We often talk about market and interest rate risk, but another very real risk for many investors is longevity risk—the risk of outliving your money. The risk of longevity can make it psychologically challenging to retire, knowing you may spend 25 or more years relying on the assets you have saved.
To account for longevity, we focus on the withdrawal rate of a portfolio, which is how much you need to withdraw to maintain your lifestyle after accounting for any income coming in, such as Social Security benefits or pensions. Traditional pension plans are becoming increasingly scarce and, depending on your outlook, Social Security may not be a certainty. Politically, there is always talk about reducing the Social Security benefits available; however, if you are currently receiving benefits or within a few years of beginning benefits, it is likely you will continue to enjoy the social insurance program. However, younger investors may want to err on the conservative side, assuming that benefits will not make up a meaningful portion of their retirement income. This makes saving to your 401(k) and other investment accounts critical.
If you have several millions of dollars, there is certainly less anxiety about outliving your money. Still, for most investors, longevity risk can be managed with asset allocation and cash flow projections. As part of a comprehensive financial plan, we run cash flow projections to ensure that you are spending within your means so that your assets are projected to last through age 100, which is longer than the typical life expectancy. Ideally we want investors’ money to stay invested in growth investments, such as the stock market, for as long as possible.
We use cash flow projections to estimate your liquidity needs for the next 10 years and fulfill those needs by laddering fixed-income investments to come due when you need the money. This can help investors avoid selling assets in a down market. Since you are fulfilling a liquidity need that is 10 years from now, you have the option to wait out a market downturn while keeping as much of your assets as possible invested for the long term.
Some theories suggest individuals should hold a percentage of stocks equal to 100 minus their age; however, that can significantly slow down the growth rate of your portfolio, especially with the prolonged low interest rate environment we’ve had for nearly eight years. With low rates, an investor can barely keep up with inflation, as target inflation is 2% while five-year CDs are currently yielding around 1.8%. Long-term studies from the Ibbotson’s 2015 Annual Yearbook, show the 10-year rolling average since 1926 for Large Cap stocks is an annualized return of nearly 10.5%.
For retirees, keeping your money in the market for as long as possible requires some decisions about when to take your Social Security. Generally, it is better to begin retirement benefits as soon as you can unless you are still working. If you are younger than full retirement age, your benefit can be reduced depending on how much you earn. However, if you are already retired, there is little advantage to delaying your benefit until full retirement age or beyond. The break-even point is an average of eight to 10 years, meaning an investor would have to live until at least 74 to break even to what he would receive if he started taking benefits at 62.
Overall, there is no one solution for retirement savings. Standard “rules of thumb” do not take into consideration how much you save, how much you spend and for how long you will need your money. This is why we feel the cash flow projection is a cornerstone of a comprehensive, customized financial plan. We then apply an academic study-based investment approach to the specifics of your situation.
If you have questions regarding how to accommodate for longevity risk in your overall financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
