Understanding risks in the Retirement Economy | Jim Hebert

The Retirement Economy will follow the “New Economy,” which existed for the past three decades. The New Economy was based on one assumption upon another. For example, the values of real estate and equities will to continue rise. Time will turn risky loans into solid assets through market appreciation. The 401K portfolios will be well managed by professional investment managers and investors will be at minimal risk, if any.

The underlying operative theory behind risk is probability. The higher the risk, the higher the probability that a substantial loss will occur —therefore, the need to offset the higher risk with a higher returns. But this fundamental economic principle was replaced with the “new method” assumption that high returns with low risk can be sustained when the risk is not disclosed, truly unknown and in essence hidden.

How was this done? Much occurred through the complex packing and selling large portfolios of credit card receivables, installment loans, mortgages and even commercial loans within the market at ever-increasing prices. The identity of the individual loan quality was lost through the packaging and selling process, and in fact, over the past two years the real values were substantially overstated. “What is concealed will be revealed,” and that is exactly what continues to happen within the financial markets underlying the Great Recession.

The Retirement Economy is based on the “age of wisdom.” Experience, knowledge, understanding and trust have clearly replaced mere assumptions. In response, those individuals nearing or in retirement have significantly changed their attitudes toward risk tolerance.

The current research conducted by Symetra, Gallagher, Senior Services and Hebert Research discovered this trend. In just the past two years, 24.1 percent of those retired or planning to retire changed their high-risk investment strategy to one of lower risk with more guarantees. The result is that a reduced total risk tolerance prevails among 67.4 percent of the retirement market.

The continuation of a movement to lower returns and lower probability of loss will have a profound effect on the financial community. Here are some of the important research findings driven by this concept:

Income after retirement declines significantly. Before retirement 21.1 percent of households earned more than $100,000 per year, but this percentage declines to 10.6 percent for retired households. In contrast, the proportion of households earning less than $50,000 per year increased from 32.9 percent to 69.9 percent after retirement.

One possible hypothesis is that those planning on retiring with substantially lower expected incomes would “make up time” with higher returns at a higher risk. However, the lower risk tolerance is not statistically different between retired and working households. So, it is not just the current Baby Boom population affected by this changing risk environment, but post baby boomers as well.

An estimated 71.3 percent of those retired expect their expenses to increase, mostly through higher medical costs. This will cause a long-term constraint in consumer spending — not what the future growth of the GDP needs.

Jim Hebert is the president and founder of Hebert Research, Inc., an international real estate, land use, and statistical research firm in Bellevue.