Three Primary Risks in Retirement

Uncommon Cents with Bowman Financial Strategies

Erik: 00:06 You're listening to uncommon sense, a podcast by Bowman financial strategies. I'm your host, Erik Bowman, and thank you for joining me today. Hi everyone. My name is Erik Bowman and I am the owner and founder of Bowman financial strategies. Thanks for taking the time to listen to this podcast. Today, I'm going to be discussing the three primary risks in retirement.

Erik: 00:34 At Bowman Financial Strategies, we work every day helping clients who are transitioning from accumulation to distribution to do so wisely and confidently. I've seen the success stories, worked with many challenges facing retirees and helped my clients craft income plans they are confident will meet their needs for the entirety of retirement. Importantly, these plans are built to provide stability and to support your standard of living regardless of market conditions. Getting motivated to take the necessary steps to create an effective retirement plan can be challenging. However, not crafting an effective plan can be catastrophic to your retirement. It's often been said that your retirement outcome is a result of your retirement income and never truer words have been said. You have worked hard, saved during your careers and budgeted wisely, knowing that the day was going to come when you will need to replace your income without working. Now you have an accumulated bucket of money to retire with and the primary goal many times is to maintain your current standard of living you enjoy now plus add in more travel.

Erik: 01:43 Well one method is to invest in the stock market, hope you're diversified and allocated correctly, and hope to get enough of a return, and hope that the market doesn't crash and take your retirement with it. At Bowman Financial Strategies, we don't ever use the word hope in our retirement plans. Our plans are designed to remove anxiety knowing that all three risks in retirement are addressed appropriately. The Bowman Financial Strategies income planning process known as the LiveWell formula focuses on three primary risks in retirement, and every recommendation in our plans directly addresses these primary risks. The risks in order are sequence of return risk, inflation risk, and longevity risk. To further break these down, let's look at them one at a time.

Erik: 02:37 The first risk: sequence of return risk. I also call this early retirement market timing risk. This risk is represented by the risk of significant negative market returns in the early years of retirement. You only have to go back to 2007 through 2009 to witness over a 50% drop in the U.S. Stock market. It's been over 10 years since that low and the markets have marched steadily upwards since then with very few exceptions. And with markets routinely setting new highs, some would say that the potential for continued growth for the next 10 years is less likely than a significant drop during that same period. If you are just starting retirement and you're fully exposed to potential market losses like 2009, and many seniors were and are, your future retirement plans may change dramatically requiring an unpleasant adjustment in your standard of living to make ends meet. We seek ways to limit early retirement market timing risk by using fixed or guaranteed rate of return solutions to reduce the exposure to pure stock market.

Erik: 03:50 The second primary risk is: inflation risk. And this is really the opposite of the market timing or sequence of return risk because inflation risk is the risk that your assets and income may not get enough of a return and be able to keep up with the ever rising costs of goods and services. If your income never increases or your assets never increase the rate of return, but the cost of a gallon of milk doubles in 10 years, your effective purchasing power has just dropped significantly. Accounting for inflation is critical to a good income plan. By failing to plan for inflation, you may misjudge the amount of money you can spend each year in retirement, finding yourself running out of money a decade sooner than you planned. This leads once again to a catastrophic change in your standard of living if you run out of supplemental income sources like IRAs, in addition to social security and pensions midway in retirement. We typically address inflation risk by having professionally managed stock and bond portfolios for our clients that are appropriately allocated for their timeline and risk tolerance.

Erik: 05:00 The third primary risk is: longevity risk. This risk can be further divided into two types of risk, longevity risk associated with income and longevity risk associated with health care expenses. Income risk is the risk of running out of income sufficient to cover your essential expenses in retirement. Having enough guaranteed income to meet your essential needs or a floor of income provides not only a financial advantage but also a psychological one. Your confidence and baseline income allows you to live anxiety free and stick with the long term plans related to your invest-able assets that may be in the stock market that are dedicated to long term inflation protection. The other longevity risk is healthcare risk, which is the risk that you may experience deteriorating health that require the assistance of qualified professionals to help you with the six basic activities of daily living also known as A.D.L.s. Contrary to what many believe, health insurance and Medicare do not pay for long term care expenses.

Erik: 06:05 If you don't have a strategy in place, you are considered "self-insured", quote unquote. This means that if you experience a health condition requiring assistance with the six activities of daily living, you will need to spend down your assets until you have $2,000 (at least that's the requirement in most states to be eligible for Medicaid as well as some income thresholds that if you exceed would make you non eligible). But if you even are eligible for Medicaid at some point, then your state Medicaid program may help. And as former president, Ronald Reagan said, "don't worry, I'm with the government and I'm here to help." So most people don't look at Medicaid as the primary route to take care of their health care expenses later on in life if they have the resources to help plan against that risk.

Erik: 06:54 Now that we understand the three basic risks, that being: sequence of return risk, (you don't want to lose a lot of money early in retirement), inflation risk, (we still need to seek growth with our retirement assets because things will get more expensive and over a long 30 year lifespan in retirement or more, things can get significantly more expensive.) And then finally, longevity risk. And that would be the risk associated with assuming that you can figure out how to have guaranteed income streams that will last as long as you live, no matter how long that is, and then the long-term care expenses that are also commonly associated with longevity. Once we gather all of your required information, we then begin using sophisticated financial software to calculate the maximum annual income using agreed upon assumptions and always addressing those three financial risks in retirement. Thanks a lot for joining me today. I truly appreciate your time. If you ever have any ideas of topics that you would like to have me discuss here, please drop us a line. You can send me an email at [e-mail] that's E R I K @bowmanfinancialstrategies.com or you can simply give us a call at [phone]. And finally you could go to our Facebook page and you can drop us a note there as well. Thanks again for joining me today. I hope you enjoy the rest of your week.

Erik: 08:20 Thank you for joining me for Uncommon Sense. The Bowman Financial Strategies financial education series. I'd love to hear your feedback on financial topics you would like to learn more about. Just drop me an email at Erik, that's E R I K @bowmanfinancialstrategies.com or go to the Bowman Financial Strategies website and send me a note on our contact page. In addition, you can always search for topics of interest in my archive on our podcast page at www.bowmanfinancialstrategies.com/podcasts. Have a great day.

Disclosure: 08:56 This communication does not constitute federal tax advice and may not be used as such. Please consult a qualified tax professional for tax advice or assistance. In addition, investment advisory services offered by Change Path, LLC, a registered investment adviser. Change Path and Bowman financial strategies are unaffiliated entities.