Friday, February 28, 2014

Any Other Risks?

Going for a ride

I never commented on the pictures at the beginning of my posts. This one is taken on the Pacific Coastal Highway 1, somewhere between Carmel and Big Sur, California. I cycled this road twice, the first time in 1995, and a few years ago in 2012 when I took this picture.

In the month of June, there are a few absent-minded tourists, some in oversized RVs, and the odd cyclist. On a nice summer day, it has a steady stream of eager travelers amazed by the natural beauty before them. Pacific 1 often runs right at land's end on a cliff hundreds of feet above the sea.

For cyclists, strong crosswinds can be treacherous especially when going uphill. In fact, I was blown off my bike by the wind, but luckily got away with a few scrapes and bruises. But the scariest facet of this road are the many bridges across gorges hundreds of feet deep. These bridges were built in the 1930s and engineers of the day never envisaged crazy cyclists passing through. So the guard rails for these bridges are about two feet tall! An unlucky combination of crosswinds and a motorist cutting me off could have easily sent me down the abyss.

Risk of an early death was acutely on my mind that day! To manage my risk I rode these bridges at the center of the road, slowing the traffic for a caravan of motorists behind me. After completing each  bridge crossing, I reverted to my usual position on the narrow shoulder allowing them to cruise past me. Fortunately that day motorists showed patience and none created a dangerous situation.

Even with these challenges I had a great ride, a memorable day of unforgettable vistas of mountains against the scintillating Pacific Ocean and a sense of accomplishment. I kept going, always aware of risks and worked hard to stay safe.

Rarely in a straight line

After this risk-fraught travel blog segue, let's return to post-retirement risks. Our task is to envision what could happen to us in the future and formulate how we can deal with each potential risk, so we can carry on with as few unpleasant outcomes as possible during this ride that is called life.

Things rarely go in a straight line. The unexpected can and usually does happen. The best we can do is know what may happen and have a plan in place to deal with adverse events.

So far, we've had a detailed look at these risks:

Examining each of the potential risks can help us make decisions on how we can minimize the odds of running out of money under all potential situations that may unfold in the future.

Other risks

The above-mentioned risks may be viewed as the most important, but there are yet others that can also have a large impact on our future.

The Society of Actuaries (SOA) has an excellent publication called “Managing Post-Retirement Risks – A Guide to Retirement Planning”:

Let's look at other risks from the SOA list (and add a few of our own) from the standpoint of predictability and risk management approaches to be as exhaustive as possible. The list will never really be complete. Other things can happen and new trends emerge. We'll have to cross these bridges when we get to them.

Declining health

We can expect our health to decline as we get older. This means increases in medical costs (particularly prescription drugs in Canada), need for assisted care and eventually long-term care.

We can protect against this in a variety of ways. Long-term care and health-related expenses insurance mostly take the financial impact away. The decision on securing coverage will then depend on affordability and expected benefits relative to premiums paid.

If this is not ideal, then self-insuring can be achieved by holding cash reserves to meet future health-related costs, or redrawing the budget by reducing discretionary expenses in certain areas to free up available funds for these emerging expenses.

Loss of employment

The dream of "freedom 55" has all but been shattered by turbulent capital markets. Is working during retirement by necessity or avocation the new pipe dream?

Employment prospects among retirees are difficult to predict because of demands different skills and economic conditions.

Supplemental income from part-time or contractual work while retired can be derailed by disappearing opportunities or declining health. The latter is bound to happen at some point, so it's best to plan conservatively for work activity during retirement, plan for less income and for a shorter period of time.  

Also, retraining may be necessary in order to maintain or improve technical skills required for your work, as this may come at a cost and take time away from paid work.

If you have a defined benefit pension plan that offers phased retirement, it may be a good solution to transition to full retirement. Phased retirement pays you a partial pension while you continue working on a part-time basis for your employer.

If you consider a career change, consider employment that is less demanding and stressful, and provides more satisfaction even if it pays less. Review carefully employee benefits provided by your new employer, as they can be a valuable source of coverage for dental and health care.

Unforeseen expenses

Unforeseen expenses such as major renovations or medical issues can be quite costly. There is also the possibility of having to take care of family members in need: aging parents requiring assistance and children coming back to the nest, and the time and expense associated with it.

 The best way to deal with this is to keep an emergency fund, held in liquid investments to cover types of expenses that could apply to you.

Estate preservation

You may want to leave significant funds to your family, children or a charity. If you live much longer than expected and your later years require significant expenses such as long-term care, your planned bequest may fall short of your heirs' expectations. Also, the estate can be depleted further by taxation if not properly planned.

You can address this by living below your means so that in any case you will have a significant estate whether you live short or long.

You can also follow a conditional approach: a planned amount if you live a good lifespan, and a lower estate if you live longer, recognizing that the primary purpose of this money is to provide retirement income. The estate value is a moving number that depends on your longevity (and your spouse's longevity) and future investment returns, two unknown variables.


The liquidity risk is the risk of not having funds available or having illiquid funds for unforeseen expenses. It is relatively easy to manage.

As time goes on, we can dispose of illiquid assets such as real estate, guaranteed income certificates and segregated funds, and keep funds invested in equity and fixed income funds or ETFs. These types of investments are fully liquid and can be traded for cash easily.

Business risk

The risk of the cessation of operations of a financial institution and the adverse impact on insurance or investment products owned by the investor. You can guard against this by investing in funds or securities that are separate from the financial institution's assets. Also, you can keep funds invested at a particular financial institution below the Canada Deposit Insurance Corporation limit.

This can also occur if you are in an underfunded defined benefit pension plan of a company going bankrupt. Pension plans subject to the Ontario pension jurisdiction provide income protection, but it is of limited value. While there are few recourses in such situations, pension legislation, Government monitoring and oversight by actuaries provide a strong safety net to ensure that pension plans are well-funded.

Risk of bad advice, fraud or theft

Americans has Bernie Madoff, and Canada has Earl Jones. There are a host of others. Risk of loss resulting from purchasing products or investments that are in a fraudulent operation is unfortunately too common.

Get advice from qualified and trustworthy sources. Only buy investment products that are commonly traded from a reputable company. Avoid investment products you don't understand fully, are illiquid or too good to be true. Get several opinions on important issues. Be cautious in giving control of assets to anyone you don't trust completely.

Even if the investment products are legitimate, you must evaluate if the seller has a conflict of interest, with respect to compensation. Ask for disclosure on commissions, sales charges and early withdrawal penalties.

Public policy risk

Personal income tax may increase or government pensions or health care benefits may be reduced in the future. The baby boomers are a powerful demographic at the polls and this will keep inter-generational transfers going for a while, but there will be a time where costs become so high that they won't be sustainable. This means there is a good chance of increases in income tax or reduction in services and payments. Either way, we will be left with less disposable income.

Grey divorce

Planning retirement involves both spouses of a couple, even if one retires before the other. If a change occurs in marital status, then the plan has to be redrawn based on each spouse going forward with its share of the family assets. Being single again means that a lot of expenses previously shared will have to be assumed by each, such as housing, car, vacations, etc.

Systemic risk ("Black swan")

I haven't spoken about the  so-called "Black Swan" or systemic risk, the risk of a pronounced secular downturn in the economy and in capital markets. I will dedicate a separate post to this in the near future and one to medical costs as well.

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