Financial Planning

Economists generally determine that the country has fallen into a recession after two consecutive quarters of negative gross domestic product (GDP) growth. Since 1967, the United States has experienced seven recessions.

The thing is, predicting a recession is a little like predicting a tornado. Experts are never exactly sure if or when one will occur, but they can cite when conditions a ripe for one based past experience. The good news for predictors is that the economy follows a similar pattern of indicators in the months leading up to a recession.

The bad news is that many those indicators have recently emerged. For example:

• Inverted Yield Curve – This is when the yield on longer-term Treasury bonds is lower than the yield on shorter-term Treasury bonds, which happened recently for the first time since 2007. On average, an inverted yield curve has occurred 14 months in advance of every recession in the past 50 years.
• Corporate Profits – Estimates for corporate earnings growth have dropped substantially since last year, from 7.6 percent to 2.3 percent.
• Global Trade – The ongoing U.S. trade war with China has resulted in weakness in the manufacturing and farming industries. Moreover, global trade volume is also down, which further reduces the market for U.S.-manufactured goods.

What to Expect in a Recession

The worst recession in U.S. history was the most recent one, between 2007 and 2009. Dubbed the Great Recession, it was short (compared to the Great Depression of 1929-1939) but it took a powerful toll on a large chunk of the population. For example, close to half of U.S. households lost at least 25 percent of their net worth; one out of every four households lost at least 75 percent of their net worth.

About one-third of households experienced one or more of the following:

• Fell more than two months behind on their mortgage
• Had their home foreclosed
• Had their home equity drop into negative territory
• Lost a job

That was a bad recession. Fortunately, while economists are seeing signs of another one on the horizon, as of now (absent any significant shocks) they do not expect it to be as severe.

Tips to Prepare for a Recession

With multiple warning signs evident, it appears we do have some time before a recession potentially hits. It’s a good idea to use this time to protect your financial situation to help minimize any impact that a recession can have on you personally. The following are some tips to consider.

Shore Up Your Finances

Start by reducing your debt as much as possible, particularly any accounts exposed to a variable interest rate. The interest on credit cards and home equity lines of credit have a habit of increasing when you can least afford it. If you have a variable rate mortgage you might want to refinance at today’s low fixed mortgage rates so your monthly payments do not increase. One way to generate a robust savings fund is to temporarily suspend contributions to a retirement plan and save that money in a readily available account.

Minimize Household Expenses

Most people have to cut back on household expenses during a recession, so you might as well start now to help you prepare. For example, consider trading in a gas-guzzling car for one with better gas mileage and lower monthly payments, or pull the plug on cable TV and switch to a streaming service. Deploying these cost-reduction strategies now not only reduces your expenses during a recession but will also help contribute to your savings fund.

In many areas of the country, real estate prices are at the top of the market. It might be worth considering selling your house now while you can get a good price. This will give you a pot of cash to sit on during the recession, which is especially helpful if you lose your job. In fact, after the sale you may consider renting until real estate prices drop and you can purchase another home at a good price – and maintain a healthy cache of savings. This strategy could also save you from raiding your investment portfolio for money – helping protect your future financial security.

Protect Your Investment Portfolio

Take a good look at your portfolio and give it a recession stress test. Consider reallocating some funds to options that tend to perform reliably during an economic decline, such as:

• Government bonds
• Treasury Inflation-Protected Securities (TIPS)
• Corporate Inflation-Protected Securities (CIPS)
• Consumer staples stocks
• Well-established dividend stocks
• Fixed Income Annuity (FIA)

Recognize that it is generally not a good idea to completely cash out of the market. The best way to accumulate wealth over time is to stay invested regardless of temporary economic declines. In fact, investors who maintained their market positions between 2007 and 2017 experienced an average 240 percent growth rate.

Once the recession has ended, think about rebalancing your portfolio to realign its strategic asset allocation with your investment objectives and timeline. This allows you to cash in on outperforming assets and buy into depressed securities that could be poised for post-recession growth.

Statistics indicate that the average life expectancy is longer than it used to be, but empirically we see this every day among elderly people who have lived much longer than they probably expected. This phenomenon spotlights a particular component of retirement planning that was not as significant in the past as it is now: long-term inflation.

While we’ve not experienced annual inflation rates this century as high as the latter part of the 20th century, inflation can balloon at any time. But what can be even more devastating to a retiree on a fixed income is cumulative inflation over time. It’s also important to recognize that specific consumer product inflation rates can differ substantially from the averages.

For example, according to the Bureau of Labor Statistics, the cost (not always the price a consumer pays) of an oil change in 2000 was about $20. However, motor oil, coolant and fluids have experienced an average inflation rate of 5.66 percent per year – so in 2019 the cost of providing an oil change was about $56.89. That’s a 184.45 percent increase in less than 20 years for a common household expense during a normal retirement timeframe.

To build a portfolio designed to provide inflation-adjusted income throughout a long retirement, consider the following tactics.

Optimize Your Social Security Benefits

Social Security benefits receive periodic cost of living adjustments (COLA) based on the Consumer Price Index (CPI), which is a weighted average of prices of common goods and services purchased by all urban consumers. However, retirees spend more of their household income on goods and services that experience higher levels of inflation, such as medical services. Therefore, Social Security benefit increases might not keep up with a retiree’s actual cost of living – especially over time.

That’s why it’s important to consider inflation in order to optimize your Social Security benefits. In other words, except for people in exceedingly poor health (expected to die within a few years) or in dire circumstances, it’s a good idea to delay starting Social Security benefits as long as you can. If you can wait until age 70, benefits will increase by as much as 8 percent each 12-month period past your full retirement age. Delaying not only increases the level of income you’ll receive each month, but it also gives you more time to save money for retirement and allows your investments more time to grow.

Inflation-Aligned Investments

Another way to inflation-proof your retirement portfolio is to allocate a portion of assets to investments that tend to increase at the same pace as inflation. The following are some options you might want to consider.

• Series I Savings Bond – The I-Bond, guaranteed by the federal ­government, helps protect an investor from creeping inflation in a couple of ways. First, the I-Bond credits the holder’s account with a fixed interest rate plus the annualized inflation rate from the preceding six months. Second, the account value does not drop when prices fall.
• TIPS – Treasury Inflation-Protected Securities (TIPS) are marketable securities whose principal increases and decreases in tandem with the inflation rate (adjusted every six months). However, the coupon rate is fixed, so payouts vary based only on the inflation-adjusted principal. Upon maturity, the investor receives the greater of the adjusted principal or the original principal.
• CIPS – Corporate Inflation Protected Securities (CIPS) are similar to TIPS, but they invest in corporate bonds and typically pay a higher yield that combines a fixed payout plus the variable CPI rate. Unlike TIPS, they are not guaranteed by the U.S. government but are backed by the financial strength of the issuing company.
• REITS – A Real Estate Investment Trust (REIT) pays out reliable dividend income that tends to rise with inflation. REITS own or finance a diversified portfolio of income-producing real estate, such as office buildings, apartment buildings, warehouses, retail centers or hotels. REIT dividends have outpaced inflation in all but two of the past 20 years, according to the National Association of Real Estate Investment Trusts.
• IPA – With an inflation-protected annuity (IPA), initial income payouts are low but rise over time to align with long-term inflation, based on a formula linked to the CPI. A differentiating benefit of an IPA is that it offers issuer-guaranteed income for life, so the retiree doesn’t have to worry about reinvesting assets during later stages of retirement.

It is a good idea to work with a financial advisor to incorporate inflation-resistant investments for your retirement portfolio based on your individual objectives, tolerance for risk and timeline.

Laws regarding retirement savings plans don’t change all that often or all that much. Occasionally, new regulations are issued mandating disclosures that no one ever reads – and inflation-adjusted contribution limits tend to inch up each year. However, there is one phenomenon that has been increasing over the past decade, and Congress is finally starting to address it.

This phenomenon is that retirees are living much longer than in the past. According to Olivia Mitchell, Wharton professor of business economics and public policy, demographers have reported that the baby who will live to be 200 has already been born. Because few people plan on 40 years (or more) in retirement, increasing numbers of retirees rely solely on Social Security benefits during their final years. As a result, many retirees begin to struggle financially right about the time when their health is failing and they need long-term assistance.

To help avoid this problem in the future, Congress is looking at ways to align retirement plan provisions with longer life expectancies.

In May of this year, the House of Representatives voted 417-3 to pass a bill titled the Setting Every Community Up for Retirement Enhancement Act of 2019 (Secure Act). While the bill offers a wealth of provisions designed to enhance retirement plans, its primary goal is to enable Americans to maximize their savings for long-term retirement income.

The following are some of the key provisions of the Secure Act:

• Eliminates the maximum contribution age of 70½ for various retirement plans
• Delays the age when participants must begin taking required minimum distributions (RMDs) from 70½ to 72
• Enables employer ability to offer an annuity option in retirement plans
• Requires plan sponsors to provide an annual calculation of how much retirement income may be generated based on each participant’s account balance
• Requires long-term, part-time workers to have the option to participate in the company retirement plan
• Requires retirement account balances to be distributed as taxable income to named beneficiaries within 10 years of an IRA owner’s death

While the Secure Act is being considered in the Senate, this branch of Congress also has been working on a bill to enhance retirement plans. The Senate’s Retirement Enhancement and Savings Act of 2019 (RESA) does not include provisions for part-time workers or increase the age for RMDs, but it does offer the following provisions:

• Encourages wider availability of multiple employer plans (MEP) for retirement plan access for small business workers
• Eliminates the 10 percent auto escalation cap on salary deferrals under an automatic enrollment safe harbor plan
• Establishes up to a $500 per year tax credit for small business owners to help defray the cost of implementing automatic enrollment in a new retirement plan (or transition a current plan)
• Repeals the maximum age (currently 70½) for traditional IRA contributions
• Requires retirement account balances to be distributed as taxable income to named beneficiaries by the end of the fifth calendar year following the year of an IRA owner’s death

These bills reflect three important changes that could address the issue of providing income over a longer lifespan. First, the new legislation would allow seniors who work past traditional retirement age to continue making contributions to a traditional IRA, up to the annual limit.

Second, delaying the age at which tax-deferred retirement account owners must being taking required minimum distributions would allow those investments more time to grow.

And finally, annuities are increasingly being recognized as an additional guaranteed income source for life (similar to Social Security, only guaranteed by the insurer rather than the government). The Secure Act offers a provision to ease the liability a plan sponsor assumes in selecting annuity providers, which may incentivize more employers to offer a retirement plan annuity option.

While the two bills are somewhat different, bipartisan support in both houses of Congress signal that there may be enough consensus to pass retirement legislation reforms by the end of the year.

Members of the college graduating class of 2017 owed an average of close to $30,000 each in student loan debt. Imagine starting out adult life with that kind of debt load?

The prevalence of this type of mounting debt for a 21- or 22-year-old is unprecedented in U.S. history – and all the more reason why young adults need sound financial advice. Financial advisors might not necessarily market to this demographic; instead, waiting until they’re older and have assets worth their while. However, if today’s young adults don’t get off on the right financial footing with regard to managing debt, saving, budgeting and investing for the future, there won’t be that many in need of financial advice once they hit middle-age.

The following are a few tidbits of advice to help recent college grads develop successful money management habits.

Be Patient

Interestingly, many college graduates know they are in over their heads and welcome financial advice; in fact, they’re hungry for it. A recent survey found that the No. 1 goal for 94 percent of Millennials is to become debt free. Unfortunately, tackling thousands of dollars in debt while earning an entry-level salary is a difficult task. The first rule of thumb is to be patient.

It takes time to pay off that much debt. The best advice is not to develop expensive habits, such as buying an expensive car, one with poor gas mileage or a make that is known for expensive repairs. Don’t get into the gourmet coffee habit. Bring your lunch to work. These are common habits among young adults with little discretionary income, but the hard part might be refraining from this type of spending once they start earning a higher salary.

Any wage increases or monetary windfalls should be directed to paying off debt and establishing an emergency savings fund to cover three to six months of living expenses – just in case they get laid off or encounter a large, unexpected expense.

Be Disciplined

Just as it takes time and patience to pay off a large debt, it also takes time and patience for invested money to compound. Once debts are paid off, extra income should be devoted to a regular, automated savings plan, such as a tax-deferred retirement plan with a company match.

Here’s an example of the reward:

• Madison starts investing $10,000 a year at age 25 for 15 years, for a grand total of $150,000. At age 40, she stops and never returns to that investment habit.
• Aidan starts investing $10,000 a year at age 35 and continues that habit for 30 years – twice as long as Madison. His total contribution also is twice that of Madison’s, at $300,000.

By age 65, Aidan’s investment grows to $790,582. While Madison invested only half as much as Aidan, by age 65 her investment grows to $998,975 – $208,392 more than him (assuming a 6 percent average annual return). That’s what the power of compound interest can do for a new college graduate who starts saving young.

Be Diligent

Compound interest works both ways, so it’s important that young adults don’t miss or make late payments on student loans or other debt. Such bad habits lead to negative information being reported on their credit report, resulting in a low credit score that can cause them to be turned down for loans or charged higher interest rates. It can even mean losing out on a job opportunity, as some employers check out candidate credit scores.

Above all else, young college graduates need to make debt payments on time, build a credit history and protect their credit score.

Ideally, no matter how large debt payments are or how little a new college grad earns, a young adult should get in the habit of saving the same amount of money each month. Even if it’s just $20 a paycheck; it’s not the amount that matters – it’s the habit.

The best way to accomplish this is to live below your means. When you get a salary increase, increase your monthly savings amount. The easiest way to entrench a savings habit is to “keep living like you’re still a college student.”

There are a number of threats that both retirees and pre-retirees are facing right now when it comes to drawing Social Security benefits. For example, there’s a new scam this year. Seniors are being solicited by callers who claim to be with the Social Security Administration (SSA). The caller says he regrets to inform that the elderly person’s Social Security payments have been suspended. The caller says it’s either because the beneficiary has been involved in a crime or there has been suspicious activity related to their benefit. Here’s the interesting part: the caller then requests that the senior repay a certain amount of his benefit to Social Security by gift card. The scammer is then able to use this money quickly with no paper trail.

If that sounds absurd, consider that over the span of just two months Social Security beneficiaries collectively lost upward of $6.7 million by falling prey to this a new, highly effective scam. Even if an elderly person is suspicious or knows the call is fraudulent, he may acquiesce anyway for peace of mind. Seniors who rely on Social Security as their primary source of income are of no mind to mess around when that income is threatened. If you or anyone you know is in this situation, be aware that the SSA does not make direct phone calls, does not threaten to stop paying benefits, and certainly does not ask to be refunded payments by gift card.

From a longer-term perspective, Social Security payments could be threatened by – ironically enough – the current administration’s strict immigration policy. The former chairman of the Federal Reserve, Alan Greenspan, recently noted that in 2010 alone, unauthorized foreign workers paid about $12 billion in tax revenues that went directly into Social Security’s coffers. Because many immigrants pay FICA taxes whether they are documented or not, this revenue source has been a mainstay to our Social Security, Medicare and Medicaid programs for as long as they’ve been in effect. Based on 2016 government data, even before the recent immigration policies were implemented, Pew Research reports that the number of unauthorized immigrants had dropped to its lowest level (10.7 million) since its peak (12.2 million) in 2007.

The unfortunate consequence of fewer immigrants is that payroll taxes may have to increase and/or Social Security benefits reduced in coming years. One economist projected that if we continue down this current path of highly restrictive immigration policies, Social Security benefits would need to be cut by nearly 25 percent.

To make the most of their benefits, many retirement planners recommend that retirees wait as long as possible to begin drawing Social Security income. The longer you wait, the higher the benefit. However, those in poor health or diagnosed with a terminal illness (only two to four years to live) may be better advised to begin taking benefits. However, there is a caveat to this strategy that should be considered. Delaying benefits not only ensures a higher payout for the primary beneficiary, but also for the surviving spouse. When the primary breadwinner takes Social Security before full retirement age, his monthly benefits are permanently reduced – that is, the amount his widow will be stuck with for the rest of her life. If you don’t actually need the income, it might be worth delaying benefits to increase the amount a dependent spouse receives upon your death.

Another little known fact about Social Security is that you can have a do-over. If you retire, start drawing benefits and then decide to go back to work, you can actually stop taking the payout and let it continue to accrue until you’re ready again. Of course, there are restrictions in place. First, you must be under age 70. Second, you have to alert SSA of this plan by submitting the appropriate form within 12 months of applying for benefits. And third, you must pay back all the money you’ve received to date. The good news is that you can reapply later and enjoy a higher benefit as if you were drawing it for the first time.