What a Recession Means for Your Retirement

The word "recession" can make anyone nervous, especially when most of your savings are in a 401(k) or IRA. Headlines about one coming, or one starting, show up often, and many of them turn out to be wrong.

This page explains what a recession actually is, who decides when one starts and ends, and what happened to stocks, bonds, jobs and Social Security in recent recessions. It doesn't predict the next one. It shows why the timing of a recession matters most around your retirement date, and how people prepare for one without guessing.

What is a recession, and who decides when one starts?

A recession is a broad drop in economic activity that lasts more than a few months. In the US, the official start and end dates are set by a committee of economists at the National Bureau of Economic Research (NBER), a private research group.

The NBER describes a recession as a "significant decline in economic activity that is spread across the economy," lasting more than a few months. Its Business Cycle Dating Committee looks at several measures, such as jobs, income and spending, not just one number.

You may have heard that a recession means two quarters in a row of falling GDP (gross domestic product, the total value of what the economy produces). That is a popular rule of thumb, but it is not how the NBER sets the official dates.

The committee also takes its time. It waits until the data is clear, which often means many months.

How often do recessions happen, and how long do they last?

Recessions come irregularly and are usually much shorter than the growth periods between them. The four most recent US recessions lasted from 2 to 18 months, according to the NBER.

The official dates come late. The NBER announced on December 1, 2008 that a recession had started in December 2007, almost a year after it began. It announced the February 2020 start on June 8, 2020, and it announced the end of the 2020 recession on July 19, 2021, more than a year after the recession ended in April 2020. By the time a recession is official, much of it may already be behind us.

What happens to stocks in a recession?

Stocks have often fallen hard in recessions, and they have often started to recover before the recession officially ended. The size of the drop and the speed of the recovery have varied a lot.

Two recent examples:

• 2007 to 2009. Federal Reserve History reports that the S&P 500 stock index fell 57% from its October 2007 peak to its low in March 2009. The low came three months before the recession ended in June 2009, and more than a year before the NBER announced that end in September 2010.
• 2020. According to the St. Louis Fed, the S&P 500 fell to 66% of its February 19, 2020 peak by March 23, 2020, a drop of about a third. By February 19, 2021, it was at 115% of that peak.

Calendar-year returns tell a similar story. In Aswath Damodaran's historical return data from NYU Stern, the S&P 500 with dividends lost about 36.6% in 2008, then gained about 25.9% in 2009. In 2020 it gained about 18.0% for the full year, despite the spring drop.

Not every recovery has been that quick, and nothing guarantees the next one will be. Past performance does not guarantee future results. The point is that the worst moment for stocks and the official news about a recession often don't line up.

What happens to bonds in a recession?

High-quality government bonds have often held up or gained in recessions, because interest rates usually fall. But not every kind of bond does well, and bonds can lose value in other years.

In both recent recessions, the Federal Reserve cut its key rate close to zero. Federal Reserve History says the Fed lowered the federal funds rate to a range of 0 to 0.25% in December 2008. The St. Louis Fed reports it cut to the same range on March 15, 2020. When rates fall, the prices of existing bonds tend to rise. Our guide to what interest rate changes mean for your retirement savings explains why.

In Damodaran's data, 10-year US Treasury bonds gained about 20.1% in 2008 and about 11.3% in 2020. Lower-rated corporate bonds (Baa grade) lost about 3.4% in 2008, so not all bonds held up. And the same 10-year Treasury lost about 11.1% in 2009 as the economy began to recover. Bonds are a cushion, not a guarantee.

What happens to jobs in a recession?

Unemployment rises, sometimes sharply. For people still working in their late 50s and 60s, a layoff can force a retirement decision earlier than planned.

Federal Reserve History reports that the unemployment rate peaked at 10% in October 2009, after the 2007 to 2009 recession. In 2020 the jump was faster. The Bureau of Labor Statistics (BLS) reported that unemployment reached 14.7% in April 2020, the highest rate in the history of that data. The St. Louis Fed notes that it had been 3.5% in February 2020.

If you are still working, a recession raises a practical question: what would you do if your job ended suddenly? One choice people face is whether to claim Social Security early. Claiming before full retirement age (67 for anyone born in 1960 or later) permanently lowers your monthly benefit. According to the Social Security Administration, claiming at 62 cuts it by about 30%. Some people use savings or a cash buffer to bridge the gap instead. Our guide on protecting your retirement savings after 50 covers Social Security timing in more detail.

What happens to Social Security in a recession?

Social Security benefits don't rise or fall with the stock market. What can change is the size of the yearly cost-of-living raise.

That raise, called the COLA, follows a consumer price index called the CPI-W. When prices jump, the raise is larger. When prices fall, there may be no raise at all. The Social Security Administration's COLA history shows what happened around the 2007 to 2009 recession:

• Benefits rose 5.8% starting in January 2009.
• There was no raise in January 2010 or January 2011. Payments stayed at the same level.
• Raises resumed with 3.6% in January 2012.

For comparison, benefits will rise 3.6% in 2027. Social Security's steady payments are one reason many retirees cover their basic bills with it and with any pension, and use savings for the rest.

Why is a recession riskier right after you retire?

Because you may be taking money out while prices are down. Selling investments at low prices to pay bills leaves less money to recover when markets improve.

This is called sequence-of-returns risk: the order of good and bad years matters once you start withdrawals. A bad stretch in the first few years of retirement can do more lasting damage than the same stretch ten years later. Our guide on protecting your 401(k) from a market crash shows it with a simple example.

How does a cash buffer help in a recession?

It lets you pay your bills without selling stocks while they are down. That gives your stock holdings time to recover.

Many retirees keep one to two years of spending in savings, money market funds or short-term CDs, with the next several years in bonds. This is often called the "bucket" approach. In a recession, you spend from cash and bonds and leave stocks alone. In good years, you refill the cash from stocks. The market crash guide walks through how people size each bucket.

The SEC's investor education office makes a similar point for people still working. In its "Don't Panic, Plan It!" article, it suggests keeping money aside in something less risky for life's surprises, "such as sudden unemployment."

Why does selling at the bottom hurt?

Because it turns a drop on paper into a permanent loss, and it often means missing the recovery. To come out ahead, you would have to guess right twice, on when to get out and when to get back in.

The 2009 example shows why this is hard. Stocks hit their low in March 2009, while the news was still very bad and the recession had months left to run. Someone waiting for good news before buying back in could have missed a large part of the rise that followed.

The SEC's investor education office warns that selling after prices drop can be a mistake, since that "can often be the best time to buy." FINRA, the brokerage industry regulator, says to "avoid impulsive decisions" when markets become volatile or economic conditions change. It also warns that scammers are active in all market conditions, so a scary economy is a good time to be extra careful with unexpected calls about your money.

Does gold help in a recession?

Sometimes, but not reliably, and it has real limits. Gold is better thought of as a small diversifier than as recession insurance.

In Damodaran's data, gold rose about 4.3% in 2008 and about 24.2% in 2020. But in 2001, a recession year when the S&P 500 lost about 11.9%, gold rose only about 0.8%. Gold also can't do several things retirees need in a downturn. It pays no income, so you must sell it to spend it. It has storage and dealer costs. Its price can swing sharply, and it has gone through long flat stretches. See how much of your portfolio should be in gold and our comparison of gold, stocks and bonds.

How can I prepare for a recession without predicting one?

By building a plan that already expects one. You don't need to know when the next recession will come to be ready for it.

People in this situation often consider these steps:

1. List your spending needs for the first five years of retirement and what Social Security and any pension will cover.
2. Keep a cash buffer of a year or two of spending outside the stock market.
3. Check your 401(k) mix against your retirement date, so money you need soon isn't all in stock funds.
4. Plan for a job loss if you are still working: how long savings would last, and when you would claim Social Security.
5. Decide in advance what you will do in a bad year, such as spending from cash and trimming withdrawals.

Our Market Insights overview explains how recessions fit with interest rates, inflation and market drops. For a plan built around your own numbers, talk to a fee-only fiduciary or a tax professional.