Are You Taking the Right Amount of Risk?

By Northwestern Mutual

When it comes to your money, do you know how much risk you should be taking? If you’re like most people, the answer lies somewhere between “maybe more” and “maybe less,” with a fair amount of “not sure” in between.

Ask around, and you’re likely to get a number of opinions. But how do you really know if you’re taking the right amount of investment risk to adequately save for goals like retirement? And how do you know if you’re not?

According to Michael Finke, professor and director, Retirement Planning and Living at Texas Tech University, the first step toward understanding is to take a comprehensive view of your finances. “Most people associate risk with just a portion of their portfolio,” he says. “They get tunnel vision when they should be thinking bigger picture.”

A bigger-picture view will take your entire financial plan into account. It also looks beyond day-to-day return chasing to long-term gains driven by your plan as a whole. This means your 401(k), IRAs, pension, annuities, mutual funds, life insurance, real estate, business interests – even things like settlements and inheritances – should all be factored in. When they are, the landscape can look quite different from a risk perspective.

For example, say you’re a 50-year-old with a pension and an IRA. If you concentrate only on the IRA and the market dips, you might be tempted to replace your aggressive stocks with conservative bonds, even though you have a pension that serves as a financial cushion. According to Finke, this “investment myopia” can lead to lower long-term returns, causing you to fall short of your overall goals. When you look at the big picture, however, the pension becomes more than just a retirement income source. In a sense, it has your IRA’s back so it can pursue the aggressive returns you need to reach your goals.

This isn’t the only scenario in which a comprehensive approach can help you reframe risk. Say you’re 45 and have a family. As part of your financial plan, you’re investing in your 401(k) and have an IRA and some investments. In addition, you have a whole life insurance policy that you took out to protect your family’s finances if something were to happen to you. On the surface, the retirement account and insurance policy may seem unrelated. But when you consider both as parts of an overall financial plan, things change.

Whole life insurance has a cash value that grows tax deferred, is eligible to earn dividends and is guaranteed to never go down. Owning such an asset may give you some leeway to take on more risk in other parts of your financial plan, like your investments. Because the cash value of your whole life policy can be accessed if you need it, you may feel more comfortable being more aggressive (taking on more risk) with your 401(k), for example.

When you’re ready to retire, the same whole life policy can continue to reframe risk. Let’s say you’re retired, and there’s a downturn in the market. Instead of drawing from your retirement account for income by liquidating investments when the value is low, you can utilize the accumulated cash value, which isn’t affected by market downturns. While using your cash value will reduce your death benefit, it can also help you weather the storm without depleting your portfolio or locking in losses. As the market recovers, you have the option (but not the obligation) of restoring the cash value. In this scenario, whole life insurance represents far more than just a death benefit. The cash value in whole life insurance serves as a unique balance sheet asset that can provide useful financial options throughout your lifetime, but especially during retirement.

The 2008 recession and its aftermath provide a perfect example of this. Many retirees had no choice but to withdraw from their portfolios at the lowest values seen in years, permanently locking in the lost market value. Those with whole life insurance, however, had another option: They could tap their cash value to help meet their income needs instead of selling their investments. And when the markets rebounded in 2009, their portfolios had a chance to recover.

Of course, whole life insurance is just one of many financial tools you can use to help manage risk. Your financial advisor can tell you about a variety of options available depending on your age and financial circumstances. The important thing to keep in mind is that no matter how you evaluate risk, the key is to step back and look at the big picture. The more you do, the more you’ll appreciate the view.

For help with your retirement, insurance or other financial needs, contact your local financial representative Kellie Wright at 585-248-4788 or visit her website.


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