As retirement nears, your focus gradually shifts—from seeking to maximize the growth of your portfolio to protecting your savings from financial risks. “We’re more responsible for managing our own retirement than we’ve ever been in the past, so it’s critical we consider the risks we face,” cations Michael Finke, a professor of personal financial planning at Texas Tech University.
The following are three financial risks to retirement savings that every investor should be taking steps to minimize as they approach retirement:
1. Market risk
This is the risk that every investor thinks about—the possibility that your lifetime savings will lose value due to a decline in the stock market. It’s true that stocks are especially susceptible to market risk in the short term. But those risks decrease over time. In fact, stocks have produced positive returns during every period of 20 years or longer since 1926.1 And historically, stocks have offered the greatest growth potential of any asset class. Bonds and cash investments offer greater stability but much less growth.
The longer you have until you’ll draw on your savings, the more market risk you can afford to take in pursuit of continued growth. So if you still have a decade until retirement, you might want to still hold most of your portfolio in stocks. As you approach retirement you can gradually convert some of those holdings to bonds and cash to help protect what you’ve accumulated.
2. Inflation risk
Rising prices gradually eat away at your savings’ purchasing power. Due to the COVID-19 pandemic, consumer prices increased by just 1.4% in 2020; but historically, inflation has averaged 3.7% percent annually since 1960.2 “If you haven’t invested in assets that rise with inflation, the money you’ve saved for retirement will buy less over time,” cautions Finke.
You can combat inflation risk by holding some growth-oriented investments, such as stocks, into retirement. “Retirees should consider accepting some market risk to make sure they have a better chance at beating inflation,” notes Finke.
You also might consider investing in products such as Treasury Inflation-Protected Securities (TIPS), which offer inflation-adjusted payments. Your Social Security, which provides a lifelong income stream, is also adjusted for inflation.
Life expectancy is on the rise: Today the average 65-year-old man is expected to live to age 84.0, while the average woman that age is likely to live to age 86.6.3 Retirements lasting on average 20+ years (and which may span 30 years or longer) increase the possibility of outliving your savings—longevity risk.
A diversified portfolio that includes exposure to the growth potential of stocks can help safeguard your income throughout your life. Longevity insurance (which offers payments that begin after you’ve reached advanced age may help, as well as certain annuities which offer guaranteed lifetime income benefits available through optional riders for an additional cost. 4
While the retirement risks you face are very real, the more you understand them, you better you can manage them