Baby Boomers have seen traditional pensions frozen or discontinued, job security threatened, 401(k) balances rocked by booms, busts, and financial crises, and health care costs skyrocket dizzyingly. Their response has been broadly characterized by inertia. No surprise there; people don’t handle ambiguity very well, and many avoid it whenever possible, even to their future detriment.
Retirees have always felt financial pressures, though the mix of traditional and contemporary forces they face today is new. And preparation is even more essential in order to sustain longer retirements through even severe market downturns.
We have identified four forces that can do a number on an investment portfolio:
- Longevity risk, the threat of living longer than you expect.
- Inflation, which can erode purchasing power and real returns.
- Market volatility and its impact on portfolio growth.
- Abandonment risk, as investors flee certain strategies at the wrong time.
According to the Center for Retirement Research at Boston College, 53 percent of working households believe their ability to maintain their current lifestyle in retirement will be at risk. The reality of longer life spans, ongoing inflation, and volatile financial markets can be a tremendous drain on investors’ assets during retirement, unless they can implement the right investment strategies to see them through.
These strategies – all with particular risks that should be considered before investing – might include a blend of dividend-paying stocks, including real estate investment trusts (REITs) and MLPs (Master Limited Partnerships), high yield and emerging market debt, and preferred securities to provide potential income while balancing the risk across these asset classes. TIPS (Treasury Inflation-Protected Securities), real assets such as real estate and commodities, and bank loans have inflation-hedging characteristics that may protect purchasing power.
Finally, there is something that many people might think is only available to institutions and the affluent: hedge funds. Hedge fund strategies are now available to average investors through mutual funds. Called liquid alternatives, these funds can have lower fees, better transparency, and the liquidity of mutual funds. They may help investors smooth the ups and downs in the financial markets.
Your financial professional can help you understand these four important risks and build a plan to help keep them at bay.
Asset allocation/diversification does not guarantee a profit or protect against a loss.
Fixed-income investment options are subject to interest rate risk, and their value will decline as interest rates rise. Lower-rated securities are subject to additional credit and default risks. International investing involves increased risks due to currency fluctuations, political or social instability, and differences in accounting standards. REIT securities are subject to risk factors associated with the real estate industry and tax factors of REIT registration.
A Master Limited Partnership (MLP) that invests in a particular industry (e.g., oil and gas) may be harmed by detrimental economic events within that industry. As partnerships, MLPs may be subject to less regulation (and less protection for investors) under state laws than corporations. In addition, MLPs may be subject to state taxation in certain jurisdictions, which may reduce the amount of income paid by an MLP to its investors.
International investing involves increased risks due to currency fluctuations, political or social instability, and differences in accounting standards.
Risks associated with preferred securities differ from risks inherent with other investments. In particular, in the event of bankruptcy, a company’s preferred securities are senior to common stock but subordinated to all other types of corporate debt.
Investment risk may be magnified with the use of alternative strategies; liquid alternatives are subject to market risk. When using hedging strategies investors should not expect significant outperformance during market rallies. It is possible to lose money when investing in mutual funds.
Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.