Retirees have every reason to be an extremely risk averse bunch. After all, most of them have an immediate or near-term need to draw income from their assets. This need for income should result in zero tolerance for investment risk or reduction in value of the assets that are intended to produce the retirement income.
It is tempting to think otherwise. Don’t like the paltry yield that is produced by your accumulated wealth in this current environment of near zero interest rates? Then just tweak your portfolio return assumption by “assuming some more risk.”
This is just a hunch, but I have a strong feeling that investment risk is much more than an abstraction for the average retiree.
I would venture to guess that the average 65 year old has very strong feelings about the type of volatility we have seen in capital markets over the past week, and that these feelings and reactions are very different than your average thirty-something who may view the week’s events as a good opportunity to reshuffle asset allocation.
How could this not be the case? Market volatility and investment risk have the potential to permanently impair the ability of a portfolio to support core lifestyle needs.
There is also a more scientific, analytic case to be made for zero tolerance of investment risk during retirement.
This “no free lunch” case was illuminated for me in a recent newsletter from Moshe Milevsky’s QWeMA Group. Moshe has the following to say on the topic of investment risk:
Here is one of the axioms of financial economics. If you are going to assume a higher expected investment return – like 6.5% -- compared to what is available with no risk, then you must also allow for the possibility that things will not work out and you might earn much less than expected. Average the two scenarios – and account for this risk properly – and you are left exactly where you started…
“Back where you started” refers to the financial results that are produced when risk free rates rather than more aggressive (and risky) return assumptions.
As discussed above, the risk that “things will not work out and you might earn much less than expected” has meaning and implications that are entirely contingent on one’s perspective.
All roads seem to lead to Rome whether using math or listening to your gut. The bottom-line is that it makes sense to be very conservative with return assumptions because there really is no free lunch when it comes to investment risk during retirement.
- tom's blog
- Log in to post comments
