Q: I am in my early 30s and I want to start investing for my retirement. What are some of the risks that I should be aware of and how can I reduce these risks?
A: Risk can be a tricky word. Many people think of risk as losing all or part of their investment. This is definitely a risk that needs to be addressed. However, there are several other risk factors that need to be accounted for in any good retirement or financial life plan. I prefer to look at the different risks that can affect the success or failure of an individual’s plan.
In the investment arena the risk that is most talked about is “market risk.” This type of risk deals with market ups and downs and the fluctuations of different industries, stocks, etc. To manage this type of risk it is important to diversify and to have a good asset allocation plan.
Some managers employ “technical analysis” to help manage the ups and downs. Diversification and asset allocation do not guarantee against market loss or
ensure market gains. They are techniques to help manage investment risk.
While managing market risk is important, you should also manage the other risks that you might face. Inflation risk is the risk that your investments do not maintain their purchasing power. Non-market assets may protect against market risk, but they often fall short in protecting against inflation risk. Your portfolio needs to guard against loss of purchasing power.
Interest rate risk is another risk to be considered. Rising interest rates can have a negative impact on bonds and other fixed income type of investments. Fixed income type investments tend to go down when rates rise and go up as rates fall. This risk can be managed by targeting maturities to the periods that money will be needed.
Laddering, or staggering, maturities may also give protection. Remember, longer duration bonds may be more susceptible to principal risk when rates are rising.
Some other risks that you should be familiar with are credit risks, tax risks and geopolitical risks. Credit risk is the risk that a bond issuer may default on debt obligations to you. It may also involve the financial stability of the companies in which you choose to invest. If you choose to own individual securities or bonds, you should monitor their financial position closely.
Tax and geopolitical risks are the risk that a change in taxes, regulations, political philosophy may affect your investment holdings. Investments should be made on the merits of the investment and how that investment fits into your plan. Investing for tax advantages, etc., might prove fruitless if things change in the future.
Longevity risk is the risk that you outlive your money. You should have a realistic spending or withdrawal plan that guards against outliving your money. Certain insurance products might be considered to provide guarantees backed by the insurer.
You should also consider the risk of dying prematurely, becoming disabled, or needing long-term care. These events can derail the best of plans. Again, there are insurance products that might help to protect you in case these events become realities.
I have thrown a lot at you, but I think that it is important that you consider and manage the potential risks that might put you off course.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Greg Epps is a registered representative and Certified Financial Planner with Epps Financial Partners. Submit questions to him by writing to Business Editor John Vass Jr., Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at jvass@timesfreepress.com.