The Hidden Risks of Playing it Safe

I met recently with a lovely client who is 87 years old. She has received a pension for her 27 years of retirement. We met because she needs to increase withdrawals from her investment accounts, as her pension and Social Security payments are no longer sufficient to cover her day-to-day expenses.

Surely you’re familiar with the idea of inflation. Prices generally rise over time. It’s been a hot-button issue in the political landscape since the post-Covid shock triggered a huge surge in prices of everything from cars to eggs to insurance.

As clients head toward retirement, we talk about the importance of planning for price increases over time. But it’s hard to fully appreciate just how big an impact inflation can have on a retirement that may last several decades.

Where Did it All Go?

Consider my 87-year-old client, now in her 28th year of retirement. Since January 1999, the general level of prices she pays has more than doubled, as measured by the Consumer Price Index (CPI). Her Social Security benefits have received cost-of-living increases, but pension benefits and annuities often do not offer these inflation adjustments.

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So what seemed like a decent pension nearly three decades ago now looks insufficient. If we replicated this pace of inflation over the next 27 years, a retirement pension of $40,000 today will cover only about $20,000 worth of goods in the future. To maintain a consistent standard of living would require an additional $20,000 from investment accounts.

A new pattern is taking shape among today’s new retirees. I meet with many people in their 60s who hold a lot of CDs, money markets, and cash. A common retirement plan is to use Social Security, maybe a pension or part-time work income, plus some withdrawals from these cash equivalents as needed. This may look quite sustainable if current withdrawals from cash are only a few percent.

But the calculus gets more difficult when factoring in price increases. The problem with keeping money in these liquid vehicles is that it doesn’t grow with inflation. The return on cash is maybe 3 or 4 percent today, but it was as low as 1 percent just a couple of short years ago.

As prices rise, the amount needed from cash increases. It may not feel like a big increase from one year to the next but it compounds and becomes a serious issue in the long run.

Choose Your Risk

Many people think they’re avoiding risk by keeping their money in safe CDs. In reality, they are exposing themselves to a new set of risks. The risk that they’ll live a long time and run out of money. The risk that prices will rise and erode their account values. The risk that rising healthcare costs could completely wipe out their savings.

The cost of health care has risen even faster than general prices. During our client’s retirement, medical costs have risen by 140 percent, according to the Bureau of Labor Statistics. The cost of in-home care or a nursing home can run well above $100,000 per year. This costs will erode most savings accounts very quickly. And that 4 percent yield isn’t going to cut it.

The secret is finding a balance between investment risk and these other risks--inflation, longevity, healthcare. I know that many people have had bad experiences with the stock market, but avoiding equities does not necessarily make for a safer retirement strategy. A well-balanced portfolio comprising broadly diversified stocks and bonds has historically provided a far better return than cash. It’s worth reconsidering how much risk you're actually taking on by avoiding the stock market altogether.

Imagining what might happen over the next 30 years is hard for most of us. But take the lesson from our client, who has seen prices rise. She is thankful that she has the investment accounts that will continue to support her lifestyle because she invested in stocks and bonds. Cash served a valuable role in her retirement plan, but she was also willing to take a moderate amount of investment risk. This balanced approach has helped her minimize several other risks as she approaches age 90.

This article originally appeared in The Berkshire Eagle.