Types of Risk

Dec 19, 2018

You may have heard of a few types of financial risk, but how well are you taking them into account? On this episode, Isaac discusses five different types of risk that you should be aware of and how best to incorporate those unknowns into your retirement plan.

Here are just a handful of the things that we'll discuss:

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Transcript

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John Stillman: Hello, and welcome to Wright Money Tips, with Isaac Wright, the president of Financial Dynamics and Associates, author to Navigate Your Way to a Secure Retirement, and chartered financial consultant. You can get in touch with the team at Financial Dynamics by simply calling 804-777-9999.

John: Isaac, always a pleasure to talk with you, and we're talking today about five types of risk. Five types of risk that you need to be aware of in your financial planning.

John: The first risk we're going to talk about today, is bungee jumping. I'm just kidding, that's not the first risk, that's a different category of risk that we're not covering today.

John: The first type we're talking about today, is probably the type of risk that most people think about when they think about risk, when it relates to their money, and that's market risk.

Isaac Wright: Yeah, sure. When you talk about your money, especially money that you have invested for your financial future, your retirement, we want to make certain people fully understand as they go into, and get close to, or even through their retirement years. That when we hear the word risk management, or understanding your risk, and we've had many shows on this, we wanted to dedicate a little bit of time to the types of risk there is out there.

Isaac: This is not a fear monger topic of conversation, we simply want to educate you up, and these are things that we evaluate when we're creating a plan for a family.

Isaac: Number one, market risk. This is what most people think of when they look at the stock market everyday, and most people understand that it's easy to know that the market's not going to stay stable every day. So, depending on how much money you have in the market, you gotta keep in mind that you have to be willing to tolerate a lot more fluctuation in the account value that you have in the stock market. And, potentially, even the income that's being generated from those investments.

Isaac: So, dividends have be cut, you may have a situation where stocks are sold or spun off. There's a lot of risk involved with owning money in the stock market, from a standpoint of having to deal with that level of volatility.

John: So that's an important risk to understand, although most people are aware of it, they don't really understand how market risk works.

John: Another one that people don't really think about, Isaac, is interest rate risk. And you say, what's the risk associated with interest rate? I don't borrow money anymore, I'm retiring, I no longer have a mortgage. The only thing that interest rates affect me on is how much money I'm getting in my savings account at the bank.

John: But there are some effects that interest rates create in your portfolio.

Isaac: I think most people, again, know about market risk, but interest rate risk is, actually, pretty important right now. As interest rates go up, it can have a significant impact on the actual value of some of the other investments you own, specifically, bonds.

Isaac: Typically, in bonds that you're owning in your portfolio, or if you own a bond fund, those funds can be under a lot more pressure as interest rates go up. Bonds typically move in the opposite direction of interest rates. If interest rates go up, the actual value of your bond goes down if you try to sell it.

Isaac: Also, just one other thing, we're finding many people have money sitting in money market accounts that are still paying less than 1%, savings accounts that are paying that are still paying less than 1%. Many places right now, we can help advise you on this, are paying 3, 3 and a half, up to 4% right now. Again you're taking on, what I call an interest rate risk, in the fact of, maybe having money that you don't necessarily need, sitting in checking and savings, that could be making more money for you in other places.

John: That's interest rate risk. Be sure you're aware of interest rates affect your investments.

John: How about longevity risk? I think longevity risk. You say, what's the risk of living a long time? Isn't that we're all shooting for?

Isaac: I think when people start asking the question, am going to run out of money, this is the type of risk that they're focused on, is whether or not they're going to have enough, depending on how long they live. Of course, what used to kill us 20 years ago, is an outpatient surgery and they give you a pill.

Isaac: If you call it morality tables, today the most recent one has actually increased peoples' life expectancy by close to two years, and that's the exact reason why, because we have so many things in front of us today that can keep us alive, but not necessarily the quality of life we may or may not want.

Isaac: Just got to keep in mind that, longevity risk is a significant issue, because we are expected to continue to live longer as we get older, because of medical advances.

John: Yes, we all want to live a long time, but we also don't want to run out of money. I guess it's kind of a risk multiplier, right? Because if you do a bad job of planning in one area or another, if you die at 78, yeah, it might be a problem that you didn't plan so well in some of those areas, but that problem is exacerbated if you live until 98.

Isaac: Yeah, John, that's a pretty good point, and I think that's why people realize. Let's say, for example, for their parents, many people today are in their 60s and 70s and still taking care of their parents, and they had no idea that they would be alive this long. Eventually we may fall into that same boat.

John: How about inflation risk? That's the fourth type of risk we're talking about, here, today, and I think people understand how inflation works, but don't necessarily factor in, from a risk standpoint, as they should, when they're planning their retirement.

Isaac: I think the issue that we see when it comes to inflation risk, is people understand that the cost for gas and groceries continues to go up. Sometimes where people fall down, when it comes to building a financial plan, is the fact that they're not tracking how their income sources are going to be able to keep up with it.

Isaac: For example, people's social security checks may get a very small cost of living adjustment, nothing close to what's out there in the real world. A lot of pensions, if you're lucky enough to have a pension, you may have a pension that doesn't have any cost of living adjustment.

Isaac: Overall, when it comes to retirement income, and any income streams that you have, you're going to have, probably, some short-comings with certain income streams, and you may be able to offset that with other moneys you've been able to save, and so forth. But when it comes down to a 20 and 30 year retirement, you're starting to look at the things that are going to cost you more than double by the time you go into retirement, versus the time you probably pass on. All the sudden, this is where people start worrying, am I doing to have enough money, and it kind of gets back to longevity risk.

Isaac: You just got to keep in mind that your cost of living, under most circumstances, will continue to increase, year in and year out, and you have to prepare for it.

John: Risk number five that we're talking about today, is kind of amazing, because people have so much angst about taxes, and constantly- hate the idea of paying taxes, love it when we get tax breaks, love saving money on taxes wherever they can. But when we talk about tax rate risk, that's something, it seems like, most people just don't devote any thought to.

John: So, what do we mean when we say tax rate risk, and how does that factor into our plan?

Isaac: I think this is a good one to wrap up on, John. Because, right now, historically speaking, we're seeing some of the lowest tax rates proportionately speaking that we've ever seen for families and individuals. Sometimes, in a way, I try to tell people this as mindset shift, it's sometimes good to go ahead and pay the known tax today, versus the unknown tax of tomorrow.

Isaac: We all know that with Social Security, Medicare, Medicaid, interest on our National Debt, and it's not really getting any better, the likelihood of increasing taxes at some point in the future, is very high.

Isaac: We're lucky enough to have a pretty favorable tax code right now. The tax rate risk, simply is, whether or not you may want to take some of your money and convert it to a Roth IRA, or some other vehicles where you go ahead and pay the tax now, and forfeit, let's call it the unknown, of whether or not you'll have to pay the tax in the future, to whatever degree that may be.

Isaac: All of these things, John, I think it's good to have this conservation about five areas of risk, so when people hear me talk about risk tolerance, and risk evaluations, and anything related to risk, hopefully this gives them a little bit more understanding and depth behind how we view it.

John: That's types of risk you need to be thinking about in your retirement planning. We'll cover bungee jumping and sky diving and all of those things in a separate podcast, that's a whole different category of risk that we'll get to another day.

John: Isaac, always a pleasure. Thanks for your wisdom, as always. If you'd like to reach out to the team at Financial Dynamics and Associates, that number to call is 804-777-9999. That's 804-777-9999.

John: Hope you have a great day, we'll talk to you again soon, right here on Wright Money Tips.

Announcer: Information is for illustrative purposes only, and does not constitute tax, investment, or legal advice. Always consult with a qualified investment, legal or tax professional, before taking any action.

Announcer: Investment advisory services offered through Global Financial Private Capital, LLC.

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