Two Factors Often Overlooked in Retirement Planning
There are myriad articles, booklets, toll free numbers and well-meaning friends with “guidelines” for retirement. In most instances, these sources are not the best for sound retirement financial planning. Experience dictates that we follow a systematic process of setting money aside for our later years, since it’s been made very apparent that social security benefits or a company retirement plan alone won’t make us very comfortable. Additionally, most discussions about retirement planning will include the aspect that we shouldn’t try to do this alone; some professional advice and certainly structured investment vehicles such as mutual funds and savings certificates are generally the foundation of a good plan. Therefore, assuming an understanding that we need to save for retirement with some professional guidance, what influences are often overlooked?
The two factors are emotional interference and risk tolerance. The existing literature regarding emotional issues and retirement focuses almost entirely on emotions that hit at retirement. The drastic changes in daily routines, responsibilities, and free-time on our hands, for example. However, there is typically no discussion regarding the emotions triggered by the fluctuations in the value of retirement accounts during the many years before retirement. If you’ve thought through the process toward retirement and have selected capable assistance (e.g. financial planner, reputable mutual funds) then you’re able to eliminate the ongoing fears and concerns regarding your finances. I often use the example of people going on line almost daily looking at their accounts, or watching the mail for monthly statements, and reacting with fear or sorrow at any dip in the value of the account. Often, this emotional reaction causes us to change our strategy or investment mix with a knee jerk reaction and ultimately these are costly mistakes.
Emotional interference is closely related to risk tolerance. Risk tolerance should be determined by the time remaining until retirement, not by the day-to-day or even month-to-month fluctuations in the retirement account value. A 25-year time horizon before retirement would dictate a higher level of risk tolerance and therefore a portfolio with more common stocks than cash instruments such as bonds or CDs. If we have only 5 years until retirement, we have less tolerance for risk and therefore the portfolio would be more heavily weighted in cash instruments. Often people are too conservative with their investment allocations when they are very young. They choose “safe” investments with much lower returns and don’t maximize their potential by using an allocation with a greater risk exposure. Conversely, more mature people with a few short years until retirement may choose very risky investments to “catch up” to their anticipated retirement needs. Neither method works very well.
A keen awareness of emotional interference and risk tolerance will serve you well in achieving your retirement financial goals. By taking the emotion out of investing, you put yourself in better position to succeed.
Article written by Patrick Catania