MDNews - Minnesota

Inflation as a Component of Risk Inflation is another risk component that needs to be accounted for during the design phase of the portfolio. Younger investors have not yet been through a big inflation- ary cycle and have little perception from which to judge its impact on their long-term spending power. Some financial writers suggest that volatility is not risk. It is only a temporary decline in value. Furthermore, they say that the best definition of risk is losing the spending power of their money. In other words, they are suggesting that risk is inflation. While I believe there is some truth to this outlook, I think there is much more to risk than just inflation. The point is that inflation is probably an overlooked aspect to risk — one that investors need to seriously take into consideration as they develop their portfolios. So, let's agree that inflation can be defined as losing the purchasing power of money. While inflation is one big compo- nent of risk, it certainly doesn't serve as a complete definition of risk. Historically, inflation runs about 3 percent on aver- age — sometimes higher, sometimes lower. As I'm writing this article the yield on 10-year U.S. Treasuries is about 2.1 percent. Ignoring taxes, which is not a wise thing to do, gives investors a guaranteed inflation adjusted return of approximately –0.9 percent. If we account for taxes the math is tougher, but the return will be even less. To complicate matters, we likely will be in a rising interest rate environment soon. So, if investors cannot hold those same 10-year U.S. Treasuries for the full 10 years, there's a chance they will also see a loss of principal. Inflation and Retirement As investors approach retirement, they can naturally assume that they need to get conservative. Typically, what they really mean is that they need to take on less risk. The belief is that as one ages and enters retirement, more of the portfolio should be allocated to bonds so as to produce income that can then be spent during the retirement years. The problem with this approach to retirement income planning is that even in our low-inflation- rate environment, it likely guarantees that the retiree is going to lose the purchasing power of his or her retirement income. If the investor has a very high risk capac- ity — a very large portfolio relative to how much money they "need" to spend each year — then inflation might not be a problem. For most investors though, inflation needs to be taken very seriously. How Risk Capacity and Inflation Affect Physician Retirement Planning Today, we're seeing clients living longer than they were even 25 years ago. A hea lthy 65-year-old retiring today will probably live another 20 to 25 years or more. It makes little sense to assume that we will be in a low inflation environment for another 25 years. Reallocating a large portion of a portfolio from equities into bonds may in fact be taking on a great deal more risk than investors ever imagined. Typically, interest rates rise in an effort to fight inf lation. Bonds cannot and will not prove to be a hedge against inf lation. Getting conser vative and migrating into bonds could very likely be a costly decision. Physicians tend to be higher earners and have the ability to build wealth and their portfolios faster than the general public. This gives them an advantage in managing the overall risk level of their portfolio, particularly in terms of risk capacity. However, it is ver y important for physicians to start the planning process early in their careers and develop a thorough understanding of risk and its various components. Bill Strand, founder and principal, has more than 30 years of experience in the f inancial ser vices industr y, and founded Paradigm: Strategies in Wealth Management LLC in 1995. Strand has par- ticular expertise working with physicians helping them not only achieve financial success but devising creative strategies to preserve the wealth they have worked so hard to build for themselves and their families. Strand meets a lot of doctors who are extremely busy practicing medicine, but they have yet to develop a plan for f inancial independence. Find out more at planparadigm.com or by contacting Strand at 763-201-1025, or via email at bstrand@planparadigm.com. ■ M D N E W S . CO M ■ MD NEWS Minnesota | 1 1

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