Should I Contribute to Retirement During a Recession?

Budgets get tight during a recession, and you may be looking for things to cut out so you can stretch your money further. With retirement farther in the future, maybe reducing or eliminating your monthly contributions seems like a good option. But that decision could cost you a lot more than you realize. Here's why you should contribute to retirement during a recession.

Understanding the Importance of Retirement Contributions

No matter how much you love your job, you probably have some plans for what you'll do when you finally clock out for the last time. Whether you're looking forward to loading up your RV and hitting the road or volunteering in your community, your plans will require money. That's where retirement accounts come in.

How Retirement Accounts Work

There are different types of retirement accounts, but they all work similarly. You put money into an account, and that money gets invested in an assortment of stocks, ETFs, index funds, money market savings, bonds, and similar products. Over time, those investments generally grow in value and generate more money through compound interest and share dividends, as well as stock dividends. Around age 65 when you retire, you can begin withdrawing these funds to live on.

Time is the key here. The longer your money is invested, the more it will earn, especially if you keep reinvesting your dividends and interest. That's why it's important to start early, contribute consistently, and max out any employer matches available to you.

Social Security May Not Be Enough

Many people who don't save for retirement assume they'll be OK because they qualify for Social Security upon retirement. But for many people, Social Security benefits won't be enough to sustain their current lifestyle, only replacing around 40% of the average worker's annual preretirement earnings .

Now you may be thinking you'll have fewer costs in old age — a paid-off mortgage, no student loans, and your children grown and gone — but illness, age-related decline, and normal inflation can pose challenges. According a recent report from the National Council on Aging, more than 17 million American adults over 65 are economically insecure.

The good news is that you can start saving today to protect your future. If you're not sure how to get started, consider speaking with a financial advisor.

How Does a Recession Affect Your Retirement Accounts?

A recession happens when a country's economic activity decreases for two more consecutive quarters. A cycle starts in which consumers buy less, so production slows, then layoffs begin, prices increase, and consumers buy even less. A recession can be kicked off by a few different economic issues:

• Poor confidence in a country's economy
• Poor stock market performance
• High interest rates preventing consumer spending
• Falling house prices causing losses in home equity and slowing consumer borrowing

It's likely that a good portion of the money in your retirement account is invested in stocks. During a recession, the value of stocks decreases, making your retirement account less valuable. It can be scary to see those numbers drop, and you may want to withdraw your money to stash it somewhere safer — but that may not be your best option.

Recessions Are Short

Yes, your hard-earned money has taken a hit. You may feel angry or scared about what these low numbers mean for your future. But the good news is that recessions tend to be short, generally lasting between 6 and 24 months. They're also frequently followed by periods of expansion during which your retirement account will gain value.

Recessions Can Help You Get More for Your Money

During a recession, the price of stock shares drops, meaning you'll be able to buy more shares for the same amount of money. When the recession passes and markets recover, those extra shares will mean more stock dividends for you and more overall value in your retirement account. This is a big reason why continuing to invest during a recession makes sense — you'll get more for your money.

Assessing Your Financial Situation During a Recession

Three things happen during a recession that could derail your financial goals:

• Inflation
• Interest rate hikes
• Unemployment

In an ideal situation, you'd continue — or even increase — your retirement contributions during a recession. Your situation may or may not allow for that, though, so the first step is to assess your finances. Here are some things to consider:

How Healthy Is Your Budget?

First off, is your personal budget up to date? If you haven't reviewed it recently, now's a good time to do so. Record recent transactions from your checking account and credit card statements to make sure you have an accurate list of expenditures. With your budget updated, consider how well you're covering your monthly expenses:

• Do you regularly have leftover income, or are you shuffling things around to make ends meet?
• Would you be able to cope if costs of essentials like food and utilities increased due to inflation?
• Do you know what expenses you can cut if costs rise, and you need to tighten your budget?

Are You Carrying Debt?

Maybe like many Americans you have some debt. Usually that's not an issue, as long as you're making payments and not letting it snowball out of control. But during recessions, interest rates often rise, and debt that was manageable may become much more expensive. Ask yourself:

• Does your debt have a fixed or variable interest rate?
• Do you have a payoff plan, and are you on track with it?
• Would you still be able to manage this debt if the interest rate rose?

How Long Will Your Emergency Fund Sustain You?

An emergency fund is vital to avoiding unplanned debt. Instead of depleting your savings or turning to costly credit cards, you can rely on an emergency during a financial crisis. Traditionally, experts advise people to save enough money to cover their essential expenses for 3 to 6 months, but the right amount for your will depend on certain factors:

• How difficult is it to get a job in your industry?
• Does your industry have a hiring season with little opportunity for hiring outside that time frame?
• Are you in a single-income or dual-income household?
• Do you have children you may need to save more for?

Strategies for Contributing to Retirement in a Recession

If costs are rising and the economy is slowing, it may be difficult to make your retirement contributions. Yet it's important to continue so you don't miss out on dividends and interest, or your valuable employer match. The easiest way to free up money for investing is to cut your costs:

• Use discounts and coupons. Check free inserts in the local paper or coupon books in the mail. Follow retailers on social media sites or use their apps to keep up with sales.
• Save on entertainment. Get a library card to borrow books, movies, and even games. Visit your local park or make dinner with friends instead of going out.
• Cut out upgrades. Maybe you can't live without your favorites streaming service, but could you pay less to enjoy it with ads? Could you reduce your home internet bill by changing providers or cutting back to a lower speed?

Another option is to automate your retirement savings. You can do this by directly depositing a portion of your paycheck into your retirement account, or you can set up automatic transfers from your checking account. Besides making saving simpler, automating your savings eliminates the temptation to spend that money on other things.

You could also take a different approach by starting a side job or setting up a passive income stream. Establishing a passive income stream takes some work upfront, but once it's established, it should provide extra money with minimal effort on your part. You can use this income to cover rising costs of everyday expenses, or to boost your retirement contribution.

Protecting Your Retirement Accounts from a Market Crash or Recession

You can't prevent a recession, but there are many things you can do to minimize the impact on your savings.

Make Decisions Based on Your Estimated Retirement Date

Your strategy for riding out a recession may largely depend on how soon or far off your retirement date is. If you're young, you'll have time for your investments to recover. If you're planning to retire in the next 5 to 7 years, you'll want to take a more conservative approach to protect what you have.

If you're coming up on retirement, it may be a good idea to meet with a financial advisor to create a plan for market downturns. Having a plan in place ahead of time can reduce your anxiety and enable you to make decisions quickly to minimize losses.

Don't Make Huge Gambles

It can be tempting to try to time the market by predicting the right time to buy and sell certain stocks to minimize losses and maximize profits. But during a recession, markets can be unpredictable. There's a good chance you may end up losing more money by trying to game the system.

Invest in Defensive Stocks

Some businesses offer luxuries, and during a recession these are the businesses that will suffer hardest. People will nix streaming services, eat out less, put off trips, and ditch movie theaters when their budgets need tightening. As a result, the stock value of these businesses drops.

Businesses that offer essentials will feel the least impact from a recession because people can't go without their products and services. Their stocks are known as defensive stocks, and they include:

• Utilities providers
• Healthcare providers
• Consumer staples (like food and toiletries)
• Corporate conglomerates (such as Procter & Gamble, Kraft Foods, Unilever, or Coca-Cola)

Shifting your money into defensive stocks when the market starts to go south could help you avoid losses. This may be a good strategy if you're close to retirement and are more concerned with keeping what you have than aggressively building wealth. The downside to these safer stocks, however, is they will gain wealth more slowly in healthy markets. That means you may need to shift your resources out of them when the market rights itself.

Diversify Your Investments

If you've heard no other advice about investing, you've probably heard this one. But what does it mean? To diversify means to invest in:

• Different classes of assets, such as stocks, ETFs, index funds, bonds, and so on
• Different areas of the economy, like utilities, healthcare, real estate, and such

Different classes of assets are impacted differently during market slumps. If you've thrown everything into one asset class and it takes a hit, you could lose most of what you have. On the other hand, if your money is spread across multiple asset classes, some of your investments may fall while others hold steady or rise.

Similarly, some areas of the economy — think retail, dining, and entertainment — can both gain and lose value more aggressively, while others are less volatile. Diversifying your investments better protects your investments in the long term.

Consider Rebalancing Your Portfolio

Traditional wisdom advocates for a diversified portfolio in which 60% of your investments are stocks and 40% are bonds, but these assets can lose value in a recession. How should you respond? There are two schools of thought here.

Some experts suggest investing more in stocks during bad markets. Their argument is that stocks will be less expensive, so you can buy more shares during the downturn and then profit when the market improves. However, the market could fall even more, and you might wait years to turn a profit.

Another option is to move your money into bonds, which tend to lose value more slowly. The risk here is that interest rates rise during recessions, and the price of bonds drops when interest rates rise. This means your bonds could be less valuable when markets improve and interest rates drop.

The right choice for you depends on your risk tolerance and how much you already have saved. If you began saving for retirement in your twenties and your savings are where they should be for your financial goals, then you're better prepared to weather an unsteady market. But if you've fallen short of your savings goals and need to protect what you have, a more conservative approach may be best.

Is it a Good Idea to Retire During a Recession?

Whether or not you should retire during a recession depends on how well your expenses and your retirement income match up. Investments generally lose value when the market dips, which could reduce your income from your investments. If you've saved a large amount and can comfortably cover your monthly expenses with your retirement income — even with some losses — then you're set to hang up your hat.

Another consideration is how long your retirement needs to last, particularly if you plan to retire early. According to a study by the Social Security Administration, a man who retires at 65 will live an average of 16.94 more years, and a woman retiring at 65 will live an average of 19.66 more years. Economic downturns can reduce your retirement income, making it harder to make your money last.

Some people opt to semi-retire by reducing their work hours or finding a part-time job. This can be a chance to consult in an area of expertise, monetize a hobby, or take a chance on something you've always wanted to try — and the extra income will enable you to withdraw less from your retirement.

The Takeaway

You can't control a recession, but you can make choices that will lessen its impact on your finances. A little knowledge and a cool head will help you stay on track with your financial goals through all the economy's ups and downs.