How to prepare for 4 big risks facing any retirement plan

The threats of a cycle of falling stock values, a surprise early retirement, long-term care costs and inflation could threaten even the strongest plans.

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But financial advisors and their clients can prepare for those possibilities through a combination of a thoughtful acknowledgement of those risks and technical strategies that reduce the potential harm, according to three retirement experts speaking in a keynote panel in front of about 2,000 attendees at this week’s Morningstar Investment Conference in Chicago.

For example, a bond-ladder strategy could render a rough year in capital markets like 2022 into “a nonevent,” said Dana Anspach. She’s the founder and CEO of Scottsdale, Arizona-based registered investment advisory firm Sensible Money, the author of multiple books on retirement strategies and a member of the committee at the Investments & Wealth Institute overseeing the Retirement Management Analyst (RMA) designation. 

By “creating a floor” of available cash flow through the maturation of bonds in a strategy Anspach calls an “income ladder,” her RIA shielded its clients from the worst impacts of the economic turmoil that year, she noted.

“It’s a specific type of bond ladder that falls under the asset-liability matching investment approach, where we’re laying out a client’s cash flows, typically for the first five to 10 years of retirement,” Anspach said. “We’re laying them out for all of retirement, but I would say they’re less accurate the further out you go. And then we’re buying bonds that mature in the amounts of those cash flows that we’ve specified, and we’ve already built inflation into that spending.”

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What happens at the end of the bull cycle?

That approach can lessen retirees’ common fear of outliving their assets, which can show up even after one bad day of stock performance. 

And, with the high —  or potentially overheated — values of stocks reflected in cyclically adjusted price-earnings (CAPE) ratios rising into the low 40s, the concerns about a sustained downturn in stocks are especially valid, according to Michael Finke. He’s a professor of wealth management and the Frank M. Engle Distinguished Chair in Economic Security at The American College of Financial Services, a training and professional development firm for financial advisors and other industry professionals that is the certifying organization for the Retirement Income Certified Professional mark. 

“We did a recent study where we looked at what the most important years are for someone who’s approaching retirement or after retirement, in which years the returns that you get on your investments have the biggest impact on the amount of income that you can draw from those investments throughout retirement. And it’s really the five years before retirement that are paramount, and maybe the first three or four years after, incrementally, that had the biggest impact on your lifestyle,” Finke said. “I think the risk has never been higher that retirees are not going to get the returns that they hope to get to be able to generate the amount of income that they expect to receive from their investments.”

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Retiring younger — without meaning to

 Another possible shock to the plan could appear in the form of a preretiree losing the job that they had anticipated would keep them in their accumulation phase for substantially longer. Anspach has had clients whose employers outsourced their roles “in their later 50s or early 60s when they had planned to work to 65,” she noted. In that event, they’ll have to alter their plans to find a workable retirement income. 

“What we try to do is stress test the plan for an earlier retirement case, say, ‘I don’t even think you’re going to work to 65, but let’s build everything as if you are done at 60 or 62,'” Anspach said. “So, if you stay for and plan for that contingency, and you get there, and if you work longer, great. That’s a better outcome than planning for the opposite event and being forced to recalibrate.”

The price of nearly everything is going up

Anspach had noted earlier in the panel that her firm usually plans conservatively for retired clients’ living expenses to rise 3% and healthcare costs to go up 5% each year, due to inflation. Although, as people get a decade or more into their retirement, they often tend to slow their spending, she said.

Nevertheless, the risk of inflation represents an even bigger one than a stock downturn, according to Finke, who described the delaying of claiming Social Security benefits through a so-called bridge investment strategy as “one of the most underutilized” approaches in planning. 

“Let’s take a moment and talk about the best way to hedge against inflation risk, because I feel like I can get on my soapbox here and say the same thing I do over and over again, especially for healthy, higher-income workers. The single best way to hedge against that risk is to delay claiming Social Security,” Finke said. “Delayed claiming of Social Security is really the most reliable way to get that inflation protection and longevity protection.”

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One of the most widespread concerns: healthcare

As retirees age in a time when people are living longer, the cost of long-term care and health expenses in general could climb above what is available to them through Medicare benefits.

“The big shock that can occur in many retiree households is having large long-term care expenses toward the end of someone’s life,” said Christine Benz, the director of personal finance and retirement planning at Morningstar and author of “How to Retire: 20 Lessons for a Happy, Successful, and Wealthy Retirement.” As the moderator of the panel, she asked Finke and Anspach “whether you think that contributes to some retirees being reticent, reluctant to spend because they’re worried about having, effectively, a balloon payment at the end of their lives.”  

The concern related to “this unknown that makes them feel just a little nervous,” certainly does affect how retirees view their spending habits, Anspach said.

“We build it into the projections, so we’ll have a particular analysis and stress-test a long-term event to occur at approximately in your early 80s,” she said. “How long would your assets last? And that informs whether we’re going to suggest long-term care insurance or not, even if the client can cover a long-term care event. We’re often bringing it up because the research shows people who have the insurance are more likely to get quality care, and I think that’s a key factor.”