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April 21, 2013

Facing the risks of retirement

(Continued)

While there are no guaranteed hedges against future inflation, exercising good judgment when estimating the size of the nest egg needed, determining the investment mix, and adjusting fixed income sources such as pensions to reflect their after-inflation value can go a long way to mitigating its damaging effects.

Public policy risk encompasses the potential hazards that underfunded private and public pensions, federal and state budget deficits, and unsustainable trajectories of Social Security and Medicare pose to all Americans, especially those facing retirement.

It is difficult to imagine a scenario where benefit cuts and increased taxes are not part of the solution to these large and difficult problems. This means that retirees should be prepared to pay for more of their retirement costs than previous generations.

Unexpected retirement costs risk is the threat posed by large, unplanned expenses such as those related to health care needs, special housing requirements, and providing financial assistance to family members who may have experienced a change in health, employment or marital status.

Market risk is the danger that poor investment returns, particularly in the early years of retirement, can cause permanent damage to a portfolio. The ebb and flow of the financial markets has little impact on the investor who is regularly adding to the portfolio. In fact periodic market downturns can be beneficial, because the resulting share price declines allow for the purchase of more shares that have the potential to grow over time.

However, once the investor begins taking systematic distributions, as many retirees do, the combination of poor returns and the withdrawals present a serious risk. More shares must be sold at lower prices in order to raise the funds to cover spending needs. These shares are then permanently removed from the portfolio and thus cannot benefit when the market eventually rebounds. The earlier in retirement this occurs, the greater the damage to the portfolio. Conversely, strong investment returns during the early years of retirement reduces the chance that the assets will be depleted prematurely.

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