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Adrian A. Hedwig
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In the newsletter this month:
Quarterly Market Review: January-March 2022
What are the Secondary Effects of the War? The Dreaded “Triple R”
Working While Receiving Social Security Benefits
Quarterly Market Review:
January-March 2022
Wall Street dealt with several major issues in the first quarter of 2022. Investors had to evaluate the impact of rising inflation, higher interest rates, ongoing coronavirus concerns, and the Russia-Ukraine war. Each of the benchmark indexes listed here lost value by the end of the quarter. However, Treasury yields, the dollar, gold, and crude oil prices ended the first quarter higher. Among the market sectors, energy increased nearly 40.0%, while utilities climbed about 5.0%. The remaining sectors ended the quarter in the red, with consumer services (-12.0%) and information technology (-8.0%) losing the most.
The yield on 10-year Treasuries rose nearly 80 basis points. Crude oil prices increased nearly $28.00 per barrel, or 38.0%, in the first quarter. The dollar gained nearly 2.8%, while gold prices advanced more than 6.0%. The national average price for regular gasoline was $4.231 per gallon on March 28, $0.950 higher than the January 3 price of $3.281 and $1.379 higher than a year ago.
January began the quarter with stocks reaching new all-time highs. Unfortunately, that was the high point of the month for Wall Street. The first month of the year turned out to be a pretty rough one for investors. The Russell 2000 lost 9.7%, the Nasdaq slid 9.0%, the S&P 500 dipped 5.3%, the Dow fell 3.3%, and the Global Dow slipped 0.6%. In all, January produced the worst first-month performance since 2009, and that includes a notable rally over the last two days of the month. Investors dealt with concerns over rising inflation, the prospects of higher interest rates, and the pace of global economic recovery, despite the fourth-quarter U.S. GDP advancing at an annualized rate of 6.9%, while nearly 200,000 new jobs were added. On the other hand, industrial production slowed and new orders for durable goods declined. Prices at the pump increased, closing the month at about $3.323 per gallon for regular gasoline. Ten-year Treasury yields, the dollar, and crude oil prices climbed higher, while gold prices fell.
February also opened the month on a high note, but stocks tumbled into the red by the end of the month. The S&P 500 fell to its lowest level since June 2021. Not only were investors still coping with rising inflation and interest-rate hikes, but a new crisis emerged in February — Russia’s invasion of Ukraine. The United States and several other nations imposed sanctions against Russia, some of which were aimed at curtailing Russian oil and natural gas exports, which resulted in a surge in energy prices. Initially, the conflict in Ukraine shook global financial markets as stocks fell, and concerns grew that heating bills and food prices would skyrocket. By the close of the month, the Dow, the S&P 500, and the Nasdaq fell more than 3.0%. Ten-year Treasury prices initially fell on inflation worries, although yields later advanced as bond prices receded. The dollar and gold prices rose. Crude oil prices jumped more than 8.0% from the previous month, reaching $95.62 per barrel on the last day of February.
Despite attempts at peace talks, the war in Ukraine intensified in March, prompting the imposition of more economic sanctions against Russia. Inflationary pressures continued to mount, which led the Federal Reserve to raise interest rates 25 basis points with additional rate hikes anticipated. Nevertheless, stocks showed resilience. Each of the benchmark indexes posted gains from February. The S&P 500 rose 5.0%, the Nasdaq gained 4.7%, the Dow added 3.6%, the Russell 2000 climbed 2.1%, and the Global Dow increased 1.9%. Although crude oil prices were trending lower by the end of March, they were still $8.00 per barrel higher than where they began the month. The yield on 10-year Treasuries advanced nearly 50 basis points. The dollar gained 1.5%, and gold prices climbed 1.9% to $1,945.70 per ounce.
Stock Market Indexes
Market/Index | 2021 Close | As of March 31 | Monthly Change | Quarterly Change | YTD Change |
|---|---|---|---|---|---|
DJIA | 36,338.30 | 34,678.35 | 2.32% | -4.57% | -4.57% |
Nasdaq | 15,644.97 | 14,220.52 | 3.41% | -9.10% | -9.10% |
S&P 500 | 4,766.18 | 4,530.41 | 3.58% | -4.95% | -4.95% |
Russell 2000 | 2,245.31 | 2,070.13 | 1.08% | -7.80% | -7.80% |
Global Dow | 4,137.63 | 4,098.73 | 1.19% | -0.94% | -0.94% |
Fed. Funds | 0.00%-0.25% | 0.25%-0.50% | 25 bps | 25 bps | 25 bps |
10-year Treasuries | 1.51% | 2.32% | 49 bps | 81 bps | 81 bps |
US Dollar-DXY | 95.64 | 98.35 | 1.71% | 2.83% | 2.83% |
Crude Oil-CL=F | $75.44 | $100.94 | 5.56% | 33.80% | 33.80% |
Gold-GC=F | $1,830.30 | $1,941.50 | 1.65% | 6.08% | 6.08% |
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
Latest Economic Reports
Employment: Employment rose by 678,000 in February, notably higher than the January revised total of 481,000. Despite the increase, employment is down by 2.1 million, or 1.4%, from its pre-pandemic level in February 2020. The unemployment rate inched down by 0.2 percentage point to 3.8%. The number of unemployed persons decreased 243,000 in February to 6.3 million. By comparison, in February 2020 prior to the coronavirus (COVID-19) pandemic, the unemployment rate was 3.5%, and the number of unemployed persons was 5.7 million. Among the unemployed, the number of workers who permanently lost their jobs declined by 100,000 to 1.5 million in February. Also in February, the number of persons who were unable to work because their employer closed or lost business due to the pandemic fell to 4.2 million. The labor force participation rate increased 0.1 percentage point to 62.3% in February. The employment-population ratio increased by 0.2 percentage point to 59.9%. In February, average hourly earnings were relatively unchanged at $31.58. Over the last 12 months, average hourly earnings rose by 5.1%. The average workweek rose by 0.1 hour to 34.7 hours in February.- There were 202,000 initial claims for unemployment insurance for the week ended March 26. Over the first three months of 2022, initial weekly claims and total claims for unemployment insurance benefits steadily decreased. As of March 19, there were 1,307,000 total claims for unemployment benefits. This is the lowest level for insured unemployment since December 27, 1969, when it was 1,304,000. A year ago, there were 3,753,000 total claims for unemployment insurance benefits.
- FOMC/interest rates: Following its meeting in March, the Federal Open Market Committee increased the federal funds target rate range by 25 basis points to 0.25%-0.50%. In support of its decision, the Committee noted that inflation remains elevated due to imbalances related to the pandemic, higher energy prices, the Russia-Ukraine conflict, and broader price pressures. In addition, the FOMC anticipates six more rate hikes, some could be by as much as 50 basis points.
- GDP/budget: Gross domestic product rose 6.9% in the fourth quarter of 2021 compared with a 2.3% advance in the third quarter. The increase in GDP primarily reflected increases in private inventory investment, exports, personal consumption expenditures, and nonresidential fixed investment that were partly offset by decreases in both federal and state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased. Consumer spending, as measured by personal consumption expenditures, was 2.5% in the fourth quarter (2.0% in the third quarter). Spending on goods rose by 1.1%, while spending on services climbed 3.3%. The PCE price index, a measure of inflation, increased 6.4% in the fourth quarter after advancing 5.3% in the third quarter. Gross private domestic investment, which includes nonresidential and residential fixed investment, vaulted 36.7% in the fourth quarter after gaining 12.4% in the third quarter. Nonresidential (business) fixed investment increased 2.9% (1.7% in the third quarter), while residential fixed investment increased 2.2% (-7.7% in the third quarter). Exports jumped 22.4% in the fourth quarter after falling 5.3% in the prior quarter. Imports climbed 17.9% following a 4.7% rise in the third quarter.
- The Treasury budget deficit came in at $216.6 billion in February, a notable jump from the surplus of $118.7 billion in January. By comparison, the deficit in February 2021 was $310.9 billion. Through the first five months of fiscal year 2022, the deficit sits at $475.6 billion, 55.0% lower than the deficit over the same period in fiscal year 2021. So far in this fiscal year, individual income tax receipts have risen 38.0% and corporate income tax receipts have increased 31.0%. Compared to the same period last fiscal year, government expenditures fell 9.0% to $506.5 billion, while receipts rose 17.0% to $289.9 billion.
- The Treasury budget deficit came in at $216.6 billion in February, a notable jump from the surplus of $118.7 billion in January. By comparison, the deficit in February 2021 was $310.9 billion. Through the first five months of fiscal year 2022, the deficit sits at $475.6 billion, 55.0% lower than the deficit over the same period in fiscal year 2021. So far in this fiscal year, individual income tax receipts have risen 38.0% and corporate income tax receipts have increased 31.0%. Compared to the same period last fiscal year, government expenditures fell 9.0% to $506.5 billion, while receipts rose 17.0% to $289.9 billion.
- Inflation/consumer spending: According to the latest Personal Income and Outlays report for February, personal income rose 0.5%, while disposable personal income increased 0.4% after each increased 0.1% in January. Consumer spending increased 2.0% following a 2.7% jump in January. Consumer prices climbed 0.6% in February after advancing 0.5% in January. Consumer prices have risen 6.4% since February 2021. Year over year, energy prices vaulted 25.7%, while food prices increased 0.8%.
- The Consumer Price Index climbed 0.8% in February after climbing 0.6% in the previous month. Increases in the indexes for gasoline, shelter, and food were the largest contributors to the CPI increase. The gasoline index rose 6.6% in February and accounted for almost a third of the overall February increase. Since February 2021, the CPI has risen 7.9% — the largest increase since the period ending January 1982.
- Prices that producers receive for goods and services jumped 0.8% in February following a 1.2% increase in January. Producer prices have increased 10.0% since February 2021. Prices less foods, energy, and trade services increased 0.9% in January, the largest increase since rising 1.0% in January 2021. For the year, prices less foods, energy, and trade services moved up 6.6%. In February, prices for goods jumped 2.4%, while prices for services were unchanged. A major factor in the February increase in the prices for goods was an 8.2% increase in energy prices, within which gasoline prices spiked 14.8%.
- Housing: Sales of existing homes reversed course, falling 7.2% in February after advancing 6.7% in January. Year over year, existing home sales were 2.4% under the February 2021 estimate. According to the latest survey from the National Association of Realtors®, housing affordability continues to be a major challenge, as buyers are getting a double whammy: rising mortgage rates and sustained price increases. The median existing-home price was $357,300 in February, up from $350,300 in January and 15.0% more than February 2021 ($310,600). Unsold inventory of existing homes represents a 1.7-month supply at the current sales pace. Sales of existing single-family homes also fell, down 7.0% in February after rising 6.5% the previous month. Since February 2021, sales of existing single-family homes have fallen 2.2%. The median existing single-family home price was $363,800 in February, up from $357,100 in January.
- Sales of new single-family homes fell 2.0% in February after decreasing 8.4% (revised) in January. The median sales price of new single-family houses sold in February was $400,600 ($427,400 in January). The February average sales price was $511,000 ($494,000 in January). The inventory of new single-family homes for sale in February represented a supply of 6.3 months at the current sales pace, up from January’s 6.1-month supply. Sales of new single-family homes in February were 6.2% below the February 2021 estimate.
- Manufacturing: Industrial production increased 0.5% in February following a 1.4% increase in January. In February, manufacturing rose 1.2% and mining increased 0.1%, while utilities fell 2.7%. Total industrial production in February was 7.5% higher than it was a year earlier. Since February 2021, manufacturing has risen 7.4%, mining has jumped 17.3%, while utilities decreased 1.2%.
- February saw new orders for durable goods decrease 2.2%. This decrease, down after four consecutive monthly increases, followed a 1.6% January increase. Excluding transportation, new orders fell 0.6% in February. Excluding defense, new orders dropped 2.7%. Transportation equipment, down following three consecutive monthly increases, led the decrease, declining 5.6%.
- Imports and exports: Import prices rose 1.4% in February after advancing 1.9% in January, according to the U.S. Bureau of Labor Statistics. Higher fuel and nonfuel prices drove the increases in both months. Contributing to the increase in February import prices was a 6.9% jump in fuel prices. Prices for nonfuel imports rose 0.8% in February. For the 12 months ended in February, prices for imports have advanced 10.9%. Over the same period, prices for fuel have increased 53.0%. Prices for U.S. exports advanced 3.0% in February following a 2.8% rise the previous month. The February advance in export prices was the largest since January 1989. Higher prices for both agricultural and nonagricultural exports in January contributed to the overall increase in U.S. export prices. Export prices have risen 16.6% since February 2021.
- The international trade in goods deficit was $106.6 billion in February, down $1.0 billion, or 0.9%, from January. Exports of goods were $157.2 billion in February, $1.9 billion more than in January. Imports of goods were $263.7 billion, $0.9 billion more than January imports.
- The latest information on international trade in goods and services, released March 8, is for January and shows that the goods and services trade deficit rose by $7.7 billion to $82.0 billion from the December 2021 deficit. January exports were $224.4 billion, $3.9 billion less than December exports. January imports were $314.1 billion, $3.8 billion more than December imports. Year over year, the goods and services deficit increased $24.6 billion, or 37.7%, from the same period in 2021. Exports increased $29.9 billion, or 15.4%. Imports increased $54.4 billion, or 21.0%.
- International markets: While business activity in the United States picked up, despite the turmoil in Ukraine, Europe hasn’t been quite as fortunate. Most of Europe has seen the war exacerbate already strained supply chains, which has sent prices for raw materials and energy soaring — despite the lifting of most pandemic-related restrictions. The European Central Bank lowered its forecast for economic growth in the eurozone from 4.2% to 3.7%, while acknowledging that the impact of the Russian invasion could be larger. In Japan, the government proposed more measures to boost the economy. China saw a drop in stock prices after reports of a worsening coronavirus outbreak across the mainland. Overall, for the markets in March, the STOXX Europe 600 Index rose 3.1%. The United Kingdom’s FTSE gained 2.0%. Japan’s Nikkei 225 Index climbed 6.2%, while China’s Shanghai Composite Index fell 6.3%.
- Consumer confidence: The Conference Board Consumer Confidence Index® rose slightly in March following a decline in February. The index stands at 107.2, up from 105.7 in February. The Present Situation Index, based on consumers’ assessment of current business and labor market conditions, improved to 153.0 in March, up from 143.0 in February. The Expectations Index, based on consumers’ short-term outlook for income, business, and labor market conditions, declined to 76.6 in March, down from 80.8 in February.
Eye on the Month Ahead
Despite accelerating inflation, the war in Ukraine, and rising interest rates, most economic indicators are still demonstrating varying degrees of strength. However, March data may begin to show some economic slowing. Gross domestic product, which ran at an annualized rate of nearly 7.0% in February, is likely to recede, while the pace of job growth may decelerate. While the Federal Open Market Committee does not meet in April, it is expected to push interest rates up by 50 basis points in May. Hopefully, a resolution to the Russia-Ukraine conflict is near.
Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities and other bonds fluctuates with market conditions. Bonds are subject to inflation, interest-rate, and credit risks. As interest rates rise, bond prices typically fall. A bond sold or redeemed prior to maturity may be subject to loss. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.
The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 largest, publicly traded companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. The U.S. Dollar Index is a geometrically weighted index of the value of the U.S. dollar relative to six foreign currencies. Market indexes listed are unmanaged and are not available for direct investment.
What are the Secondary Effects of the War? The Dreaded “Triple R”
Key Takeaways:
- Fears of the dreaded “triple R” are growing—encompassing a recession, rising rates, and a loss in real household incomes. This is influenced by the war in Ukraine, along with the rapid rise in inflation.
- It is a dangerous time for investors, especially for those that draw a straight line from economic events to portfolio changes. We must be intentional and focused on our goals, including understanding what was already priced in and managing any risks to our convictions.
- We should remember that the link between geopolitical conflict and investment markets is notoriously weak. Even the link between economic recessions and investment markets is weak.
- More troubling, the link between sustained higher rates and investment markets does present a risk to investments, which we seek to address via a combination of targeted holdings and portfolio robustness.
- As investors, we can add value during economic weakness in two ways. First, we can take advantage of negative sentiment, buying into unloved assets where any impairment is likely to be temporary. Second, we can diversify against true economic risk factors to reduce the impact of any such event.
One of the growing narratives from the war in Ukraine is the idea of secondary-effect risks. This includes the well-publicized effect on commodity prices, but it has evolved into a growing chain of challenges. Prominently, several respected voices have noted that we now have the pre-conditions for a global recession and real pressure on household incomes across the globe.
Many of the questions voiced thus far are along the lines of:
- Could the spike in commodities cause the global economy to slow or enter a recession?
- If inflation gets out of hand, how aggressively will the central banks act?
- How severe could the market downturn get if we see a combination of a recession and rising rates?
- At what point does it become a buying opportunity?
For investors asking the first three questions, the logic is presumably that if economic growth is at risk, you might consider selling growth assets. However, for investors with long-term goals, we think this approach may be strengthened by embracing the fourth question—using an approach that is a) risk-aware, b) intentional, c) contrarian, and d) aligned to your goals.
Portfolio Response: Readiness and Robustness
As long-term investors, we need to remain humble and not overestimate our ability to predict the outcome of seismic macro-events. We have no advantage over other investors in predicting the course of the conflict, in the same way we had no advantage in creating a roadmap of COVID-19 in 2020.
What we can do, however, is thoroughly assess the investment landscape and look for investment opportunities. As patient, long-term investors operating in a market influenced by fear and greed, we understand that excess returns could become available when the price of an asset diverges significantly from a reasonable assessment of fair value.
This time is indeed different, but the way we are responding is similar—with a principled approach that is opportunistic and robust. The caveat is, given the level of uncertainty, that we would like to see a wide gap between current prices relative to their fair values when we make meaningful changes.
Does an Economic Downturn Impact Markets?
As we contemplate investment decisions—or any financial decisions, for that matter—it can be tempting to predict where the economy or earnings cycle is heading. That is, in theory, we could pick when (or which part of) the market is about to weaken and seek shelter until it reaches a cyclical low. The challenge, of course, is that this approach is notoriously difficult to do because you need to predict the future twice—once to get out of risky assets at the right time and again to re-enter them at the bottom of the cycle.
Even the market has difficulty pricing in such signals. For example, in mid-2018 the global bond markets started pricing in a deteriorating economy while global equity markets were pricing in a further expansion. Then it suddenly reversed in late-2018, as equity markets priced in a decline while bond markets did the opposite.
So, what does that mean in a multi-asset portfolio context? To us, it means a few things. First, a key when dealing with fears of a recession is to distinguish between true risk (a negative knock to corporate fundamentals) and negative sentiment (investors repricing their expectations).
Exhibit 1 For more than 100 years, prices have oscillated around the fundamental return.
At an individual level, falling real wages hurt. This means that wages are rising by less than inflation, so your net savings are dented, potentially impacting your financial goal progression. At a portfolio level, this also might be an issue, with defensive assets earning less than the inflation rate. This results in a reduction in your real purchasing power, which can also hamper goal attainment. There are no easy answers to this challenge in an environment such as today’s, but one approach is to focus on real outcomes after inflation. At a portfolio level, this means holding assets that may protect you against a spike in inflation, which is something we take seriously as a portfolio robustness measure.
Adding Value in a Downturn Putting aside the eroding challenges of inflation, we believe investors can benefit by buying into negative sentiment, especially if they are willing to take a long-term view. The long-term nature should not be underestimated, given that most economic recessions prove temporary and are recoverable in the investor timeframe. By taking such an approach, we can be anti-cyclical (or “contrarian”) when others aren’t. Furthermore, weathering a recession will likely be easier if the motive is to be fearful when others are greedy and greedy when others are fearful, to paraphrase Warren Buffett. We seek to not only navigate downturns, but to help our investors profit from them. This tends to be possible because negative sentiment is often exacerbated in a crisis. For evidence, we show the difference between changes in sentiment and fundamentals during the Great Financial Crisis of 2007 to 2009.
Exhibit 2 During the financial crisis of 2007 to 2009, prices fell far more (as a function of negative sentiment) than corporate fundamentals. Such periods are an opportunity to add value.
The second consideration in a multi-asset context is to diversify our risk drivers. This goes beyond questions such as whether U.S. companies can sustain high profits or for how long inflation may rise.
We may seek to understand the answers to these questions (and many more) within the context of valuations, but we should also acknowledge the role of uncertainty.
Diversification Is Not Only About Spreading Your Eggs
Diversification is an important tool to manage uncertainty, however, we believe it must go beyond “spreading your eggs across multiple baskets”. To us, it is about understanding the underlying risks to assets—whether that be economic or market-risk factors—not just volatility or correlations (as these can change quickly and drastically).
For example, corporate bonds and equity markets can behave very differently, yet both are susceptible to an economic shock (damage to corporate earnings could cause equity values to fall and bond spreads to widen). All else being equal, this offers less diversification than holding equities with an unrelated asset, such as inflation-linked bonds or nominal government bonds. The message is to diversify against fundamental risks and be very intentional with how you are diversifying if you want to reduce the impact of an economic recession.
Today’s Positioning Points and an Opportunistic Mindset
The current crisis has been impacting valuations of assets classes—obviously in Russia, but also beyond the Russian markets. Most notably, the sovereign bond yields of other central and eastern European countries have risen, and their currencies have fallen. In addition, corporate bonds have also been hampered, with credit spreads widening—both for high yield and investment-grade debt—not just in Europe but also in the U.S. market.
Within equities, there have been clear winners and losers, with global energy firms rallying and stock markets more closely tied to Russia suffering large losses, such as Germany’s. These are potential investment opportunities we are deeply researching in the hope it will provide robust risk-adjusted returns for our investors in the future.
Bringing this together, we don’t necessarily buy into the rhetoric that one should engage in widespread selling based on fears of an economic recession. Naturally, we want to be diversified to reduce the impact of any downturn, but by taking a long-term view, we should only really care about a permanent impairment to earnings and the price paid for those assets. Moreover, if the economic cycle dents corporate profits in the near term, we may have the opportunity to buy into the negative sentiment and ride it out until the cycle reverts. This is one of many areas where we can add value, by maintaining a long-term view when others won’t.
©2022 Morningstar Investment Management LLC. All Rights Reserved. Morningstar Investment Management LLC is a registered investment adviser and subsidiary of Morningstar, Inc. The Morningstar name and logo are registered marks of Morningstar, Inc. See end of newsletter for further disclosures.
Working While Receiving Social Security Benefits
The COVID-19 recession and the continuing pandemic pushed many older workers into retirement earlier than they had anticipated. A little more than 50% of Americans age 55 and older said they were retired in Q3 2021, up from about 48% two years earlier, before the pandemic.1
For people age 62 and older, retiring from the workforce often means claiming Social Security benefits. But what happens if you decide to go back to work? With the job market heating up, there are opportunities for people of all ages to return to the workforce. Or to look at it another way: What happens if you are working and want to claim Social Security benefits while staying on your job?
Retirement Earnings Test
Some people may think they can’t work — or shouldn’t work — while collecting Social Security benefits. But that’s not the case. However, it’s important to understand how the retirement earnings test (RET) could affect your benefits.
The RET applies only if you are working and receiving Social Security benefits before reaching full retirement age (FRA). Any earnings after reaching full retirement age do not affect your Social Security benefit. Your FRA is based on your birth year: age 66 if born in 1943 to 1954; age 66 & 2 months to 66 & 10 months if born in 1955 to 1959; age 67 if born in 1960 or later.
If you are under full retirement age for the entire year in which you work, $1 in benefits will be deducted for every $2 in gross wages or net self-employment income above the annual exempt amount ($19,560 in 2022). The RET does not apply to income from investments, pensions, or retirement accounts.
A monthly limit applies during the year you file for benefits ($1,630 in 2022), unless you are self-employed and work more than 45 hours per month in your business (15 hours in a highly skilled business). For example, if you file for benefits starting in July, you could earn more than the annual limit from January to June and still receive full benefits if you do not earn more than the monthly limit from July through December.
In the year you reach full retirement age, the reduction in benefits is $1 for every $3 earned above a higher annual exempt amount ($51,960 in 2022 or $4,330 per month if the monthly limit applies). Starting in the month you reach full retirement age, there is no limit on earnings or reduction in benefits.
The Social Security Administration may withhold benefits as soon as it determines that your earnings are on track to surpass the exempt amount. The estimated amount will typically be deducted from your monthly benefit in full. (See example.)
The RET also applies to spousal, dependent, and survivor benefits if the spouse, dependent, or survivor works before full retirement age. Regardless of a spouse’s or dependent’s age, the RET may reduce a spousal or dependent benefit that is based on the benefit of a worker who is subject to the RET.
Back to Work
In this hypothetical example, Fred claimed Social Security in 2021 at age 62, and he was entitled to a $1,500 monthly benefit as of January 2022. Fred returned to work in April 2022 and is on track to earn $31,560 for the year — $12,000 above the $19,560 RET exempt amount. Thus, $6,000 ($1 for every $2 above the exempt amount) in benefits will be deducted. Assuming that the Social Security Administration (SSA) became aware of Fred’s expected earnings before he returned to work, benefits might be paid as illustrated below.
In practice, benefits may be withheld earlier in the year or retroactively, depending on when the SSA becomes aware of earnings.
The RET might seem like a stiff penalty, but the deducted benefits are not really lost. Your Social Security benefit amount is recalculated after you reach full retirement age. For example, if you claimed benefits at age 62 and forfeited the equivalent of 12 months’ worth of benefits by the time you reached full retirement age, your benefit would be recalculated as if you had claimed it at age 63 instead of 62. You would receive this higher benefit for the rest of your life, so you could end up receiving substantially more than the amount that was withheld. There is no adjustment for lost spousal benefits or for lost survivor benefits that are based on having a dependent child.
If you regret taking your Social Security benefit before reaching full retirement age, you can apply to withdraw benefits within 12 months of the original claim. You must repay all benefits received on your claim, including any spousal or dependent benefits. This option is available only once in your lifetime.