Understanding the Key Risks in Retirement, Part I

Planning for these risks can improve the odds of a successful retirement

Rather than thinking of retirement as the end of something, retirement should be viewed as simply beginning the next phase of life. It’s a phase reached through a lifetime of hard work, dedication, and achievement to one’s career, family and employer, and themselves. And like the earlier phases of life, retirement carries with it a number of risks. While the risks themselves may be similar to what you have faced leading up to retirement – investment risk, inflation, health care, etc. – their impact may be much greater, and the opportunity to adjust to them much smaller.

The way we prepare for retirement has changed substantially in recent history. Nearly gone, for example, are the days of relying solely on employer-provided pension plans and Social Security to fund retirement. Now more than ever, there is a greater reliance on personal savings and investments to supply the income needed in retirement. As a result, the combination of unpredictable investment markets and longer life expectancies (among other risks) has led many to question whether they have enough money to live comfortably in retirement. Below are some of the risks you are likely to encounter which may significantly impact your retirement goals.

Investment Risk

Long-term trends have shown that stock investments will provide the best opportunity for investment return, followed by bonds and then cash. During retirement, one approach to reducing overall portfolio risk may be to reduce or eliminate stock exposure. However, a poor asset allocation strategy can have a devastating effect on your retirement income strategy. Being too conservative may cause you to prematurely run out of money while being too aggressive increases your exposure to market volatility.

A sub-risk to this is something known as the sequence of returns risk – the idea that poor market performance in the early years of retirement can significantly impact the long-term sustainability of those assets. Proper retirement planning will include a good asset allocation foundation, along with an understanding of how to respond to different market conditions.

Inflation Risk

Inflation is sneaky. You may not realize it’s happening over the short term, but over the long term, it can decimate a retirement strategy by eroding the value of assets set aside to meet every-day expenses.

Inflation has historically averaged about 3% annually, which may not seem like much, but that can have a dramatic impact on the purchasing power of your income over the course of your retirement. Just consider the changes in the cost of goods such as gas, milk or bread over the past 25 years for further evidence of inflationary impacts. The increasing cost of goods and services has to be accounted for when building a retirement income plan, either by investing in a way that provides an increasing level of income or by adjusting your retirement goals over time.

Stay tuned next month for part two

Article provided by Rebecca Ross, Vice President and Financial Advisor at Robert W. Baird & Co., member SIPC. She has 34 years of financial services industry experience and can be reached at 239-541-9090 or rross@rwbaird.com.