Understanding and Mitigating Risks in Retirement Plans

A comprehensive and well-oiled retirement plan is critical because it can assist an
employee in avoiding running out of cash after retiring from active employment, especially
considering that bonuses and salaries will no longer be coming every month. A good plan can
help individuals estimate the returns they can make on their investments, what risks lay ahead,
how much risk they should shoulder, and how much money they can securely cash out from their
portfolios. An effective retirement plan can allow a retiree to be financially stable, live a
comfortable life after getting out of employment, and attain retirement goals. As a retirement
planning exercise, my goal in this memo is to elaborate on the financial and risk considerations
that go into planning for retirement. Specifically, I will break down the discussion into six major
areas: (1) the important factors to consider when developing a retirement plan, (2) the
relationship between risk and return and its effects on decisions about saving for retirement, (3)
how risk factors influence asset allocation, (4) how fiscal and monetary policies might affect
retirement plans, (5) how changes in monetary and fiscal policy can impact retirement plan
savings, and (6) the implications of the time value of money with respect to saving for
retirement.

1. The important factors to consider when developing a retirement plan
   Planning for retirement is an intricate process that requires an individual to consider a
   broad array of factors, not just those related to finances but all aspects of life. This includes life
   expectancy, health, number of dependents, marital status, age, and other income sources one has,

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such as pensions and social security. For example, an individual’s age can determine the amount
of income available and the type of investment decisions one can take. Young adults (21-35
years) might not have adequate income to invest because they have just gotten into employment.
However, they might have ample time to make smaller investments and see them mature, an
integral and valuable element of retirement savings. This can be explained using the compound
interest principle. Ideally, compound interest allows people (those in employment) to cash in on
interest, and the more years one has, the more interest they can earn. Even if one sets aside $500
a month, it will be four or five times more if one invests at 30 or 45 years than wait to start
investing at 45 years. Contrarily, early- and midlife (36-50 years) comes with multiple financial
strains, including credit card debt, family health insurance, insurance premiums, student loans,
and mortgages. This can limit the amount of investment one can make (Anderson, 2021).

2. The relationship between risk and return and its effects on decisions about saving
   for retirement
   The risk-return tradeoff must be considered deeply for any investment decision
   involving retirement savings. The big question is: how much losses or risk is one willing to
   shoulder? It is everyone’s wish to have a secure and long retirement and, to that effect, tend to
   save and build up an allegedly secure investment portfolio over time. However, in today’s tech-
   savvy, globalized, and unpredictable markets, one faces multiple risks that can disrupt those
   retirement earnings and savings, diminishing expected returns. These risks, among others, can
   include market volatility, low-interest rates, government policy uncertainty, sequence of returns
   and withdrawal timing risks, and increasing longevity. Therefore, it is integral for an employee
   planning for retirement to consider the relationship between potential risks and the expected
   return on investments (Wong et al., 2018).

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For example, one must conduct market due diligence and make informed decisions
about whether investing in a particular industry might be beneficial in the long run. This includes
forecasting things like interest rates in the future. Two or three decades ago, people could
comfortably depend on fairly predictable and substantial interest rates to stack their savings.
These interest-bearing investments ranged from purchasing government bonds (Treasury bonds)
to classic bank savings accounts. These old-fashioned savings modalities were attractive because
of their perceived stability (and they still do). Upon retirement, savers could rely on such
interest-earning savings to guarantee income. According to Wastler (2021), this made sense
twenty years ago because interest rates stood at 4%. But a drop in interest rates to between 1-3%
within the last two decades means, coupled with inflation, means that savers can no longer rely
on these factors. The situation might even worsen in the future.

3. How risk factors influence asset allocation
   Asset allocation is a critical factor to consider during retirement planning. It entails
   deciding where to invest or limit money in the market. Asset allocation involves balancing risk
   and returns or rewards by apportioning or allotting an individual’s assets based on personal goals,
   investment horizon, risk tolerance, and available investment capital. As an investment strategy,
   asset allocation considers how individuals can effectively and meaningfully distribute their assets
   – cash and equivalents, fixed-income, bongs, and stock/equities – to minimize risk and maximize
   returns. However, before making any investment, one must understand each asset class’s
   different types of risks. In other words, the way one allocates assets in cash equivalents, bonds,
   and stocks – which are the primary investment determinants – significantly determines the risks
   they are willing to absorb and, ultimately, the returns. For example, when deciding to invest in

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bonds, one must consider potential risks associated with such decisions, including inflation rates,
interest rates, the issuer’s ability to repay debts, corporate credit ratings, and low liquidity.

4. How fiscal and monetary policies might affect retirement plans and savings
   Whereas one might perfectly figure out the right markets or places to allocate their
   assets, changes in fiscal and monetary policies might wipe out or increase their savings and
   earnings. Therefore, an employee must highly consider federal and state fiscal and monetary
   policies before making their retirement investments plans because they can significantly impact
   how much their savings will earn or be worth. Interest rates, inflation rates, tax rates, and saving
   policies like 401(k)s and IRAs are some of the important fiscal and monetary regulations to
   consider (Investing Basics, 2015). For example, higher inflation rates can significantly wipe out
   personal savings in several years. An investment of $100, at a 3 percent inflation rate, will be
   equal to $67.3 in two decades. This represents a loss of nearly 30 percent of the investment’s
   value.
   Equally, an employee’s tax bracket, income level, and available tax-deferred retirement
   savings modalities can significantly determine how much retirement savings one can make. By
   optimizing their pre-tax payments to IRAs (Individual Retirement Accounts) and employer-
   sponsored 403(b) or 401(k) plans, one can capitalize on the tax-deferred benefits of these plans.
   The benefit of 401(k) plans is that employees can raise or match their investments to a specified
   amount allowed by their employer. For instance, if one makes a 3% contribution of their yearly
   income to their plan, their employer can deposit an equivalent amount to their retirement
   accounts. This accounts for a bonus of roughly 3%, which can multiply in a few years.
5. The implications of the time value of money with respect to saving for retirement

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In the simplest terms, time-value-of-money shows the disparity between the future and
the present value of money. The concept is integral for individuals planning for their retirement
because it helps calculate whether the money held at the moment can return a higher value.
Estimating an investment’s present/current and future value, the concept considers multiple
variables, including the rate of return or interest rates and the number of years and compounding
periods. The following formula is used to calculate the time value of money.

Understanding an investment’s future value is integral for retirees. This information can
help them understand how much an investment might earn or be worth in the future. For
example, an investment of $800 at a 5% annual interest rate might be worth %1,023.03 in five
years. The $800 investment might earn an individual $49 in five years (Zimmermann, 2022).
These statistics can help an employee planning for retirement estimate the worth of their
investment in the long term.

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References

Anderson, L. M. (2021). 7 key factors to successfully creating the retirement you deserve:
Beginners guide to starting early, financial planning, investing well, and traps to avoid.
L.M Anderson.
Investing Basics. (2015). Financial planning and analysis guide book for beginners: Planning
your financial future. CreateSpace Independent Publishing Platform.
Wastler, A. (2021, May 10). 5 retirement risks and what to do about them. Mass Mutual.
https://blog.massmutual.com/post/five-retirement-risks
Wong, R. S. (2018). Saving for a better retirement: How risk attitudes affect choice of
retirement. Psychological Reports, 122(1), 305-322.
https://doi.org/10.1177%2F0033294118755093
Zimmermann, S. (2022), May 9). Time value of money (TVM). Annuity.org.
https://www.annuity.org/personal-finance/investing/time-value-of-money/