Last night, our Ring spotlight camera went off. Something went bump in the night. Turns out it was a feral cat scaling our porch screen. Could have been worse. We installed the cameras because there is a risk that our Amazon package could be picked up before we got home. Burglary, Vandalism, White Walkers, you know that sort of thing.
The funny thing is that we live in a good neighborhood. It's gated and we haven't had any burglaries or porch piracy in the neighborhood in the ten years we've lived there (knock on wood). So is it really a risk necessitating installing cameras in the front and back of the house? Obviously, that is our perception of said risk and frankly that's all that matters. Our risk tolerance on this topic is low. We installed cameras and now have a greater degree comfort having done something to minimize this risk.
The Night is Dark and Full of Risk
When financial planners talk about your risk tolerance we are referring to a specific type of risk. Typically, we're talking about the risk of volatility in your investment portfolio. But is that the only kind of risk that your financial plan faces? Unfortunately, not. Let's take a look at some of the dangers that exist and self-assess your tolerance.
Volatility Risk Tolerance: If riding the dragon roller coaster ride makes you sick, it's not a good investment plan for you. In times past, planners would have clients fill out subjective questionnaires that produced several qualitative descriptions of your tolerance of market swings. Conservative, Moderate, Growth, Aggressive Growth. But these words are almost meaningless to both advisor and client. Given that, we believe there's a more effective, quantitative methodology for assessing our client's risk to market volatility. To learn more, click here.
Illiquidity Risk Tolerance: How many months of expenses do you have in your savings account? Would you like more or less? Answering that question helps me understand how comfortable you are putting your cash to work in a longer term strategy. Advisors often admonish clients to put their cash to "work" for them. However, a client may have a low tolerance for what they perceive as low cash balances. Frankly, my client's perception is all that matters. My job is to offer them several perspectives to help inform their perceptions.
Inflation Risk Tolerance: The problem with low-interest cash holdings at the Iron Bank is the imperceptible loss of purchasing power. Like frogs in hot water, we croak along as prices rise and our dollar buys less. When you are working, your income may keep pace. But in retirement, your financial plan will have to keep pace. Consider that if you retired in 1999 living off of $75,000 of net income, you'd need $114,435 in 2019 to have the same lifestyle, Source .
These numbers aren't exact because they are not specific to retiree lifestyles. In retirement, healthcare will likely play a larger role in your budget. Healthcare costs have risen faster than general inflation. If prices on everything went up 52.58%, what expenditures would you cut first?
Longevity Risk Tolerance: Face it, all men must die. However, with the advances in healthcare, living standards and healthy living it may take a while. Long life means long retirement income streams. Long life means more years of compounding inflation. Longevity risk is a nice way of saying running-out-of-money risk. Too many retirees rely solely on Social Security in retirement once their savings and retirement assets are depleted. My grandparents didn’t live a long time, but they lived longer than their savings. I can tell you, it's not much of a life. And remember, your grandfather died at 85 before all of the healthcare technology of today. Do you have longevity in your family history? Do you drink, smoke or juggle asbestos? Have you had an elderly family member relegated to penny pinching in their later years?
Tax Risk Tolerance: Will your taxes in the future be higher or lower in the future than they are today? Your answer to this question may or not be correct, but higher taxes a risk we must address. Higher taxes in the future will inform our strategies on Social Security benefits. Currently, Social Security is taxed based on a concept called "Provisional Income." This is just a polite way to enforce means testing. The Congressional Budget Office states that there must be a reduction in benefits or an increase in taxes by 2029, Source. Expect both to some degree.
Battle for the Dawn
You have financial goals, a place you want to be. The path is beset on all sides with the risks I've listed, but there are more. The point is you must fully understand the risk and then decide how important it is to you. We don't know to what extent these risks will factor into your retirement. Where some grandmothers can withstand high levels of volatility, some young entrepreneurs can't. There's now wrong or right answer when looking into an unknowable future sequence of events.
Once you decide your goals and prioritize which risks keep you up at night we can get to work. Your informed perspective created your perceived tolerance. And frankly you are all that matters. Different financial strategies and tools can help to minimize certain risks. No one strategy or tool has magical properties. Which is why the planner and client must create a custom plan. If you'd like to revisit your plan, click here to contact us.