This is a very good article about the risks you face in retirement. It was written by Wade D. Pfau, Ph.D., CFA, , a Professor of Retirement Income in the Ph.D. program for Financial and Retirement Planning at The American College in Bryn Mawr, PA.
The transition to retirement fundamentally changes the nature of risk.
A worthwhile approach is to distinguish risks based on whether they jeopardize the asset side of the household balance sheet, or the liability side (future spending needs) of the balance sheet.
Another division could be whether the risks impact society at a macroeconomic level, or whether they are individual specific. This allows for a consideration of four categories of risk as highlighted in the following figure.
Let’s first consider macroeconomic risks to the asset side of the balance sheet. This is the upper-left quadrant. Poor market returns will translate into less financial assets on the retirement balance sheet. Even more deeply, financial market returns near the retirement date matter a great deal. Even with the same average returns over a long period of time, retiring at the start of a bear market is very dangerous because your wealth can be depleted quite rapidly and little may be left to benefit from any subsequent market recovery. The risk is essentially that retirees experience market downturns which are larger or longer than the downside tolerance built into their retirement plans.
As well, with interest rate risk, decreasing interest rates may provide capital gains for a bond portfolio, but they also lead to lower annuity payout rates and lower interest payments on reinvested funds. Increasing interest rates, on the other hand, may result in capital losses for a bond portfolio, though annuity payout rates and interest on reinvestments will grow. The risk here is if the duration of one’s assets doesn’t match the duration of their liabilities.
Next, let’s consider the lower-left quadrant which includes more individualized risks that impact asset values. As cognitive abilities decline with continued aging, retirees are increasingly at risk of becoming victims of bad advice, fraud, or even outright theft. The danger with this is that nefarious individuals find a way to siphon off assets from the household balance sheet.
Read the complete article here: Breaking down retirement risks – MarketWatch.