Running out of money is a real risk during retirement

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hand reveal blank wallet, isolated on white backgroundIs your financial advisor an order taker?

Have you hired someone to provide advice and then find that when you make a suggestion they are willing to comply with no discussion? That could be a formula for failure.

It is your money and ultimately everything is your decision. However if your suggestion is not in your best interest then there needs to be a polite yet firm discussion about what is ultimately best for you.

This is similar to getting medical advice from your doctor. You might have some ideas but their role is to diagnose and make a specific recommendation.

The best way to provide an example of how this might happen is to consider a couple that is a few years away from retirement. This is a time that many start to be more focused on investment risk.

People often become more risk-averse as they get older. They don’t have the time to recover if their investment portfolio declines and they no longer have decades of earning power ahead of them.

There is less margin for error. Investors want to preserve their capital.

For most investors the level of risk they take with their investments is determined by how they allocate their money between stocks and bonds. Stocks do better over time. However, they are more risky and volatile in the short term.

We will assume the investment advisor suggested holding 60 per cent of the couple’s portfolio in stocks and 40 per cent in bonds. However the client suggested changing the allocation to 40 per cent stocks and 60 per cent bonds.

There can be two outcomes. First, the investment advisor could agree or second, the advisor might initiate a discussion.

The investor’s concern is the risk of losing money and therefore they want to manage that risk by having less exposure to stocks. On the surface that is a reasonable thought but there are other considerations.

Ultimately the investor has to manage all risks. The two main financial risks are having their portfolio decline in value and also the risk of the couple out-living their capital.

My opinion is that for most investors outliving their capital is a more significant risk. We are living longer and very few people have significant pensions.

We have to be financially self-sufficient during retirement and that requires a combination of not losing capital but also not running out of purchasing power from our portfolio.

Our investments have to provide the cash flow we so desperately need during retirement. Any investment decision must be made in the context of maintaining that cash flow.

If the client reduced the stocks in their portfolio from 60 per cent to 40 per cent then the likely outcome would be to have an investment portfolio that is less profitable. A less profitable portfolio could result in them running out of money.

An exercise that should be done before investment decisions are made is to understand the purpose of the funds. The client will likely require a certain amount of income every year during retirement from their investment portfolio.

There might be more risk to them running out of money during their lifetime, which is far more significant than having a portfolio that has slightly higher volatility.

Investing is done for a reason. Articulate your investment objectives and then work backwards from those objectives to see what is the best investment strategy.

Clients are required to make investment decisions and we recommend those decisions be guided by their long-term financial objectives.