Over the last week or two, I have had a very similar conversation with two different clients.  They occurred while we were reviewing their investment portfolios and evaluating whether the risk profile and asset allocation we had in place was still appropriate for them.  Both have been very successful accumulating assets during their working years and are entering their retirement years with comfortable nest eggs.  They have been investing for many years, but like many of us, they have been shaken by the turmoil in the markets over the last couple of years.

While trying to determine if we could take some of the investment risk out of their portfolios, they both made almost the exact same comment…”If I liquidated all of my investments into cash, I couldn’t spend it all in my lifetime.”  That’s a nice thing to be able to say.  But is it true?  Maybe.  But they had not considered a few risk factors.  And it is part of my job to point out the risks to their plan.

Longevity Risk

When they said that they couldn’t spend all their money in their lifetimes, they had simply divided their nest egg by their current spending to get the number of years their money should last.   The resulting number of years was more than they thought they would live.  But what if they live longer than expected?

It would be easy to plan our future if we knew just when our lifetime was going to end.  I have often said that the best retirement plan is the one where the check to the funeral director bounces.  That would mean you ran out of money just as you ran out of breath.  But we don’t know when our time will be up, so we have to plan like it is far into the future.  In fact, I usually run a financial plan that shows the client living until they are 95 years old.  Most of us probably won’t live that long, but we would rather plan like we might live to 95 and have some money left for our heirs rather than running out of money before we die.  If longevity is in your genes, we may even run your plan to age 100, or higher.

A recent survey of baby boomers by Allianz Life Insurance Company illustrates the importance of considering this risk factor.  77% of the respondents said that they fear outliving their assets more than they fear death!

Inflation Risk

Inflation hasn’t been a big concern recently.  But over time, even a small level of inflation can greatly affect your standard of living.  When prices go up, you will be taking a bigger piece of that pile of cash each year, just to maintain your lifestyle.  And that pile is supposed to last the rest of your life.  So, if we need that pile to last us 20 or 30 years, increasing prices can have a major effect.

Health Risk

Neither of my two clients who said they could live off of the current value of their assets for the rest of their life considered the effect of health care expenses as they age.  They are both still very healthy.  But, the older we get, the more costly it becomes to maintain our health.  And, if we happen to get sick on our way out, it’s even worse.  It’s expensive, and getting more so, to fight diseases and illnesses.

Most folks in the final years of their life require more assistance and they may move into retirement and nursing homes.  Costs can be substantial.  The average cost of a nursing home in the U.S. in 2009 was $210/day.  And that cost has increased dramatically over the last several years.  It’s easy to see how a couple of years spent in a nursing home can make that pile of cash dwindle pretty quickly.  It is important to note, however, that this risk can be mitigated to some degree by owning long-term care insurance.

So, with the gut-wrenching volatility we have experienced in the investment world over the last couple of years, many people would like to just stop playing the game and “go to cash.”  But when you eliminate risk from your portfolio, you also eliminate potential growth.  If your nest egg is large enough, and your lifestyle is modest enough, you may be able to do so.  But, just make sure you’ve considered all the risks.