Retirement should be a happy time in life. In fact, recent “happiness” studies have shown that general happiness levels have a U-shape. They tend to bottom out in mid-life and then rise again to ultimately peak in old age. In general terms, the old are happier than the young.
But it's hard to enjoy those golden years if your retirement needs aren't taken care of. That is where the five risks of retirement come in. These are the concerns you need to be aware of — whether you are 30 or 70 or anywhere in between — as your retirement years stretch out ahead of you.
In a nutshell, the five risks of retirement are: longevity, inflation, volatility, expense and solvency.
These conveniently form an acronym, LIVES, as in "a cat has nine lives." You could also rearrange them into EVILS, as in "the evils of a bad retirement," if that helps you remember them better. Let's look at each one.
1. Longevity risk is pretty simple to understand. With life expectancy increasing and medical advances proliferating, many retirees today could easily enjoy 25 to 30 years in retirement ... without any income. Moreover, just think of how many different curveballs financial markets could throw over a three-decade period.
2. Speaking of possible market curveballs, inflation risk is a serious concern for retirees. When inflation takes hold, goods and services become more expensive. The price of everything goes up, including non-avoidable costs like basic necessities, property taxes and medical care.
You don’t have to be a market wizard to understand the following chart from the St. Louis Fed. The interest rate on the ten-year US treasury note peaked in 1981, and then declined for an incredible 35 years (until 2016).
Every retiree needs to be concerned about a possible reversal of this trend. High inflation will return at some point, and it will make retirement more expensive when it does.
3.Volatility risk is another important concept for anyone in retirement, or anyone thinking about how to approach retirement. The basic rule of thumb is: The less cushion you have, the less volatility you can handle.
If you have saved "just enough" for retirement, and markets then become extremely volatile for a period of months or quarters, the safety of your retirement nest egg will feel threatened. If you don't have a well-designed plan, this could keep you from sleeping well at night or, what’s even worse, lead you to make an emotional investment decision you will surely regret.
4.Expense risk touches on the need to pay for unknown life events. Something will come up, it always does — especially over a long span of retirement years. The same pool of retirement assets that covers routine costs will have to absorb these occasional big-ticket items that come up out of the blue.
5. The final risk, solvency risk, has to do with outside sources of income, like social security and pensions. A great many retirees rely on social security for a significant portion of their income; a great many also rely on a pension plan, funded either by a private corporation or a state or local government.
Sadly, income sources like this need an asterisk when laying out a budget for retirement. That is because there is a risk that such income sources will not be there in the future, or just won't be worth as much.
While thinking about retirement risks may not be the cheeriest of topics, not thinking about them will likely end up being more disappointing. The good news is there are ways to mitigate these risks. With planning and foresight and preparation it remains possible to plan for and enjoy the stress-free retirement you deserve.
Dr. Richard Smith, the founder and CEO of TradeSmith, is a pioneer of behavioral investing techniques. His company, TradeSmith, is dedicated to empowering individual investors through the use of intuitive, easy-to-use software tools.