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What a Growing (or Shrinking) Economy Means for Your Retirement Portfolio

Every month, the Bureau of Economic Analysis (BEA) releases a revised estimate for the growth or decline in real gross domestic product (GDP). The latest estimate shows output in the U.S. declining by 2.9% for the first three months of 2014, the worst showing since Q1 2009 when the country was still in the heart of the recession.

Real GDP, according to the BEA release, is “the output of goods and services produced by labor and property located in the United States.” While this figure provides investors, economists and corporate executives with a useful benchmark for making decisions, it could also have broader implications for retail investors. By understanding the impact that a growing or shrinking economy has on your retirement portfolio, investors can stay one step ahead and better protect their capital.

Let’s consider two scenarios:

Scenario 1 – The U.S. economy is contracting

There are a multitude of reasons why the economy contracted. The BEA cites a smaller than expected increase in personal consumption and a larger than expected decline in exports. Bad weather was another reason, which PNC Senior Economist Gus Faucher said was “a significant drag on the economy, disrupting production, construction, and shipments, and deterring home and auto sales.”

With both the S&P 500 and the Dow Jones Industrial Average hovering around all-time highs, the perception that the economy is slowing shrinking could affect the markets. Be sure to talk with your fee-based financial advisor about the potential impact on your portfolio, and how to hedge against this possibility.

Scenario 2 – The U.S. economy is expanding

According to a previous BEA release, real GDP increased by 2.6 percent in the fourth quarter of 2013. This coincided with a year in which the S&P 500 returned 32% in one of the greatest bull markets of recent memory.

Although overall optimism was high in 2013, it is important to note that the economy as a whole grew at only a fraction of the rate at which the major indices grew, suggesting that investors perceived economic growth to perhaps be stronger than the reality. In this scenario, investors should consider a diversified approach that allows them to ride the bull, but also gives them the flexibility and the liquidity to reduce market exposure should the bull run come to an end.