The Problem Of Risk In Retirement
At some point you are likely going to have a moment of realization where the weight of uncertainty will be uncomfortable. You’ve always known that your fixed income and savings will have to support your retirement until the end of your life. But if you were to experience a financial setback sometime after you retire, will this still be possible?
Up until now you’ve had the flexibility and options needed to handle financial setbacks.
- Save a little more
- Spend a bit less
- Take on more investment risk to increase gains
- Earn more money
- Push back your retirement date
But now you realize your flexibility and options aren’t available anymore or have changed.
You no longer have the risk capacity you once had.
Risk capacity is your ability to tolerate a decline in the value of your assets without experiencing a painful drop in your standard of living. Once you retire, your risk capacity diminishes sharply and continues to fall as you age. This should lead you to ask questions such as:
- What happens if I live longer than expected?
- What if drops on Wall Street reduce the value of my portfolio of invested assets?
- Will I still be able to get back into the workforce and earn money if I absolutely need to?
- Will I be able to manage unforeseen expenses or spending shocks?
- Will a recession, high interest rates or inflation affect my retirement spending goals?
- What will I do if my health and mental capability declines?
Fear of painful cutbacks or running out of money will hinder your ability to enjoy your retirement if it causes you to avoid spending your savings on those things which would otherwise make your golden years fulfilling. No one should have to face life with this type of uncertainty or fear. You have worked and saved and prepared. You deserve to enjoy your retirement years, especially early on while you are younger, healthier, and sharper.
The financial risks facing you as a retiree can be anticipated and planned for, helping you to face them with confidence.
First, you need to understand the risks, so you can take control and get prepared for the impact they could have on your retirement lifestyle and spending goals. Let’s go over some common risks facing retirees.
Reduced Ability to Earn Money and Save
While you are still in your career, it is easy to imagine that you could jump right back into the workforce and save more money if you faced a financial setback after you retire. The truth is that no one escapes an eventual decline in their human capital. As we get older and further away from our last work experience, we face fewer options to earn a paycheck and save more money.
Reduced Allowance for Lifestyle Expense
Unless your fixed income covers 100% of your retirement lifestyle, you must have the ability to regularly withdraw from your portfolio of invested assets. For the rest of your life this income stream must be able to cover the “gap” between your living expenses and the amount of your fixed income. A market decline could reduce the value of your portfolio and hinder its ability to meet your retirement spending goals. You will have to lower your standard of living so you don’t run out of money before you die.
Investment Risk Increases
Furthermore, a drop in the value of your portfolio may have a more severe impact on your ability to meet retirement spending goals if the drop occurs during your early retirement years. Withdrawals can quickly reduce the shrinking portfolio even further, leaving a smaller portion to experience the next market recovery. Bear markets have historically occurred once every ten years on average. No one can predict the timing, duration, and magnitude of these events. That means the date you choose to retire could precede the next bear market, and only hindsight will allow you to know if that was the case.
How long do you expect to make withdrawals from your portfolio of invested assets? Think about this: 50% of retirees will outlive the average expected lifespan. The truth is, we cannot know exactly how long we’ll live nor how long our retirement plan needs to last. How we respond to that truth is important.
Much like the lifestyle cutbacks we’ve discussed, conservative spending in retirement can decrease your chances of running out of money but can also negatively affect your enjoyment of life when it may not be necessary. Your lifespan could be less than average.
To handle unforeseen expenses without taking on debt or making untimely withdrawals from their portfolio of invested assets, retirees need to remain flexible with their spending and maintain liquid assets (i.e. cash and CDs) which can handle spending shocks. Common emergencies retirees face include:
- Helping a family member in need
- Rapid change in the expenses for the household (healthcare, taxes, etc.)
- Home repairs
- A significant medical event with long-term care needed
If you need your money to grow over time to meet spending goals, there is no “safe” or risk-free strategy. If you take all investment risk off the table by placing your savings in the bank, you’re now vulnerable to inflation risk which will quietly erode your purchasing power over time. You won’t feel it happening, because your balance always grows a little and never experiences the negative returns of the stock market. But consider this: if inflation were to rise at 4% annually, your purchasing power would be cut in half every 18 years, and it would then take $200 to purchase $100 of groceries at today’s prices.
Although inflation has been low recently, there’s no guarantee this will last, and you must have an “after inflation” positive return rate for your money – and purchasing power – to grow.
Declining Cognitive Abilities
We are all potentially at risk for a reduced mental capacity that will diminish our ability to make sound decisions. If this happens to you and you’re the one handling financial matters for the family, someone else will have to take over without the benefit of your knowledge and experience. Without a sound succession plan to follow, they could wind up making decisions which will jeopardize the remainder of your retirement. Furthermore, financial predators are lurking in wait for this type of situation and are ready to act.
Awareness of the risks retirees face can help you to take control of your finances and to design a retirement plan that will give you the confidence about the future that you want. Given your uniqueness and preferences for risk in general, there is no one-size-fits-all planning approach to soften the impact of these risks for you. However, a Financial Planner uses a tool called a Monte Carlo Simulation that can demonstrate the impact these risks can have on your financial plan, showing you a range of possible outcomes and success rates by using different variables. We can’t predict the future, rather we offer this as an educational tool and reference point to help you make your own decisions about how to best prepare for your retirement.
I hope this information has been helpful for you. I am happy to answer more questions or to help you design a financial plan that will give you the confidence about the future you want. Working with me is easy: