Post Retirement Planning and Investment Risk

The conventional advice to retirees is that they should invest in low-risk financial instruments during retirement. Alternatively, the advice of some advisors is that “safe” investments would simply expose your retirement fund to other risks. There is merit in both positions, which is why portfolio diversification can be a great strategy at any life stage. Ultimately, retirees must invest so that they can sleep well at night and protect the real value of their investment. Retirees should base their investment decisions on the following:

1) Risk tolerance- Some people are gamblers, while others are ultra-conservative. Your risk tolerance is primarily influenced by your personality. The main point about investing and risk is that you should be comfortable with the level of risk that you’re taking. No one else can tell you what your comfort-level is. You certainly do not want to invest exclusively in growth options that leave you perpetually worried.

2) Depth of reserves- The level of risk that you can withstand would be dependent on the depth of your reserves as well. Someone who invests 40% of his retirement fund in growth options would find that the nominal amount exposed to loss would be significant. 40% of a $200,000 retirement fund is a significantly higher risk than the same percentage of a $2,000,000.00 retirement fund in terms of the actual dollar value.

3) Inflation risk- Although you’re seeking to provide security for your money, you may inadvertently cause a real loss or substantially lower real returns in the long-run. The good news is that you do not have to put your retirement fund at risk to beat inflation. Use the Consumer Price Index as a guide and seek high-yield CDs or bonds that provide rates of return that outstrip the inflation rate.

4) Understand the risk-return trade-off- The higher the risk associated with a financial instrument, the greater the potential return is. This trade-off is a primary reason that diversification should take place. This is because neither situation is optimal for the retiree. Low risk-low return increases inflation risk while high risk-high return increases the risk of loss. Conservative investing does not necessarily imply investing exclusively in low-risk funds. It suggests that the majority of your investment should be split between cash and income options and a relatively lower percentage assigned to growth instruments.

5) Understand averages- In choosing mutual funds; beware of making selections based on averages alone. Apart from investment fees and charges being a significant aspect of most mutual funds, averages can be misleading. One portfolio may have a better average than another. However if the higher-average fund is volatile, reaching extreme highs and lows, this could be riskier than if you have a moderate-return fund that does not tend to either extremities.

Some retirees leave the bulk of their retirement funds in savings accounts, while their higher-order investments are money-market funds. In economies where the inflation rate is medium to high, this is likely to do nothing for the preservation of your savings. This would mean that your fund would dwindle faster, especially if you didn’t optimise your choice. Even if you are making a low-risk investment, it is incumbent on you to choose the best-performing fixed deposit or money-market fund.

The argument that high-risk growth options are not for retirees is a half-truth. The real truth is that the non-working retiree should not invest a significant portion of his savings aggressively. Given that retirees are living longer, they are more exposed to the risk of outliving their savings and inflation risk. Once portfolios are diversified according to risk tolerance, financial reserves and needs, then the retiree would be in a better position.

Article by Darrell Victor