’s eventual rebound.