When it comes retirement planning, we naturally tend to focus on the risks we’re most aware of, say, the possibility that this nine-year-old bull market could give way to a ravaging bear and take a big chunk out of our savings or that an unscrupulous or incompetent adviser might talk us into inappropriate or expensive investments. And those are valid concerns. But our retirement plans can also be endangered by risks that aren’t as apparent, which can make them all the more insidious. Here are three risks that may not be top of mind but that you should still guard against as you plan for and enter retirement.
1. Complacency risk. Maybe you set your savings rate early in your career when your budget was especially tight and haven’t raised it since. Or perhaps you were automatically signed up for your 401(k) at a default rate of 3% to 6% and you never increased it. Still, aided by the double-digit market returns of recent years, your retirement account balances seemed to be growing nicely, so you never bothered to gauge whether you were actually on pace to build an adequate. You’ve just been going with the flow, hoping it’ll all work out in the end.
In short, you have fallen prey to complacency risk. You’ve let yourself be lulled into a false sense of security that you’re on the road to a secure retirement—or at least making reasonable progress toward that goal—while in reality, you may be well short of where you need to be. So how can you avoid an unwelcome surprise late in your career, such as realizing you’ll have to stay on the job more years than you’d planned or dramatically scale back your retirement lifestyle?
The best way to protect against this risk to periodically give yourself a retirement check-up. The process is pretty simple. You go to a retirement income calculator that uses Monte Carlo simulations to make its projections, plug in such information as your income, the current value of your retirement accounts, how much you’re saving each year and the age at which you plan to retire, and the tool will estimate your probability of achieving your goal. If the tool estimates your chances at less than 80% or so, then you know you need to make some adjustments, such as saving more, investing differently, scaling back your planned retirement lifestyle or a combination of these.
But unless you make the effort to do this sort of assessment every year or so—or hire an adviser to do it for you-you can’t really know whether you’re on track toward a secure retirement or just fooling yourself.
2. Emotions risk. This risk tends to be highest during periods of market extremes when emotion and impulse are more likely to affect our investing decisions. When stock prices are climbing rapidly and hitting new records, many investors get swept up in the euphoria and invest more aggressively, eager to capitalize as much as possible on expected future gains. Conversely, when stock prices plummet—as they did by more than 50% during the late-2007-through-early-2009 market slump precipitated by the financial crisis—the emotional pendulum swings the other way, and fear of incurring further losses drives us to invest too cautiously.
But whether it’s getting overly excited when stocks are on a tear or too pessimistic when the market is taking a beating, letting your emotions sway your investing strategy can inflict real damage on your retirement prospects. Bull market giddiness can lead us to take on too much investment risk and leave us vulnerable to larger losses than we can handle, while bear market pessimism may lead us to jettison stocks and miss out on the explosive gains that typically accompany the early stages of a market recovery,
One way to manage this risk is to set—and then preferably put in writing so you’ll be more likely to stick to it—an asset allocation strategy that will increase your chances of being able to ride out stocks’ ups and downs without reacting rashly to them. The basic idea is to invest enough in stocks to generate the returns you’ll need over the long term to build an adequate nest egg but also enough in bonds to provide short-term downside protection during market routs. A risk tolerance-asset allocation tool like the free version Vanguard offers and that you can find in RealDealRetirement’s Toolbox section can help you come up with such an asset mix. Whatever stocks-bonds blend you ultimately decide on, make sure you rebalance occasionally to ensure that gains or losses in different holdings don’t cause your portfolio to stray too far from your target mix.
3. Longevity risk. You might think that this risk—essentially, the possibility that you could live much longer and spend a lot more time in retirement than expected—would only be an issue after you retire, the danger being that if you underestimate how long you might live (as many people do), you might spend down your nest egg too quickly and outlive your savings.
But longevity risk can also come into play during your working years. If you assume you need to save enough during your career to support you for 20 years after you leave your job and you actually end up living 25 or 30 years in retirement, you’re not going to accumulate nearly enough savings to maintain your pre-retirement standard of living throughout your post-career life. Which is why it’s important that you understand how long you might be depending on your savings to support you, and then save during your career (and spend during retirement) accordingly.
It’s impossible to know exactly when you’re going to shuffle off this mortal coil. But you can get a more realistic sense of how long you may be around by going to the Actuaries Longevity Illustrator. Just plug in such information as your age, whether you’re a smoker or non-smoker and an assessment of your overall health, and the Illustrator will estimate your chances of living to specific ages (80, 85, 90, etc.) or for a given number of years (10, 20, 30, whatever). If you’re married or have a partner, be sure to include that person in the assessment.
With these estimates in hand, you are able to better assess how much you ought to be saving during your career and how much you can safely afford to spend once you’re retired. Of course, you won’t entirely eliminate longevity risk. But you’ll be much better equipped to deal with it.