When contemplating the level of RISK in your financial life, we all immediately think about the risk in our investment portfolio. Make no mistake, calculating the volatility of one’s portfolio is important and all about setting and managing the risk-return ratio to the portfolio through asset allocation, asset selection, and rebalancing the portfolio from time to time.
There are other risk factors to consider when doing a financial and/or investment plan. Of course, that assumes you have a written financial plan. If you do not, then please consider doing so as it will increase the likeliness of success. The following is far from an exclusive list of risks.
Often aligned with portfolio risk, INTEREST RATE risk can play havoc with our finances. When interest rates go up, then bond prices go down and the converse is also true. While considered a “safe” investment, many bond holders have been shocked to see the destruction in principal as interest rates rise. After all, we have been in a bull market for bonds since the early 80s. Interest rates for mortgages have doubled since the first of the year, credit card costs are near all-time highs, car loans are more expensive, and the inexpensive cost of a home equity loan or margin is not so inexpensive anymore. Interest costs mean less discretionary money.
Secondly, INFLATION/DEFLATION risk must be addressed. While we have not experienced deflation in recent history, it simply destroys wealth. It is much harder to fix than inflation. If the financial plan projects inflation below its long-term averages, then spending power will be destroyed.
Next, is SEQUENCE OF RETURN risk. If you retire and the market goes up the first couple of years, you are going to feel rather good about your financial position. However, if the portfolio declines, it is going to cause anxiety and reduce your standard of living likely for years to come as the portfolio struggles to recover.
This can often lead to a conversation around DEBT risk. Often to replace income, one turns to credit cards and other forms of debt. While debt can be a good thing, it needs to be managed. As example, using it for appreciating assets is one thing, but using it otherwise can lead to trouble.
When writing a financial plan, we generally project to age 95 and sometimes even 100. You must consider LONGEVITY risk. What if you live too long? It is rare for one to run out of money, but as principal declines, people reduce their lifestyle to accommodate the reality of living longer than expected. However, being too fearful of this risk, may mean a reduced lifestyle in retirement, so it is two sides of a coin as risk always is.
Too often people do not address LIQUIDITY risk. Do you have enough cash to fund a short-term emergency or opportunity? Do you have enough liquidity to weather a bear market? Liquidity risk is not just about having enough, it is also about having too much liquidity which becomes unproductive.
TAX risk is another risk to any financial plan. Nothing wrong with paying taxes, it means you made money. But paying needless taxes reduces spendable income. It can also make other expenses go up like Medicare premiums.
LIABILITY AND ASSET PROTECTION is another risk that is often overlooked in planning. Do you have enough personal liability insurance? Do you have an umbrella policy and is it sufficient? For those on a board of directors, whether being paid or as a volunteer, does the organization have Directors and Officers liability coverage? Is it enough? Have you even read the policy?
All of these risks and others should be factored into your financial/retirement plan. Risk cannot be avoided, but it can be mitigated. Hopefully, your financial advisor has introduced the concept of risk to your financial plan beyond the portfolio. If you are a do-it-yourselfer, we trust you have addressed these risks. If you would like to discuss how we can help you mitigate these risks, take advantage of our one-hour complimentary meeting in person in our Tampa or Clearwater office, or if you prefer, via Zoom.