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davidlerner.com > Budgeting  > How to Manage Longevity Risk and Inflation in a Volatile Market

How to Manage Longevity Risk and Inflation in a Volatile Market

The market environment has been highly volatile through 2022.

Stocks and bonds, historically known to be negatively correlated, are falling in tandem and breaking historical patterns.

The reason for this is that the driver of negative returns is shared by both — sky-high inflation, exacerbated by the war in Ukraine, and concerns that the Federal Reserve will raise rates aggressively to fight the rocketing inflation and push the economy into a recession.

All the major asset classes will struggle in that environment.

Longevity risk and inflation are two of the biggest risks retirees face, meaning they should carefully plan ways to access guaranteed income over the course of their retirement years.

Longevity Risk

Longevity refers to the risk of outliving your retirement savings.

Longevity issues arise as people enter retirement, typically with a fixed amount of money to fund their retirement years (either as defined contributions pensions or a lump sum) but with no idea of how long they’ll live and, therefore, no idea how long their money needs to last.

If you don’t receive a lifetime pension, longevity risk is a function of two unknowns:

  • How long you will live
  • How investment markets will perform over that period

Longer life expectancies lead to increased longevity risk, the biggest financial threat according to recent research from Boston College’s Center for Retirement Research.

According to CDC’s National Center for Health Statistics (NCHS), life expectancy at birth in the United States is 76.1 years. Life expectancy at birth for males in 2021 was 73.2 years and 79.1 years for females. These CDC statistics are averages, meaning some people don’t live that long, and others live much longer. Crazy as it may sound, your time in retirement could last longer than your time in the workforce.

The high life expectancy at birth is due to declining death rates at all ages. Advancements in medicine and safety, plus a reduction in some risk factors, have contributed to Americans living longer.

NB: There has been a shift away from Defined Benefit pensions in favor of Defined Contribution plans. This shift is shifting responsibility for managing longevity risk to the individual.

Inflation

Planning for retirement income doesn’t just mean the risk of living longer but also preparing for potential surges in inflation and market downturns.

Inflation, which is presently running at levels most Americans haven’t seen in their adult lifetimes, is pushing negative consumer sentiment.

Beginning retirement in a down market means withdrawing from a dwindling nest egg.

Having a high proportion of your investments in equity-like instruments means you can suffer a direct hit that can impact your nest egg for your entire retirement.

For instance, if your nest egg was just sufficient to create an expected lifetime income using the conventional 4 percent drawdown rule, you could go from a position of having enough retirement funds for the rest of your life to falling short in less than a year.

How to Manage Inflation in A Volatile Market

Laddering can be an excellent strategy for using an annuity in a rising interest environment. Annuities are typically offered in multiple lengths — 3, 5, 7, 10, even as long as 15 years, allowing you a lot of flexibility in how you create a ladder.

For example, you could ladder a series of 3-year annuities or a series of 7-years. Doing this will offset some inflationary risk and turn accumulated savings into a continuous income stream.

It would also help if you considered balancing your portfolio during periods of volatility. You need to ensure that your asset allocation remains in sync with financial goals.

While income and objectives for retirement are not likely to have shifted, the allocation of assets to reach those goals may well have because of shifting valuations. Your risk tolerance also needs to remain in focus.

How to Manage Longevity Risk in A Volatile Market

Longevity presents a critical risk of living to very advanced ages with depleted financial assets.

This risk can be managed by setting and fine-tuning the underlying investments, asset allocation, and the amount of income drawn annually from the pension.

Accumulating adequate savings throughout your working life is crucial. A product that protects against longevity risk is a lifetime annuity or pension.

Unlike account-based pensions, a lifetime annuity isn’t exposed to market returns and, as a result, doesn’t suffer when there’s a downturn in the market. This means that a lifetime annuity provides a guaranteed income stream for life.

However, despite the certainty, these are unpopular as the rate of return is locked in at the time of purchase.

Conclusion

Instead of focusing on day-to-day volatility, stay the course and don’t panic — focus on the things you can control. Make sure that you’re invested correctly based on your goals.


IMPORTANT DISCLOSURES

Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. 

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. 

Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable– we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances. 

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