Don’t Let a Recession Ruin Your Retirement
The hot topic at the pickleball courts over the July 4th weekend was the increasing likelihood of an economic recession this year. Which surprised me since most of the players I know are retired.
Typically, a recession is accompanied by rising unemployment. If you are retired, that aspect of a shrinking economy does not pose a direct threat to your financial security.
But the other hallmark of a recession, decreasing asset values, can be a bigger threat to retirees than it is to younger folks. That’s because many retirees rely on positive investment returns to supplement their Social Security income.
When I started out as a stockbroker 40 years ago, you could get high yields on investment-grade bonds. For that reason, most retirees simply converted their retirement savings to bonds and lived off of the interest payments.
That strategy will no longer work for most retirees. In 1981, the 30-year Treasury bond paid more than 14%. By 2011, that yield had dropped below 4% and has stayed there ever since.
It’s easy to generate meaningful income in retirement when government-guaranteed bonds are paying 14% interest. That works out to $70,000 annually on a $500,000 investment.
But when the yield drops to 4%, that same investment is producing only $20,000 of yearly income. I don’t know many people who can live comfortably on that level of income.
For that reason, many retirees gradually shifted more money into the stock market as bond yields fell. And for the past 20 years, that strategy has worked pretty well.
Even after its recent 20% decline, the S&P 500 Index is still up 380% over the past two decades. That equates to a compound annual growth rate of roughly 8%.
Cash Flow is Cool Again
Here’s the problem for many retirees. The next 20 years are not likely to be as rewarding for stock market investors as the past 20 years.
Three months ago, I explained why the stock market will struggle to produce high returns going forward. In sum, we won’t see the type of inexpensive labor, affordable energy, and cheap money that padded corporate profits in the past.
That being the case, my pickleball buddies have a valid point. Most of them can expect to live another 20 years in retirement, perhaps longer.
In that regard, it isn’t a recession that scares them. It’s what a recession implies for their future retirement income that has them worried.
What they really want to know is this: Where can they put their money now to produce a reliable stream of income over the remainder of their lives?
I believe the answer to that question will drive much of the stock market’s behavior over the second half of this year. We already started seeing it during the first half of this year but nobody noticed.
Dividend stocks are back in vogue. They were shunned while high-multiple momentum stocks were the all the rage last year. But now that rising interest rates have deflated future earnings multiples, current cash flow is cool again on Wall Street.
Just Passing Through
That’s good news for pass-through securities such as master limited partnerships (MLPs), real estate investment trusts (REITs), and business development companies (BDCs). Many of them pay yields in excess of 6%, about twice what you can get from a 10-year Treasury note.
For example, the Global X MLP ETF (MLPA) currently yields 6.8%. Its top three holdings are energy midstream operators Enterprise Products Partners LP (NYSE: EPD), Energy Transfer LP (NYSE: ET), and Magellan Midstream Partners LP (NYSE: MMP).
Since energy stocks are the only sector of the S&P 500 Index in positive territory this year, their yields are relatively low. But for all the other sectors of the index, share prices are low and dividend yields are high.
Consider the VanEck BDC Income ETF (BIZD), which currently pays a dividend yield of 8.8%. Its share price is down 15% this year on fears that a recession could trigger a wave of small business loan defaults.
The same thing happened two years ago at the onset of the coronavirus pandemic. However, once Wall Street realized that the world was not coming to an end, its share price quickly rebounded.
Also taking a hit this year are real estate investment trusts (REITs), since many of them own commercial property. During a recession, companies cut back on office space to reduce overhead.
For that reason, the Invesco KBW Premium Yield Equity REIT ETF (KBWY) is down 10% this year. It pays dividends monthly, currently at an SEC 30-day yield of 7.2%.
This fund tracks the performance of the KBW Premium Yield Equity REIT Index. To do that, it “will invest at least 90% of its total assets in the securities of small and mid-cap equity REITs that have competitive dividend yields.”
Those aren’t the kind of businesses that are getting much attention from professional portfolio managers these days. They have bigger things to worry about. But when it becomes apparent that the worst is behind us, don’t be surprised if these pass-through securities find renewed popularity on Wall Street.
Let’s Hear From You
Above, I shared my thoughts on one way to deal with an impending recession. However, not everyone has the same investment objectives or risk tolerance.
I’d like to know what steps you have taken, or will soon be taking, to protect your portfolio. You can do that by sending an email to my attention at firstname.lastname@example.org.
I might use some of your responses in a future Stocks to Watch article. We have a lot of savvy investors among our subscribers with decades of investment experience that could be helpful to our readers.
Editor’s Note: It pays to keep investments simple. Peter Lynch said it best in his classic 1994 book Beating the Street: “Never invest in anything that you can’t illustrate with a crayon.”
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