Money Management

How to Keep Your Retirement Money Safe – A More Practical Way

By  Opher Ganel

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Do you know how well you’re doing preparing for retirement?

Unless you’re in the distinct minority, I’d guess you don’t. Not really, and that’s no surprise because good retirement planning is hard. Unfortunately, much like going to the dentist, it’s as crucial as it is unpleasant.

Why Retirement Planning Is So Hard

First, you have to predict market returns over a long retirement period and do so many years ahead of time.

Next, you have to predict how much you’ll need to cover your retirement spending – and with a majority of Americans never budgeting for this year or next, how likely are they to know what they’ll spend years or decades ahead of time?

Then there’s the uncertainty of inflation.

When even the Fed can’t predict how bad inflation will be next year, let alone over the next decade or three, how can you possibly do it? And that’s for overall inflation. Predicting how prices will change in specific areas important for retirees – healthcare, property taxes, and enough leisure activities to fill so much more free time – is even more challenging than knowing how overall inflation will behave.

Finally, we’re dealing with money – a taboo subject for most people, and one that strikes many with unspoken anxiety.

The 7 Biggest Risks to Your Retirement Plan

As I wrote elsewhere, there are 7 big risks to your retirement plan. Here they are in brief, but you should read the details there, along with what you can do to mitigate them.

1. Market Risk

To the extent that your retirement portfolio is invested in stocks (which is where most of it should be), a major bear market can devastate your finances.

2. Sequence-of-returns Risk

If your portfolio suffers major losses just before, or worse, just after you retire, your regular draw-down can cause your retirement finances to spiral down, crash, and burn even if the same loss wouldn’t be a problem had it happened later in retirement.

3. Interest-rate Risk

The fixed-income portion of your retirement portfolio will likely be invested in bonds and/or CDs. A large increase in market interest rates will decimate the principal value of your bonds, whereas a major drop in interest rates would dramatically reduce the fixed income you get as you reinvest maturing CDs.

4. Inflation Risk

Even tame inflation of 2%/year (remember those years?) doubles your costs if you stay retired (and alive) for 35 years. Inflation at the current 7.5% more than doubles your costs every 10 years.

5. Investor-behavior Risk

f you’re like many people, seeing your portfolio value drop by 20, 30, or 40% may well send you running for the exit, locking in your losses forever. And if you think that level of loss is unrealistic, here’s some unwelcome news. According to Hartford Funds, in the 93 years from 1929 to 2021 the market crashed >40% 8 times (every 11.6 years on average), >30% 17 times (including the >40% ones, on average every 5.5 years), and >20% 26 times (every 3.6 years on average).

6. Longevity Risk

While we can look up life expectancy numbers, and even age-based numbers, (a) by definition half the people live longer than those numbers, and (b) those averages mean little when you look at a sample of 1 – you. If you live longer, your retirement portfolio has to survive longer. If you do and it doesn’t, you’re sunk. This means you need to have a significant portion of your portfolio in stocks most of the time.

7. Health Risk

As we age, our health deteriorates. For some, it’s as small a matter as increasing aches and pains, reduced flexibility and muscle strength, etc. For most, it’s an increase in doctor visits and prescriptions. For many, it can be significant illnesses that put you in the hospital for days, weeks, or months, and potentially require long-term care. These expenses add up to huge sums. According to Fidelity, “…an average retired couple age 65 in 2021 may need approximately $300,000 saved (after tax) to cover health care expenses in retirement.” And that’s just the average!

The Ideal Solution to Most of These Risks

The ideal, obvious, and really difficult solution for most of these risks, is to have a lot more money than you’ll need.

For example, if you’ll need $100,000/year in retirement, expect to get $30,000 in annual Social Security benefits, and have $3 million, you could invest in a very low-risk portfolio that keeps up with inflation, and simply spend down your portfolio over 42 years (if you even live that long).

That means market risk and sequence risk are not major concerns for you. Having more money also averts (the financial impacts of) longevity and health risks.

The problems here are that (a) it’s hard to amass so much, especially without also raising your standard of living far above the $100,000 level; (b) inflation could increase your costs much faster than your portfolio can accommodate, and (c) if you plan on leaving a bequest to your kids, the longer you survive, the smaller your bequest becomes.

A Less Ideal But More Plausible and Practical Solution

To address the above problems without increasing your needed portfolio even more stratospherically, you have to invest a significant part of your portfolio in stocks.

The venerable 4% rule says that if you split your retirement portfolio equally between stocks and bonds, you’d need 25 times your expected first-year draw. With the above example numbers, this would be $1.75 million, 42% less than needed with a nearly stock-free portfolio!

Also, according to Forbes, stocks tend to perform well following an interest rate hike, as long as these hikes cool down but don’t choke the economy. Thus, stocks are a reasonable asset to own to overcome interest rate risk, and handily outpacing inflation means they address inflation risk too.

However, that raises the 7th risk, of investor behavior.

When, not if, stocks sell-off and the market craters by 20, 30, 40, or 50%, will you have the stomach to stay the course and not panic-sell, locking in your losses?

If you’d pull the plug on your stocks and stay on the sidelines for a long time, you’re setting yourself up for big losses.

Your answer will likely depend on how much of your portfolio is in stocks, so you’d have to keep your stock allocation low enough, whether that’s 70%, 60%, 50%, or some other number, for you to stay the course when the market drops.

Note that putting a significant portion of your investments in stocks brings back market risk and sequence-of-returns risk, which I’ll address in more detail in an upcoming article.

The Bottom Line

Retirement planning, like visits to your dentist, is unpleasant but crucial.

You have to take into account and address multiple uncertainties and 7 significant risks.

The simplest and most ideal solution is to have a lot more money than you’d expect to need. However, given how little most Americans manage to save for retirement, telling you that even if you’re ahead of 90% of Americans approaching retirement you need to double your nest egg and/or cut your retirement budget in half isn’t practical.

Instead, you have to invest in higher-return, but thus higher-risk assets such as stocks. How much of your portfolio needs to be invested there is the big question you have to answer for yourself. My next piece will help with figuring that out.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.

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About the Author

Opher Ganel

My career has had many unpredictable twists and turns. A MSc in theoretical physics, PhD in experimental high-energy physics, postdoc in particle detector R&D, research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. Now, I use all these experiences to also offer financial strategy services to help independent professionals achieve their personal and business finance goals.

Connect with me on my own site: OpherGanel.com and/or follow my Medium publication: medium.com/financial-strategy/.

Disclaimer: To make Wealthtender free for our readers, we earn money from advertisers, including financial professionals and firms that pay to be featured. This creates a natural conflict of interest when we favor their promotion over others. Wealthtender is not a client of these financial services providers. Learn how we operate with integrity to earn your trust.