Market risk is what people think of most often when the word “risk” is mentioned. According to Investopedia,
“Market risk is the possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets. Sources of market risk include recessions, political turmoil, changes in interest rates, natural disasters and terrorist attacks. Systematic, or market risk, tends to influence the entire market at the same time.
“This is in contrast to unsystematic risk, which is unique to a specific company or industry. This type of risk can be reduced through portfolio diversification.”
In other words, there are ways to hedge some of your market risk, especially when choosing and diversifying between individual components of your portfolio. But overall market risk (like a possible recession) can’t be controlled except by diversifying your assets even further into something called “non-correlated” asset classes. Non-correlated assets or investments aren’t directly affected by stock market performance.
An independent financial advisor has access to many different types of asset classes, and can help you truly diversify your portfolio to hedge against market risk.
Risk tolerance is one of the first things a financial advisor will assess when they meet with you. Some people are risk-averse, and are comfortable with lower returns as a result. Others want to take more risk with the possibility of higher returns, and are willing to accept the odds of losing. Most people fall somewhere in the middle, and their portfolio needs to be designed accordingly.
Sequence of Returns Risk
In general, the older you get, the less risk you should take with your investments. One of the reasons for this is due to sequence of returns risk in retirement. Financial outcomes can be dramatically different depending on whether the stock market goes up or down toward the beginning of someone’s retirement.
Rather than trying to explain this, here is a very simple example so you can understand the concept.
- It’s all about percentages.
One percent of one dollar is a penny. One percent of one hundred dollars is one dollar. But one percent of $100,000 is $1,000.
In other words, when the numbers get higher, the losses can spiral.
- A simplified example:
Let’s say Retiree A retired in 2008 with $500,000. The markets went down a lot that year, let’s say this person lost 37% that year like the overall S&P did. That means their account lost $185,000.
But Retiree B retired in 2013 with $500,000. Let’s say they gained 32.4% that year, just like the overall S&P did. If so, they would have gained $162,000!
This would mean that, in their second year of retirement, Retiree A would have only $315,000, while Retiree B would have $662,000.
If Retiree A didn’t touch it at all, their portfolio may have regained its original value by 2012 based on the S&P results during that timeframe. But if they had to withdraw 4% each year to live on—or were required by the IRS to withdraw funds annually due to Required Minimum Distributions, which start at age 70-1/2—their losses might have continued. Retiree B would likely be in a much stronger position for years, even if they were making reasonable retirement withdrawals.
As Investopedia puts it, “Two retirees with identical wealth can have entirely different financial outcomes, depending on the state of the economy when they start retirement, even if the long-term market averages are the same.”
Unfortunately, there are no crystal balls to predict when the next market crash will happen. It has been 11 years of market growth and some financial experts remain bullish, while others are saying that we are long overdue for a market correction. A financial advisor who specializes in retirement understands sequence of returns risk and will develop a retirement plan for you to help hedge against market risk, and sequence of returns risk.
Losing a loved one is hard enough as it is. But should a tragedy befall your family, life insurance can help ensure the mortgage payments and other financial expenses are covered so your loved ones can maintain their lifestyle without the additional stress and worry about debts and lost monthly income on top of everything else.
Life insurance is critical when you have a young family, but it may be equally important for retirees. Some people don’t realize that when one spouse dies, the surviving spouse gets only one Social Security check—the largest one. Along with a death benefit, spousal income replacement can be provided through the use of permanent insurance policies.
An untimely death is a risk to surviving family members, but living a very long life can exacerbate retirement risks, like running out of money or the possibility of needing long-term care. The Department of Health and Human Services estimates that 70% of retirees may need some form of assisted living care, and without financial resources, many family members have to fill the gap.
Long-term care is extremely expensive, the average cost for a semi-private room in a full-time nursing facility was $7,441 per month in 2018 according to Genworth. That’s close to $90,000 per year! Medicare may cover a stay of up to 30 days, but the average person who needs care will need it for around three years.
It’s imperative for you to include a contingency plan for long-term care, especially since people in America today who’ve made it to age 65 can expect to live another 19 years on average according to the Centers for Disease Control.
For younger families, the news about health care can be grim. The leading cause of bankruptcy in the U.S. is due to medical expenses not covered by insurance.
But older people are also at risk. Many people think that once they sign up for Medicare at age 65, all their health care costs will be covered. But this isn’t the case.
In fact, Fidelity estimates that the average retired couple will need $285,000 in today’s dollars for medical expenses in retirement, excluding long-term care. A whopping 42% of that—$119,700—is for copays, coinsurance and deductibles. Thirty-nine percent, or $111,150, is for premiums for Medicare parts B and D, while the remaining 19% is for prescription medications.
- Accidents and Liability
Having adequate home, auto, business and umbrella liability insurance is critical at every age, since your risk and exposure to loss applies to all of your fixed assets as well as your investments.
Insurance to protect against loss from fire, theft, accidents, weather, natural disasters and financial damages due to lawsuits just makes good economic sense.