Risk Intolerance Dooms Retirement Savings
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Millions of Americans are unprepared for retirement because of risk intolerance. There are other reasons, too, of course, but I’ll suggest that low-risk investing is a huge one! Risk intolerance has a massive societal cost.
I once read a book where economist (and actor) Ben Stein labeled “risk tolerance” as “institutionalized malpractice.” Before you get excited, let me explain what I think he meant and why it is important.
The idea behind risk tolerance is that each person has a different ability to withstand portfolio volatility. Based on that personal ability, the perfect portfolio would be one that maximizes performance without exceeding the personal volatility limit. Based on that ability, there’s no point in pursuing a more aggressive portfolio posture because the client would suffer too much as prices rise and fall.
My experience (not formal research) suggests that most people are naturally risk-averse. Their risk tolerance starts low and rises as one ages, with experience, education, cultural norms, and success. It also cycles up or down with specific circumstances, the economic climate, and a variety of other factors. But – generally – people prefer less risk over more risk.
This creates a professional dilemma. Risk-free investments aren’t adequate to meet most people’s financial goals. Simply, a lot of people don’t earn enough to accumulate enough for their retirement needs. Retirement years can easily last as long as working years.