John E. Girouard
Nov. 20, 2018
Everyone wants to know how to create the elusive “recession-proof” portfolio. In 2008, I was asked to write a column on the topic, and since millions of us were still reeling from losing everything, the title I suggested was, On Monday I was Ready to Retire, Now It’s Tuesday.
Catchy, yes, but when people woke up to find $10.2 trillion in wealth had been wiped out from the American economy, they wanted answers. More importantly, they wanted to take back some semblance of control over their financial lives and find a way to protect themselves from “next time,” which had quickly become their new worst fear.
In particular, folks nearing retirement age—with less time to earn and recover—were asking where they could invest their money so it wouldn’t disappear again in a few years. And honestly you’d think that by now, after having had 47 recessions in our country (yes, that’s the real number), that Wall Street would be capable of answering that question. From the Great Depression to the Great Recession, economic disasters have become embedded in our cultural subconscious like a recurring nightmare… But must we always live with the threat of waking up in a cold sweat?
As if market volatility weren’t enough of a boogeyman, we’re also fighting against human nature. Biologically it seems we’re programmed to make absolutely terrible choices when it comes to money and investments. Not only do we spend too much money on frivolous, instant-gratification purchases that prevent us from saving for retirement, but apparently we also have no idea how to play the market.
Even though “buy low, sell high” should be programmed into all our psyches by now, many investors seem to do the exact opposite. The average investor has earned total returns of just 2.5% over the past 20 years, while the S&P 500 has returned an average of 9.5%. If that’s not enough evidence, just look at how many people jumped on the cryptocurrency band wagon last year, only to see 90% of their profits and principal wiped out 12 months later. Just last week, the market cap of the entire cryptocurrency market plummeted by $15 billion in just 24 hours, and bitcoin hit its lowest level of the year, according to CoinDesk. Needless to say, these days no one is asking me about investing in bitcoin. (Finally, progress.)
Don’t get me wrong, we all make financial mistakes. I’ve made plenty in my day, and I’m a firm believer that it’s one of the best ways we learn. As we age, our financial decision-making capabilities tend to evolve along with our priorities. We begin to realize that we’re investing for our life, not for some arbitrary Wall Street target, like beating the S&P 500. Honestly, who cares? Do you really want to sit around bragging about your market prowess while the rest of your friends are out enjoying their golden years?
No matter how old and wise we become, the reality is that we’re never able to control the markets or the economy. Thankfully, though, we can exert control over our emotions, which I’d argue have much more to do with our returns than the markets themselves. (Folks who got scared and pulled out in 2008, I’m talking to you.)
To keep my clients sane and their money protected before, during and after a recession, I sit down with them for something I like to call the “income generation conversation.” We touch on a lot of different topics, but one of the most important is the emergency fund. You’ve likely heard many times that it’s good to have between three and six months’ worth of living expenses set aside in the event of a job loss, health crisis, or other unforeseen circumstance. What you likely haven’t heard is that those numbers only make sense when you’re actively employed. Once you’re retired, you need to have a full five years’ worth of living expenses in cash, or at least out of the market.
Before you start complaining about how much money that is, stop and think about what it would feel like to have to draw down on your accounts while the market is at a low point. Chipping away at your savings before they’ve had a chance to recover means a double whammy for your wallet.
Perhaps you did the math and know that you have enough saved to last until you’re 100. Good for you. But what happens if you’re forced to take withdrawals after the market loses another $6.9 trillion in shareholder wealth, like it did in 2008?
Once you’re retired, you can’t afford to wait for the markets to recover in order to enjoy your golden years. Those grandkids are only going to be young for so long. Which is why the most important thing you can do is to set your retirement accounts up so that you can weather any storm. Here’s a rundown on five separate portfolios I would recommend setting aside to ensure just that.
- Portfolio A: Determine how much money you need to support your lifestyle for five years, and take those funds out of the market. Put them in a layered CD or bond portfolio, or even fixed annuity to make sure that you always have your near-term cash flow secured.
- Portfolio B: This portfolio will be the next one you tap if a recession comes and you spend through Portfolio A. Since it will have at least five years to grow to replace portfolio A, it can take on some risk, but to be safe we should only assume a 3% rate of return during that time frame. (For context, 100% equity portfolios in large company stocks have been shown to recover all losses over a five-year period. But portfolio B should be no more than 40% equities.)
- Portfolio C: If you’re following along, you’ll know that this portfolio will have ten years to grow before one might need it to support their lifestyle. Here you can assume a bit more risk, since time is on your side. You can invest more in equities, and in good years when you exceed 4% growth, you can use your excess to make up for possible inflationary increases in your lifestyle.
- Portfolio D: This portfolio has—you guessed it—15 years to grow. Here, one can feel good about completely leaving emotion out of the equation and knowing that you’ll see the markets recover before you need this money.
- Portfolio E: Here you’ll leave excess money that you want to grow, and annually you can move the money over to cash. Remember that cash is a non-taxable liquid asset, and it is your friend. You can use it to move into a retirement facility, or give it away to family.
Whether you follow the above religiously or come up with a variation on your own plan, remember that your life cannot be put on hold if the market tanks. While it’s true that these portfolios may not be wholly “recession-proof,” they are largely “emotion-proof.” Anytime your strategy involves removing the temptation to have a fire sale with your assets, or draw down on your accounts during a downturn, it is a very good strategy indeed.