Your Willingness, Ability and NEED to Take Risk

For our best savers, risk can and should be reduced

When enrolling in our service, our clients are asked a short series of questions designed to help us understand the level of risk appropriate for their investment portfolio. Our goal is to best understand (at least initially), two important characteristics:

• The investor’s willingness to take risk. Behavioral and personality factors play an important role in this discussion, often a much more important role than their age and/or years to retirement.
• The investor’s ability to take risk. “Even if an investor is eager to bear risk, practical or financial limitations often limit the amount that can be prudently assumed.”1.

It is the establishment of a risk objective that largely dictates the portfolio’s return objective. Sometimes, though, it is important to work from the other direction – establish a return objective that dictates how much (or how little) risk is appropriate for the participant. In other words, we also want to address our client’s need to take risk.

Let’s look at two examples:

• Spending Sammy has spent more time living for the moment rather than focusing on a savings approach for retirement. At age 55, Sammy has managed to accumulate $400,000 in his 401(k), and now wants to save $20,000 per year for the next ten years.
• Saver Sandra started early in her career with a savings strategy, and at age 55, she has accumulated $800,000 in her 401(k) and can still dedicate $20,000 per year in additional contributions.

Sammy and Sandra have both heard they should save at least one million dollars by the time they are age 65 to enjoy their retirement. So they ask their adviser to calculate the rate of return needed to successfully get to $1 million.

For Sammy, a rate of return over the next ten years of 6% compounded will get him there. Certainly an achievable goal. Over ten year historical periods, however, a balanced portfolio of 60% stocks and 40% bonds have failed to meet that objective just about 10% of the time. So Sammy needs to take at least a moderate level of portfolio risk to achieve his objectives.

Sandra is in an entirely different situation. Her $20,000 yearly contributions will get her to $1 million even if her investments earn nothing for the next ten years. Sandra may be willing and able to take risk, but has no need. A more conservative level of risk certainly makes the most sense for Sandra.

If you have done a great job of savings over the years, make sure you think about your need to take risk. The lower returns that may result from lower levels of risk taking may be entirely appropriate for you.

1. John L. Maginn, CFA, Donald L. Tuttle, CFA, Jerald E. Pinto, CFA, Dennis W. McLeavey, CFA, Managing Investment Portfolios, A Dynamic Process, Third Edition, 2007

What About My Five-Year Retirement Plan?

So often we are approached by clients with this question: When do I need to start thinking about my retirement? What they are really asking is how will I know that I am able to retire. The Wall Street Journal, a few years back, published a 5 year pre-retirement plan. Over the next several months, we will be relaying the steps they outlined so investors close to retirement can begin answering this question.

5 Years from Retirement

1. Start to think about what your lifestyle choices will be in retirement. Talk with your spouse and make sure you are both on the same page.
2. This is a great time to take a look at the BIG question: Will I have enough to retire? This will be a two-step process of determining what you will need to spend in retirement and what your projected income stream will be from your retirement savings
3. Make sure you have taken care of the legal questions: Do I have a will? Have I appointed a power of attorney? Have I set up health care directives? How will my estate be handled?

Being able to answer these questions will help get your retirement plan in motion. It will allow you to address problem areas and gain confidence in your overall retirement strategies. Next month, we will take a look at what we should be doing 4 years out!

Looking Forward

1. The online health care exchange for the Affordable Care Act has been opened; however, it has seen several problems arise. This month the website will have maintenance to help fix these problems.
2. The advanced estimate for 3rd quarter GDP will be released. This allows for an inside glance at how the US economy is continuing to grow.

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