If a frog is placed in boiling water, it will jump out. If it is placed in cold water that is slowly heated, it will not perceive the danger and will be cooked to death. This common metaphor can be particularly applicable to retirement-investment risks. While the market volatility of recent weeks fuels banner headlines and makes investors jump, other risks are much more subtle, but just as significant. CPAs can therefore help by elaborating on their clients’ market risk concerns and bringing their attention to overall retirement-investment risks.

Boiling Water

Sharp stock-market downturns make for dramatic news. However, they do not necessarily involve dire consequences for every investor. In their book, Asset Dedication, authors Stephen Huxley and J. Brent Burns point out that “volatility itself does not harm.” They explain that volatility only creates risk when three factors combine:

1. Investment value goes down;
2. Funds have to be withdrawn from the portfolio; and
3. Investments which decreased in value have to be sold to produce the funds needed.

For example, if an investor has a low probability of needing funds from stocks within five years, a three-year stock-market downturn today would not present a significant risk. Furthermore, for anyone contributing to their portfolio for the long run (i.e. investing for retirement), a market downturn is more of a buying opportunity than an investment threat.

To steer clients away from the hot waters of market risk, CPAs can encourage them to ask themselves thought-provoking questions such as:

1. What withdrawals do I expect to take from my investments?
2. What unexpected withdrawals would I like to be prepared for?
3. For what period of time should I seek to shelter future withdrawals from stock-market volatility?
   
   (Depending on an investor’s ability, need and willingness to take risk, the answer can be none, a particular number of years or my lifetime.)
4. With that in mind, what mix of investments (stocks, bonds, etc.) makes sense for me?
5. What resources (people, information, expertise, etc.) do I need to make informed decisions?

Most clients will benefit from the guidance of a personal financial expert (such as a CPA, PFS) to explore questions three and four. CPAs need not provide investment advice to steer clients to wise investment decisions. Simply asking judicious questions can expand your clients’ perspectives and help them discover their own answers, solutions and resources (see Do You Know What Is Most Important to Your Clients?).

CPAs who wish to deepen their knowledge of investment- or retirement-planning principles can find individual self-study CPE courses in the foundation in personal financial planning that the AICPA offered in association with The American College. Foundation courses are an excellent resource for PFS credential candidates, as well as for CPAs pursuing well-rounded tax practices.

Slowly Heated Waters

Guiding clients in assessing themselves for other retirement risks can help them avoid “slow-boil” consequences such as:

• Lack of Retirement Savings. Last April, a Harris Interactive survey conducted for the AICPA showed that two out of five (40%) working Americans said they don’t expect to ever be able to afford retirement. Another Employee Benefit Research Institute survey found more than half (56%) of its respondents having less than $25,000 in savings and investments (excluding their primary residence and any defined benefit (DB) plans.)
• Retiree Overspending. The risk of spending too much in retirement and outliving one’s money is particularly challenging. Retiree spending has to cover essential and discretionary expenses and account for the huge uncertainty of medical care. Longer lives and the spiraling cost of medical and long-term care amplify this uncertainty. While retirees may be called upon to provide support for a parent or an adult child, low interest rates on fixed-income investments may lead them to earn too little and spend down their savings faster than planned.
• Longevity. Retirees generally plan to live to their projected life expectancy. However about half of the population will live past (or well past) that point. According to Morningstar, a 65-year-old couple has a one in four (25%) chance of one of them living to age 96.
• Inflation. With the U.S. annual inflation rate at 3.6 percent in July and the 10-year Treasury bond having dipped below two percent for the first time in at least 60 years as reported in the Financial Times, the ever-present risk of inflation eroding a portfolio’s purchasing power is particularly relevant in planning scenarios.
• Benefit Solvency. Traditional DB pension plans, Social Security and Medicare are facing well-publicized challenges that may alter retirees’ long-term benefits.
• CPAs can contribute to their clients’ more secure retirement by inviting them to check the temperature for each one of these risk factors in their planning. They may be exposed to more heat than they can handle.

Conclusion

A recent paper from The Pension Research Council revealed that the financial and economic crisis of 2008-2009 wiped out about a quarter of U.S. household’s net worth. It concluded that the crisis has deeply shaken the foundations of retirement security. As a consequence, the above retirement risks have only become more menacing.

The paper recommended financial education and a greater understanding of risk. AICPA’s financial literacy initiatives such as Feed The Pig or www.360financialliteracy.org address these recommendations and are aimed at averting the gathering retirement crisis. However, the sum of each CPA’s individual efforts to help clients assess their retirement risks may have the greatest impact.

Jean-Luc Bourdon, CPA, PFS is a wealth manager with WalpoleFinancial Advisors, LLC (WFA) in Goleta, CA. Bourdon currently serves on the AICPA’s PFS credential committee. He is past chair and member of a PFP Networking Group. Bourdon volunteers as a financial literacy advocate. His opinions and comments expressed within this column are his own and may not reflect those of WFA or the AICPA. This information is being provided for informational purposes only and does not constitute investment or tax advice.

* The AICPA’s PFP Section provides information, tools, advocacy and guidance to CPAs who specialize in providing tax, retirement, estate, risk management and investment advice to individuals and their closely held entities. All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter apply to become a PFS Credential holder.