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Thursday, September 16, 2021

What kind of risks do you need to take when it comes to planning retirement income?

Recent research from the Deloitte Center for Financial Services focused on retirement preparedness, showing a number of practical barriers that were either preventing or discouraging people from saving for long-term needs. Such barriers often included conflicts of financial priorities, lack of trust to financial service providers, and poor understanding of the products serving the market. The following research by DCFS was focused mostly on suggestions to overcome these barriers. It explained additional, psychological factors that should be considered, in order to create an approach to solve this problem. A great number of studies proved that people are not rational all the time, and often fail to do what should be done in their best financial interest. When planning for retirement income, it’s impossible to separate a client’s risk tolerance (or aversion) from their future retirement funds. Investors and advisors may focus on the different methods of withdrawal when planning retirement income, but it’s not always the most important factor. A client’s receptiveness to risk will be a huge determining factor. Those that fear risk, may not make the proper investments that will grow into a suitable retirement fund, while those on the other side may stand to lose it all right before they retire. Because of this, it’s also important for investors to not only be aware of their risk tolerance, but also their objective capacity to take risk. Comparing someone’s risk capacity with their stated risk tolerance can be a good way to reconcile poor retirement planning stemming from risk tolerance. As long as an advisor can explain to their clients these concepts, it will go a long way in their future retirement income. Most people when actively participating in the workforce have one thing on their minds, to save enough to retire comfortably. While the right investment approach is important for investors at any stage of life, it is critical for investors who have reached their retirement income life cycle. Managing retirement income portfolios is the hardest job in the money management business and also the most important — because retiring investors cannot afford mistakes. Retirees are very sensitive to the losses because they do not have the luxury to wait for their capital to recover. It may lead to reactive behavior during the crisis when their portfolio loses the money. The knee jerk reaction is to save what can be saved by selling low. Unfortunately, it is the worst thing the investor can do. It is impossible to time the market, therefore, when the market will start to recover, the investor who is sitting on the sideline will miss the opportunity to recover losses. It is of paramount importance for advisers to help retirees to design an investment strategy that would allow sitting out the storm without actually realizing the loss, but rather giving the chance to recover from the downturn. Even outside of risk tolerance and investment risk, it is just as important to take into account the risk that a client may be exposed to in other aspects of their lives. Often after retirement an advisor may recommend withdrawing a client’s 401(k) portfolio for reinvestment. However, when looking at the risk of the client’s wealth holistically this may not be the best idea. A client might own a small or large business or other high risk assets. This presents a major risk from losses, unpaid debts, or litigation. To mitigate against the worst case scenario of the business failure and possible bankruptcy, an advisor could recommend an investor to keep the 401(k) invested. 401(k)s are considered the gold standard of creditor protection. However, traditional and Roth IRAs are also offer protection up to $1,1245,475.  There are exemptions, however, such as the IRS, divorce, and a solo 401(k). In these exemptions your 401(k) can still be taken. There are also legal differences between states in non-bankruptcy events. So when assessing the risk to a client, using the protection of 401(k) can in some cases be a safety net if the client could be exposed to a lose-it-all scenario. Many industries are applying the concepts of behavioral science to increase the effectiveness of communication. We live in a world where various cognitive and emotional biases are in constant motion. It plays a significant role especially in investing combined with tightening industry regulations. Financial advisors should be fully aware that financial services represent one of the most appropriate fields for leveraging a behavioral approach. If you recognize the benefits of behavioral science, you should seek to determine which behavioral factors most prominently impact clients’ decision-making processes. Always remember to measure each client’s willingness to take the risk as accurately as possible.  Incorporating this into an advisory practice will essentially help you build a unique element of trust and reach a meaningful relationship with clients. Overall, it’s important to make sure that you have a thorough understanding of all kinds of risk your clients may be exposed to. With this knowledge and the understanding of how clients react to these risks, you can become a more trusted advisor to your clients.

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