Hammering Home the Importance of Managing Risk
Every carpenter has basic tools they use at the start of any job, including a hammer, tape measure and saw, among others. They are fundamental to the work at hand.
Like carpenters, financial advisors also have fundamental tools starting with a risk tolerance analyzer or questionnaire. Retirement plan providers also offer risk assessment tools online.
While different risk assessment tools work similarly, a study from MassMutual calls into question just how effective they are or, at the very least, how well retirement savers understand what those tools tell them.
The MassMutual Retirement Savings Risk Study1 finds that while most retirees and pre-retirees understand the importance of protecting their assets from market volatility, not everyone may understand the risks they are actually taking.
The study reports that 94 percent of pre-retirees and 92 percent of retirees “strongly agree” or “somewhat agree” that it is important to take steps to avoid major stock market losses right before retirement. One in two pre-retirees (49 percent) and one in three retirees (32 percent) are apprehensive about taking too much investment risk, according to the study.
Those findings seem perfectly logical and sound. Retirees and pre-retirees typically have fewer years to recoup stock market losses and are typically advised to pursue preservation over growth when it comes to their retirement investment strategy. Suffering a significant loss of retirement savings due to a market correction of 20 percent or more may irreparably reduce those savings and with it, retirement income.
Yet, 59 percent of pre-retirees and 32 percent of retirees describe their primary investment strategy as focused on either “aggressive growth” or “moderate growth,” according to the study. Thirty-two percent of pre-retirees and 49 percent of retirees characterized their investment mix as a balance between growing and preserving their savings. Only 6 percent of pre-retirees and 18 percent of retirees described their strategy as primarily preservation, the study finds.
Many of those surveyed may be taking more risk than they realize, possibly ignoring advice from their financial advisors or both. Study respondents who worked with a financial advisor (46 percent of pre-retirees; 57 percent of retirees) said their advisor has recommended they change their investment strategy. Of that group, 73 percent of pre-retirees and 88 percent of retirees reported that their advisor recommended that they invest more conservatively.
When study respondents were asked about which of two investment theories they subscribed to – becoming significantly more conservative as they approach or enter retirement, or not becoming substantially more conservative – respondents leaned towards conservatism. But based on descriptions of their asset allocation strategies above, some people may be taking more risk than they realize.
What’s an advisor to do? How can you help clients better understand the risks they face in the marketplace? How can you protect your clients from hammering their thumb when they’re trying to hit a nail?
What may help is educating clients about market risk and how different asset allocations strategies respond to different market scenarios. A stochastic or Monte Carlo simulation of how your clients’ investment portfolio reacts to different market conditions may help him or her better understand the risk dynamics.
When talking to retirement plan sponsors, some promote target date funds or managed accounts as a potentially simple and easy way for retirement savers to not only achieve their goals but to manage their investment risk. Automatically shifting assets to more conservative investments as investors approach or live in retirement may help ameliorate risks from volatile markets.
MassMutual’s research shows that many respondents indicated that target date funds might be beneficial, especially if the investor lacked the discipline or time to adjust his or her investments. Sixty-six percent of pre-retirees and 44 percent of retirees agreed that TDFs would help, according to the study.
Whatever the preference for TDFs, risk should be a critical consideration for both retirement savers and their advisors. TDFs and customized investments may be a good solution for many people to better manage risks, whether they need to take more or less risk, are still working or retired, or simply need a track to run on.
So before you watch clients saw off their financial security by taking too much risk with their retirement savings, help educate them about the importance of asset preservation as they near and enter retirement. Years from now, they’ll be grateful that you hammered home the importance of protecting their assets.
E. Thomas Foster Jr. is head of strategic relationships for retirement plans for Massachusetts Mutual Life Insurance Co. (MassMutual).
1 MassMutual Retirement Savings Risk Study, https://www.massmutual.com/-/media/Files/MM%20Risk%20Study%20Report.pdf
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