Helping Clients Recession-Proof Their Retirement Income Stream

In a historically low interest-rate environment financial advisors have had to think creatively about how to access yield for their clients who need income. That's caused some people who traditionally have invested in investment-grade credit to move out on the risk spectrum and buy more high yield. But in a recession, that could be a huge problem, he says.

"We don't think high yield is worth the risk," he explains. "It goes along with the idea that the economy is fine. When there's a recession, high yield is going to suffer because these are the least creditworthy borrowers."

Joseph Polakovic, owner and CEO of Castle West Financial, also thinks that the risks of fixed income are too great for income investors. He looks to stock dividends instead for his income clients, focusing on the high-quality companies that can withstand a recession.

With the markets strong now and no recession in sight, Battifarano says for his clients who need to take required minimum distributions, he is doing those much earlier in the year because of the higher valuations. He points out the average price per earnings ratio is trading at 19 times earnings, compared to the historical norm of 15. "You just don't know what tomorrow will bring. And if you have to generate some liquidity, you might as well do it at 19 times, versus whatever it will be in the future," he says.

Balance Short- and Long-Term Needs

The three sources say financial advisors need to think about how to balance their clients' short-term retirement income needs in a recession, with their long-term needs for future income. The last thing clients should do is tap assets that were geared for long-term savings for short-term needs. People who tapped equity markets for income during the 2008 financial crisis locked in those losses.

Polakovic says financial advisors should keep about two years of clients' short-term income needs in conservative investments, "to let them ride the wave" of a recession, he says.

For de Souza, that means putting two to three years of income requirements in cash while clients ride out a few bad years. "Now markets don't usually decline for two or three years in a row. That rarely happens, but I'm being extra cautious," he says.

Analysis by Sam Stovall, chief investment strategist at CFRA Research, shows that from 1945 to 2019, there were nine bear markets where prices fell between 20% and 40%. These markets declined 11 months on average and took 14 months to recover. There were three "mega-meltdown" bear markets with declines of 40% or more, which lasted on average 23 months and took 58 months to recover.

Battifarano says clients need to have a cash management plan for cash flow needs, especially during a recession. "Figure out what your spending requirements are, and try to stick to those. Have ample sources of liquidity in advance. You don't want to be in a portfolio that's 100% equities that's had a drawdown of 30%, and now you're forced to sell for living expenses. That's the worst position to be in," he says.