Don’t Forget these critical retirement risks

Do you remember the Seinfeld episode where George is required to give a speech to the Yankees top executives on risk management because his resume said he was a risk manager?  He knows nothing about the topic of risk management so he buys a book by that title. However, he can’t get past the first page, so he asks a blind man where he can get a textbook on tape. He tries to listen, but he can’t do it. In his desperation, he convinces one of Jerry’s girlfriends to become his intern and assigns her the task of reading his risk management textbook and writing a speech for him. However, the speech gets mixed up with one of Jerry’s comedy routines and he gives a speech to the Yankees top brass on the problem with Ovaltines!

All retirees are dealing with risks whether we think about them or not.  But most retirees, or those planning on retirement, may be a bit like George Costanza and don’t know how to think about the risks in retirement. Those blind spots can lead to unexpected problems or poor planning in our retirement years.

The Center for Retirement Research at Boston College recently released a report that confirmed retirees’ expectations are different from the probable risks they will face. Compare these five retirement risks they identify with your own list:

• Longevity risk: outliving your money
• Market risk: unexpected investment losses
• Health risk: unexpected health costs
• Family risk: helping family members with unforeseen needs
• Policy risk: cuts in Medicare, Social Security or other programs

 If I were face to face with you, I would ask you to rank these five risks in the order of greatest risk to least in your retirement. Before reading more, why don’t you give that a try before I show you the probabilities Boston College thinks are most likely compared to answers single men gave?

If you are similar to the single men they interviewed you would have ranked these five risks as follows (value):

1. Market risk (31%)
2. Longevity risk (14.6%)
3. Health risk (9.6%)
4. Family risk (1.1%)
5. Policy risk (0.3%)

The objective real risk the Boston College researchers suggest are as follows:

1. Longevity (26.2%)
2. Health (14%)
3. Market (10.8%)
4. Family (3.2%)
5. Policy (0.1%)

The most interesting take away for me is the difference in the way the men interviewed think market risk is the greatest risk they face in retirement compared to the researchers who believe longevity and health risks rank higher by a big margin.

You may not agree with these findings, but as we have discussed on this blog site before, its good to have someone challenge our beliefs in order to break down cognitive bias in our approach to managing money.

The researchers think retirees exaggerate financial market volatility. On the other hand, health and longevity risks are not considered as important risks by the retirees because they underestimate the probability of outliving their savings or to accumulate a large amount of health care costs.

Research like this always leaves us asking for more information. How would these risk ratings change for different socioeconomic classes for example?  But even without additional information, there are at least 5 important things to consider from this research that are of practical importance for any of us either retired or planning to be one day:

1. Politics is on our mind and if you believe the politicians, the future of the world hangs in the balance of the next election. That may be true. However, it appears that none of us should be worrying about anybody taking away our Social Security or Medicare anytime soon. That is the least of our risks to worry about.
2. If longevity risk is the greatest risk, perhaps we should consider locking in more guaranteed monthly income for life from sources like annuities that will not quit paying until our death.
3. As longevity increases, we can expect health care costs to rise. Perhaps this adds to the case for locking in some sort of long-term care insurance for expenses that Medicare is not going to cover.
4. As a student of the market, I am less convinced of the researchers putting market risk at number 3 because I know at anytime the market could lose 50% of its value. However, if fixed costs are covered by social security, pensions and annuities, we should be prepared to ride out such a dramatic drop in market values and ride out the storm. If that’s the case, then I can justify lowering it in importance.
5. Benjamin Graham wrote one of the greatest investing books ever called, The Intelligent Investor. He is known for his concept of the “margin of safety” whose purpose is to render forecasts unnecessary. You could also call it leaving your plans with room for error. I know that many are in a hurry to leave their job ASAP and retire, but as this discussion of retirement risks shows, its not a bad idea to also have a margin of safety in our planning.

If you think about the forecasts all the experts made for the year 2020, none of them predicted a game changing pandemic. Its easy to realize that no matter how many risks we try to identify and plan for, it’s the unknown events in our future that are our greatest risk. We can’t plan for what is unknowable, but that’s no excuse to not plan for those risks we do know exist and leave a margin of safety for what we don’t know.

I would love to hear how you are managing your retirement risks!

Joe Kesler, Smart Money with Purpose