2nd Quarter 2019

Investing Spotlight: What Is Risk?

Most people worry about market risk — the possibility that investments in the stock market may lose value. But that’s only one type of risk that may affect you. For example, in trying to avoid market risk, some investors may end up exposing themselves to other uncertainties. Here are three key financial risks to balance when planning for retirement.

  • Market Risk — This is the risk that your investments will lose value due to the market going down. There are different ways to mitigate market risk, and they depend on your investing time frame. When you have years to go before you need the money, you can typically accept more market risk because you have more time to recover before you need to take withdrawals. Stocks have higher market risk than bonds or cash, but they also historically have delivered higher returns over the long run. One way to mitigate market risk is to diversify your portfolio — spreading investments among different types of stock or bond funds.1 Varying your investments among large-company stock funds, small-company stock funds, and international stock funds may make sense because each type of investment could perform differently. As you get closer to retirement and tapping those investments, you can’t afford to take as much market risk. You may want to start shifting more money to bonds and cash, which tend to have lower returns over the long term but less market risk.
  • Inflation Risk — This is the risk that costs will rise faster than the return on your portfolio. Say you invest your money very conservatively — keeping it all in cash, for example. You might not lose money in the stock market, but your portfolio could lose purchasing power by increasing less than inflation. In that case, the value of your investments will not keep up with rising prices. One way to mitigate inflation risk is to invest for the long term in stocks, which have traditionally outperformed inflation. That means you are increasing your market risk. Because you are planning for a retirement that could last 20 or 30 years, you may want to consider a combined approach. Continue investing some money for the long term with stocks while keeping some conservative investments with cash/bonds for shorter-term needs. Bottom line: It’s important to balance market risk and inflation risk based on your investing time frame.
  • Longevity Risk — This is the risk that you outlive your money. When you’re deciding how much you can afford to withdraw from your savings every year in retirement, it’s usually wise to prepare for a longer-than-average life expectancy. Today, the average 65-year-old man can expect to live to age 84 and the average 65-year-old woman to about age 86, according to Social Security Administration life expectancy figures. Nobody knows for sure how long they will live, but you can take some steps to mitigate longevity risk for the years ahead. One way is to save more through the years. Another way is to maximize pension and Social Security income. Every year you wait to claim Social Security beyond your full retirement age (age 66 for people born from 1943 to 1954), for example, increases your annual benefit by 8% per year —that can be a good strategy for people with longevity in their families. Another option is to continue investing some money in stocks in retirement.

Need help balancing these risks? One strategy that aims to take the guesswork out of balancing risk is investing in a target-date fund.2 With these types of investments, professionals create a diversified portfolio based on your time frame — starting out with more money in stock funds for the long term, then gradually shifting to more conservative investments as you get closer to retirement. Target-date funds typically have a retirement income fund that has a static allocation if you are taking withdrawals. For more information about these options, go to Choose Your Investing Approach in our Retirement Education Center or speak with your ICMA-RC Retirement Plans Specialist.

1 Diversification does not protect an investor from market risks and does not assure a profit.
2 A target-date fund is not a complete solution for all of your retirement-savings needs. An investment in the fund includes the risk of loss, including near, at or after the target date of the fund. There is no guarantee that the fund will provide adequate income at and through an investor's retirement. Selecting the fund does not guarantee that you will have adequate savings for retirement.

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