We looked at some of the big risks that everyone faces when it comes to finances and investing in the previous post, and we’re continuing to do so here.
Big Risk 3: Living too Long
I’ve phrased risk number three as living too long because it’s evocative, and more memorable than inflation risk, which is the real culprit. Inflation is a huge deal. It’s the silent killer, particularly in retirement if you don’t have an indexed pension. All your investing should be focused on beating inflation and minimising its effects.
We tend not to think about inflation when we’re working, because generally earnings rise above the level of inflation, so we’re earning a little bit more in real terms every year. Once you’ve retired, and if you don’t have an indexed pension, or the indexation isn’t enough to keep pace with real inflation, then inflation is a killer. Really, all of your investing should be focused on beating inflation and beating its effects.
Take a fairly typical 30-40 year retirement horizon – can you remember how much a pint of beer was 40 years ago in 1980? Probably about 35p. Now it’s what – £4.50? That’s a somewhat extreme example, but you could start your retirement spending £30k per year and end it spending £100k – will your portfolio cope? Will you live too long and outlive your wealth?
This is a key argument in favour of leverage. While inflation works against your wealth by eroding the buying power of money, it works with your debt to reduce its value in real terms over time.
My parents bought the house I grew up in in 1979 for about £4,500. The average wage was £6,000 p/a then, and it was a stretch for a single income family. £4,500 though! My next laptop will probably cost that much! How many of us would love to have a mortgage of less than ten grand?!
So, there’s real value in using leverage to accelerate wealth-building, because the amount of debt is reduced by inflation over time. As long as you understand and protect against the downsides of such borrowing.
If you’re not comfortable with debt in that way, then you’re going to have to invest a lot of money and work it hard as it grows, in order to get to a point of having enough to retire. And you’re going to have to manage the withdrawal from that money in retirement, to keep inflation in its place.
Big Risk 4: Behaviour Risk
All other risks feed into this one, in my opinion. Our ability to behave well towards our money, or not, is the biggest risk of all.
If you get your approach to market risk wrong, you might bail out at the wrong time, or fail to invest in a timely manner. One risk leads to another. Inertia and FOMO risk, that we talked about in the previous post, are behavioural risks.
Managing our portfolios is easy compared with managing ourselves. If managing myself was easy I’d be three stone lighter with abs like Gorka Marques (yes, I follow him on Instagram). For some people self-discipline comes easy; for most it does not.
My father is a machine in this regard. I honestly don’t think he’s wasted a single second of his life. I take after him to a point but his level of self-discipline is staggering – I bet you know someone like that too. Maybe it’s you!
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