How to Plan and Prepare for Retirement: Know Your Risk Tolerance
Planning refers to any method of thinking out acts and purposes beforehand. We plan our daily schedule, we plan for holiday’s, and some of us even plan out our strategy before hitting the mall on black Friday, but what about retirement planning? How do we approach the investment universe from a planning standpoint? What is your risk tolerance?
There are a multitude of occurrences that can factor into retirement planning. Personal investments, retirement plans through work, life events, goals, the list goes on. That’s why it’s important to sit down with your financial advisor and evaluate your individual needs as you look to your financial future. At North Main Financial, we try to make it as simple as possible by asking you a series of questions then allowing the answers to help guide us in the direction that’s most applicable to you. So, what are some of the considerations? Let’s take a look.
Aggressive vs. Conservative
First, think about what you want to achieve, which is intended to be a broad question. When saving for retirement the thought process is different between a 25-year-old and a 55-year-old for example. At age 25 you may be looking at things in terms of the next 30 to 40 years of working experience of which you would like to save or invest so you could retire when the time comes. In this fictitious example, a person might think it’s good to be more aggressive with investing. However, it’s critical to understand the ramifications of being more aggressive versus more conservative.
If you are going to be more aggressive, very often you are only thinking of the up side – greater growth possibilities – but you should also consider that, especially when we take a short look at history, there’s another side to that mountain. While there are some growth possibilities over a long period of time, there may also be some short-term downside risks as well. Look at the specific investment (stock, bond, fund, exchange traded fund) then look at the history of that specific investment and recognize what the history has been, in good and not so good times. Then ask yourself, how has it performed during those time periods. As you move through that thought process consider if the investment is the kind of thing, from a risk standpoint, that fits your profile.
On the other hand, if you want to be more conservative how does that look? You’re going to have less upside over time, but you may have less downside risk. Of course, we’re talking about this in very broad terms. You may have better downside protection and that’s something to keep in mind when looking at things from a risk standpoint. There are differences between the various investments and how they perform at different times. You are now on the path to understanding your risk tolerance.
For example, with a CD, if it’s offered by an FDIC bank, it is federally insured meaning it is protected by the Federal Deposit Insurance Corporation from going down or losing money. This provides some confidence in knowing you won’t have any regress in your value, it is simply going to accumulate interest over time. Whereas the stock of a publicly traded company is going to vary a lot day-by-day, moment-by-moment, in a positive or negative way. Bottomline, make sure to understand the upside and downside of all your available options and know what your risk tolerance is when going through the thought process.
How Does Age Factor In?
We’ve talked about the idea of risk tolerance and that can change over time. What about the fictitious 55-year-old? Most often our thought process is different as we age when thinking of retirement. The 55-year-old is looking at retirement in a closer window. A 25-year-old has a longer time frame and may want to be more aggressive, and that allows for the normal ebbs and flows of the financial universe. So, at 55 do you want to be more conservative? Do you want to just put everything in the proverbial coffee can? That may not be the wisest thing to do.
Several decades ago, from a planning standpoint, retirement was a time when you just stopped working. And from a life expectancy standpoint, retirement wasn’t an extraordinary amount of time. In today’s world, retirement can be an additional season of life. Sometimes lasting as long as your working years. We are living longer, and our retirement assets need to be able to sustain us. When you are looking at retiring at age 60 or 65 it’s very easy, from a planning standpoint, to plan for 30 to 40 years of retirement. And yes, that is a very real possibility with the advancements we’ve had in health care.
If we are indeed looking at a 20, 30, or 40-year time frame it wouldn’t be very wise of us to look at a hard stop line. We look at the extended time frame, even for our fictitious 55-year-old, and make sure that the investment choices we are making for that person are going to be able to weather that kind of time. In short, make sure the choices you are making are not only applicable for today but for an extended period.
Rewind to 30 years ago and think about the number of things that have changed, it’s remarkable. The economic cycles we’ve gone through, boom cycles, regressions, now looking forward over the next 30 years we anticipate that we are going to have multiple cycles there as well. So, when we’re talking about that 55-year-old we think about multiple decades of necessity. Meaning that we need for our investments to not only handle what we need today but they also need to handle what lies ahead a few decades out.
As we get closer to retirement we tend to move from the accumulation phase to the income-generation phase. The difference is, in the accumulation phase you are adding to your account. You then shift to the income-generation phase, which as the name suggests, is when you use your investments and retirement accounts to produce income for you. As you make the transition your risk tolerance may change. Your financial advisor can help make sure the decisions you are making are keeping in step with your risk tolerance. At North Main Financial, we spend a lot of time with clients analyzing investment options, changes that take place in the market, and looking at new options as they come to market to help make sure their investments are doing what they want them to do.
Don’t Let Experience Unnaturally Influence You
Based upon our experiences we tend to sometimes have desires to move in a particular direction. If we’ve had good experiences in one space, we may be inclined to move in that direction and of course if we’ve had a bad experience, our instinct is to shy away from that space. It’s important, as you are looking at your choices, not to let experience unnaturally influence you. Be agnostic if you can. Yes, we do tend to run in patterns and there is some repetition but typically over time, one thing is not 100 percent good or bad. Historically there are companies that were dominant in the 1970’s and 80’s that are non-existent now. As you are going through the thought process, be deliberate, be thoughtful. Remember, don’t just think about where something has been, but look at where it is going.
What Direction Should You Go?
It depends on what you want to achieve. If you are saving for college expenses, you know that has a terminal nature since the assets will be spent on a secondary education. You will think differently about that than say, a retirement account or something you are wanting to utilize in perpetuity. As you make those choices remember to stay step with what you are wanting to achieve and to stay within your risk tolerance.
When you think about the impact of making good decisions over time relative to how you invest, the impacts could be life changing. It’s just math. If you look at the difference between just one percentage point of average return in an investment over 10, 20, or 30 years, you could be talking about tens of thousands if not hundreds of thousands of dollars in difference. Remember, life changes. You can make decisions today then go in a different direction down the road because your goals have changed, your work situation has changed, along with a myriad of other things.
Because of this, you should meet with your financial and tax advisor at least once a year to re-evaluate your retirement plan and make sure your investments are still meeting your needs. It’s important to note that investing is subject to risks including loss of principal invested. No strategy can assure a profit against loss. Past performance does not guarantee future results
Interested in hearing more about this topic? You can listen to the full episode of the North Main Financial radio show on WSIC by clicking here: Episode: 9-25-18 “Making Wise Investment Choices
If you have questions or would like to talk with us further about our services, give us a call at (704) 987-1425 or visit us at www.northmainfinancial.com. If you wish to schedule an introductory meeting, we would be happy to meet with you at no cost or obligation to you.
These Blogs are provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of SagePoint Financial.