Retiring at age 65 gives us an average life expectancy of about 20 years, which means half of us will require retirement income for longer than two decades. Entering retirement is a time of transition, with many changes to accept, not least of which is what type of investments one should hold. The common approach has been for individuals to reduce market exposure as they age.
Some financial advisors feel more equity exposure is needed to adequately fund a retirement over this time frame. Other planners believe that the riskiest day of your life is the day you retire, because at this point that you have the longest period to fund in retirement, and perhaps it is also when you have the most assets, and the most assets to lose.
There are two types of investment recommendations that arise from this viewpoint. Firstly, that one’s retirement date coincides with the low point of stock market exposure of one’s total financial assets. The other less common is the belief that when regular income is taken from an investment portfolio in retirement, a rising equity allocation over time could be appropriate.
According to Morningstar.ca, a person’s “total wealth” is made up of their financial capital and human capital. Hopefully, at the point of retirement, financial capital is strong as a result of diligent savings and investment plan during the working years. Human capital is generally the present value of a person’s future ability to earn an income. At retirement, some human capital may still exist, given that we may retain the option to go back to work in our retirement, and we may have deferred employment income accumulated in the form of a government and/or a corporate pension. However, it is diminished relative to our earlier working years, which means that it acts as less of a buffer to risk to our financial capital.
People face financial risks throughout their lives, but the type of those risks and how they are dealt with changes over time. One of the biggest shifts a retiree makes is from mortality risk, where the worry is about dying prematurely and leaving dependents financially destitute, to longevity risk, which is the potential for a person to live longer than expected. In retirement terms, this is the risk that you could live longer than your financial assets. For those in or nearing retirement, the fear of outliving assets is sometimes cited as a bigger worry than death itself. The responses to these risks differ, Life insurance is often cited as the solution for mortality risk. For longevity risk, guaranteed lifetime income could be part of the answer.
Your retirement day is important on many levels. Like any major life transition, your perspectives could change. Some of those changes could be more visible, such as the focus changing from total return to generating income. Possibly more subtle but equally important is the greater reliance on one’s saved financial capital as one’s human capital or income earning ability diminishes as a proportion of your available total wealth. Certainly, there will be changes in which risks you choose to emphasize, such as mortality risk before retirement and longevity risk after retirement.
No doubt, you’ll have thought about what to do with your time when you have moved past the responsibilities of your working life. It is also a good time to review your investments with a trustworthy financial advisor.