In recent months, we’ve witnessed a series of unprecedented events impacting the economy and your personal finances. The coronavirus pandemic and ensuing global economic crisis, combined with social unrest in the wake of the senseless and tragic deaths of George Floyd, Breonna Taylor and Ahmaud Arbery, illustrate that defining a “new normal” is a fluid process—with much work yet to be done.
As countries around the world focus on reopening their economies and protesting social injustice, we explore how consumers and the financial markets are responding, what this means for your planning in the weeks and months ahead and six things you can do now to stay on course toward your goals.
COVID-19 continues to drive financial markets
By the first week of June 2020, all 50 U.S. states had received a green light from their respective governors to reopen all or parts of their economies. However, consumer confidence and the virus itself will continue to play a significant role in determining how quickly the economy and job market will bounce back, and how the financial markets may react going forward.
“We’re basically looking at three scenarios,” said John Canally, CFA, Chief Portfolio Strategist for TIAA’s Investment Management Group. “The upside case, our base case and the worst-case scenario.”
The upside case. The best case, according to Canally, is that COVID-19 passes quickly, economic activity normalizes during the summer months, and global monetary easing and fiscal stimulus reignite growth. The upside case would also include a rollback of U.S. and China trade. The biggest concern for investors in this scenario is a potential uptick in inflation. So, even in a deflationary environment, investors still need to be thinking about how they can protect against inflation.
The base case. According to Canally, a more likely scenario entails a sharp but brief recession through the summer months followed by a cautious recovery—beginning in the third quarter—as long as policy decisions remain supportive.
“This is our base case,” Canally said. “However, even in this scenario, we expect to see U.S. corporate earnings fall by at least 20%, and interest rates and inflation to remain low for an extended period. While the markets are tracking to that now, investors should expect a bumpy ride for the markets and economy through year-end.”
The downside case. The downside case is that the impact of COVID-19 lasts throughout the summer months and into the fall. In this scenario, economic reopening fails due to a significant resurgence in cases and hospitalizations, and countries and economies are forced back into lockdown. Other concerns include a spike in cases due to states reopening too quickly.
“In the downside case, we would expect global trade to become more protectionist and interest rates to remain low, not just for a couple of years, but possibly for a decade. That has real implications for investors trying to figure out how they will take income in retirement.”
Markets are positioned for a smooth reopening
Performance on the health front will continue to be the leading indicator of how successful the recovery will be, with the markets paying close attention to the number of new cases and hospitalizations, as well as progress toward drug therapies and, ultimately, a vaccine. As a result, Canally anticipates the U.S. economy to experience a “W”-shaped recovery, marked by continuing market volatility.
“Currently, the markets are priced for a smooth opening, with no second wave,” Canally said. “However, stocks may retest recent bottoms if shutdowns become necessary during the summer or later this year.”
As a reminder, equity markets generally lead the economy, meaning that the recent run-up in stocks implies that economic activity will improve in the next six to nine months.
“At current levels and valuations, the upside and downside risks for large capitalization U.S. stocks are roughly balanced, due to the fact that markets are forward looking and have already priced different scenarios in, including how long it may take to return to prior growth levels. Since 1960, it has taken 20 months, on average, to get back to the prior peak in GDP (gross domestic product) following a recession.1 This time, our base case expectation is that the economy will get back to normal by the middle of next year,” Canally said. “But keep in mind, since the markets are forward looking, they are already pricing that in.”
A recent bright spot is the unexpected jump in employment growth. The labor market, which typically lags overall economic growth, added 2.5 million jobs in May, marking the largest monthly gain in new jobs since the Bureau of Labor Statistics started tracking the data in 1939.2 However, keep in mind that the employment data released each month is subject to revision, so that gain could be revised away in the coming months. Moreover, collecting and compiling the data for the monthly jobs report is a difficult task in normal times—and even more so during a pandemic.
What does this mean for your planning?
Below, TIAA Chief Financial Planning Strategist Dan Keady, CFP®, joins Canally to weigh in on navigating the economic recovery, including six ways to help you remain on track during uncertain times.
Review cash flow
“It’s really important to understand that the recovery is a process, not an event,” Keady said. “When it comes to your planning, you want to balance the opportunity in the upside scenario while building in a measure of downside protection.”
One way to help accomplish that goal is by building cash reserves.
“Many people have found extra money in their budgets due to spending more time at home,” Keady said. These extra savings can help pay down outstanding credit card debt or add to emergency savings. “Remember, low savings rates or cash reserves, plus high credit card debt, lead to financial fragility. So reviewing your cash flow is step one in difficult times.”
Rely on a plan
During the extended bull market, many people thought they didn’t need a plan or professional advice. That complacency is now coming home to roost.
“Not having a plan is like going on a road trip without GPS or a map,” Keady said. “It’s going to be a lot harder to get where you’re going without clear direction. Our planning process is designed to match your financial plan to your goals—the things that are most important to you. Using our asset location worksheet, we connect your goals to your time horizon and evaluate the purpose of each asset you own. We also stress test your strategy for extreme market events, like we saw in March. This is built into the more than 500 scenarios we run when we create your plan.”
Regularly updating your financial plan is also key. For example, your financial consultant will work with you to determine if you’re still on track to reach your goals, or if any adjustments or course corrections are needed.
Create a buffer
Those adjustments may include the ability to create a buffer to help protect longer-term assets during periods of volatility.
“Maybe you’re spending less because you’re not traveling or eating out as much. In that case, you may want to consider drawing less money from your investment portfolio, which can help reduce sequence of return risk,” Keady said.
Sequence of return risk occurs when you draw down on assets that may have fallen in value due to market volatility. One way to create a buffer and allow longer-term assets time to recover is to consider using emergency savings or other cash reserves to support spending.
“Our planning process factors in six months of emergency savings for this very purpose,” Keady said.
Increase guaranteed income
For those in or nearing retirement, Keady also recommends reviewing your sources of guaranteed income.
“Years ago, when I started in this business, most people were able to build a strong, guaranteed income floor in retirement through the combination of Social Security and a pension,” Keady said. “Today, most people don’t have a pension, and Social Security alone is not enough to meet their monthly expenses in retirement.”
The solution? Consider annuitizing a portion of assets to increase the amount of fixed, guaranteed income you receive each month. If you’re ten years or less from retirement, think about building a future self-pension using guaranteed fixed-income products to build an income floor above Social Security.
Review your investment policy
Another important planning consideration is your investment policy. These guiding principles not only determine how and where your money should be invested, but help you avoid emotional decision making, which can quickly derail your strategy. According to Canally, there are four things you want to make sure your investment policy addresses:
“While your investment-related tax bill may not be top of mind right now, managing tax risk is an important element of planning,” Canally said. “As you’re reviewing your portfolio, consider if it makes sense for you to sell certain investments to offset gains in others to reduce your tax exposure.”
It’s also critical to have a plan in place to help generate the income you will need in retirement while preserving principal and managing inflation and market volatility.
“Even in our base case, we expect interest rates to remain low for an extended period. As a result, accomplishing your goals will require adherence to a disciplined, repeatable and unemotional process. This is especially important when it comes to strategic asset allocation,” he said.
What is your process for allocating your assets among stocks, bonds and cash? Do you prefer an active or passive approach? For example, active portfolio management focuses on outperforming the market in comparison to a specific benchmark such as the S&P 500 Index, while passive portfolio management mirrors the investment holdings of a particular index in order to achieve similar results. These are all components of managing risk, along with understanding when to buy and sell investment holdings.
“Back in March, the smart thing to do was to buy securities that had fallen in price and sell holdings that had risen in value. However, many investors did the opposite,” Canally said. “This is where ongoing oversight and professional advice can really pay off.”
Keady agrees that having an ongoing, non-emotional and rules-based process in place can not only help to avoid poor decision making but can provide a level of confidence.
“That becomes increasingly important when faced with challenges, such as a job loss or furlough,” Keady said. “That’s why it’s so important to stress test your plan for extreme events. We want to make sure that no matter what happens, you have a plan in place to deal with it.”
Control what you can
According to Keady, when faced with a major challenge like a job loss, it’s important to “control what you can control by taking action.” That begins with scheduling time to meet with your financial advisor to update and review your plan. This provides an opportunity to review your cash flow to understand what’s coming in and what’s going out, how much you have in your emergency fund and how long those savings may last. It’s also critical to apply for unemployment or other benefits you may be eligible to receive.
“We also want to look at things like access to severance pay or a spouse’s income, the ability to reduce or eliminate non-essential expenses, and debt,” Keady said.
He recommends contacting your mortgage lender, student loan provider and other debt servicers to learn about options for debt relief or restructuring. Finally, know your options for COVID-19 retirement plan loans and withdrawals. However, he cautions that these should be viewed as a last resort. “Big transactions in your retirement plans can greatly impact your long-term planning.”
Keady also urges those considering an early retirement package to meet with their financial advisor.
“Again, our Life Goals Analysis planning process runs through all of the different scenarios to help you decide if this makes sense for you,” he said. “This allows you to see the impact early retirement may have on your ability to accomplish all of your goals, and factors in Social Security benefits, how you will pay for healthcare and other considerations.”
“Finally, no matter where you are in your journey today, we can’t emphasize enough that you really need a partner in the planning process during these uncertain times,” Keady stated. “Your financial advisor can meet with you to discuss any changes in your values or goals, and help you translate those into your plan.”
To learn more about the outlook for the markets and economy in the months ahead, the importance of comprehensive planning to help protect against future uncertainty or ways to stay on course in any market environment, contact your TIAA financial advisor to schedule time to address your questions and talk about your needs.
1TIAA Investment Management Group, Daily Market Update, May 20, 2020.
This material is for informational or educational purposes only and does not constitute fiduciary investment advice under ERISA, a securities recommendation under all securities laws, or an insurance product recommendation under state insurance laws or regulations. This material does not take into account any specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on the investor’s own objectives and circumstances.
Advisory services are provided by Advice & Planning Services, a division of TIAA-CREF Individual & Institutional Services, LLC, a registered investment adviser.