Webster’s Dictionary explains risk as a hazard, danger, peril, exposure to loss, injury or destruction. Often in life we measure risk as the potential of losing something of value, weighed against potential to gain something of value. Must we independently measure future value when the only constant the future holds is change? Should we rely on the past to offer us confidence in our future?
The retirement plan industry today is vastly different from that of 1974, when the Employee Retirement Income Security Act was passed. Today we are far more accountable to modifying potential detriments and newfound risks to our retirement, such as life expectancy risk, deflationary risk, market volatility risk, mortality risk, inflation risk, withdrawal rate risk and long-term care risk. Each of these risks has the potential to create future erosion, and the only way to recapture this erosion is to avoid it in your planning years.
Of all the risks mentioned, longevity risk is, hands-down, the most dangerous. Over time, with improved medical technologies and health awareness, people have been living longer and longer. The Social Security Administration reports that a married couple age 65 today carries a 73 percent chance that one of them will live to 85 years old and a 47 percent chance one lives to 90. Longevity risk has become a risk multiplier for all other risks because the longer we live, the more likely that we will be affected by all other risks. We need to think like an actuary and begin with the end in mind. In other words, if we knew we were going to die tomorrow it would not matter if the stock market crashed next week, the IRS announced an increase in taxes, or health care and pharmaceutical inflation continued to rise.
However, what if we live to 100 or older? We would have a much greater risk of being impacted by all these threats. We must remain focused on the foundation for all retirement savings. Why do we give up current enjoyment of our earnings for retirement tomorrow? We do this in order to have a dependable income stream once we reach our definition of retirement that is sustainable and does not interfere with our legacy planning wishes. It only makes sense, then, to understand what future retirement income needs look like so we can efficiently position our risk accordingly. In other words, understanding how retirement income streams work economically defines how to allocate our savings today.
Researchers at the Center for Retirement Research at Boston College recently studied retirement preparedness. In the study they reviewed 10 surveys of consumer finances run by the Federal Reserve. Of all the results considered, the most convincing was the wealth-to-income need ratio. This ratio remained unchanged over time, despite longer lives, declining Social Security replacement rates, rapidly rising health care costs and low interest rates. People retiring in the future may continue to have less and less resources than past generations. Rather than fighting emotions around these systemic risks (risks we have no control over), we must tailor different elements of all our risks to make the most of things we can control, yet still evaluate factors somewhat or completely out of our control. When we concentrate on these non-systemic risks (risks within our control), we tend to subdue our emotions around systemic risks and focus on the welfare of our family. Jack Welch once said, “Control your own destiny or someone else will.” Until next time remember, “The only thing forever is yesterday.”
ANDREW S. MILLER is a Chartered Retirement Plan Specialist with the College of Financial Planning. You can contact him at email@example.com.