The primary objective of managing a retirement portfolio often shifts when you stop working. Whereas the main goal during working years is to accumulate capital, the main goal during non-working years frequently becomes to preserve capital.
Preserving your hard-earned savings requires managing multiple retirement risks. Here are some of the most important risks to consider, and how they may be mitigated.
Understanding Retirement Risks
Most of the risks that you need to consider during retirement are always present. There’s always the risk of market volatility, inflation, and interest rate changes, for example. These and others take on a new urgency once you stop working, however.
1. Market Volatility
Anyone who’s been investing for retirement knows that markets don’t constantly go up. Corrections are generally considered a necessary period of market activity, and there can be crashes at times. At the very least, plenty of choppiness is common as equities go up and down.
Market volatility is always a risk, but a less urgent one when you have years to save and invest. With income from a job, you could likely wait for markets to recover from a downturn. You don’t necessarily have time to wait out a temporary downturn if you’re reliant on your portfolio for retirement income, though.
2. Sequence-of-Return Risks
Sequence-of-return risk refers to the timing of returns and withdrawals from a retirement portfolio. Negative returns early in retirement can significantly deplete your portfolio, leaving less capital to recover from subsequent market downturns. The problem is compounded if you still need to take withdrawals during the early down period.
This risk is related to market volatility but not the same. Market volatility is simply the risk of markets going up and down. Sequence-of-return is the more specific risk that markets could go down early during your retirement, leaving you with less to invest later on.
3. Inflation
Inflation erodes purchasing power over time, which can be particularly damaging during retirement if you have fixed income sources. If your investments don’t keep pace with inflation, your retirement income may not be sufficient to cover your expenses.
Even low inflation rates may cumulatively reduce how much you can afford later in retirement. High inflation may have an even faster effect, possibly one that you’d notice in just a few years.
4. Interest Rate Fluctuations
Changes in interest rates can impact the value of many different investments. Bonds are often directly impacted by interest rate fluctuations, and stocks, mutual funds, and real estate can be indirectly impacted.
In most cases, rising interest rates cause lower bond, stock, and real estate prices. If you’re paying off variable-rate debt, a portfolio downturn could come right as your debt payments are going up.
5. Longevity Risk
Longevity risk is the possibility of outliving your savings. Increasing life expectancies can make this a real risk, particularly if you’re a younger retiree and in good health. You might need your portfolio to last decades.
6. Healthcare and Long-Term Care Costs
Healthcare costs are a serious concern for many retirees. If you need major or ongoing care, the associated medical expenses and long-term care costs can quickly drain your retirement savings.
With proper planning, the possibility of a major medical issue can still be disconcerting. Without planning, the possibility of a serious or ongoing medical issue might be downright scary.
Mitigating Retirement Risks
Multiple strategies might be used to mitigate the risks that retirement portfolios are exposed to. There’s ultimately no way to remove all risks, but informed strategies can greatly reduce how much of a negative impact these risks have on your retirement savings.
1. Diversification
Diversifying into multiple types of assets may help mitigate market volatility and sequence-of-return risk. If your portfolio contains a good mix of stocks, bonds, real estate, precious metals, and other assets, then a downturn in one sector or asset type won’t affect all of your savings.
A financial advisor can recommend different assets and specific investments that you might use to diversify your portfolio’s holdings. You can find a financial advisor if you’d like to speak with someone about your investment holdings.
2. Conservative Asset Allocation
Moving a larger portion of your assets into fairly conservative investments can further reduce the risks that market volatility presents, and correspondingly sequence-of-return risk too.
More conservative assets normally don’t have the same growth or appreciation potential that less conservative assets do. There’s usually at least a loose correlation between risk and potential reward, after all.
More conservative assets usually don’t fall as much during downturns, however. Sacrificing some upside potential for lower downside risk may be an effective way to limit losses during a correction or crash.
Bonds, annuities, and certain blue chip stocks are assets that might carry less risk than what’s currently in your portfolio.
Before purchasing any specific investment because it carries less risk, discuss the investment with a knowledgeable financial advisor. They can review it and other investments in light of changing risk tolerance.
The process of deciding what types of assets you invest in is often referred to as “asset allocation.”
3. Portfolio Rebalancing
Your retirement portfolio isn’t static, and neither are your financial needs during retirement.
Portfolio rebalancing involves a regular review and adjustment of your portfolio, to maintain your desired asset allocation. Some assets may be sold and others bought, in order to maintain your target percentages for different assets.
It’s often necessary to rebalance a portfolio after large gains or losses in a particular investment. You may also rebalance periodically to adjust for your age, financial needs, health care needs, or other changes in your situation.
Rebalancing your portfolio helps ensure that your portfolio’s asset allocation aligns with your risk tolerance and time horizon.
Deciding Which Strategies to Use
Which specific strategies you should use to mitigate retirement risks depends on your situation, including your retirement plans and your portfolio’s holdings.
A financial advisor can give you personalized advice on which strategies could be helpful. If you haven’t previously worked with a financial advisor, we can help you find a financial advisor who will go over all of this in detail.
Retirement Income Strategies
One of the most effective ways to counter retirement portfolio risks is to develop income streams that aren’t as tied to market conditions. There are a few common ways of sourcing income during retirement.
1. Continue Working
Continuing to work is often the least desirable method of maintaining income, but taking on a job doesn’t have to be all bad. Consulting could keep you working part-time in your field, which can be both lucrative and interesting if you enjoy your work. You could also look for part-time jobs related to travel or hobbies that you hope to do anyway.
You probably won’t be able to work forever, but this can be an especially good way to counter sequence-of-return risk. It could also let you delay Social Security and qualified withdrawals, which can have other benefits.
2. Social Security
Most retirees who have worked are entitled to Social Security. How much you’ll receive depends on your work and income history.
Social Security can be an especially important income stream later in retirement, since it’s generally paid until you pass away. This is one source that’s the perfect antidote for longevity risk.
To maximize potential Social Security income later in life, delay accepting payments for as long as possible. Waiting until age 70 will usually net you the largest monthly payments once you begin taking Social Security.
Even if you can’t wait that long, payments normally increase for every month you delay. You can likely expect an additional ⅔ of 1% for every month you delay after turning 65 (until age 70).
3. Annuities
Annuities are policies that can be purchased in order to secure a steady stream of income. In exchange for your payment now, the annuity company (often an insurance company) will give you regular payments in the future. There are a few different features:
- Fixed/Variable: Fixed annuities usually pay a set amount regardless of market performance. Variable annuities are usually pegged to a specific index, and may fluctuate some depending on the index’s performance.
- Immediate/Deferred: Immediate annuities usually begin making payments after purchasing them. Deferred annuities may stall payments until a future date.
- Term: Annuities may last for a set term, or life annuities may last for the duration of your life.
A life annuity may supplement Social Security as another income stream that counters longevity risk. All annuities can provide income that could help mitigate market volatility, inflation, and interest rate risks.
4. Qualified Withdrawals
If you have a traditional IRA or 401(k), strategic withdrawals from these accounts might provide income and reduce your tax burden.
You normally must be at least 59½, and the withdrawals should be carefully managed so that they have maximum usefulness but don’t deplete your principal. Withdrawing so that the principal is reduced can compound sequence-of-return risk if there’s a downturn.
Because this is a more advanced strategy, it probably should be done with guidance from a financial advisor or other qualified professional. They can help strategize how much to withdraw and when to take the withdrawals.
How a Financial Advisor Can Help You Manage Retirement Risks in Your Portfolio
A financial advisor brings expertise that can be quite helpful when managing retirement portfolio risks. With their knowledge and experience, they may help in quite a few ways:
- Assess and Plan for Risks: Advisors may help identify the specific risks that are most pertinent to your situation, and develop strategies to mitigate them.
- Optimize Asset Allocation: By understanding your financial goals and risk tolerance, advisors can suggest adjustments to your investment mix so that your portfolio better aligns with your needs.
- Implement Advanced Income Strategies: Advisors have the expertise needed to plan and execute sophisticated retirement income strategies that account for your expected lifespan, tax situation, and income needs.
- Regularly Review and Rebalance: By monitoring your portfolio’s performance on an ongoing basis, advisors can keep you abreast of any substantial changes. They also can rebalance so holdings align with your desired allocations.
If you’d like to talk with an advisor about your retirement portfolio, get matched with a financial advisor who knows retirement planning and risk management. Answer a few questions, and we at Invested Better can match you with a qualified advisor who can give you personalized guidance.
