PRIM Quiz

Retirement Income Risks and your Personal Style

In this quiz, we are going to take a deep dive into understanding each of the retirement income risks, assess your emotional reaction to them, and then determine your Personal Risk Style. This will help you build a PRIM that is both financially fulfilling and emotionally comfortable throughout your retirement journey.

LONGEVITY RISK

Longevity Risk creates the fear of outliving your income.

Living beyond your income can have severely adverse effects on your lifestyle, sense of independence, and emotions. It could mean having to live with your children, being supported by the government or outright homelessness. The loss of independence can be quite embarrassing and emotionally difficult to acknowledge.

We all know that people are living longer. Back in the 1950s for example, people did not need much retirement planning. During those years, when someone retired at age 65, their expected lifespan was only another seven years or so. It’s not terribly difficult to plan for just seven years in the future, and most people simply made-do. In the 1950s there was little fear about outliving your income.

The retirement planning picture today is quite different. A person retiring at 65 is expected to live well into their 80’s, and possibly longer. The fastest growing population in America is people living beyond age 90. If that turns out to be you, a retirement of 25 to 30 years is not out of the question.

Under the best of circumstances, managing retirement income for that long is quite challenging. In fact, 41% of CPA financial planners say running out of money is their clients’ top concern, including clients who have a high net worth.

And it doesn’t end there.

Further research reveals that 61% of people between the ages of 44 to 75 fear running out of money more than they fear death.

Which Do You Fear More?

What does this all mean? Almost everyone is subject to Longevity Risk.

Now it’s your turn.

Take a moment and ask yourself what your life would be like if you prematurely spent-down your money and saw your income disappear while you were still quite healthy.

How would you feel if you lost your independence? What if you had to rely on family, friends, or the government for assistance? What if you had no choice but to cut back on all the things you enjoy, like travel, restaurants, movies, and music?

Not Fearful Very Fearful
1 2 3 4 5

My Longevity Fear Ranking:

INFLATION RISK

Inflation Risk results in the fear of loss of lifestyle (quality of life) because your income will not keep up with increases in the cost of living. When income falls behind the rate of inflation, the amount you can buy for each dollar goes down leaving you with two choices:

  1. Cut back on your expenditures, which means your standard of living goes down.
  2. Deplete your savings to make up the loss of purchasing power, which then opens the door to another risk: Excess Withdrawal Risk (discussed next).

How Inflation Affects Purchasing Power

Inflation risk is slow moving. It eats away, little by little, year after year, at the value of your money. Many people hardly notice, until one day they wake up and realize they can’t afford to buy the same items because things have become so much more expensive.

Let’s look at this another way. If an item costs $1 today, it would cost $1.05 after one year of 5% inflation. However, after ten years of 5% inflation that same $1 item would cost nearly $1.63 due to compounding.

The chart below shows what things could cost in the future:

Most people are concerned about inflation, but rarely do they describe it as ‘fear’, the way they would describe running out of money or experiencing a potential stock market collapse. Nevertheless, inflation’s long-term effects can be devastating.

Okay, now it’s your turn again.

Take a moment and ask yourself what life would be like if your income did not rise to offset inflation.

Would you be concerned if you found yourself unable to afford the things you enjoy? Would you feel pressure or anxiety every time you went to the store? Would you make substitutions and buy cheaper versions of things you like?

On a scale of 1 – 5, where 1 means you have absolutely no fear attached to this issue and 5 means that it is off the charts, where would you put yourself?

Not Fearful Very Fearful
1 2 3 4 5

My Inflation Fear Ranking:

EXCESS WITHDRAWAL RISK

Excess Withdrawal Risk results in the fear of running out of money as assets deplete at a much higher rate than planned. When people do run out of money during retirement, it is not uncommon for them to suffer emotionally as they lose their identity, sense of well-being and sense of independence. Add to that embarrassment and the stress of being forced into difficult choices for self and family, it is no wonder that the fear associated with this risk comes as no surprise.

Imagine this: you and your partner are stranded on a desert island with a bottle of water and two cups. You stumble on a magic lantern during your search for food. Upon rubbing the magic lantern, a genie appears! He tells you that he will come on a regular schedule to refill your water bottle, however he has certain rules:

  1. You drink two cups of water a day, enough to sustain yourselves comfortably.
  2. He will only add two cups of water to your supply each time he comes.
  3. If there is no more water in the bottle he will not add any water at all.
  4. If you want, you may drink more than two cups of water, but if the bottle is empty, he will no longer come.

You and your partner follow the genie’s directions and drink only two cups of water a day. You find that you live well and the genie appears every day to refill the two cups of water. Life is good and you always have a full bottle of water.

Soon, however, a rare heat wave arrives at the island and it gets much hotter than you can bear. The heat is so unbearable your heads throb and sweat begins to pour out of each of you like an open faucet. As your thirst goes through the roof, you realize that you can no longer sustain yourselves sharing two cups of water. You need to drink more to survive, and you do. Now, every time the Genie appears, despite the refill, you see the level of water in the bottle slowly diminishing.

Then one day your partner falls ill and his temperature skyrockets. He needs to drink even more water to hydrate and to keep the fever down. Without realizing it, and with no other choice, you give your partner the last drops of water from the bottle. Then it hits you both— no more water. And, no more Genie!

Imagine if that were you and your loved one on the island. How would you feel at the moment of realization that things are not going to work out too well for you? It would probably be devastating, wouldn’t it?

Excess withdrawal risk works the same way as our desert friends’ water. In a perfect world, each time you withdraw funds from your investments for income, your money will replenish itself and grow back to its original level.

Unfortunately, if you begin taking larger withdrawals due to inflation or an emergency, your money will not have the time necessary to fully replenish. Like the bottle of water in the desert, your money will eventually run dry. When that happens, your income (your two cups of water) will run dry as well.

Excess withdrawals can hide under your financial radar, until one day you wake up and realize you are about to run out of money. By then, of course, it’s too late to fix the problem. Running out of money due to excess withdrawals from your investments will not end as badly as the story, but it will change your life, always for the worse.

In the illustration below, look at how quickly assets deplete as the withdrawal percentage increases.

Excess Withdrawal and Rates of Asset Depletion

Again, it’s your turn.

Take a moment and ask yourself what your life would be like if you began taking excess withdrawals and saw the level of your assets dropping month after month.

Would you continue to live life as normal? Would you be nervous watching your assets deplete faster than expected? Would the prospect of running out of money put stress and pressure on you and your loved ones?

On a scale of 1 – 5, where 1 means you have absolutely no fear attached to this issue and 5 means that it is off the charts, where would you put yourself?

Not Fearful Very Fearful
1 2 3 4 5

My Excess Withdrawal Fear Ranking:

SEQUENCE OF RETURN RISK

Most people understand Market Risk; the fear of losing money when the stock market declines. However, few people understand Sequence of Return Risk; the risk of taking systematic withdrawals from investments when the market is declining. Taking withdrawals by selling assets when the market is falling is a bad idea in most circumstances because:

  1. You are compounding a loss by selling shares when the market is low.
  2. When the market recovers, you have less assets available to take advantage of the recovery.

Taking withdrawals by selling assets when the market is falling at the beginning of your retirement years (the sequence of negative returns is working against you) is an especially bad idea. Why? Research shows the likelihood of an early depletion of savings rises dramatically.

Let’s say you retire at age 65 and start taking withdrawals from your market- based 401(K) to produce retirement income. If the market goes up 5%, and you then withdraw only the gains, your principal remains intact.

However, if the market goes down 5%, not only have you lost principal, but you still must make a withdrawal for your needed income. This further compounds your losses by forcing you to take out additional principal. The market did not provide a good “sequence” of return for you.

Below is a comparison of how positive and negative sequence of returns can affect retirees. In the example, both investors begin with the same asset value: $250,000. They experience the same average growth rate of 6.6% over a 30-year period. As a matter of fact, they have the exact same returns, just in reverse order. They also withdraw the same amount of money each year ($12,500 inflated by 3% for inflation).

Investor A experiences an unfortunate sequence of returns in the first three years by enduring negative market returns. Investor B experiences the same losses, but not until the last three years (a fortunate sequence). As you can see, Investor A runs out of money by year 17; Investor B still has assets remaining after 31 years.

Return Sequencing Results (Success or Failure)

Sequence of returns can be a true ally, or it can be the reason your income fails you in retirement. The problem, of course, is that no one can predict when the market will decide to tumble! This is why building a PRIM using only a market-based Variable Income Driver is not for the faint-hearted.

Your turn again.

Take a moment and ask yourself how you would feel if you experienced both market losses and an adverse sequence of returns early in retirement.

Would you feel comfortable taking a withdrawal out of a depreciating asset? Would you have confidence that your portfolio would bounce back? Could you sleep at night if you were making withdrawals and experienced another market decline like we did in 2008?

On a scale of 1 – 5, where 1 means you have absolutely no fear attached to this issue and 5 means that it is off the charts, where would you put yourself?

Not Fearful Very Fearful
1 2 3 4 5

My Sequence of Return Fear Ranking:

IDENTIFYING YOUR RISK STYLE

Now let’s add up your fear rankings and identify your risk style:

Longevity Fear Ranking

Inflation Fear Ranking

Excess Withdrawal Fear Ranking

Sequence of Return Fear Ranking

Total

You're a Risk Taker

You have ice in your veins, and risk doesn’t seem to have much of an emotional effect on you.

A Risk Taker jumping over a gourge seperating two cliffs

Risk Takers embrace risk. The upside potential and the excitement that risk brings with it all serve to outweigh any fear of danger or loss. If they fall, it’s no problem. They just pull themselves up and try again. These risk takers like to wing it and sometimes the ride is more important than the results.

You're a Risk Avoider

Risk is not your cup of tea. If you see risk coming, you prefer to move in another direction.

A Risk Taker jumping over a gourge seperating two cliffs

Risk Avoiders march to a different beat. These types simply do not like the downside. They fear making mistakes that may hurt them in the future. Risk stresses them out.

You're a Risk Manager

You are willing to take managed risk but are careful about it.

A Risk Taker jumping over a gourge seperating two cliffs

Risk Managers figure out how to take measured risk. This may be uncomfortable for them, but they understand it may be in their best interests. Balance is the keyword for risk managers.

Each PRIM uses a specific technique by which its drivers produce income.

  • Risk Takers use some type of Systematic Withdrawal technique such as a percentage of assets.
  • Risk Avoiders use a Flooring approach which guarantees a floor of income to assure that certain expenses are always covered.
  • Risk Managers use a Bucket System and employ a combination of techniques whereby each bucket creates income for specific periods of time as you age.

Each technique works differently and each has its pros and cons. In my book, The Perpetual Retirement Income Machine, we explore each technique and explain why each caters to a specific Risk Syle.

Contact us today to see how your Risk Style will help define your retirement plan

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