If it were possible to Google the most frequently discussed topic in recent client conversations, there is no doubt the top “hits” would be something related to “Are we in a recession?” or “Are we going into a recession?” And with good reason. We are all subject to so many channels of financial and economic news, it’s almost impossible to avoid the cacophony of opinions and alarming headlines. As wealth advisors and stewards of our clients' investment portfolios, we vigilantly watch these developments as we seek to keep our clients informed and our planning strategies up to date. To check out our thought process on recessions, you can check out an article we published a few weeks ago.
We’re certainly sensitive to the consternation associated with this topic. Still, we tend to answer “Are we going into a recession?” with another question: “How relevant is it to you?” This question is not meant to be flippant nor to understate the very real and painful consequences of an economic contraction to millions of people. But for our clients, the relevancy of a recession should register mostly as a curiosity rather than a stomach-churning, keep-you-up-at-night question. Why? A sound investment and wealth plan will have already assumed recessions will happen at least several times over the decades. We’ve already planned for it. Said differently, the recession question is not an “if” but a “when” as part of the normal economic cycle. As such it should be accounted for in every plan.
A few key metrics are foundational to formulating and sticking to the plan. As noted in the chart immediately below, a critical fact to keep in mind is the average number of months for a stock market recovery, defined as how long it takes the market to trend back up and exceed the prior high point. On average, the S&P 500 takes about 20 months to rebound to the prior high point during recessionary periods. The longest recovery took 54 months (about 4.5 years). Of course, history provides us no guarantees that future recession-related market declines will rebound with the same cadence, but these are foundational data points to understand when constructing an asset allocation and retirement cash flow strategy.
We also recognize that recession relevancy and associated planning differ depending on the stage in the financial journey. For this reason, we delineate below the spectrum of circumstances in order to provide an applicable perspective for each.
Currently Employed or Approaching Retirement
A recession can be a frightening development if it means the loss of a job. There are few circumstances that are more taxing on a family’s balance sheet and psyche. Even with the best wealth planning, losing the security of the bi-weekly deposit into the bank account will still be troubling, to say the least. For this reason, we strongly advise having at least six months of after-tax living expenses in a savings or money market account. This amount could be even higher if a job or career is relatively unstable. This amount should be completely segmented from other investible assets as it is simply a liquid emergency fund. The role of this cash is not to grow but to provide peace of mind so that the family can avoid painful disruptions to their lifestyle, leaving time for a thoughtful and patient job search.
Once the cash emergency fund is established, the mix between growth-oriented and stable assets should be evaluated on a continuum. The further one is from retirement, the more doable it is to wait out the unavoidable market declines and subsequent recoveries. This allows a larger percentage in stocks for long-term growth. With that said, the asset allocation decision is not “set it and forget it,” and it requires vigilance through the years as retirement timelines and life circumstances change.
There is one silver lining to a recession while working, assuming job loss isn’t a factor. Declines in stock markets so often associated with a recession provide an opportunity to buy stocks on sale at depressed levels, increasing the chances of stronger returns when (not if) the recovery takes hold.
Currently Retired: What’s Your Number?
Retirees have different asset allocation needs compared to those still working. Aside from the traditional inputs to this decision (expected returns, volatility measures, dividends, and interest, etc.) is a single important number: the number of years of living expenses invested in stable, high-quality bonds and cash. Knowing that expenses are covered for several years regardless of stock-market behavior yields many psychological benefits. It’s also a defense against the worst enemy of successful investing: panic-selling. This is not complicated math, but it does take some work. Getting to this number requires a good estimate of living expenses offset by stable retirement income (Social Security income, pension income, etc.). Having this number “covered” by stable assets gives a high degree of confidence the portfolio can withstand even the most frightening of market storms. Even with this number in mind, it’s difficult to completely ignore the doom and gloom in the news as we noted in our article back in June. But knowing one can maintain a lifestyle for several years without ever having to sell a stock to fund it can help ward off fear-driven selling that could cause severe long-term damage. While this number is by no means a substitute for a detailed and updated investment strategy and comprehensive wealth plan, it can be very helpful to keep in mind when it seems the stock market may never find a bottom.
Something Else to Keep in Mind
Always keep in mind the business model of the financial media and opportunistic salespeople. Both can exploit a recession to exacerbate the doom and gloom to sell advertising (through salacious and bombastic TV or online content) or “safe” financial products that take advantage of people’s fear and mostly benefit the salespeople. All one has to do is flip on cable news to see the suddenly pervasive advertising for these products. Fear can be a powerful motivator, but having a well-grounded understanding of the relevancy of a recession to your specific circumstances can be an effective antidote to the scourge of short-termism.
Recessions are serious and can be very damaging professionally and personally. Growth and contraction cycles are the prices we pay for living in what is one of the world’s largest and most dynamic economies. It’s important to acknowledge and accept this volatility as a fact of life. More importantly, assume sharp downturns as a given, and factor it into the plan that accounts for the inevitable. No two recessions or bear markets are alike except for one common attribute: they always end.