Risks We Face in Retirement
Historically, our view of retirement has been very different than it is today. If you look back 100 years or more, many people didn't even retire and worked until they simply passed on. Eventually, the concept of retirement became more prevalent, partly due to the passing of Social Security in the 1930s. People were living longer and either decided they wanted to stop working at some point or they were physically unable to do the labor in their older age.
Even when Social Security became the answer to our retirement needs, we had a very narrow view of what that money would cover. We expected that it would cover our day to day expenses for a few years until we die. This has vastly changed over the years as people continue to live longer, resulting in people needing a larger nest egg and incurring more risks than ever before.
I listened to a presentation in 2015 at the annual ASPPA conference in Oxon Hill, MD (D.C. Area) and I thought it wrapped up all of the risks associated with nearing and living in retirement very well. This is not an exhaustive list but certainly outlines some of the most relevant risks…here you go:
Longevity
One of the more obvious risks is longevity risk, which is the risk that you outlive your savings and therefore didn't project a long enough time horizon you would need income for. This can lead to shortages of money, that as we say in the 2008/2009 timeframe, sent many elderly folks back to work or living in much poorer conditions than they would prefer.
Inflation
Inflation is the cost of goods rising over time. Thankfully, there are many retirement vehicles and specific products that are adjusted for inflation, meaning that they look to at very least keep up with inflation year over year, and optimally to outperform it. There is, however, a chance if inflation increases more than a retiree was expecting, that retirement funds no longer meet those needs and leave folks under prepared.
Market
When preparing for retirement, most are (and should be) diversified in different types of investments (equities, debts, commodities, etc.). As with the stock market as we have seen over the last decade or so, the market can be volatile at times and can lead to very large losses. There is always the potential to lose earnings or principal if there are large changes to the market. While you can't ever completely eliminate risk in the market, diversification is absolutely crucial to combat this sort of risk.
Interest Rate
This risk has to do with the fact that interest rates can change over a period of time. This primarily impacts the bond markets but is an important risk to consider none-the-less because it could cause losses. Especially when you begin to look at long term bond holdings when interest rates rise, it could negatively impact those investments.
Credit
This risk is associated with the potential for the borrower of debt to default by failing to make payments, etc. When you begin to look at some of the high yield junk bonds, the interest rate may be much higher but that is for good reason as they have a much higher chance of defaulting. This can be a good investment but it's imperative you understand the potential risk it could cause if you have too much invested in below investment grade bonds.
Issuer
While relatively similar to other risks mentioned is probably less popular or known. This refers to the potential of an issuer (corporation offering stock for example) to drop in credit rating, therefore negatively impacting anyone associated or invested in that company. This again has to do with the type of investments you are making and the general market but is specific to the risk you take on by working with the issuer.
The last couple are probably not as quickly associated with holding investments or preparing for retirement but continue become increasingly more well-known and expensive.
Healthcare
Healthcare is the leading cost in retirement and can easily be more than six figures in a single year for certain health problems. With individuals living longer, they aren't necessarily still living with a higher standard of health in retirement. They may have to be sustained for 10 years with a very serious degenerative disease and this will very quickly eat away at retirement. It's important to consider this to be one of the largest costs in retirement, even if you feel like you have a pretty healthy history.
Dependent Care
This is the risk that you'll be responsible for providing some of your income to a dependent care provider either for family members or for yourself. Of course, if you ever needed to have a provider for care, you'd want to still be able to live comfortably and with people you feel respect you and this can get very costly.
Unexpected
This is a “catchall” and could be any and everything your mind thinks about...maybe an earthquake destroys everything in your home or a nuclear bomb wipes out your city (though you'd likely be dead). Of course, there are insurance products but they aren't going to turn things magically back to how they were--you will incur some unexpected costs you need to prepare for along the way.
I'll leave you with the takeaway I heard from this presentation which is that once you are in retirement, if you can use conservatively 3% of your entire nest egg each year, you are in great shape (without other risks considered). My personal views are that each individual has different needs and benchmarks aren’t exactly accurate but at least it gives you something to tangible to shoot for.
PHOTO CRED: @harlynkingm
Have questions or want to submit a topic: reach out to maddi@minervawealthplanning.