The first few years of retirement can be a critical time for the nest egg you've spent a lifetime building. And the economic and market environment you retire into can set the course for the rest of your non-working years.
With stubborn inflation showing signs of sticking around for the foreseeable future and recession still a possibility, now could be a good time to review your plan. Inflation, which is expected to stay elevated at least into 2024, according to Fidelity research, can eat away at the value of your savings by increasing the cost of everything from food to housing, gasoline, and even automobile repairs. Similarly, if the US economy were to enter a recession, it could also drag your retirement portfolio down, so it's important to have a sound financial roadmap in place.
Source: Bloomberg Finance, L.P. and Fidelity Investments (AART), as of 3/15/23
The tricky part is that inflation and recession can each have a different impact on your portfolio. As a consequence, the strategies for dealing with them can differ, and may sometimes seem to work in opposition to each other.
For example, during inflationary times, you might consider boosting the growth part of your portfolio by investing in stocks, which historically have outpaced inflation. But during recessionary times, stocks tend to lose value. Since people nearing and in retirement are facing both challenges, it's important to build a portfolio that attempts to manage both risks in tandem.
Here's a look at how you can tackle the potential double challenge of inflation and recession, so you can keep your retirement plan on course.
Stick to a financial plan
The core of any well-constructed financial plan is to have a good understanding of cash flows, that is, all sources of income and expenses, says David Peterson, Fidelity's head of wealth planning. In the first year of retirement, aim to withdraw no more than 4% or 5% of your retirement savings. Each year after that, it's generally considered sustainable to adjust the dollar amount of that first withdrawal for inflation.
Typically, we suggest trying to cover essential expenses in retirement with “guaranteed” sources of income like Social Security benefits, pensions, and annuities. Then cover discretionary expenses with incomes sources that might be variable, like investment income or income from real estate.
This means if the income doesn't come in, you can cut back on these optional expenses without threatening your overall livelihood. And this may also allow you to avoid tapping into your portfolio, which ideally you'd let alone during periods of market volatility. Bigger withdrawals early in retirement might inhibit your portfolio's recovery when markets eventually rebound. "Drawing down a portfolio too much during times when market values are decreasing can be devastating to its ability to generate enough returns later to ultimately cover expenses over a lifetime," Peterson adds.
Now's a good time to take a close look at your budget and carefully assess your spending. Also, make sure you have an emergency fund set aside in a liquid account with 6 months to a year of estimated living expenses, in cash, which can help in the face of a market downturn.
"It's always a good idea to review your financial plan periodically regardless of the economic environment," says Brad Koval, director of financial solutions at Fidelity Investments. "In periods of market downturns, you may want to spend less, and in periods when markets are doing really well, you may consider spending a little more, as long as you are managing your income around those events and not overdrawing."
Read more in Viewpoints: How can I make my retirement savings last?
Make the best use of cash
While it may have made sense to simply hold cash in a standard checking or savings account when rates were less than 1% and there were few better short-term options, rising interest rates over the last 2 years means you may receive more interest from money market funds and certificates of deposit (CDs), which currently offer more attractive returns than standard bank deposit products, according to Federal Reserve Economic Data as of July, 2023. However, it's important to understand the overall risk profile of your portfolio; you should consider going through the financial planning process with a financial professional to understand how adding different investments can affect the different goals you may have for your portfolio.
Many CDs are offering yields of 5.3% as of July 11, 2023. You can also consider building a CD ladder, which might include CDs that mature at different times, such as in 6 months, 12 months, 18 months, and 2 years. When a CD in the ladder matures, it essentially gives you an opportunity to reevaluate your cash needs. You can take maturing principal to pay for living expenses, or to reinvest in longer-dated CDs, or some other investment.
"This is an opportunity to better manage your cash given the fact that bond yields are currently the healthiest they've been in 15 years," says Naveen Malwal, an institutional portfolio manager at Fidelity.
Read more about CDs in Viewpoints: Time for CDs? Or shop for CDs now.
Bond strategies
Similarly, you can build a bond ladder. Bonds can be a double-edged sword if interest rates rise. That's because bond prices move in the opposite direction of interest rates. So if you've bought bonds at the prevailing interest rate, and rates go up, your bonds will be worth less if you sell them prior to maturity. Of course, if you hold them to maturity, you shouldn't care about the market price as you will get the bond's principal value at maturity plus interest payments along the way, so near-term price fluctuations may not matter to you.
A bond ladder can help with bond investments when yields and interest rates are increasing. As with a CD ladder, a bond ladder means bonds mature at different intervals in the future. When a bond matures it allows you take the cash and invest in new, potentially higher-rate bonds in the future.
Watch our bond ladder video. Or shop for bonds now.
Annuities to consider
The guaranteed payout of a life annuity is always worth considering. But it can help provide an additional cushion during periods of market volatility, because your income won't be tied to a source that depends on markets. Higher interest rates have also increased payout rates for annuities recently.
Among the options, you can consider a single premium immediate annuity (SPIA), which can provide immediate income in exchange for a lump-sum investment.1It can offer a pension-like cash flow,2and the guaranteed income isn't subject to market volatility. Immediate fixed income annuities even have optional features and benefits, such as a cost-of-living adjustment (COLA) to help keep pace with inflation and beneficiary protection such as a cash refund.
And for someone who is just a few years away from retirement, something called a deferred income annuity (DIA)3 can provide guaranteed income and a steady cash flow for life. While DIAs provide a fixed payout, the payout is deferred until a predetermined date in the future that you select.
With a DIA, you may also take advantage of periodic investing to secure income payments in varying interest-rate environments. Each investment you make enables you to lock in income that is added to your final cash flow payment when you are ready to start. Similar to dollar-cost averaging, you may potentially benefit from a range of interest rates.
Similarly, a deferred fixed annuity, also known as a single premium deferred annuity, or SPDA, can play a role in the conservative part of your portfolio by providing a fixed rate of return. A deferred fixed annuity guarantees a rate of return over a predetermined time, typically 3 to 10 years, similar to a bank CD, which can also offer a fixed rate of return for a set period of time. And just like a CD ladder, if you're not ready to begin drawing income, you can roll those assets into a new contract with a new guaranteed rate of return.
Good to know: Many CDs are FDIC-insured up to $250,000, whereas annuities are subject to the claims-paying ability of the issuing insurance company. When interest rates increase, as they have over the past 12 months, that tends to drive up the rates offered by deferred fixed annuities.
Read more about annuities in Viewpoints: Understanding annuities. Or shop for annuities now.
Diversify your portfolio
Investments including annuities, bonds, and CDs can add ballast to your retirement savings to help overall portfolio value, Peterson says. But he emphasizes that it's important to understand that their returns, which are closely tied to prevailing interest rates, and are unlikely to provide the level of long-term growth and inflation protection that stock and other investments have historically helped provide.
Now's a good time to make sure you have the right mix of stocks, bonds, and other investments to meet your long-term goals for growth. It's impossible to time the market, and you shouldn't try to do that because of news headlines. But it's important to know that stocks often begin to recover, often rapidly, before the end of recessions. And during periods of high inflation, the recovery historically leads to higher returns than during lower-inflation periods. By staying invested, you won't miss the upswing.
During high-inflation periods, commodities tend to outperform bonds when economic growth has reached a peak. When recession risk has become evident, fixed income has tended to perform better. Tilting a portfolio toward more defensive exposure (with a mix of stocks, bonds, and commodities) during a recession may provide diversification benefits regardless of whether there's inflation.
Read more about building a defensive portfolio in Viewpoints: Seeking shelter in volatile markets. Or explore our managed accounts.
For illustrative purposes only. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. It is not possible to invest directly in an index. Fidelity proprietary analysis using historical index returns. Domestic Equity—Dow Jones U.S. Total Stock Market Index; Commodities—Bloomberg Commodity Total Return Index; Investment-Grade (IG) Bonds—Bloomberg U.S. Aggregate Bond Index. Source: Fidelity Investments (AART), as of 4/30/22. Regimes: A period is categorized as a high-inflation regime if the secular component is greater than the long-term average inflation, or a low-inflation regime otherwise.
Similarly, returns from a balanced portfolio have historically tended to outpace cash in high-inflation environments with market volatility. Over the past century, holding a balanced, diversified portfolio when inflation had already hit 4% (or above) has surpassed cash returns over the subsequent 3- to 10-year periods. Note: Diversification does not ensure a profit or guarantee against loss.
Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. It is not possible to invest directly in an index. Balanced Portfolio: 42% Domestic Equity—Dow Jones U.S. Total Stock Market Index; 18% Foreign Equity—MSCI ACWI ex USA Index; 35% Investment-Grade (IG) Bonds—Bloomberg U.S. Aggregate Bond Index, 5% Cash—Bloomberg 1-3 Month T-Bills. Inflation: 12-Month rolling CPI-Urban Index. Returns are calculated starting in inflation period but include all subsequent periods for their holding horizon. Source: Bureau of Labor Statistics, Haver Analytics, and Fidelity Investments (AART). Asset class total returns are represented by indexes from the following sources: Fidelity Investments, Bloomberg, ICE BofA, and a Fidelity Investments proprietary analysis of historical asset class performance, which is not indicative of future performance, as of 4/30/22.
While no one can predict the future, you can plan for a challenging retirement environment that includes inflation and possibly a recession by being proactive. Inflation and recession won't stick around forever. By planning now for them, you can ride out the storm and potentially find smooth sailing later.
