The Seeming Irrationality of Unneeded Risk
I might be hitting my head against a brick wall, but it's a rather poor show that "RDQ" gets all the down arrow glory and doesn't share. Maybe I need a few arrows with this doozy of a post.
Let me roll out my pre-retirement risk credentials. I quit a corporate job when I reached the level of director, with lots of stock purchase opportunities, a high salary, and a solid pension package. I left all that to start my own business—a very risky move, but one that was well within my risk envelope.
Before I retired, my portfolio was heavily invested in developed world funds and specialist China and Southeast Asian "special situations" funds. My wife Suzie's advisor nearly lost his eyebrows when he first laid eyes on my portfolio's risk level. I simply shrugged my shoulders; I was totally comfortable with my exposure.
In short, I'm no stranger to financial risk and have a very high tolerance and ability to take it. But here's the thing: I'm now retired and have dialed down my risk level because I simply don't need to stretch for significant growth to support my lifestyle.
A fixed-term annuity is now one of the main planks of my retirement. I still have a very high capacity for risk, but I've deliberately chosen a retirement income and cash flow strategy that gives me what I need at the lowest possible risk, outside of social security. I truly wonder why such a small portion of retirees opt for this choice.
In my mind, once your income goal can be easily met, or once the required growth to support your desired lifestyle is minimal, taking on additional risk becomes unneeded and, therefore, irrational. To reiterate, I still have the financial capacity to absorb losses but no longer need to take those risks to achieve my lifestyle goals. If you're in that position, why would you still take the risk?
I guess it will be a combination of the normal behavioural biases: FOMO People see a rising stock market and worry they are leaving money on the table by locking in a lower, fixed return and Loss Aversion: The idea of giving up control of a lump sum of money in exchange for an income stream can feel like a "loss" to many, even if it's financially sound risk mitigation tool.
When you couple this with a general negative perception of annuities due to complex products, high fees, and stories of unsuitable sales along with the fact many people don't understand the different types (like a fixed-term vs. variable) it is understandable why the entire category might be dismissed out of hand. It must be said I'm not Captain Kirk's sidekick Spock, full of logic and no emotion, when the market goes on an upwards rip, I feel the FOMO just like anyone else!
It's not just behavioral biases at play; even established theory seems to be misunderstood. Modern portfolio theory (MPT) actually supports the use of fixed income products and bond ladders within a retirement portfolio but this seems to be overlooked in favour of other elements of MPT. Here's what I find particularly puzzling: the investment community often portrays annuity purchases as unsophisticated, as if only financial novices would "give up" market upside. This seems backwards to me.
The sophisticated approach is optimizing for your actual situation, not maximizing for theoretical returns you don't need. Once you've won the game and have a strong plan for inflation management, why keep playing with money you don't need to risk? It seems to me to be the opposite of a smart strategy.
Of course, I recognize there are valid reasons some retirees might choose higher risk - perhaps they want to maximize bequests to family or charity, or they're concerned about long-term inflation exceeding what fixed income can handle. These are rational choices for their specific situations.
If you're retired and can meet your lifestyle goals with lower-risk strategies, taking additional risk isn't bold—it's somewhat counterintuitive. The goal isn't to die with the most money possible; it's to live comfortably without worrying about sequence-of-returns risk or market volatility derailing your plans.
Yep, I'll suffer those down arrows gladly because sometimes I think it's refreshing to challenge conventional wisdom just to keep our views flexible and not get stuck in a rut. Occasionally, the most contrarian position is possibly the most sensible one.
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