Measuring and Managing Your Financial Risks in Retirement

In
prior posts, we’ve discussed the three M’s that constitute the
actuarial process for keeping your spending in retirement on track and
consistent with your spending goals:Measuring your Funded Status each yearMonitoring your Funded Status from year to year, andMaking changes in your assets or spending liabilities when your Funded Status falls outside a reasonable corridor (guardrails).In
this post, we will discuss two more M’s: Periodically Measuring and
Managing your financial risks. If you have completed Steps 1 and 2 above
and are contemplating increases in your spending plan this year, we
suggest that now may be a good time to measure and possibly manage your
financial risks before implementing your plan.2023 and 2024 were
good years for equity returns, with returns on the S&P 500 index
exceeding 20% in each year. Despite higher-than-expected essential
expense costs, many retirees may be looking at beginning-of-year 2025
Funded Statuses in excess of 140% and may be contemplating increasing
their spending for 2025 as a result. We don’t necessarily want to pour
cold water on reasonable spending increases, but we do suggest that you
take the time to kick the tires on your plan to see how it will hold up
under possible less-favorable-than assumed future experience.Let’s
take a look a some “stress-tests” you may wish to consider to measure
your risks. All of these tests can be relatively easily performed using
the Actuarial Financial Planner (AFP) workbook.Less favorable than assumed investment returnThe
Shiller Price to Earnings Ratio as of January 10 was almost 37. This
compares with the historical mean for this measure of 17.2. Thus, it is
reasonable to assume that future equity returns may be lower than
historical averages. To stress-test less favorable than assumed
investment returns on equities, you can override and reduce the current
default 8% per annum assumption on risky assets and/or you can reduce
the value of your current equity holdings (by 50%?) to see what the
possible impact would be on your Funded Status.Possible risk
management tip: If the present value of your current non-risky
assets/investments don’t cover the present value of your essential
expenses, you might consider increasing your asset allocation to
non-risky assets/investments. You may also wish to consider maintaining a
higher Rainy-Day Fund for this risk.Higher than assumed future inflationWe
have no crystal ball with respect to future inflation. Government
deficits continue to increase, but the incoming president has promised
to reduce the cost of groceries and gas, reduce taxes, deport illegal
immigrants, increase tariffs, etc. Climate change is likely to
negatively affect the price of home insurance and/or home prices. To
stress-test for higher inflation, you can override the current default
inflation assumption of 3% per annum, increase expected rates of
increases on various expense items and/or increase your current input
estimates for selected expenses. If you rely on your home equity to fund
a significant portion of your retirement, you may wish to stress-test
the impact of losing some or all of your home equity.Possible
risk management tip: If you are looking to manage inflation risk in
expenses and are also looking to increase investments in non-risky
assets, you may wish to consider building a TIPs ladder or, if possible,
you can also defer commencement of your Social Security benefits.
Investment in equities has historically been a good inflation management
investment. You may also wish to maintain a higher Rainy-Day Fund for
this risk.Lower than assumed future Social Security benefitsAt
some point in the relatively near future, Social Security is going to
need an infusion of more income to keep paying promised benefits. In
lieu of saddling current workers with the entire burden of making the
system solvent, Congress may decide to reduce benefits for some current
and future beneficiaries. If no action is taken, current best-estimate
actuarial projections show an initial 17% decrease across the board for
beneficiaries in 2035, but this was before passage of the Social
Security Fairness Act of 2025, so it is likely that the 2025 Trustees
Report will show an earlier trust fund exhaustion date. Of course, it is
likely that Congress will take action prior to the trust fund
exhaustion date, but it is not clear whether earlier action will result
in potentially higher or lower benefit reductions for certain
beneficiaries.To stress test for lower than assumed future Social
Security benefits, you can input a negative amount in an “other asset”
cell with a deferred starting date or you can simply reduce your current
Social Security benefits to see what the impact is on your Funded
Status.Possible risk management tip: You may wish to consider
buying an annuity with a deferred commencement date to cover the
expected decrease in your benefits or you may simply maintain a higher
Rainy-Day Fund to address this risk.ConclusionDespite
experiencing significant levels of inflation, many retirees are better
off financially than they were several years ago and may be considering
increases in their spending plan as a result. We don’t want to be “Debby
Downers”, here, and we certainly don’t know what the future will be,
but you may wish to stress test some of your assumptions before
committing to those spending increases.