I’ve been retired for more than a decade and I’m often asked about my biggest retirement regret. It’s an easy call for me. I most regret retiring with an inadequate understanding of the risk I was taking.
It could have been disastrous. Research documents the risk of poor investment returns early in retirement, “sequence of returns risk”, and I retired in 2005, just before the Great Recession. A relatively conservative equity exposure and substantial retirement savings saved me and I weathered the storm quite well. Still, I have the lingering feeling that I won a bet without fully understanding the odds.
Sometimes it’s better to be lucky than good.
A better description of my mistake is that I was more focused on investment performance than the risk to my standard of living. I’ve come to understand that retirement planning is, from most perspectives, more risk management than portfolio management, although the latter seems to get all the love.
Retirement planning is often explained in terms of two schools of thought, a probabilist school and a safety-first school. Probabilists focus largely on maximizing portfolio returns and minimizing the probability of a shortfall. In a sense, they try to outrun standard-of-living risk with better portfolio returns.
In the safety-first school, the goal is to first insure the risk of an unacceptable standard of living with annuities, maximized Social Security benefits, TIPS bond ladders and the like, and only then to pursue greater portfolio returns. For safety-first advocates, almost any probability of a disastrous outcome is too much risk.
We can look at retirement income as a portfolio optimization problem in which we try to sustain or improve our desired standard of living. The downside is that we could make it worse.
Alternatively, we can view it as a risk management problem and try to minimize our risk of losing our standard of living as we age, at the possible cost of limiting our upside. Of course, nothing says we can’t choose a goal in between that better fits our risk tolerance, insuring more or less downside and risking more or less upside.
A result of focusing my retirement decision primarily on investing is that it drew my attention from the other risks of retirement, like unexpected expenses. There was a risk that I would have high medical expenses and very expensive health insurance (I did). There was a risk that my adult children would need substantial financial assistance (they did). There was a risk that we would retire into a brutal bear market (we did.) There was a risk that I wouldn’t be able to buy affordable long-term care insurance (I can’t).
There were dozens of other risks, some manageable, some not, that I didn’t consider but would have had I approached my retirement planning more from the perspective of risk management than simply as an investment game.
As I said, I weathered the first decade of my retirement in great shape. Still, I feel a little like a basketball player who took a really poor game-deciding shot and somehow saw it go in.
If I had it to do over, I would take a better shot.
Please feel free to send any questions you might have regarding retirement planning to JDCFinance@gmail.com and I will try to answer them in a future post.