Recession is a word that can leave a sour taste in anyone's mouth. For the vast majority of people, there's no good association with recession; the only things they can think of are economic uncertainty, job losses, declining stocks, dwindling retirement savings, and stress.
A recession can impact nearly everyone's finances, but it can have an even greater impact on retirees or those approaching retirement because there isn't as much time to recover from them.
It's pretty much impossible to predict with certainty whether a recession is coming. Some people think the signs are there; others think the pessimism isn't warranted. Either way, it's always better to be over-prepared than under-prepared.
If retirement is on your mind and you're wondering if it's a good idea, here are three things to consider.
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1. Is your portfolio built to withstand stock market drops?
Reducing exposure to volatile stocks is a sure way to recession-proof your portfolio. Additionally, as you approach retirement, you can shield your nest egg by diversifying beyond stocks.
Notably, if the stock market drops significantly when you are nearing retirement, or already retired, the negative returns can drain your savings faster than usual, and potentially losing money to cover your living expenses. This situation is called "sequence of returns risk," and it can shorten your retirement savings' lifespan -- especially if it occurs early in retirement.
Transitioning your portfolio to include more bonds and cash while approaching retirement is a solid strategy to reduce risk and provide some stability.
Bonds typically don't have the upside of stocks, but they also far less riskier than stocks, assuming you're buying high-quality bonds. You generally don't have to worry about losing money during recessions.
Keeping at least a couple of years' worth of bonds and cash on hand can potentially help you avoid having to sell stocks during huge down periods.
2. When do you plan to claim Social Security?
Social Security is an important income source for many retirees. Luckily, Social Security benefits are immune to stock market fluctuations. If your monthly Social Security benefit is $2,000, it'll remain $2,000 no matter what's happening in the stock market or economy.
If you can survive solely from your Social Security check (many retirees can't), retiring during a recession may not be as directly impactful because you won't be relying on withdrawing from other sources, such as a retirement or brokerage account.
This can help buy you some time for a potential recovery if stock prices plummet during a recession. During the past four recessions, stock prices have dropped significantly, but they eventually bounced back each time.
^SPX data by YCharts. The grey vertical columns highlight recessions.
Past happenings don't guarantee future happenings, and you shouldn't assume you'll have time for your portfolio to bounce back in the event it experiences a sharp decline. However, it's much easier to be patient when you don't have to rely on your stock portfolio for your livelihood.
3. Are you open to having a fluid withdrawal strategy?
Being open to change is more important than the initial withdrawal strategy you use when you go into retirement.
Take the "4% Rule," for example, which says retirees can withdraw 4% of their retirement savings in the first year of retirement and then adjust the withdrawal amount according to inflation every year after without worrying about outliving their savings.
This strategy has worked for many retirees, but it's not as effective during recessions or down periods in the market because it can accelerate how fast you go through your savings.
The 4% Rule is just one example, but it highlights how a dynamic withdrawal approach -- one that you're willing to adapt at short notice -- is needed to ensure you're not put in a position where you could possibly outlive your savings.
Retiring during a recession isn't the best idea and can come with added stress. However, it's not an impossible task, and many have navigated it successfully. The best thing you can do is diversify your portfolio beforehand and be open to adjusting your withdrawal strategy along the way.
