Tuesday, August 18, 2009

Which Recovery is Good for Your Retirement?

We are at or near or nowhere near a recovery. No one knows. But that doesn't stop the speculation and with good reason. Most investors try and position themselves near where they feel the seeds are planted - the green shoots if you will. But this recovery, which had devastating long-term effects not only on retirement plans but the investors who use them to secure the future, is different than previous returns to normalcy.

In the recent past, we have had three major blows to the economy. 1973 was a good example of an oil driven recession. Most Americans were caught completely by surprise. For many people, it was the first time they had ever felt globalization in their paychecks. And more than just the long lines at the pumps brought this realization to their front door steps.

The recession that began in the third quarter of 1973 was not initially inflation driven. In fact, it was the nominal interest rate of 10.2% and inflation rate of 7.4% (if they seem high compared to our current rates, they are), the collapse of investments, consumer withdrawal and the overall lack of spending that pushed the unemployment rate to almost 10%.

The recovery was spurred forward by a huge tax rebate engineered by Alan Greenspan. And while inflation seemed to come under control, albeit briefly, unemployment rose as some industries that are traditionally hurt during a recession - housing, manufacturing - took longer to recover. By 1980, the trouble with banks (deregulation led to riskier lending practices, higher federal deposit minimums) only added to the problem. By 1982, the prime interest rate was at 20%.

Banks failed, Savings & Loans collapsed and the corporate tax increase and the deficit spending by the government instituted by the Reagan administration all contributed to the length of the recession. But it was the contraction of available money (money supply) by the Federal Reserve that caused the downturn. And helped its recovery by 1984. By that point, inflation was down to 3.2% and two million Americans had returned to work.

The next recession hit the world as consumer confidence (which had soared, declined) and consumer spending (spurred on by unrealistic optimism) became global players. We had developed into a nation of consumers and the world was now our producer. When we stopped spending with the first Gulf War and the rise in oil prices, the rest of the world's economy (the exceptions were Japan and Germany) fell.

The recession that began in 2008 is well documented and still lingering. But the signs of recovery are beginning to poke through. The problem is, what and when will it end and when it does, what will the new post-recession economy look like?

The credit shocks that the economy has felt are still reverberating. Bondholders will be offered riskier high yield bonds to help alleviate this debt burden. Current bondholders will be asked to lengthen the maturities on the bonds they currently hold and job creation will be the last piece of the puzzle needed to see any meaningful recovery.

Business are still testing their limits, stretching what few resources they have in an effort to position themselves for their shareholders. This pressure will keep job regrowth to a minimum as businesses figure out what to do next. Just as many investors have removed risk from their portfolios, so have the businesses we invest in (whether it be directly through stock purchases or indirectly, through mutual funds).

This makes planning for a retirement in this environment doubly difficult. Those close to retirement will have little time to bring their portfolio losses back to pre- 2008 levels quick enough to make a significant difference (the economy needs retirement in order to create jobs for people entering the workforce).

Those looking at a retirement ten-years and beyond have lowered their risk significantly as well, opting for index funds and indexed ETFs or by lowering their investment contributions. Both of these will force retirement further into the future.

Although consumers won't see raises for many years to come, the slowdown is allowing many banks the opportunity to work through the bad loans still on the books. Businesses will begin capital spending but only barely in the next year.

The key to benefiting from this recovery involves more than increasing your savings (which is considered an economic inhibitor) and getting your financial house in order (refinancing during these low lending rate events and realigning spending). The key is still investment and a healthy dose of investment risk. Confidence in the fact that you may not lose your job, you will keep your house and possibly even build that emergency savings account for the first time leaves the average person with a risk gap that only stocks can fill.

If you do not maintain at least a 5% contribution level and keep it in actively managed funds, those looking to pick stocks in this sort of market, you will miss out on some unusually attractive opportunities at rebuilding what you may have lost.

In other words, 90% of Americans will feel the recovery long before any other part of the economy will. They just won't realize it.

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