Market volatility and real risk in retirement

When the global financial crisis shook world markets in 2008, the ripple effects impacted investors across the board, including those close to retirement.

While those in their 20s and 30s had the luxury of time to weather the downturn, individuals with two, five or even 10 years to go before retirement were hit the hardest; having run out of ‘runway’ on their investment time horizons.

Cushioned by choices

Not surprisingly, those approaching retirement are frequently the most concerned about the state of the global economy and ongoing market turbulence. However, if a client’s retirement plan has been correctly structured, the impact of market volatility will be cushioned by the choices the client and financial adviser made together.

There are specific strategies which advisers can employ to protect clients from the risk inherent in market downturns. Most retirement funds move savings into less risky assets as clients near retirement to offer protection at the time when capital preservation is of paramount importance.

However, this focus on ‘de-risking’ often excludes individuals from the growth potential of ‘risky’ assets like equities. The danger is that relying exclusively on cash and bond yields will not protect a client’s portfolio sufficiently from the effects of inflation; which will erode the buying power of the client’s retirement investment portfolio.

Diversification qualities

Long-term retirement investing, like any other portfolio creation, must include growth assets such as equities, because the level of diversification that comes from such a move does have protection qualities.

This fact is highlighted by research done by the Organisation for Economic Cooperation and Development (OECD), which examined the impact of the 2008 global recession in a book called ‘From Crisis to Recovery: The Causes, Course and Consequences of the Great Recession’. Brian Keeley and Patrick Love contributed a chapter in which they noted that pension funds were worth about US$27 trillion across OECD countries in 2007, and dropped by more than US$5 trillion following the crisis. “Around half the funds’ investments were in the property market and corporate bonds and deposits,” wrote Love and Keeley.

In today’s complex global market, the best risk strategy to adopt is diversification and that means ensuring that no asset class – be it property or equities – is too dominant in a portfolio.

Professional advice on retirement planning must be realistic, flexible and closely monitored. Client expectations must be managed carefully and the time horizon of the investment explained. For example, there is an old saying that everybody is an investor or saver, until the markets become volatile and then everyone is a trader.

Clients panic during times of turbulence and forget about their long-term investment philosophy. However, the biggest mistake anyone can make is to be impulsive in their investment decision making, especially when it comes to retirement.

Sticking to strategies

We live in uncertain times but this cycle will correct in time. The most effective way to invest in this environment is, therefore, to remind clients to stick to their investment strategy. The most effective way to structure this strategy is to pre-plan for potential risk and volatility.

While an adviser can never eliminate risk, adopting a goal-based financial planning approach with a realistic outcome-based investing strategy can be beneficial to the client. This approach aims to protect a client from having to make hard decisions around deferring retirement in the event of market losses. It also concentrates on helping clients set clear, deliverable goals, and remove the emotional stress from making investment decisions driven by market volatility.

No matter how close a client is to his or her golden years, an annual review of a retirement investment portfolio is essential. It is the adviser’s responsibility to take the emotion out of the decision making and review process and apply a rational and scientific thought process in helping clients achieve their retirement goals.