Can some investments help manage retirement income risk better than others?

Retirement Income Planning Risks

One element we outline for new clients is helping you understand the importance of aligning your investment choices with the various risks you will encounter in retirement. For example, rather than debating whether you love or hate annuities, or if owning stocks is too risky or you feel bonds are boring or how insurance fits into your plan; different types of risks require different types of tools to manage them. There are pros and cons to every investment, but once you understand how to address each risk with the type of investment that’s best suited to manage it, I think it becomes clear, in most cases, you can benefit by using all of these tools in building out a successful retirement income plan.

Liquidity Risk

Holding investments like cash, CDs, U.S. treasuries and short-term bonds can be a great way to help manage short-term risk. There can be some financial upside. All of these investment choices have the ability to earn some interest and they are safe from the stock market. The nice thing is you’ve got liquidity and they are a great defense against sequence of return risks. They are all great choices to stash away your first year or two of income you’ll need in retirement. Conservative investors may want to keep the money necessary to fund the first 2 to 5 years of their retirement in these investment options.

Longevity Risk

One longevity fighter you or your spouse or both can look forward to is social security. Now, you may have to wait longer than others to hit your “normal retirement age” and many of us may have the anticipated future dollar amount threatened by the poor management of this very necessary program – but something will be there. Pensions and income annuities, whether they be variable annuities or fixed annuities, fixed indexed or single premium immediate annuities (SPIAs) or deferred income annuities (DIAs), these can all provide predictable income to help manage the risk of a long life and the fear of outliving your money. Many annuities provide principle protection or are not invested in the market at all. Because many are not subjected to any market downside, they can help manage sequence of return risk. Most importantly, you can use pensions and annuities to do what no stock, bond, or mutual funds can do, and that’s provide guaranteed, lifetime income. Some pensions have a cost of living adjustment to help recipients manage inflation and there are some annuities with inflation protection options available but many times they can add significantly to the cost. Remember, these investments are designed to cover essential expenses throughout your retirement.

Legacy, Lifestyle and Inflationary Risks

This is what a diversified portfolio is best suited to cover in my opinion. The goal of equities in an investment portfolio is to grow wealth over the long run. To achieve this, you need to feel safe enough to stay with your investment strategy even if the equity portion declines by 20 to 50 percent. And understand, markets drop 10 to 15 percent every 12 to 18 months on average and drop 20 to 30 percent every 5 to 6 years. During these times it’s important that you stick to the plan. This sense of security can only be created by having enough cash to cover short term emergencies and a sound income plan in place to cover basic expenses while the equity side of your investment portfolio recovers. Stocks are for the long-term, to manage inflation and to capture the market upside over time. You can use equities to cover discretionary expenses like trips or a new car. They can also be used to leave a legacy to children.

There’s More

Last but not least – you know why you have/should have insurance? To help protect against catastrophic losses. The ones you are not in a financial position to absorb; like the cost of long-term care or a car accident or you home burning down. Life insurance can be a great way and a very tax efficient way to transfer wealth and leave a legacy for a spouse or children. Maybe the cheapest, most tax efficient way to do it. You can use it to manage the risk of being disabled. An umbrella policy could help provide some liability protection if somebody got hurt on your property or at your business. And of course, we’re all familiar with health insurance. It’s the best way to manage health costs in today’s world.

So, when taken all together, I’ve highlighted a few reasons why an investor might consider some exposure to different types of investments. They all have different functions in a comprehensive plan and some are better at protecting you against various risks than others. This is what a fiduciary should focus on – a client’s best interest is served when all risks have been evaluated and the best investment vehicles to manage those specific risks have been considered, analyzed and put in play to help protect the client and their future.

To optimize the rest of the portfolio you must have a plan for long term care. Whether that’s paying for long term care insurance, self-funding from your investments or having an understanding within the family that some child or other family member, or siblings could take on or share the responsibility of caring for you. Not to have this covered is a disservice to the rest of the family. Your responsibility as a parent, as an adult and as someone that’s aging, as we all will, is to have a plan. Where you’ll spend those years and how you’ll pay for them, who to call in case of an emergency or in the passing away of a spouse. And taking that one step further, having burial plans and directions already in place and paid for. Never a fun subject, but it’s a very kind gift to leave things in good order for your loved ones and they’ll never forget at a tough time how much easier things were because there was a plan in place.

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