What is risk? If you ask most investors, they would tell you that risk is the chance that an investment will go down in value. But this is only one type of risk – market risk. Investors face several other additional types of risk in retirement. These risks, if not addressed, can chip away at your retirement savings. Unfortunately, most retirement savers are far too fixated on market risk and do not pay close enough attention to the other types of risk.
Market risk is the chance that an investment’s actual returns will be different than expected due to overall price fluctuations in the market. Under this definition of risk, equities have the most risk and cash has the least. Market risk, however, is not the only risk out there for retirement savers.
What about the chance that you might not have enough set aside to meet your retirement spending needs, a savings shortfall risk? This can be compounded by retiring too early and/or spending too much in retirement. Longevity risk is the chance you will live much longer than expected and outlive your savings. Inflation risk is the chance that inflation will erode the purchasing power of your savings. In all of these cases, the “riskier” asset is cash and the “safer” asset is equities. Other risks to watch out for include legislative risk, the risk of law changes to taxes, pensions, Social Security and Medicare. What if someone dies early or becomes disabled? Fire consumes your home? What if you get sued? Catastrophic events risk is often overlooked and can be hedged with insurance and proper estate planning.
Investors need to rethink the concept of risk and how it can change over different life stages. As a young saver you have time on your side and many years of future income to put toward retirement savings. Market risk should not be a big concern. The bigger risk at this stage is the savings shortfall risk. You should invest for high returns and make sure you are getting a savings program going.
Savers in midlife can also accept high levels of market risk. They still have very long time horizons and many future years of income and contributions. They should still seek higher returns and watch that they are saving enough to avoid a shortfall. They should reduce their market risk as they near retirement.
Once retired you have no more future income to fund contributions and must now shift your focus to balancing market risk with longevity and inflation risk. This still requires seeking attractive returns and maintaining a healthy equity exposure. Longevity is the greatest risk for new retirees.
A senior retiree has likely spent down some of their retirement savings and needs to focus more on minimizing losses while at the same time generating returns that keep pace with inflation. Now is the time to pay attention to market risk yet balance it against the risk of losing purchasing power.
Damien helps individuals invest and manage risk. He is a Certified Financial Planner™ professional and a principal of Walnut Creek Wealth Management. These are the views of Damien Couture, CFP® and should not be construed as investment advice. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Not all recommendations are suitable for all investors. Each investor must consider their own goals, time horizon and risk tolerance. Your comments are welcome. Damien can be reached at 925-280-1800 x101 or Damien@WalnutCreekWealth.com.