Most clients head into retirement without much thought about the risks that could disrupt their plans.
Having saved and invested for retirement for 25 or more years, they look forward to enjoying their much-anticipated retirement lifestyle. And retirement could last for as many years as they spent saving.
But life can throw curveballs they did not plan for. For example, what if they live longer than anticipated and the money they have saved for retirement runs out? What if they become ill and need to draw down on their savings to cover health-care costs? What if the markets do not perform as well as they expected?
Some clients plan for such contingencies, says Heather Holjevac, senior wealth advisor at TriDelta Financial in Oakville, Ont. “But most do not understand the implications of certain life events as they age.”
Matthew Williams, head of institutional and client service at Franklin Templeton Investments Corp. in Toronto, says the three main risks that retires underestimate are: longevity risk, market risk and income-replacement risk.
> Longevity risk
The average Canadian male lives for 22.6 years beyond the standard retirement age of 65, Williams notes, while the average female lives for 24.5 years beyond retirement age. Increasing longevity brings on the risk that clients might outlive their money or have to adjust their planned lifestyle to accommodate a reduced income.
One of the main consequences of living longer, Williams says, is the dramatic increase in the cost of health care, especially in clients’ later years. In addition to health-care costs, clients can also face costs associated with living in a long-term care or retirement facility, or those associated with assisted living.
Williams suggests clients purchase long-term care insurance prior to retirement to reduce that risk.
> Market risk
No one can predict the behavior of the market and how it will affect a client’s retirement portfolio. A decline in the market during the early years of retirement can lead to a depletion of assets available for later retirement years.
For example, if a client loses 10% of the value of a portfolio worth $100,000 early in retirement, only $90,000 will be left to grow in the portfolio to support future retirement years. In order to reduce market risk, Williams suggests creating three buckets of assets: a “consumption” bucket for short-term needs; a “longevity” bucket comprising a balanced portfolio with a 40% equities/60% fixed-income asset mix; and an “intergenerational” bucket that can fund unanticipated expenses such as health-care costs.
> Income-replacement risk
Williams says people spend more during their early retirement years because they are more active. Based on the retirement lifestyle they choose, they may travel more or engage in hobbies such as golf and sailing, which can be costly.
When retired clients reach their mid-70s, retirement expenses may start to decline. But expenses go back up in later years, when health-care costs increase. The “U-shaped” pattern of expenses, Willians says, must therefore be monitored carefully to ensure that clients’ portfolios generate sufficient income to meet their expenses at the various stages of retirement.
This is the second part in a two-part series on risk. Click here to read part one.
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