I’LL ACKNOWLEDGE THAT today’s topic isn’t the most upbeat. I want to talk about risk—and, specifically, some of the underappreciated risks related to retirement.
In thinking about risk, the hardest part—in my view—is that it defies a single definition. Because of that, there’s no uniform yardstick for measuring it and thus no single strategy for managing it. As Howard Marks states in his book The Most Important Thing, “Much of risk is subjective, hidden and unquantifiable.”
Still, a lot of discussions about risk fall back on quantitative measures, such as portfolio volatility or sequence-of-return risk. While I agree that both of those are important aspects of risk, they aren’t the only ones, especially for retirees. As Marks notes, even Benjamin Graham, the father of investment analysis, whose major book is full of formulas, acknowledged that, “The relation between different kinds of investments and the risk of loss is entirely too indefinite… to permit of sound mathematical formulation.”
Drawing up your retirement plan? Here are some risk-related topics to consider:
Stock market malaise. What’s the biggest risk for stock market investors? Ask most people—myself included—and we’d point to the potential for a 30% or 50% drop, like we saw in 2000, 2008 and 2020. But there’s another risk to consider, which is that the market could go “sideways” for a period of years—in other words, that there wouldn’t necessarily be a sharp drop but that growth might simply be anemic for a long stretch. We saw something like that in the 1970s.
What does this mean for retirement planning? If you’re earlier in your career, I wouldn’t worry about this particular risk. Over the long term, I’m confident that share prices will grow in line with corporate profits. In fact, if you have a decade or more until retirement, a period of malaise might be a good thing, allowing you to buy into the market at cheaper prices.
But if you’re closer to retirement, it’s an important scenario to consider. To assess this risk, I suggest building a long-term cash flow model that assumes investment returns of just 1% or 2% a year over the next 10 or 20 years. See what the impact would be if your expenses continued to increase with inflation while your portfolio grew at a slower rate.
Of course, you can’t control the market’s performance, but at least you’ll have a sense of whether this is a risk that would impact you. You could then develop a plan B. Note that when I suggest having a plan B, this doesn’t need to be an airtight plan. I’ve found that retirees sleep better if they have at least a rough idea of how they’d adapt to a negative scenario. Until not too long ago, the Pentagon apparently maintained a contingency plan to defend against an invasion by Canada. That’s obviously unlikely, but it never hurts to have a plan.
Health. When it comes to health, there are two distinct types of risk to consider. The first is a sudden event, such as an accident or stroke. The second is a cognitive decline that occurs over time. The financial impact of the first is what you would imagine: increased expenses for care, either at home or in a facility. For working-age people, this could also result in the loss of income, potentially permanently. While an unpleasant prospect, the solution is straightforward: to secure sufficient disability insurance.
I view the second type of health risk—cognitive decline—as more of a challenge. For starters, cognitive decline doesn’t manifest itself obviously at first. The result might be past-due bills or other mistakes. While a late phone bill is no problem, other errors can be more serious. The IRS, for example, might not be as forgiving as the phone company. If a whole-life insurance policy lapses, not only would the insurance be lost, but also it might generate an ugly tax bill. An error like that could be irreversible.
Cognitive decline can also lead to overspending and inappropriate gifts. In the extreme, it can lead to questionable estate plan changes. Marlon Brando, for example, changed his will 13 days before his death, sparking years of wrangling.
Cognitive decline also exposes people to outright fraud. Over the years, I’ve witnessed several fraud attempts targeted at older folks. I recall a neighbor who was convinced that someone in Nigeria was going to pay her top dollar for her old TV. We found out about it when she knocked on our door, looking for packing tape. My wife tried to dissuade her, but she was absolutely convinced. Fortunately, FedEx refused to ship the package, but it was a close call. Others aren’t so lucky.
While, sadly, there’s no cure for cognitive decline, what I recommend is that older folks begin to involve their children in their finances. There may be resistance because money is seen as a private matter. But whether you’re the parent or the child, I would try hard to push through that resistance. If you don’t have children, try to involve a trusted friend. Even a light helping hand on the tiller can help.
Latent risks. Investment worries tend to change from year to year. But by the time a worry becomes significant enough to notice, it’s often too late to do anything about it. Inflation is today’s example. As I mentioned a little while back, Treasury Inflation-Protected Securities (TIPS) were a good deal a year ago. But after the inflation we’ve experienced over the past year, these bonds are now much less of a good deal. That said, I view the current bout of inflation as a good reminder that risks that may appear to be latent can often resurface.
What other latent risks should you potentially consider? An example might be pension risk. If you have a traditional pension from a private company, you might view it as “guaranteed” income. But it’s worth periodically checking the health of your old company. Be aware of whether your pension benefits fall within the benefits cap set by the Pension Benefit Guaranty Corp. Again, you don’t need an airtight plan, but ask yourself how you might adjust if your benefits were reduced.
Condo associations represent another type of latent risk. Anyone who’s ever owned a condo knows about the dreaded special assessment. These can be particularly unpleasant for folks who have downsized specifically for the purpose of better managing their housing costs. While some assessments are impossible to predict, condo owners often report that they saw certain big ones coming—roof and window projects, for example. The solution? While you can’t move to avoid every assessment, it helps to keep your ear to the ground in your community—and that might prompt you to sell sooner if you were already planning to move.