Low Risk Investing

Millions of current retirees and baby boomers use conservative investment strategies to minimize their risk of large losses. Their biggest fear is stock market crashes like the ones that occurred in 2000-2002 and 2008. This causes some investors to become too conservative too soon. Many of them do not know there are other types of risks that also impact their financial security during their retirement years.

Two-Edged Sword

On the surface, low risk investing sounds like the way to go for investors who are already retired or are nearing retirement age. But, there are no free lunches on Wall Street. Unless you have so much money you can never outlive your assets, low risk also means low performance and low performance may undermine your financial security.

Retirement Assets

There is also the question of adequate retirement assets. Do you have enough to:

• Retire when you want to
• Live in comfort for all of your retirement years
• Have financial security late in life when you need it the most

Longevity

The main culprit is the risk of outliving your principal. Subtract your current age from 95 and you will see the problem. If you are 55 you have a 40 year investment horizon. If you are 65 you have a 30 year investment horizon. A lot can happen in 30 or 40 years: Stock market crashes, rampant inflation, recessions, interest rate spikes and other financial phenomena. 

Need for Total Return

Your need for performance declines as you age so you can afford to take less risk. But, the need for performance does not go away. For example, you and your spouse may have just retired at age 65. One of you has a 75% probability of living to age 95 so you have a thirty year investment horizon. Your goal is to preserve the value of your assets for thirty years and never run out of income or purchasing power.

What type of return do you need? The above couple may have the following requirements:

• Annual distributions are 4% of their assets
• Inflation is 2% (inflation reduces the purchasing power of their assets)
• Investment expenses are 1.5% (advisors, managers, custodians)
• Taxes on income and realized gains are 0.5%
• They need an 8% annual return just to break even

Types of Investments

Low risk investing has the following investment characteristics:

• CDs, t-bills, short-term notes, money market funds, and short-term bonds
• Blue chip stocks that pay higher dividends
• Real estate equity that has rent rolls
• All investments have a quality rating of A or better

Financial Goals

Your biggest financial risk is not volatile returns. It is not achieving your financial goals. For example, your goals are to never run out of income or principal. Your failure to achieve these goals could be catastrophic. So your number one goal is not low risk. It is making sure your investment strategy will enable you to achieve your financial goals for the lowest possible risk.

Risk & Reward

Watch-out for the following investment scams:

• High performance for low risk
• High income (Promissory Notes) for zero risk
• CDs that produce double digit returns
• Risk free offshore accounts that produce substantial returns
• Claims by advisors that they can time the market to reduce risk

Investment Expenses

Low risk investing puts a major premium on low investment expenses. For example, 10% of your assets are invested in a "safe" money market fund that produces recent returns of 1.5% after all fund expenses are deducted. You are paying an advisor 1% to help you plan your retirement and invest your assets. Your net return is 0.5% which is no where near the return you need to offset distributions, investment expenses, and the erosive impact of inflation.

Paladin says.....

Low risk investing works if there is zero chance you will never run out of income or principal. Even if one spouse is in assisted living that costs $5,000 per month. For the rest of us, we will have to take prudent risk to make sure we produce the net returns we need to achieve our financial goals.