Permanently giving up your job is risky business. You've got to worry about your investments dropping in value, outliving your money, and inflation eating away at your purchasing power. Even worse, you could develop a health problem or be forced into retirement earlier than you planned. With those issues in mind, here are five retirement risks explained, as well as strategies for managing them:
Inflation. A major threat to retirees' portfolios is inflation, which eats away at the value of investments and reduces purchasing power. To combat inflation, investors should consider adding exposure to stocks, commodities, and real estate, which each act as a hedge, says Frank Armstrong, founder of Investor Solutions and coauthor of Save Your Retirement: What to Do If You Haven't Saved Enough or If Your Investments Were Devastated by the Market Meltdown. That's one opinion. There's an ongoing debate among those in the retirement planning industry about the best way to stay ahead of inflation after retirement. Some financial advisers say investors should maintain a substantial allocation to stocks. "If you are in your mid to late 60s and in reasonably good health—and have every prospect of living into your 90s—you might want to keep anywhere from 35 percent to 50 percent in equities," says Jerry Miccolis, a certified financial adviser for Brinton Eaton Wealth Advisors and author of Asset Allocation for Dummies. "But if you're in your mid 70s and in failing health, and this portfolio is really all you've got (and your investment horizon isn't that long), you ought to have a third or less in equities." Other advisers think stocks are too risky. "Equities, as we have just seen, are anything but a reliable inflation hedge," says Zvi Bodie, a professor at Boston University and the Massachusetts Institute of Technology and coauthor of Worry-free Investing: A Sure Way to Achieve Your Lifetime Financial Goals. He has 100 percent of his retirement money in Treasury Inflation Protected Securities (TIPS), government bonds that promise a rate of return above inflation.
Outliving your money. Once they make it to age 65, American men can expect to live 13 years, and women are likely to live 15 years. But relatively healthy 65-year-olds should consider the possibility that they'll live past 90. Traditional pension plans, Social Security, and annuities offer the best protection against outliving your assets because the payouts continue as long as you live. Social Security recipients even get annual cost-of-living increases, which are tied to the consumer price index. Social Security payouts can also be increased by approximately 7 to 8 percent for each year you delay claiming between age 62 and 70.
Investment risks. After you retire, investment losses can have a dramatic impact on your finances. "If you have taken on too much risk on the upside, the downside can absolutely ruin your retirement," cautions Jeff Ivory, a partner with Stonebridge Financial Partners in Bingham Farms, Mich. Retirement savers need to balance safety with the need to build wealth. Instead of chasing the highest possible returns in a retirement account, retirees may want to consider significantly dialing down their risk. It's also important to keep between five and 10 years' worth of living expenses out of the stock market, so other riskier assets have time to weather any market conditions. "People are realizing that they can't count on the stock market and real estate as a way of compounding their wealth," says Brad Barber, professor of finance at the University of California at Davis graduate school of management. "For preserving your principal and keeping up with inflation, inflation-indexed bonds and TIPS are the way to go."
Health problems. Losing health insurance before age 65—when Medicare eligibility kicks in—can be financially devastating. Plus, even government health insurance may not be enough. A 65-year-old couple with Medicare retiring in 2009 will need approximately $240,000 to cover medical expenses throughout retirement, according to a Fidelity Investments estimate. That number includes likely out-of-pocket expenses, deductibles, coinsurance costs, and some services excluded by Medicare. It doesn't take into account over-the-counter medications, most dental services, and long-term care expenses. For this reason, many retirees purchase supplemental health insurance policies. Reviewing medical bills for errors, asking your doctor about less expensive tests and medicines, and even offering to pay cash in exchange for a break on medical bills that are not covered by insurance are good strategies. And prices for medical services are sometimes negotiable.