Financial Risk when Investing for Retirement

February 19, 2024
12:05 pm

Risk is a part of life. We all make decisions without knowing the outcome. Even investing and saving for retirement involves an amount of risk.

But for many nearing retirement, risk is the sword hanging over their heads. The weighting of a portfolio could affect the risk of retirement investing.

Nigel Green, CEO of deVere Investment, stated, “A sudden downturn, fuelled by economic uncertainties, geopolitical events, or unforeseen crises, could spell disaster for those heavily invested in stocks. Retirees, in particular, face a precarious situation as they may not have the luxury of time to recover from significant market setbacks.”

It is essential for those nearing retirement to have a well-balanced portfolio that aligns with their financial goals and individual risk tolerance.

Generally, the younger an investor is, the higher the risk they can take in investing, as they have the advantage of time on their hands to smooth out the volatility in the markets. They aim to grow capital. For example, a portfolio for a younger person could consist of a moderately aggressive risk profile of 75% equities and 25% bonds.

As investors get nearer to retirement, they should focus on growing capital and preserving wealth. This means taking fewer risks, as there is no time for markets to recover if they perform poorly. For example, a portfolio of a person in their fifties could consist of a balanced risk profile of 50% equities and 50% bonds.

The risks associated with a heavy reliance on stocks are real and potentially detrimental to financial security in retirement. Equities have a higher potential for return but also carry a higher risk, while bonds carry lower risk and offer lower returns.

What is financial risk?

Financial risk is the chance of losing money on an investment or not achieving the return expected.

What can cause financial risk?

External factors – Market volatility is one of the leading causes of risk. Markets can become volatile due to geopolitical events, interest rate changes, war, pandemics, elections or natural disasters, e.g. the COVID pandemic brought most global markets to their knees. Also, there might be industry and law changes as well.

Internal factors – These include things like underperformance and poor cash management, etc.

Kinds of financial risk tolerance?

Risk can be classified into many categories. The type of risk tolerance also depends on the length of the investment period, as longer investment periods can handle more risk because time can ride the ups and downs in the market.

Defensive
Defensive investors tend to target capital preservation. Their investments will typically be deposit-based but with some exposure to risk assets to provide the potential for maintaining capital at or above inflation.

Cautious
Cautious investors tend to target a modest level of growth via a portfolio of mixed assets. Their portfolios will primarily be invested in fixed-interest assets but also defensive equity and property so as to achieve relatively stable long-term returns. In the short term, they typically expect some volatility.

Balanced
Balanced investors tend to target longer-term capital growth. Their investments will be mainly in fixed interest, equities and also some ‘alternative’ asset classes. They typically expect some volatility in return for the possibility of higher long-term returns.

Moderate Growth
Moderate Growth investors tend to target a return using a portfolio with a higher equity content and a wider geographical spread. Their investments will be predominantly in equities, with exposure to fixed interest and property, to provide growth-orientated diversification. They typically accept some volatility in return for the possibility of higher long-term returns.

Growth
Growth investors tend to target long-term capital growth by adopting a higher risk level. Their investments will typically be equities and some ‘alternative’ asset classes to achieve long-term capital appreciation.

How to mitigate financial risk

Diversification
This means spreading investments over different asset classes, geographical regions and sectors to reduce risk, e.g. selecting equities, bonds and cash in other sectors like energy and financials across various regions like the US, UK, Europe and Asia.

Asset allocation or weighting
These are the percentages or weighting of assets in a portfolio. Those chasing growth will have a higher percentage of equities than bonds and cash.

Unit cost averaging
Dripping money into the market can reduce the risk of timing the market. This means investing a fixed amount regularly. This could help lower the average cost of stock or shares.

By acknowledging the limitations of the current bull market and working with advisors to implement a diversified and risk-aware investment strategy, retirees will be best positioned to safeguard their financial well-being. Chat with a financial advisor to review the risk of your portfolio.

Please note, the above is for educational purposes only and does not constitute advice. You should always contact your advisor for a personal consultation.
* No liability can be accepted for any actions taken or refrained from being taken, as a result of reading the above.