The October issue of The Money for Life Letter, is all about ‘price risk’.
Actually, it’s about the absence of price risk, or getting rid of it. But you need to understand what it is before you can get rid of it. Otherwise you won’t know it’s gone…
Price risk is what financial advisors call the risk of an investment’s price fluctuating. Your shares have price risk, because their price goes up and down.
Property does too. You might think all investments have price risk, but dividends and annuities don’t, for example. Wine can have price risk if you plan on selling it, but it doesn’t if you are happy to drink it instead if the price falls.
It might seem odd to have a name for such an obvious concept. The point is to separate a particular type of risk out from the others so you can discuss it in isolation. For example, price risk is a different type of risk to the risk of a broker committing fraud, or governments like Greece defaulting on their bonds.
But the problem with price risk is that it creates uncertainty.
An investment might be worth $100, but because of price risk it can be priced at $50 one day and $150 the next. That uncertainty is a retiree’s biggest enemy because your income is reliant on fluctuating investments while your living expenses are fairly steady and unavoidable. If the price of an investment falls, you have to sell more of it to cover the same amount of living expenses. That leaves you with fewer assets when prices go up again.
So, it might pay for you to test your retirement wealth for price risk.
Do you know how much of your wealth relies on assets that go up and down in price?
If there was a crash in prices across the board – the stock market, property market, bond market, etc. – how would your retirement finances fare?
Would they be in trouble?
It’s no coincidence that Australian retirees were worst hit by the GFC, according to a report by HSBC. They own more price risk-sensitive investments than other countries. But it doesn’t take a financial crisis to bring the dangers of price risk home.
I’m especially worried about the dangers of price risk to your portfolio because of demographic changes. In short, as more and more baby boomers retire, they will sell more and more of the assets they have accumulated. That selling will put a lot of downward pressure on investment prices.
I’m always looking for ways you can escape this selling pressure, and recently presented my best idea in The Money for Life Letter. I show how to opt out of price risk and the uncertainty that goes with it.
So stop and think about your investments. Just how much of your wealth is affected by ‘price risk’?
I bet you’ve never thought to ask yourself that question before. And yet it’s undoubtedly the key to ensuring you preserve your wealth in retirement.
Nick Hubble+
Editor, The Money for Life Letter
