How do you define risk? Most people are aware of the conventional thinking when it comes to investment risk. If asked about risk, they usually think in terms of their portfolio. They may say it’s based on the amount of equity vs. fixed income exposure. The higher the amount of equity exposure, the more perceived risk, return, and volatility. Conversely, the higher amount of fixed income exposure, the less perceived risk, return, and volatility. However, when planning for a retirement income strategy, there is another, higher level risk that must be considered. This is the risk between predictable income and variable income.
Predictable income is income that we expect to receive for as long as we live and is not tied to the market. Examples of this income are Social Security, Pension, Annuities.
Variable income is the income we hope to receive based on our investments. We hope this income will last as long as we live. This income is based on market performance and can be affected by withdrawal rates and sequence of return.
When designing a retirement income strategy, this is the first risk we asses. What percentage of your income is based on predictable sources and what percentage is based on variable sources?
Are you too reliant on market returns for your income? Is this unsettling? Do you have too much predictable income and not enough exposure to the market thereby taking on excessive inflation risk? Does the ratio of predicable-to-variable income match your overall risk profile?