How much risk should I take in retirement? It’s an important question, but I think that the financial industry has it wrong. And since they’ve got it wrong, this faulty method of risk management then gets passed on to investors and clients. In this post I’ll share a different way of looking at risk and what you could be doing instead.
But first, a story. A man sits down with his doctor and the doctor breaks the bad news that the man has cancer. The man is completely shocked. Then the doctor shows the man an iPad with a questionnaire to determine how much chemotherapy the man is comfortable with. The man looks up, even more shocked by this question, and says, “the least amount possible to get rid of the cancer, obviously!“
While that’s just a silly anecdote, it’s kind of how we usually look at risk as well. It’s common in the early meetings with an advisor for them to ask you about risk tolerance or to fill out a questionnaire. They then use that to try and pinpoint how comfortable you are with risk. But I’m not so sure that’s the best way to determine the how much risk you should have in your portfolio. Your risk tolerance today is going to look a lot different than it did back in March of 2020, when we saw one of the fastest drops to a bear market in history, or back in 2008 or 2009, when we thought we were in the worst of it.
First, I’ll share how we think about it at Streamline Financial, and then I’ll share some other big risks that you might want to be looking out for.
Here’s how we look at risk.
Rather than try to identify your risk tolerance and build an investment plan from that, at Streamline we focus first on the key factor in retirement: your future income. The whole purpose of retirement planning is making sure you have enough money coming in so that you can keep doing the things you want to do. We believe that once you create a solid income plan, that will dictate the risk of your investment plan and your asset allocation, and how much risk you should be taking on. That’s why we work with our clients to focus on an income plan before creating the investment plan, tax plan, and all the other parts of the system. We have found that we have a much better chance at creating a successful retirement plan when we do it this way. And our clients think so too.
If that makes sense to you and you’re planning for your retirement, but you may not be ready to talk with an advisor, or you’re just more comfortable doing it yourself, click here for a DIY retirement plan.
Many people think that market risk is the biggest risk. They worry if the next market crash could ruin their retirement. Market risk is important, but it can be covered with proper planning. The risk that most people don’t think about as much is kind of a silent killer. It’s the fact that the US dollar loses value over time. This means that $100,000 invested in 1970 could be worth only $50,000 in a relatively short amount of time. We call this cash risk or inflation risk. The reason it’s a silent killer is because you won’t get a statement showing a negative percentage return. It seems like it’s holding value. But as everything else around us gets more and more expensive and inflation goes up, that dollar value is actually decreasing every year.
Another big risk has to do with the year you choose to retire and start withdrawing funds. Someone who retired in 2007 could have a much different outcome than someone who retired three years later in 2010. The first few years of your income plan and withdrawal plan are absolutely critical. There is a graphic in the video above that illustrates this comparison of two retirees who did everything the same, except for the year in which they retired, with drastically different results. It was just the first few years of retirement that made all the difference.