Common Risks In A Financial Plan
Fee-for-service financial planner and founder of PlanEasy.ca
No financial plan is immune from risk. No amount of planning is going to eliminate risk entirely. In fact, there are many common risks in a financial plan that may cause issues down the road. What we need to do is identify what types of risk a financial plan may face and find ways to reduce that risk or mitigate it where possible.
When we talk about risk we naturally assume that means investment risk. While this is one common type of risk, there are also many other common risks we need to watch out for.
Some of these risks can be reduced or sometimes even eliminated with proper planning. For each major type of risk below, we’ve highlighted a few ways to help mitigate the impact this risk may cause, but even with these tips its usually impossible to eliminate these risks entirely.
A financial plan will typically cover 30-50+ years. Over this time span there are many unknowns that may occur. A good financial plan will be flexible enough to absorb these unknowns and still be able to reach the same goals with only minor tweaks.
This flexibility is important. It’s impossible to eliminate all these risks. It’s very likely that even the best laid plans will experience some disruption along the way. Having some flexibility, and knowing where that flexibility exists, will help reduce the stress and impact if the unfortunate were to happen.
Investment risk is a common risk in almost every financial plan. It’s nearly impossible to reach big financial goals like retirement without taking on some investment risk.
The problem with investing is that results are never guaranteed. There can easily be long periods with very low investment returns. Certain sectors and/or countries can experience poor long-term results, sometimes taking decades to recover, if at all.
With proper planning this type of risk can be reduced, but never completely eliminated. Having a diversified portfolio can help reduce investment risk. Also, having the right asset allocation will help ensure your investment risk is in line with your personal risk profile.
Possible ways to mitigate investment risk: Diversification (both geographies and sectors), correct asset allocation (for personal risk profile), delaying CPP and OAS turning investment assets into a government pension, purchasing an annuity with part/all of investments etc
Inflation Rate Risk
Inflation rate risk is a common risk but it’s one that’s rarely talked about. It’s been a long time since we’ve experienced super high inflation rates so there is some “recency bias” affecting our perception around inflation rate risk.
If you ask someone who lived through the high inflation of the 1970’s they will certainly tell you about the level of uncertainty that comes with high inflation.
While super high inflation is hopefully unlikely, even modestly high inflation rates can have a big impact on a long-term plan. Even just going from 2% inflation to 3% inflation will add an extra 21% to your average expenses after 20-years.
Possible ways to mitigate inflation rate risk: Correct asset allocation (for personal risk profile), delaying CPP and OAS turning investment assets into a government pension, purchasing and inflation adjusted annuity, defined benefit pension (if indexed to inflation)
Longevity risk is basically the risk of living a long and healthy life. This is something we all hope for but it means there is a higher chance that we’ll outlive our money. It makes it more likely that we could run out of money in retirement… but even before that point it can also create a lot of stress as investment assets are slowly depleted.
This can be a very real risk for retirees that rely on their own investment assets for the majority of their retirement income. There is a 10% chance that either partner in a couple could live to age 97! Planning for a young age may increase the risk of outliving your money.
Possible ways to mitigate longevity risk: Delaying CPP and OAS turning investment assets into a government pension, defined benefit pensions, low withdrawal rate from investments, keep primary residence as a “fall back asset”, purchasing an annuity.
Having a health scare can have a big impact on your financial plan. This may cause a disruption to income. It could cause increased spending on things you’d normally do on your own, like cleaning, cooking, and child care. It may also lead to specialized treatment that isn’t covered by provincial and/or private health plans.
Possible ways to mitigate health risk: Build flexibility into your financial plan, have the option to work longer, reduce savings rate, or draw on investment assets for a period of time, consider purchasing critical illness insurance.
- Avoiding the Risk of a Long and Healthy Life
- Common Risks in a Financial Plan
- When do I need Life Insurance?
Risk of Unexpected Death or Disability
One of the largest assets we have is our ability to earn an income. Over the course of our lifetime this asset is worth millions. A disruption to this ability to earn an income, even if only for a short period of time, can be devastating.
This type of income disruption can be in the form of an unexpected death or it could be in the form of a disability. Although an unexpected death would be devastating, the risk is actually very small, especially at younger ages, this is why term life insurance is so inexpensive in your 30’s and 40’s even if you feel you need a large amount (which you may not!).
Despite life insurance being a more common form of insurance, there is actually a much higher risk of long-term disability, yet this is often the risk that goes unplanned for. Protecting against disability can usually be done through long-term disability insurance, and if purchased through a group plan can be very inexpensive.
Even in retirement, the risk of an unexpected death or disability can cause a large disruption to a financial plan. The unexpected passing of a partner or spouse will cause a reduction in CPP or OAS benefits, an increase in the amount of taxes owed, and trigger higher RRIF/LIF withdrawals.
Possible ways to mitigate risk of unexpected death or disability: Purchase term life insurance and long-term disability insurance, have a fully funded emergency fund, dual income with a high savings rate, flexible spending.
Probably the most common risk we all face is property risk. This is the risk of theft, damage, loss, liability that comes from owning personal property. Property can be anything from a laptop, to a vehicle, to a house or cottage, to jewellery etc. etc.
Thankfully property risk is one of the best covered risks. Vehicle owners are required to have vehicle insurance. Home owners (at least the ones with a mortgage) are required to have home owner’s insurance. There is also renters/tenant insurance. There is even umbrella insurance that can boost your liability coverage by $1M+ for very little cost.
With all this mandatory or easily accessible insurance coverage, property risk is usually the smallest risk within a financial plan but depending on the deductible there can still be a financial impact so it’s a best practice to have a fully funded emergency fund as well as adequate insurance coverage.
Possible ways to property risk: Purchase home insurance, vehicle insurance, renters/tenant insurance, umbrella insurance etc. Have a fully funded emergency fund.
Financial planner, personal finance geek and founder of PlanEasy.