The approach to invest as a retiree is generally different from that of a younger individual. Each group is in a different phase of life and require different retirement financial choices. They've got different objectives, financial prospects, and, most importantly, different time lines to achieve what they desire financially. These dissimilarities demand distinct risk tolerances for them - and thus different retirement financial options.
As a retired person, don't look to see which fund or stocks did best in the last 12 months. The investments that do best almost always have the most risk (equivalent chance to rise or fall). Instead, you would like any retirement financial option to possess a high 'risk adjusted return," which means, you want the maximum return for an accepted amount of risk, not only the highest return. By selecting retirement financial options based on risk profile, you'll have a more secure portfolio than with a focus on returns. As investment experts know: you CAN control your risk but you cannot control your return.
When you comprehend your tolerance for risk, you will better select retirement financial options consistent with your tolerance. This will allow you to sleep much better - aware that tomorrow you probably will not be destitute. That is because although we prefer to look for big returns, no reward will ever be large enough if the consequences of losing are far too much to bear. Realizing what we can't afford to lose is the first rule of sound retirement investing.
All of us make investments for income and appreciation. More of either is welcomed. But sadly 'more' comes at a risk. Higher retirement investment returns certainly are related with higher risk profiles (in most cases). And greater risk indicates greater chance of loss. Nevertheless, where there is very little or no risk, your effective return - after taxes and inflation - is usually little, none, or slightly negative (if you get 1% at the bank, after taxes and loss of purchasing power, you have a negative return).
Numerous retirement financial options include a published 'Sharpe ratio.' You will notice this number for instance in Morningstar when evaluating mutual funds. Read the description in Morningstar and also you will understand how this is a essential barometer that will help you choose suitable retirement financial options. (the Sharpe ratio is a way to quantity investments that offer the most return for a given amount of accepted risk).
We are able to apprise ourselves of our retirement investment risk tolerance by thinking about our answers to four concerns:
1. Status - What's your present economic situation?
2. Objective - What do you want to accomplish through your investing?
3. Loss level- How much of what you own are you willing to lose searching for higher earnings (note: when we speak of loss, in most cases, investment losses are temporary and not permanent)?
4. How much do you need to earn on investments to meet retirement financial goals
As a retiree, your economic status is determined by your income from social security and/or pension along with what your retirement savings can supply for income. And you're lifestyle is practically set for the duration of your retirement years.
The amount of earnings and wealth you have decides how much you can afford to lose in your retirement financial options -i.e. the amount of fluctuation you can tolerate in your portfolio. If you have only minor savings and little or no pension/social security, all of which you count on for living expenses, you will need a safe profile in any selected retirement financial option. However, if you live comfortably on a pension and social security, you may afford to take more risk, within reason of course, with retirement financial options that can offer a higher return.
However, here's a paradox. If your pension and social security are not enough for your living expenditures, you might have to get a particular return on your retirement portfolio just to make it financially. In that situation, it might be prudent to not opt for the least risky retirement financial options because they won't pay sufficiently to pay your expenses. For example, if you really need to take 6% yearly out of your portfolio and it's all sitting in bank accounts earning 1%, you'll have the problem of eroding your principal over time and outliving your cash. More risk is a retirement investing necessity in such a situation.
The table shows the circumstances and financial risk degrees associated with the four elements that determine your retirement investment risk tolerance. Use your circumstance to each element to see what degree of financial risk tolerance you need to attribute to yourself and also to your retirement financial options.
4 Elements That Determine Your Risk Tolerance
|Element||Low risk||Medium risk||High risk|
|Maintain status||Moderate increase status||Large increase in status|
|Status||Barely Secure||Moderately Secure||Very Secure (comfortable)|
|Loss Capability||Little or None||Moderate||High|
|Need to Earn
||Little or None||Moderate||High|