By: Mary Grace Musuneggi, CLU, ChFC, CFS, RFC
When new clients come to our firm, they sometimes begin by saying, “I just don’t want to lose my money.” I normally laugh and say it’s the first time I’ve ever heard that, as most people who come here hope they will…and then I get a laugh from the client. No one ever wants to lose money. Even losing $5 on the lottery or $100 at the casino can be painful for some of us. But the thought of losing your retirement money is a nightmare.
So one part of our job is to assess the amount of risk a client is willing to take to meet their financial goals. For a few, the amount of risk they are willing to take is zero. These clients are typically referring to market risk, or risking their assets in the stock market.
In the financial world, though, this represents only one of many risks associated with money. Besides market risk, there is interest rate risk. Some people believe only investing in bonds will eliminate some of the market risk, but bonds face interest rate risk. When interest rates go up, the value of a bond can go down. We are facing that risk currently as interest rates were at a historic low and now they are rising.
Another risk is inflation risk. If your money does not keep up with inflation, you will face purchasing power risk. Simply put, if you have $100,000 today and you have the same $100,000 ten years from now, you will have actually gone backwards. With a 3% annual inflation rate, your $100,000 needs to be worth more like $135,000 in ten years, just so you can continue to purchase the same amount of “stuff” with your money.
And then there is tax risk. You may get a good rate of return on your investment account, but 30% of it goes to the government. I would certainly want to keep more for me and not give more to them. There is an expression in the financial world that says, “You can save more money saving taxes than you can saving money.” Finding investments that are tax advantaged can decrease this risk.
Consider for a moment some not so typical risks. The “family risk“ includes caring for elderly parents; dealing with children’s education costs; having children return home; having children return home and bring their children with them; having a spouse lose a job; losing a spouse; getting a divorce; or entering a nursing home. All of these circumstances can take tolls on your finances, some of which are a lot more significant than losing money to market risk or inflation risk. You may have absorbed all the risks of investing, or designed your portfolio to mitigate some risks, only to find lifestyle or family situations put all that planning at risk anyway.
And of course one of the greatest risks to any life plan or financial plan is longevity risk–outliving your money. Too often when we do a financial analysis and plan out to age 90, 95 or 100, the client’s response is “I will never live that long.” Or “I hope I don’t live that long.” Or “I will never make it to 80 let alone 95.” But statistics prove that this may not necessarily be the case, and currently we have clients in their 90’s who admit they never thought they would live that long.
So what investment do you use to deal with all of these risks? No one investment is the answer. If you want growth, safety and liquidity, you can’t have it all. If you want to eliminate any market risk, you cannot have growth. If you take on an investment for growth, you can’t necessarily get liquidity and safety. Some investments will deal with one or two of these issues. Portfolios will give you more options, and good planning can help with even more. In fact, at the end of the day, it is all about the plan.
As Benjamin Franklin once said, “If you fail to plan, you are planning to fail.”