Longevity risk: the risk of outliving your money…that is, the risk of running out of money before you do breath.  This is the number one fear of most retirees…and for good reason.  Retirement can last thirty years or longer, is the time of life when very expensive medical emergencies may strike or a sudden meltdown of the market could rob you of your financial resources.  When you add in the uncertainties of the shrinking purchasing power of your fixed savings caused by inflation, rising property taxes, lower interest rates and your inability to work, it is easy to understand by Longevity Risk is top-of-mind for most retirees.  Not much we can do about inflation and taxes except use our votes wisely to selecting honest, caring political representatives.  Health can be controlled somewhat by eating right, exercising and not abusing our bodies by excessive smoking and drinking.  Not much we can do about being excluded from the labor market nor can we control the economic cycles and interest rates.  In fact about the only thing we can control for certain is how much risk we take with our retirement money.

If you have your retirement money in a risky place like the stock market and there is a meltdown, you’ll probably suffer a significant loss with no way and no time to make it up.  In fact, if you lose your retirement money because you gambled in the market and lost, there will be no second chance…you’ll be dependent on the government, your children or a welfare organization.  Not a pleasant thought and probably the main reason most retirees say living longer than their money is their number one fear.  Unfortunately, far too many retirees have not taken steps to reduce their investment risks by heading for the safe places. Why is that?

First, you’re bombarded with advertisement, advice and promises that encourage you to keep your money in the market.  You’re told that “longer term” you’ll do a lot better with stocks, bonds, mutual funds, diversified portfolios and other risky investments than if you keep your money in safe places like bank CDs, government bonds and fixed annuities.  You’re presented with slick graphs and charts showing that here’s how much better you’ll do with your money at risk.  The entire brokerage industry is dependent upon you to put your money at risk in the market and they’re working very hard to make sure you do.  You can’t read a newspaper personal advice column, watch the news or read any of the thousands of magazines or newsletter devoted to investing without being told you’ll be much better off by placing your retirement money with Wall Street for safe keeping.  You’re never reminded of the market meltdown of 2000-2003 or the early 1970’s nor are you reminded that currently Wall Street is awash in losses from their profligate activities.  The incessant calls from your broker are about how now is the time to buy at bargain prices.  What about the losses you already have?  You’re scared into believing that unless you put your money at risk you’ll not make a reasonable return.  In fact, you’re told that if you keep your money super safe you’ll realize your greatest fear of outliving your money.  The truth is, you’re a lot more likely to outlive your money by taking risks you can’t afford than you are keeping it super safe and earning an interest rate that goes with safety.  Remember that risk and reward are always traveling companions:  if you have a chance to make a big return, it is certain that you are taking risks of loss.  On the other hand, if you take zero risk of loss, your earnings will be positive and certain but not above market.  So which do you prefer: the possibility of great growth but also the possibility of great losses OR absolute safety and a low but certain return?  As Will Rogers once said, “I’m more interested in the return of my money than the return on my money”.  I think Mr. Rogers had it right when it comes to the average retiree.

The current state of the economy is less than reassuring: unemployment is rising, dollar is very weak and falling, oil is teetering near $100 barrel, housing market is totally depressed, sub-prime credit problems are spilling over into autos and credit cards, inflation is heading higher and there is widespread talk of recession.  The Federal Reserve — the nation’s guardian of monetary policy — is obviously scared stiff judging from the drastic moves they’ve made in recent weeks to rapidly force short-term interest rates into the basement.  Most economists — including me — are skeptical that a nosedive of the economy can be avoided: recession is heading our way is what I see.  Yet, you probably have most of your retirement assets in mutual funds [check your 401(k)], portfolios containing stocks and bonds and other risky investments.  Have you forgotten what happened when the dot.com bubble burst?  Have you thought about what you’d do if the market drops drastically?  Do you realize you’ll not have a second chance if you lose too much of your retirement money?  What can you do?

One option is to look into locking in a guaranteed lifetime income you can’t outlive.  You see, there is insurance for longevity risk: insurance companies which are among the world’s largest, strongest and oldest financial institutions are willing to guarantee you a lifetime income you can’t outlive if you’ll deposit with them some of your retirement money.  They will take the risk associated with the markets, stocks losing value, real estate crashing and other unforeseeable developments that can erase your retirement money.  You’ll still be left with taxes, inflation, health issues and non-investment risks but you’ll not be able to outlive your money.  How can insurance companies make such guarantees?  The same way they are able to insure your home, car, health, life, business and other valuables: the law of large numbers and spreading the risks.  If you live too long and they lose money on guaranteeing you a lifetime income there is someone else in your cohort group that didn’t live as long as they were expected.  So, over time the numbers average out and the insurance company is able to manage the risk and make a profit.  You, on the other hand, got protection from your most feared risk in retirement: outliving your money. 

How do you find out more?  Ask your financial advisor to talk to you about a guaranteed lifetime income secured by an insurance company.  By the way, if your advisor starts talking about “variable annuities” tell him or her that you want something without risk: mention a fixed annuity without downside risk and one that allows you to start, stop or store your guaranteed lifetime income.  You don’t have to give up control  of your money to get a guaranteed lifetime income because in the past couple of years insurance companies have begun offering new products that specifically take care of longevity risk faced by retirees.  These new plans allow you to change your mind if your circumstances change.  Insist on flexibility and insist on no market risks.  If you choose not to investigate this option but instead keep your retirement money exposed to the market, make sure you have a good answer for the following question: “What will you do if the worse case becomes a reality?”

Here are some links if you’re interested in finding out more about longevity risk and how to insure against it:

 http://findarticles.com/p/articles/mi_m0EIN/is_2007_July_23/ai_n19378797 

http://www.financial-planning.com/pubs/fp/20060201023.html

https://www.forethought.com/ffs/forethought.portal?_nfpb=true&_pageLabel=forethought_annuities_home

The economic storm clouds are gathering and it’s looking like the U.S. is in for some tough financial weather.  If the U.S. catches an economic flu will the rest of the world get pneumonia?  The warning signs include a credit crunch, a real estate depression, rising inflation (including gas prices), higher unemployment, a weak dollar with rising deficits, widening trade balance, lower interest rates engineered by the Fed, a highly volatile stock market and widespread forecast of economic recession.  The Bush administration and Congress, with the endorsement of the Fed, are crafting a stimulus package to bail out the economy.  Consumer confidence is low and sinking with investors rushing toward safety with their retirement dollars.  In the first few trading days of 2008, investors have moved billions from the stock market into safer options.   If you’re leaving you money in the market, make sure your retirement plans won’t be derailed by the worst case outcome.  If so, you need to head to higher investment ground.  If you’re taking your dollars out of the market to safer places, what are your options?

First there’s bank CDs, Treasury bills and money market accounts.  The good news is that these are super safe, ready available and easy to cash in when the time comes.  The bad news is the interest rates they pay don’t even keep up with inflation.  These options are super safe if your only concern is “safety of principal” but they are extremely unsafe if you’re afraid of “outliving your retirement money”.  Since these options have historically not kept up with inflation, they may be a good short term parking place for your retirement money but are not a long term solution.  Plus, income taxes take a big bite out of your paltry earnings.

Corporate or government bonds can provide you good safety but not during times of low interest rates.  As rates rise — and you may be assured that the interest rate cycle has not been cured — the market value of fixed rate bonds will decline.  Yes, you’ll get your principal back at maturity but in the meantime you’ll have a hard time keeping up with inflation.  Plus, if you have to sell before maturity the loss could be a shocking surprise.  Not a good long-term solution and much too risky for the short term.

What about real estate?  Since most retirees are not real estate gurus, the safest route is to put your money in real estate investment trusts where it is professionally managed.  Given the recent track record of “professional real estate investors who fueled the sub-price meltdown” are you sure you want to entrust your money to them?  Maybe a good long term solution but why buy when prices are dropping like a rock?  International investments available in mutual funds and stocks are getting strong endorsements at this time… so maybe this is the ideal place! The last time I looked  mutual funds (which are nothing more than a collection of stocks and bonds inside a single investment) and corporate stocks waxed and waned with economic gyrations.  If the U.S. sneezes and the rest of the world catches a cold, you’ll be caught outside without a coat.  Generally way too much risk for retirees and that why your exposure to international markets, even in the best of times, is a small fraction of your total portfolio.

How about annuities?  These are savings options guaranteed by insurance companies that offer more than safety if you stick to the fixed variety.  Variable annuities are nothing more than mutual funds wrapped in a tax deferred package by an insurance company — they still have risk plus the ownership costs are much higher than just plain mutual funds.  Stay away from variable annuities.  Fixed annuities on the other hand come in several varieties: traditional fixed that mirror a bank CD and offer a set interest rate plus no current income taxes on earnings; index-linked which offers the opportunity for a higher rate because the interest rate they pay depends on the movement or growth of a stock/bond market index like the S&P 500 … but if the market nosedives you don’t because the worse you can do is the minimum return guaranteed by the insurance company; lastly there is the income annuity which guarantees you a period certain or lifetime income in exchange for depositing with the insurance company all or some of your retirement money.  The income annuity can give you what employers once guaranteed their retiring employees: a lifetime income you can’t outlive — even if you live to be 125.  If you haven ‘t yet discovered the fixed annuity option, get in touch with your financial advisor and demand to know more about them — just steer clear of the variable annuity because they pose market risk just like a stock, bond or mutual fund.  Oh yes, don’t be leery of fixed annuities because they are guaranteed by insurance companies because you’ll be dealing with some of the world’s oldest, largest and financially strongest businesses that have weathered wars, economic depressions and failure of governments.  These are the same companies that insure your home, car, life, health, business and virtually every valuable you own or risk you face.

When the economy goes into a tailspin and investments sink like a rock thrown into a lake, wall street and its army of brokers go into battle mode because their commissions hang in the balance.  Their war cries include “now is the time to buy at bargain prices”, “don’t sell just buy more to average down” and “over the long run you’ll do just fine by leaving your money in the market”.  Remember: no sale – no commission and that is bad for Wall Street and it brokers.  Granted, longer-term the stock market has outperformed the safer alternatives but the ten years you need to ride out the market cycles is a substantial portion of your retirement years. Years when you’ll be worried about your financial well-being, whether your money will run out before you do and whether an emergency will force you to sell at a loss before the long term has run it course.  Retirement is a time to keep what you’ve got rather than speculate in hopes of making more.  If you lose your retirement money, there will be no second chance.  Consult with your financial advisor and check out all the safe options — it could be the most important retirement decision you’ll make.

If you’d like to hear and see what others are forecasting for 2008, click below:

http://www.youtube.com/watch?v=op4BNyU6QQ4

If you’d like to know where to invest your retirement money, there are virtually thousands of asset allocation calculators that will tell you. Go to the web site on any mutual fund company or brokerage firm for the free use of their asset allocation program. You simply answer a few questions about risk preference, give your age and presto they’ll tell you where to invest your retirement money. There’s only one problem: the results you get are rigged to give answers that create sales for the host company and their brokers. Invariably the recommendations will be stocks and bonds — no bank CDs, annuities or other non-brokerage options. I call this “broker-channel bias” because the advertising might of the large investment firms put other alternatives at a disadvantage. Far too many retirees are listening to the loudest voice when it comes to investment choices. My advice is to re-balance your mindset about retirement choices before you re-balance your retirement portfolio. Let me illustrate my point.

Here are the abbreviated questions asked to assess risk for a 65 year old. My answers are underlined.

1. If I inherited $10,000, I’d want to invest it in the stock market: strongly disagree
2. I will accept the possibility of loss, if gains are likely: strongly disagree
3. If potential return is twice normal, I’d accept up to 50% loss: strongly disagree
4. I avoid investments that are risky or unpredictable: strongly agree
5. If my investment dropped 20% in 2 weeks, I’d sell and go elsewhere: strongly agree
6. I prefer growth and performance over low risk: strongly disagree
7. I would choose job security even if the salary were lower: strongly agree
8. I’ll have sufficient money for a comfortable retirement: strongly disagree
9. I’m content waiting five years to recover market losses: strongly disagree
10. A stock market decline of 20% is a buying opportunity: strongly disagree

Not surprisingly I got the lowest risk tolerance score available.

Here’s how the investment allocation calculator said I should invest my retirement money.

1. Corporate bonds 52%.
2. U.S. large cap stocks 22%.
3. U.S. small cap stocks 11%.
4. Short term U.S. Treasury 10%.
5. International stocks 5%

Let’s say that I follow this advice and shortly thereafter the global economy goes into a tail spin, stock markets plummet and interest rates rocket upward. Can’t happen you say, check the conditions of the late 70’s and early 80’s. How have my investments fared? U.S. Treasury obligations are short-term (meaning less than 5 years), but higher rates will cause their value to decrease: the longer to maturity, the bigger the loss (actual loss if I sell and opportunity loss if I continue to hold). Not too bad, but I’ve got losses. Higher rates would cause corporate bond values to drop, and the recession could also undermine the creditworthiness of the issuers. Double trouble brewing here! The stocks would all decline in value with the recession: the losses range from bad to catastrophic. Not to worry, it’s only my retirement money. I could go back to work were it not for the recession… and my age. Can I handle the loss of 30% – 40% of my retirement money? I’ve just learned that there is a world of difference in diversifying a portfolio to “work toward retirement rather than making it through retirement”.

The fact is that retirement stakeholders are making terrible mistakes with their investment choices, because institutional advisors are putting their “returns” before your “retirement safety”. Rather than hedging investment risk using an asset allocation model, you might want to consider hedging against longevity risk (living too long) or the loss of a regular income. Some of the finest minds in the financial world say that the diversified portfolio approach used since the 1950’s is in real need of updating. I agree completely and encourage you to be aware of broker-channel bias the next time your broker calls. One last thing: consider all the options before investing.