The Big Three Retirement Risks

Strategies for Managing Longevity, Inflation and Market Risks

By GARY LISKA | Special to the Palisadian-Post

As you transition from accumulating assets during your working years to gradually converting your savings into retirement income, your risks also shift.

When you’re saving for the future, your risks are generally simple and straight-forward. Aside from life and disability income insurance to provide income protection for your family in case you’re no longer able to work, you’re subject to the risk of stock market performance. But given the historical long-term performance of stocks, time can be your greatest ally in dealing with periodic short-term volatility.

However, when you enter the “decumulation” phase and start taking distributions from your retirement accounts, your risk picture becomes a bit more complex, requiring thoughtful, active management.

Let’s take a closer look at a few of these risks, and explore a few steps you can implement to help better control and minimize them.

Longevity risk: Back in our grandparents’ day, there wasn’t a lot of retirement planning required. Most people could count on the tandem of Social Security and a company pension to provide a reasonable amount of guaranteed monthly income. And with retirements typically only lasting about 10 to 15 years, retirees could simply transition their portfolio to fixed income and withdraw 4 to 5% of their savings each year to live comfortably.
Retirements today, however, are a different matter. Did you know that the chances of at least one member of a healthy 65-year-old couple living to age 92 or older are greater than 50%? It means you need to financially prepare for a retirement that may last 30 years or longer. And fewer and fewer employers continue to offer pensions. More and more of the responsibility for retirement savings has shifted onto our individual shoulders.

Inflation risk: Rising prices erode the purchasing power of your savings. If your investment rate of return isn’t keeping up with inflation, you’re actually losing money. Since 1960, the annual rate of inflation has averaged 3.7%. Given the historically low current interest rate environment, that means that more conservative investments like CDs, Treasury bills and even high-quality corporate bonds are acting as a drag on your portfolio.

Market risk: While all investors (both pre- and post-retirement) face market risks, it’s also true that the impact of poor stock market performance during the first few years of your retirement tends to have a more dramatic impact on the ability of your portfolio to generate enough income to last your lifetime. This is often referred to as “sequence of returns” risk and needs to be carefully considered as part of your investment plan.

A New Perspective on Risk

The ever-present potential for a market downturn gave rise to a traditional strategy of gradually shifting your allocation from stocks to bonds the closer retirement came. But while this helps minimize market risk, it also heightens and intensifies both longevity risk and inflation risk.

A potential 30-year retirement requires that your portfolio be structured not only to deliver short-term income, but also to ensure the assets you won’t need to touch until later in retirement have the potential to grow. It just doesn’t make sense to invest assets you won’t need to touch for a decade or longer the same way you invest assets you need to depend on for income over the next few years.

Instead, you should strive for a more balanced “total return strategy,” which seeks to find an optimal mix of income and price appreciation—allowing part of your portfolio to keep growing while the other part generates income. It’s an opportunity to create better diversification, increased tax flexibility and a more sustainable lifetime income stream. And even if the stock market experiences a major correction, the longer-term assets earmarked for later in retirement should ideally have time to recover in value.

You also might consider investments like Treasury Inflation-Protected Securities (TIPS), which offer inflation-adjusted payments.

When it comes to retirement risks, the better you understand them, the more effectively you can manage them. We’re living longer, healthier and more active lives than ever before. Making sure you have the means to fully fund that lifestyle is going to take careful planning.

Now is the time to reach out to your financial advisor, because the sooner you start, the more options you will have available.

Gary K. Liska may be reached at 310 712-2323 or seia.com.