Broker Check
Does an inverted yield curve predict a recession?

Does an inverted yield curve predict a recession?

September 29, 2019

I was asked about the coming recession at the soccer field this weekend. For people in the real world like my clients and the parents of my son’s soccer team, the economy is not an important topic unless they lose their job or if nobody calls for take-out from the restaurant they own.

But recently there’s been media chatter about the “inverted yield curve” and how it often signals a coming recession. I’m always skeptical about tools like these. With 18 years in this profession, one thing I have learned is that nobody can predict the future. Another thing I’ve learned is most of us don’t know as much as we think we do. So I check with experts and plan for the unexpected.

What is an inverted yield curve?

When the markets think U.S. Treasury bonds will pay higher interest rates in 10 years than they are paying now, that’s normal. When the markets think that interest rates on 10-year Treasury bonds will be lower than the current one-year Treasury note, that’s an inverted yield curve.

Since 1955, every time we have had an inverted yield curve, an economic contraction follows. The fact that we currently have an inverted yield curve could be a signal that a recession is coming. And if that’s true, maybe you think it will affect your financial goals.

How to prepare for a recession

I often remind clients that most of their big financial goals are long-term. For example, they want to have enough money to pay their bills for a 40-year retirement. If your priorities are long-term then recessions are less of a concern.

According to the Capital Group from National Bureau of Economic Research and Thomson Reuters data, here’s why recessions should not disrupt your long-term plans:

  • Most recessions last about 11 months.
  • The Gross Domestic Product falls about 1.8 percent during the contraction.
  • Stock markets grow around 3 percent during the contraction.
  • Employment falls by about 1.9 million jobs during a recession. (Compare this to the 12 million jobs that are added during an average expansion.)

Think in financial buckets

I often talk with clients about the importance of timing regarding their financial goals. Specifically, here is what I mean:

  • When your goals call for you to consume money in the next two years, you should keep it in a cash saving account at the bank because:
  • If you need the money in 24 to 48 months, you can do a bit better with a diversified bond fund in a brokerage account, in which:
  • If you think you need this money in 48 to 60 months you will do better with a diversified investment fund that owns stocks and bonds. The benefits include:
    • This is a cheap, old, balanced fund. They do a nice boring job.
    • They own between 75 percent and 25 percent stocks and 75 percent to 25 percent bonds.
    • The mix is adjusted based on the manager’s assessment of the economy.
    • You stand to have a growth rate of 7.93 percent per year over a 20-year average with a Dodge and Cox Balance Fund (DODBX)
  • If you think it will be five years or more before you need the money, a good stock fund has the following benefits:
    • This is a cheap exchange-traded fund.
    • You own all segments of the U.S. stock market.
    • You want to leave it alone for five years before you think about selling.
    • You’ll get a 9.3 percent annual growth over a 15-year average with a Vanguard Total Stock Market account (VTI) that holds all U.S. stocks.

It’s my opinion that every reader will benefit from an on-going conversation with an experienced, professionally trained, fiduciary, fee-only financial planner. The dialog will help you be sure that your financial decisions are lined up with your financial goals. I’m confident you will love the experience.

A great place to start looking for the right planner is to talk with a couple CERTIFIED FINANCIAL PLANNER™ professionals.

To find a CFP® professional near you, start your search here.

As you visit with financial planners, I suggest a couple things to check:

  • Is the advisor always the client’s advocate – a fiduciary advisor?
  • Is the advisor only paid by clients, not any financial product manufacturer or distribution network? That would be a fee-only advisor

These two points help assure that you are working with a professional who is committed to your best interest at all times. It seems sort of obvious to me that a professional would work in this way, but it’s not automatic.

A fiduciary, fee-only, CFP® professional can help you make great retirement income choices and develop a comprehensive financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared to understand your options at every step along the way.

Yes, I am a CFP® professional. I’m always a fiduciary and I only work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice. 

If this article has you thinking about your own circumstances, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.