What is RISK? According to the dictionary, RISK is the chance of loss or injury; danger or peril. RISK in the investment world has long been associated with the potential for loss, fluctuating asset balanced and the chance for a higher rate of return. I've heard many people say “If I take on more risk, my return will be higher.”
But what is other risks should we be thinking about? Especially, when it comes to our investments and our retirement plans? Risk takes many forms in our day to day lives. Risk may take the form of LONGEVITY RISK, INFLATION RISK, PORTFOLIO/ALLOCATION RISK or SPENDING RISK. Let’s take a look at these risks in a little more detail.
We are living longer than ever before. This is a great thing! I want to live as long as possible (with good health of course). A large problem facing most people today and for years to come will be out living their money. The average retirement age is around 63 (maybe a little higher). Consider living until your mid 90s! That is a long time to need an income. It can be very difficult to save all that money up front to ensure that you have enough for those 30 plus years. More likely, you will need to have your money grow while you are spending it to make sure you have enough. Where can you invest that money to give you the essential growth to make your money last?
Buying Power! A key to retirement planning is staying ahead of inflation. An investor needs to maintain buying power and to do that the investor needs to stay ahead of inflation. Let’s assume that inflation is 3%. You, as an investor, are earning 2% on your money and your tax rate is 25%. You will eat into your principle very quickly at this rate. Your rate of return is not keeping up with inflation, and add tax on top of that; your money will run out if you live long enough. As investors we want our return to be higher than the rate of inflation. We need to maintain some level of buying power.
Related article: Inflation and retirement planning
What is the balance between GICs, BONDS, and EQUITIES? That question differs between every investor. Understanding when the money will be needed and for how long will go a long way in determining the asset mix. An investor’s personal experience in previous investments or philosophy on investing will have an effect on the diversification of that person’s portfolio.
Related article: Model investment portfolios
Spending too much or not enough is also a risk. Naturally, if you blow through your money in the early years of retirement like it is spring break you run the risk of having nothing left for the remaining years. Not spending enough robs you of a lifestyle you have saved long and hard for and have earned the right to enjoy. Also, it could leave behind a large sum of money that could pose a tax problem depending on your situation at the time of your death.
Related article: A simple way to track your spending
Lastly, things happen in our life that we have no control over. Health is one of those things. We may have a turn for the worse in our health but live another 10-15 years. Our expenses will go up to cover our added health care expenses as well as our continued income needed in retirement. That can deplete our retirement accounts quickly.
When in doubt, consult your financial advisor. Manage risk by completing a Retirement Plan and a Risk Profile questionnaire. Determine your investing objectives and what you will need to do to achieve them. Then DO IT and stick with it.