How To Mitigate Retirement Investment Risk

I recently received a financial advertisement in the mail that mentioned some retirement investment risks I thought were pretty good to keep in mind.  Along with each were some practical tips in mitigating the risks, or ways to make them less severe.

Before discussing a few of these risks, lets first look at the nature of risks.  Risks are interesting in that that they haven’t occurred yet.  But, they are potential issues that could occur in the future.  As a software project manager during my day job, I know the key to good risk management is identifying risks well before they are realized, or actually become issues.  If you can identify them early you can develop mitigation strategies to keep them from turning into big problems.

What’s the worst that could occur if you don’t shut down risks?  Just look at people who have lost their retirement money in the stock market in the recent downturn.  Or, what about the people that chose to invest in the wrong company, or with the wrong person?  Still, some have created risk to their future gains by not risking enough in the way they choose their investment allocations.

Market Volatility

This particular risk is obvious.  Over time the market has ups and downs.  Obviously, we’ve seen the downside in the last year or so.  Unfortunately, there is just no way to predict the highs and lows of the stock market.  Certainly, we’d all have own our own tropical island if that were possible.  :)

Note:  you can see the changes in the market over a number of years with this interactive S&P 500 volatility chart at Yahoo finance.

Probably the best way to reduce the impacts of market volatility is to have the right asset allocation for your particular situation.  Finding an asset allocation involves identifying investment classes based on a number of criteria.  This criteria may include (but not limited to) how much time you have until you retire, goals, or what you’ll be doing in the future, and certainly, your level of risk tolerance.

Inflation

Inflation is basically when everything increases in price and your money buys fewer goods, or loses purchasing power.  In other words, inflation makes your future retirement income less valuable, so you want to invest in something that will more than offset inflation.

Inflationrate.com provides a pretty cool calculator to see the effects of inflation across time.  The example they use is alarming:  From December 1957 through December  2007 the calculator will tell you that inflation was 639.56%.  Something that cost $1 in December 1957 would cost $1+ ($1 x 6.3956)= $7.40. Ouch!

In order to combat inflation you commonly here the recommendation of investing in growth stocks or growth stock mutual funds to earn higher returns.  Obviously, there is a trade off to keep in mind with such investments.  The more you invest in growth assets, the more risk you must be able to tolerate because these types of investments are more volatile.

Investment Integrity

We’ve all heard about integrity issues in the last year when it comes to people managing investments or with individual companies.  This is definitely a risk you have to keep on the radar screen as unfortunately, the world will always have greed in it. Whether it’s an individual who is dishonest with the management of peoples’ resources, or a company that is taking short cuts to try to become more profitable, there will sadly be investments wiped out when they fall.

Certainly, there are more and more controls being put in place to deal with such risks, but you have to remember you’re still the overarching manager of your money, so it’s your responsibility to mitigate this risk from occurring.

How do you do that?  Well, an important and timeless guideline in investing, never putting your eggs in one basket, still applies.  Don’t take your entire retirement assets and place them in the invested trust of one or a few corporations.  Spread the risk and invest using mutual funds or in many companies of different types and industries.

I thought this recent Crown Financial Ministries devotional was quite fitting for this subject:

When investing, there are no sure things; so the principle of diversification is essential to long-term stability. Divide your investment money into several parts and don’t risk it all in one place. Diversify not only in different investments but also into differing areas of the economy.

Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth.”(Ecclesiastes 11:2 NASB).

In regards, to avoiding risks with investment managers, do your homework and research before signing up to work with someone.  Find an advisor from a trusted source through your church community, or from friends who have worked with the person for several years.

What are some other forms of investment risks and how would you recommend mitigating them?