… and how they can help us through COVID-19
By Brandon BuckinghamMr. Buckingham is Vice President of Advanced Planning at Prudential Financial, Inc. Visit www.https://www.prudential.com/
We climbed out of the Great Recession just a decade ago, and yet, there are lessons that many did not learn from that crisis, as well as mistakes we may be doomed to repeat navigating the economic fallout of the COVID-19 pandemic.
Today’s financial challenges, from equity market volatility to unemployment and historically low interest rates, all come at a time when Americans are faced with the prospect of needing to generate income for longer life spans. In times like these, we are reminded of the power of a strong financial plan, especially as the shocking pandemic has shown that we cannot predict when a recession, job loss, or health crisis may arise.
Like before, risk-based portfolio construction and sound financial guidance remain key. The shocks caused by COVID-19 have also provided a renewed focus on the importance of understanding clients’ financial needs and goals, as well as testing financial plans across various market scenarios, unexpected life events, and a range of life span longevity time frames. In other words, protecting outcomes through planning and testing has become increasingly important. Getting this right can be the difference between running out of money, just surviving retirement, or clients being able to live the way they actually want in retirement. To achieve financial wellness in retirement, it is prudent to review what the past decade has shown us, including the unpredictable nature of recessions and their ability to carry multiple negative impacts for retirement plans that were not designed to withstand them.
Learning from the Great Recession
While it is too soon to predict the long-term impact of our current recession, we do have critical information to apply from the Great Recession of 2007-09.
The period was characterized by sustained slower wage growth, which reduced lifetime earnings, retirement savings, and future Social Security and pension income for many workers. This was particularly damaging for workers in their late 50s because of the way Social Security computes benefits. One analysis found that age-70 income fell by 5% annually for adults who were 55-59 years old during the Great Recession.
While the equities market came out of this period into a historic bull run, a closer analysis reveals that the market recovery was not enjoyed by all market participants equally. According to a Federal Reserve Survey of Consumer Finance taken 10 years after the market crash, the median value of retirement holdings jumped 70% for the top 10% of U.S. households. This was not the case for the average American: middle-income groups experienced account values that remained stagnant or even declined in the decade following the crash.
Other studies have also found that many retirees and near-retirees can feel the effects of financial crises years later. The Center for Retirement Research at Boston College found that half of working-age households were at risk of being unable to maintain their standard of living post-financial crisis, an increase from 44% before the recession started.
Those Who Learn from History Are Not Doomed to Repeat It
While having an awareness of the difficulties that recessions can bring to retirement plans is critical, it’s even more vital to take action. The first important step is building a diversified portfolio that can weather downturns. Portfolio construction is especially key for proper retirement planning as needs change according to the different stages of an individual’s life.
Diversification should mean having a mix of different asset classes as well as having tools at your disposal that will perform throughout different market conditions. Importantly, that translates not only into the classic mix of equities, bonds and other securities, but also can include products like annuities that protect future income streams and provide an opportunity to participate in market rebounds, while protecting against declines.
Despite an extremely challenging time for the economy, the market has shown an ongoing appreciation for annuities as current realities increase their relevancy. Annuities sales overall are only down 4% this year, according to LIMRA, which is an indication that consumers are eager to protect and eventually grow their assets through insurance products that offer both safety and flexibility, even at a time of uncertainty.
Individuals with varying investment horizons are participating in a flight to the safety of annuities, which is exactly what happened during the 2008 financial crisis. Those that are looking to protect against potential further market downside without losing the ability to capture market upswings are specifically looking at indexed variable annuities. Sales for this slice of the annuities market have been the strongest this year, up 44%. And although sales for fixed annuities are down compared to last year, their payouts are ranging between 2.30% and 2.85%, which still looks very attractive when compared to 10-year treasury rates below 0.70%. There are also annuities with income benefits as high as 5.5% beginning at age 65. I am optimistic that the annuities market will continue to improve through the rest of 2020, as more individuals are attracted to the security and predictable income they can provide.
Stress Tests and Outcomes
In addition, financial and income plans should be tested through various market conditions. When thinking about the Great Recession and stress tests, we are reminded of the Dodd-Frank tests for financial institutions. Just as critical financial institutions are required to have enough capital and resources to overcome various financial stresses, this concept should also be applied to personal finance. Those who took this lesson to heart following the housing bubble market crash designed financial plans that can weather a wide range of market conditions or reductions in employment-based income. Incorporating products that continue to protect assets and provide stable income even through the worst scenarios proves extremely valuable in times of crisis.
Another important factor in navigating a recession is a focus on outcomes. This means understanding what retirement will look like in terms of lifestyle and how to achieve that goal. This challenge is exacerbated as Americans are living longer lives on average compared to prior generations. What is often overlooked is the stress retirees will have in trying to calculate how long they will live and if they’ll have enough money to maintain their lifestyle. In other words, while wealth accumulation is critical, the decumulation phase is also significant in plotting out what retirement looks like. In practice, even if retirees have sufficient savings to live the way they want, the constant worrying about a longer life can prevent them from actually enjoying it.
If the past two recessions have taught us anything, it is that we don’t know what tomorrow will bring. With sound financial planning, however, retirees can have greater financial stability. This won’t happen solely through old-fashioned portfolio construction and asset allocation. A renewed approach that brings the same vigor employed by Wall Street’s institutions to individual financial planning, as well a more prominent focus on desired financial outcomes, will be key to guiding and protecting clients through the various economic cycles they’ll inevitably encounter.