Objectives tend to be positive desires. I want to fund travel and maintain my standard of living. Risks tend to be stated negatively. I want to avoid going broke as the result of unexpected medical expenses and I want to avoid outliving my wealth.
Desires tend to be more personal. I want to retire in Florida. I don't want to burden my three children.
The Mission Statement is where we create our own personal definition of success. Desires in the Mission Statement identify those objectives we believe would make our retirement a financial success if they are met. Risks are those outcomes that we believe would make retirement successful if they can be avoided.
Risks tend to be the bad outcomes that most or all retirees face. Not everyone has children or wants to retire in Florida, but no one wants to go bankrupt, see their purchasing power eroded by inflation, or go broke late in life as the result of long-term care expenses.
Whether we sort these into two different lists for organization purposes or combine them all as simply strategic objectives, they need to be treated the same in the negotiation process (remember what is desired and what is possible?). In other words, they all belong in the Mission Statement, even though we may create the lists separately because that's the way we think. I want to retire in Florida and I don't want to be wiped out by inflation are both strategic objectives.
The negotiation process is where we reconcile what we want with what we can afford. As an example of the negotiation process, we might desire not to be bankrupted by long-term care costs but we may not have adequate wealth to make the premium payments for LTC insurance. In the negotiation process, we might need to change our insurance strategy to a Medicaid strategy and create more modest strategic objectives accordingly.
What, then, are the common financial risks of retirement?
During a panel discussion a few years back, my friend and colleague, Robert Powell, waved a list of retirement risks at me while asking a question. I recently got around to asking him for a copy of the list and he referred me to a piece written by the Society of Actuaries (download PDF). It lists fifteen risks and I think it's a great place to start. These include:
|Society of Actuaries Retirement Risks List|
|Longevity||The risk of outliving retirement resources|
|Inflation||Loss of purchasing power.|
|Interest Rates||Lower interest rates make retirement less affordable.|
|Market Risk||Loss of invested retirement savings.|
|Business Continuity||An annuity provider or pension plan goes out of business.|
|Employment||Loss of supplemental job income.|
|Public Policy||Loss of social program benefits or tax increases.|
|Unexpected Health Care Costs||A major cause of bankruptcy.|
|Lack of Access to Caregivers||Unavailability or unaffordability.|
|Loss of Independence||Accident, illness or chronic disease.|
|Change in Housing Needs||Housing that doesn't accommodate physical decline.|
|Death of Spouse||Can be a major financial setback.|
|Other Change in Marital Status||Divorce can be a major financial setback.|
|Family Member Needs||Family members outside the retired household need support.|
|Bad Advice, Fraud, Theft||Can result from declining mental acuity.|
Probability of Ruin estimates (or attempts to estimate) the probability that a retiree will deplete a portfolio of investment savings invested in stocks and bonds, but there are worse things than depleting a portfolio. Losing one's standard of living, for example, would be worse. With an adequate floor of safe income, a retiree could deplete a savings portfolio and still maintain his or her standard of living. In fact, depleting a savings portfolio and living out one's final years funded by pensions and Social Security benefits is a rational strategy.
[Tweet this]Are these common financial risks addressed by your retirement plan?
Bankruptcy, or insolvency, would be worse than either of these outcomes so the list of financial risks in retirement should include the major risks of bankruptcy. I previously wrote about an elder bankruptcy study by Dr. Deborah Thorne in Why Retirees Go Broke. Dr. Thorne's study identifies the following reasons that bankrupt elder Americans cited as the cause for their insolvency:
|Cited Reasons for Bankruptcy from Thorne Study|
|Credit Card Interest and Fees|
|Illness and Injury||Duplicate|
|Aggressive Debt Collection|
These reasons should be included in a comprehensive list of retirement financial risks, though some overlap items in the SOA list. Only “Credit Card Interest and Fees” and “Aggressive Debt Collection” are not included in the SOA list. I would personally add "Legal Liability" to the lists and encourage retirees to consider relatively inexpensive Umbrella Liability Insurance policies.
Lastly, the Institute for Financial Literacy also provides a list of financial risks of retirement cited by bankruptcy filers that includes:
|Bankruptcy Reasons Cited by Institute for Financial Literacy|
|Birth or Adoption of Child (9.7%)|
|Death of Family Member (7.5%)||Duplicate|
|Retirement (forced or poorly timed, 6.7%)|
|Identity Theft (1.9%)||Duplicate|
The only risks cited by IFL not arguably cited by the SOA or Thorne Study are "Birth or Adoption of a Child" and "Retirement, forced or poorly timed".
I'm going to modify the plan outline I proposed in The Retirement Plan I Would Want, Part 7 just a skosh by rolling Risk Mitigation objectives into the Mission Statement:
The risks I identified above should be included under the Risk Mitigation Objectives heading. I've probably missed a few risks and hope to see the omissions noted in your comments. Otherwise, this should offer you a fairly comprehensive list of potential financial risks of retirement. Are they addressed in your retirement plan?I. Mission Statement
Desired ObjectivesA. Strategic Objective Onea. Recommended strategy to achieve objective oneb. Alternative strategiesc. Justification for strategic choiceB. Strategic Objective Two, etc.
Risk Mitigation Objectives
C. Strategic Objective Three
a. Recommended strategy to achieve objective threeb. Alternative strategiesc. Justification for strategic choice