Introduction
In this blog post, we’re still looking at potential risks you might face in retirement. In the last two posts, we assessed the first two risks – sequencing and inflation. The others to consider are longevity and behaviour.
Longevity Risk
Longevity risk is essentially the risk of living too long. Say what?! I mean living too long in relation to your money. Can you imagine running out of money in, say, your late 70s because you’ve spent too much early on in retirement.
Imagine going from a £30,000 annual lifestyle to having state pensions only? You could kiss goodbye to holidays and changing the car and having meals out. I know that’s unlikely to be the case for folks listening to this who are engaged with their personal finances and who are likely to have good plans and investment approaches in place.
One thing I’ve noticed in my career is that most people significantly underestimate their longevity. None of us know, of course, how long we might have. But whenever I tell a client in the financial planning process that we’re planning for them both to live till age 100, they’ll usually say either, ‘Oh, I hope I’m gone before then’, or ‘That’s unlikely – I drink too much wine!’
Planning to spend your last penny by age 85 is madness. The odds are about even that one of you (if you’re in a couple) will live to age 90 if you’re 65 now. Now I’m not suggesting you take up smoking and blindfolded jaywalking to make sure you don’t make it past age 80.
Life is worth living and enjoying every day we’re given, so this really is about making your money match your lifespan, not the other way around! Again, planning is the answer. If we factor in longevity assumptions into our planning, we’re unlikely to base our spending patterns on too-conservative assumptions about how long we’re going to live.
Behavioural Risk
I talk about behaviour risk all the time, and my definition is the risk of you doing something stupid with your money. Forgive the bluntness, but this is actually the number one risk for all investors, no matter the time of life.
Here’s an example. Two investors hold identical funds. Those portfolios, because they are identical, go up and down perfectly in sync. But one investor, when markets are down, sells out for a bit ‘to let things settle down’, inevitably buying back into the fund when they are significantly higher than the bottom.
The investor who buys and holds retires with twice that of the investor who tries to time the market. They held identical funds, but the differentiating factor was their behaviour. Essentially all risks come down to this, and this is a key point:
Risks are never abstract; they don’t happen in isolation – they are triggers for investor behaviour, and it is that which makes the real difference.
Investment risk might make you panic about your portfolio and sell out to limit any future losses. You’ve crystallised the loss and you are the cause of that loss, not the markets. Inflation risk might make you underestimate the return you need and not invest aggressively enough to keep up. That’s not the fault of the investment, but the investor – it’s a behavioural issue.
Longevity risk might make you underestimate your longevity and invest accordingly. Again, the behaviour is the issue, not the makeup of the portfolio – that springs FROM the behaviour. A big part of the reason I do what I do is to arm you with sufficient information so that you can guard against these behaviours, even if you’re not fully aware of those behaviours in yourself.
That’s not a failing by the way – it’s incredibly hard to see behavioural biases in ourselves – much easier to notice them in others, which is why a good adviser who is attuned to this stuff can be worth their weight.
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