Changing Risks in Retirement, Part Three: Spending, Inflation, and Cognitive Decline

This article is part of a series; click here to read Part 1.

Spending shocks

Unexpected expenses in retirement come in many
forms, including:

  • unforeseen need to help family members
  • divorce
  • changes in tax laws or other public policy
  • changing housing needs
  • home repairs
  • rising health care and prescription costs
  • long-term care

Retirees must preserve flexibility and liquidity
to manage unplanned expenses. When attempting to budget over a long retirement
period, it is important to include allowances for such contingencies.

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Compounding inflation

Retirees face the risk that inflation will erode
the purchasing power of their savings as they progress through retirement. Low
inflation may not be noticeable in the short term, but it can have a big impact
over a lengthy retirement, leaving retirees vulnerable. Even with just 3
percent average annual inflation, the purchasing power of a dollar will fall by
more than half after twenty-five years, doubling the cost of living.

Sequence-of-returns risk is amplified by greater
portfolio volatility, yet many retirees cannot afford to play it too safe.
Short-term fixed-income securities might struggle to provide returns that
exceed inflation, causing these assets to be quite risky in a different sense:
they may not be able to support a retiree’s long-term spending goals.
Low-volatility assets are generally viewed as less risky, but this may not be
the case when the objective is to sustain spending over a long time horizon.
Retirees must keep an eye on the long-term cumulative impacts of even low
inflation and position their assets accordingly.

Declining cognitive abilities

Finally, a retirement income plan must
incorporate the unfortunate reality that many retirees will experience
declining cognitive abilities, which will hamper portfolio management and other
financial decision-making skills. For the afflicted, it will become
increasingly difficult to make sound portfolio investments and withdrawal
decisions at advanced ages.

In addition, many households do not equally
share the management of personal finances. When the spouse who manages the
finances dies first, the surviving spouse can run into serious problems without
a clear plan in place. The surviving spouse can be left vulnerable to financial
predators and other financial mistakes. Survivors often become more exposed to
fraud and theft.

While liquidity and flexibility are important, retirees should also prepare for the reality that cognitive decline will hamper the portfolio management skills of many as they age, increasing the desirability of advanced planning and automation for late-in-life financial goals.

This article is part of a series; click here to read Part 2.

This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon.

 


Originally posted at https://retirementresearcher.com/changing-risks-in-retirement-part-three-spending-inflation-and-cognitive-decline/

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