Risk—It’s all around us but what is it?
Twenty-five years ago, my parents gave me an inspirational poster that hangs in my office with a lithograph of a sailboat that says: “Risk—You cannot discover new oceans unless you have the courage to lose sight of the shore.” Appropriate for me since I’m a sailor. I understand that risk because I do like to see the shore and when plotting the course to a distant destination like Provincetown from Boston. It does make me a little uncomfortable when I lose sight of the shore about halfway there.
I often counsel clients, friends, and family about taking “compensated (or more likely not taking un-compensated) risks.” When asked to define risk,most of our clients tell me “it’s the risk of the stock market going down” when what they really mean is it’s the “risk of my account going down all the way to zero because of the stock market decline.” Interesting, because that has neveractually happened to any of our clients in their entire lives. Also interesting because the “headline risk” of what might be happening in the stock market is not as relevant to your accounts as you might suspect, since the exposure to the stock market in a typical Compass Capital managed account is approximately less than 40%. In other words, 60% of a typical account is NOT in the stock market. Correlations to the market are another topic.
It seems risk is an individually perceived concept. While the typical investor is focused on systemic market risk or volatility risk and perhaps inflation risk, the two risks that get my attention most as a planner and advisor are “event risk” and “longevity risk.”
Event risk by definition is unexpected. Therefore, it is important to have a flexible retirement solution in the event liquidity is needed. Having the ability to adjust distributions from a portfolio on an as-needed basis can be critical. The exogenous event risk is simply the wildcard that upsets the applecart and blows all of our predictions about expected outcomes away. It’s the “Black Swan or the two standard deviation event.” Think of any of the major meltdowns that have occurred for seemingly trivial and unrelated reasons or the ones that we don’t even know exist yet.
Longevity risk is a really interesting and in my opinion the most dangerous risk. I usually plan out to age 100 for clients when preparing a financial planning scenario. Typically the client says, “I’ll never live that long, although my dad is 91and going strong.” To which I reply, “What if you’re wrong?” “What if you outlive your money?” To win that bet you might need to lose and die before you’d otherwise wish to.
Possibly the largest single concern for retirees is that they will outlive their assets. Even sizable portfolios can be rapidly depleted given a combination of unsustainable distribution levels and/or an uncooperative market. Longevity risk is a greater concern now more than ever. In the U.S. today life expectancy at birth in 2013 is 78.7 years. For U.S. men, the average life expectancy is 76, while it’s 81 for U.S. women. Furthermore, if we look at couples at age 65, at least one person has a 50% chance of living beyond age 92 and a 25% chance of living to at least age 97. Planning to age 100 does not seem like such a stretch.
Want to know your life expectancy? You can use Social Security’s simple Life Expectancy Calculator to get a rough estimate of how long you (or your spouse) may live http://www.socialsecurity.gov/oact/population/longevity.html
Considering advancements in healthcare, these trends are likely to continue. Unlike our fathers, fewer retirees than in the past will receive distributions from defined benefit pension plans. The days of working 40 years for the same company and receiving a percentage of salary during retirement are coming to an end for many. In 1980 there were 148,000 private sector defined benefit plans compared to just 47,000 in 2004. Also in 1980 there were 30.1 million active participants in defined benefit pension plans, but by 2004 that number fell to only 20.5 million. These statistics suggest that a lower percentage of retirees’ income is being received in a regular “paycheck-like” manner. The responsibility of both funding and managing retirement assets—a tall order given that many investors make poor investment decisions, and don’t save enough—now falls squarely on the shoulders of the individual.
The risks that you face while drawing down your assets are much different than the risks you face while in your accumulation stage. Therefore, traditional portfolio risk measures such as standard deviation or beta are not necessarily the best benchmarks for measuring risk. Measures such as inflation risk or longevity risk, on the other hand, are much more important and relevant to an investor in distribution mode.
So what if you could add guaranteed income protection to your current investment strategy? We all routinely insure health (sickness), life (death) auto (accidents), home (fire, theft) and other property, but have you insured your retirement income (running out of money)? We now have the tools to offer you protection from the potential of outliving your money. Compass Capital Corporation, as your investment advisor, now has the ability to offer a way to combine our investment strategies with a Contingent Deferred Annuity (CDA) offered by Transamerica Advisors Life Insurance Company. We can now structure guaranteed withdrawals as early as age 60 that may increase with age and/or interest rates. Investors can lock in 4-8% as a Coverage Percentage depending on their age at lock in and will never decrease as long as the account has not been subject to excess withdrawals. Automatic step ups are permanent. There are no surrender charges and the investor can turn off the guarantee at any time. You do not need to buy an annuity in the traditional sense with all of its many layers of fees and surrender charges.
This CDA solution is called the RetireOneTransamerica II Solution and is an effective way to insure against the risk of outliving your money. A prospectus is available which discusses the risks charges and expenses and should be read carefully before investing. Call us for more information if that is a discussion you’d like to have.