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Retirement Risks

Keith J. Hardman
Published on October 23, 2023

“By failing to prepare, you are preparing to fail.”
—Benjamin Franklin

Preparing for a financially secure retirement encompasses far more than saving a healthy nest egg. Even for savvy investors, substantial risks remain that could derail the best-laid retirement plans if not appropriately addressed. This month we will explore some of the key hazards to consider when crafting a retirement strategy. What are those hazards? Three key ones are longevity risk, market volatility, and spending shocks. Those who do not adequately anticipate and address these potential risks are setting themselves up for failure in retirement by increasing the likelihood of running out of money.

Longevity Risk: with the marvelous improvements in healthcare, elder care, and lifestyle behaviors, average lifespans continue extending. Longevity risk is important to consider as it is not uncommon for today’s retirees to live well into their 90s or even to/past 100. This longevity trend brings both benefits and financial challenges. On one hand, the gift of more years to enjoy life is wonderful. However, greater longevity also amplifies the risk of eventually outliving savings if withdrawals are not properly managed.

Far too often retirees make the mistake of building retirement strategies to last only up to average life expectancies. Yet by definition, 50% of people will live beyond average life expectancy. Failing to adequately plan for one’s full longevity potential can lead to premature depletion of assets. With online tools such as the Actuaries Longevity Illustrator1 (available for free) one can generate a personalized longevity estimate. This allows creating withdrawal strategies that sustain through advanced ages, even past age 100.

Market Risk: retirees depend heavily on investment portfolios to generate income for living expenses and discretionary spending. This reliance makes retirees particularly vulnerable to market risk – the potential for investment losses from volatile or declining markets. Poor market performance, especially in the early critical retirement years, can erode principal.

Moreover, sequence of returns risk magnifies this impact. Sequence of returns risk refers to the fact that experiencing poor investment returns or outright losses shortly before or after retiring can adversely affect portfolios, as insufficient time remains to recoup losses before withdrawals must begin. High net worth investors with substantial market exposure face amplified sequence of returns risk.

The key strategy for mitigating market risk in our view necessitates building a well-diversified, balanced portfolio across asset classes appropriate for retirement investing, while retaining some growth exposure. Being judicious and flexible about portfolio withdrawals, ready to reduce spending during extended market declines, also helps preserve principal.

Spending Shocks: unexpected “shocks” can upend even the best-crafted retirement plan. Spending shocks such as surprise medical expenses and long-term care needs top the list of concerns. But other unforeseen costs like major home repairs, supporting loved ones, divorce, or the death of a spouse can also strain budgets. Insufficient cash reserves to handle shocks jeopardizes income sustainability.

Mitigating spending shock risks involves both proactive preparation and building financial flexibility into plans. Maintain ample emergency funds of six months to a years’ worth of living expenses. Prioritize health and wellness to hopefully minimize medical surprises. Evaluate long-term care insurance to offset potential needs. Use other insurance products to moderate risks. Build financial cushions for anticipated big-ticket expenses like cars or home projects. And maintain room to adjust spending downward if the unexpected strikes.

While longevity, markets, and spending shocks represent the three main risks retirees will face, other concerns certainly exist. Evolving tax policies could lead to higher tax burdens down the road. Unexpectedly needing to retire early due to job loss or health issues could require assets to stretch further. Overspending temptations could drain savings faster than planned.  Failing health and reduced cognitive abilities also make managing finances more challenging.

I’ve heard it said that, “Retirement is like a long hike through the wilderness – it pays to be prepared for the bears and pitfalls ahead.” And while achieving retirement readiness certainly centers on building an adequate nest egg, truly retiring with financial peace of mind requires much more. Longevity planning, mitigating market volatility, handling surprise expenses, and navigating all the other risks discussed here is vital for preserving hard-earned wealth once careers end. We encourage you to start the conversation with your advisor today to map out strategies tailored to your situation. That’s the path to enjoying a retirement focused on living your dreams, not worrying about money.

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