Seven Risks That Threaten Working-Age Household Finances More Than the Stock Market
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One of the concerns of most of my working-age clients and recent retiree clients is stock market risk. They worry if the stock market were to crash, they would lose a lot of their wealth.
That is why I usually recommend investment portfolios that include a mix of riskier assets (like stocks) and less risky assets (like bonds or money market funds). I use this mix of assets to temper the amount of expected risk that clients are exposed to in their investment portfolios.
But even with a diversified mix of assets, most clients are still exposed to some meaningful amount of stock market risk. And clients and advisors are correct in needing to carefully consider stock market risk when evaluating a proposed investment plan.
But what most working-age clients don’t understand is this: stock market risk is usually not one of the biggest risks to their overall financial lives.
Short-Term Stock Market Risk Is High, Long-Term Stock Market Risk Is Much Lower
To be clear: if you have a short-term investing horizon, investing in the stock market can be very risky. Since 1972, there have been six drawdowns of more than 20% in the US stock market. They are summarized below:
That means that you should expect the stock market portion of your investment portfolio to decline by at least 20% at least once every 8-10 years. In other words, if you’re scared of the stock market going down by more than 20%, you should be, because it’s very likely to happen a few times over the course of several decades!
But it’s also important to note how fast the stock market usually* recovers from steep drawdowns. Since 1972, the longest that it has taken the US stock market to recover from its full drawdown is 5 years and 8 months. In other words, if you can be patient, it is quite possible that severe losses may be completely eliminated within just a few years.
*Now to be clear: past performance is no guarantee of future results. And in fact during the Great Depression, it took between 15 to 25 years for the stock market to full recover from the drawdown depending on how you measure stock market performance during that time period. So drawdowns can be quite long, especially if the stock market decline is quite severe.
So here is the question: does a drawdown lasting several years matter to you? It depends. If you are about to retire or if you just retired, and the stock market went down by 40-50%, that would have a very detrimental impact on your financial life. It may even force you to go back to work. That is why most financial advisors recommend that your portfolio be at a relatively lower risk level around the age that you retire.
But what if you are around 50 years old, all your kids are through college, and you are still 12-15 years from retirement? In that situation, you probably shouldn’t care as much about short-term market downturns, because you have a much longer investment horizon. And with a longer investment horizon, you have the ability to take more risk in your portfolio, because even if there is a stock market drawdown of 30-50%, you can probably ride out such a decline.
In other words, most working households, especially those under age 50 and more than 10 years from retirement, shouldn’t be as worried about the stock market portion of their portfolio, because the stock market is more likely than not to recover from any drawdowns before they retire. That’s why most working-age households place too much emphasis on stock market risk.
The Real Financial Risks that Working-Age Households Face
What most households don’t focus enough on is the many other risks that, in aggregate, are much more likely to have a large damaging effect on their household finances. These risks have nothing to do with investments, but they absolutely can have an impact on your wealth.
1. Death
Many households don’t appreciate the scale of the financial risk to their loved ones if one of the spouses unexpectedly passes away. If one spouse in a two-earner household dies, the effect on the surviving family is often ruinous if there isn’t sufficient life insurance in place, because income is reduced significantly, but expenses usually don’t go down that much.
What is the chance of dying during your prime working years? It’s fairly low, but definitely not zero. For men, the chance of a 30-year old male dying before age 55 is about 11.7%. For women, the chance of a 30-year old female dying before age 55 is about 6.6% (Source: Social Security mortality tables). As you might imagine, wealthier and healthier people tend to have meaningfully lower mortality, but even for wealthy, healthy people, the risk of death is not insignificant.
Most households vastly underestimate the amount of life insurance necessary to financially protect surviving family members. More often than not, the only life insurance that most households have in place is the skimpy amount of life insurance that they get through work. This insurance typically pays anywhere between 1x to 2x of salary, and many people think that this is sufficient protection. But in fact something closer 10x to 15x their salary is usually closer to what each of the wage earners needs in terms of a death benefit in order to protect their families during their 30s and 40s. When I show my clients what would happen to their surviving family members if one of the spouses were to die without sufficient life insurance, they are usually shocked at the financial devastation from a loss of earnings.
Fortunately, term life insurance is relatively affordable, especially for young families. The best time to purchase term life insurance is right after a couple gets married but BEFORE the first pregnancy, because typically insurers won’t underwrite someone who is pregnant. Healthy non-smokers at age 30 can typically buy $2 million of 30-year term life insurance for between $1,200-$1,800 per year (note: the actual price of the insurance will depend on the health and other underwriting characteristics of the insured.) That provides great long-term protection for an affordable price.
2. Disability
There are many conditions that cause either a serious or permanent disability, preventing the affected person from working and earning money. These include:
A serious injury
A cancer diagnosis or after-effects from a cancer or cancer treatment
Mental health problems
Chronic arthritis or other pain
Nervous system disorders like Lou Gehrig’s disease or multiple sclerosis.
Serious health conditions such as these can affect a person for months or years. But while the affected person isn’t able to work, the household bills keep coming in. In many cases, this results in the household exhausting much or all of its savings in order to keep the family’s finances afloat.
Most serious is a “permanent disability,” which is a condition that results in the person no longer ever being able to work. This can be calamitous to the household, because not only does household income fall, but in addition the disabled person often has ongoing medical bills or long-term care needs for the rest of their life.
Disability insurance helps fill the gap in income when someone becomes disabled. Broadly speaking, there are three types of disability insurance: short-term disability insurance, long-term disability insurance and disability retirement insurance.
Short-term disability insurance, which usually covers the first 90 days or 180 days of a person’s disability is a nice-to-have, but really is only necessary for those who have close to zero savings. Long-term disability and disability retirement insurance is what most working households need, and they usually should try to procure as much disability insurance as they can get.
Much like with employer-sponsored life insurance, many people believe that employer-sponsored disability insurance is sufficient to protect them, but this usually is not the case. Long-term disability benefits through work are usually 60% of income, but the issue is that these benefits, when paid for by employers, are typically taxable. That means that a beneficiary might receive somewhere between 40-45% of their prior salary after tax, and that’s often not enough. In these situations, it’s very beneficial to get an individual disability policy to supplement the employer-provided policy. An individual policy will typically provide a benefit equal to 10-20% of salary on top of the employer-provided policy. That doesn’t sound like much, but in practice it makes a huge difference to household finances.
Also keep in mind that no retirement contributions are taking place while you are disabled. That’s where disability retirement insurance can be very helpful - it pays money into a fund to build a retirement nest egg, which is important because most disability insurance benefits end at age 65 or age 67 at the latest.
Finally, single people especially need strong disability protection, because if they become disabled, there may be no one to support them. I find that most single people have not thought about the financial ramifications of becoming disabled, but once they understand the risk, they in particular understand the need to have strong disability insurance, especially if there is no contingent safety net that could be provided by parents or other family members.
3. Losing Your Job after Age 50
Speaking of loss of earnings, let’s talk about losing your job.
People lose their job all the time. But the long-term impact of losing your job can depend on your age and your profession.
Usually, if someone gets laid off early in one’s career, the long-term wealth impact of that lay-off is usually negligible. Younger people tend to have an easier time finding a new job, although younger people who take longer career breaks (in order to raise children, for instance) can find it harder to get a job with a salary similar to what they were earning before the career break.
However, getting fired after age 50 can be extremely damaging to a household’s finances, especially for high-wage earners in industries and roles where there is persistent age discrimination against older workers. This applies especially to people working in the technology sector, positions in many professional services sectors, some physically demanding trades, and senior managerial roles across multiple industries.
Here’s is the common potential downside scenario that I see:
Between ages 30-50, spouses are spending heavily to raise children, and they fail to save sufficiently for retirement during these years in order to pay for raising children and for children’s college education.
The premise of the retirement plan is that once the kids have flown the nest, parents can focus heavily on retirement savings at that time.
The key assumption in this plan is that the parents can maintain their existing income levels in their 50s.
This plan may work, but if and only if the parents can actually maintain their income levels. In practice, there is a significant risk that those income levels may be hard to maintain if an age 50+ professional is fired. Moreover, the time when older workers are especially at risk for being fired is in a recession, and it especially hard for workers over age 50 to find any job in a recession.
This is why households need to prioritize retirement saving even when they are raising children. And almost always, saving for retirement is a higher priority than paying for their children’s college education.
4. You Get Sued For Significant Damages
The United States is a litigious society. That means that life can be going along fine, and then all of the sudden somebody gets hurt because of your actions or negligence, which results in your entire life savings being at risk.
Some situations that can result in significant claims include:
Severe auto accidents involving a member of your family that result in severe injury or death of of an occupant of the car or another car.
Drownings of children in pools.
Your dog attacks someone, causing significant injury or emotional distress.
Someone injures themselves in your house, on your property or on the sidewalk outside your house.
A tenant in a rental property that you own sues because of an injury or damages within the property.
It should be emphasized that you are responsible not only for damages caused by you, but also damages caused by your children. In particular, it is possible that you could be sued for damages caused by adult dependent children or children on your insurance policies.
Remember: it only takes one person looking for a lawsuit plus a hungry plaintiff’s attorney for your household to face significant financial and emotional distress. And even if the claim is bogus, defending yourself can cost tens of thousands or hundreds of thousands of dollars in attorney’s fees. There is no such thing as an inexpensive liability defense case.
Most households have some liability protection through their homeowners and auto insurance - typical coverage amounts are between $100,000 to $300,000. But this amount is insufficient to protect against a serious liability claim. Almost all high-earning households should be purchasing umbrella insurance to provide additional liability protection over and above the liability coverages in their auto and homeowners insurance policies.
4. Damaging Loss of Business Value
Households that own and operate a small business with employees generally have a lot of their wealth tied up in the business. While small business ownership obviously provides an opportunity to create wealth and provide emotionally meaningful work to the owner, it also introduces multiple risks to this wealth. These include:
An economic downturn (especially for companies that have lots of debt or that are in industries sensitive to broader economic environment).
The loss of several key members of management all at once.
The loss of a customer who provides a significant proportion of the company’s revenue.
Death or disability of the owner.
Damage to the business’s facilities, causing the business to go idle.
The business getting sued.
Any one of these things could be disastrous not only for the business, but also for the business owner’s family. Business owners need to work with an experienced commercial insurance agent to understand the risks specific to their business and the costs of insuring against those risks. In addition, business owners usually need significantly more access to liquidity than most households. They should be able to get access to 2-3x of their usual earnings, either through savings or through borrowing facilities that they can access quickly.
5. Your House Is Seriously Damaged and You’re Underinsured
For many families, a house is their most valuable asset. However, protecting the value of that asset and the contents therein depends on having a plan if the the home is damaged or destroyed.
Homeowners insurance obviously protects the home against many potential perils. But even with homeowners insurance in place, risks in homeowners insurance plans can remain or crop up over time:
Insufficient insurance to actually protect against a total loss. Very often, households fail to update the amount of insurance coverage on their houses even as costs to replace structures and fixtures goes up over time. A recent study published in the Connecticut Insurance Law Journal noted that 77% of insurance of homeowners insurance claims in California fell short in fully protecting against the claimed loss and that the average payout fell short by 35%.
Lack of flood insurance. Flood insurance is not covered by traditional homeowners insurance and must be purchased separately.
Lack of sewer backup coverage. Sewage backing up into the home can be a very destructive peril, potentially causing tens of thousands or hundreds of thousands of damage to the contents and the structure. I have seen houses damaged by sewer backups, and as you can imagine, it’s a pretty ugly and disgusting situation. Unfortunate, this peril is not covered under most base homeowners insurance policies, and most homeowners don’t have this coverage. Homeowners in areas that have older municipal water infrastructure and sewage lines are advised to consider adding this insurance.
An earthquake, landslide or mudflow. “Earth movement” coverage is also not covered by most homeowners insurance policies, especially in areas prone to earthquakes and landslides. This insurance can be expensive, but the cost needs to be weighed against complete loss in the event of a disaster.
No wildfire coverage. Fire has traditionally been a covered peril, but with climate change and the growing number of wildfires, insurers are increasingly reluctant to provide coverage for wildfire coverage.
The most important things to do is a review of your homeowners coverage with your insurance agent at least every couple of years and to discuss the tradeoff between the cost of the insurance and coverage options.
6. Your Elderly Parents Have Lengthy Long-Term Care Periods
People are living longer these days, which is in general is a good thing. However, there is also a growing portion of seniors who end up requiring lengthy periods of long-term care. This is especially true if the person has Alzheimer’s or another dementia-related condition. Long-term, debilitating physical ailments are also can also come from strokes, neuropathy, heart disease and diabetes, among other conditions.
All of these conditions can lead to a loved one needing long-term care over a number of years, and the cost of this care can be great, especially if the person does not have any long-term care insurance in place. This can often result in the elderly household running out of money. Most long-term care costs are NOT covered by Medicare or other medical insurance.
Quite often, the children of the parent need to make a hard choice about how to support the parent: either pay out of pocket for care or have one of the children or a child’s spouse stop working in order to care for the parent. Such an extended period of support can be both financially and emotionally draining for the supporting family members. It is important to create long-term financial plans to account for a potential need to support parents financially if they have few financial assets in retirement.
7. You Have a Lengthy Long-Term Care Period Early in Your Retirement
Similar to caring for your parents, you or your spouse having a long-term care period early in your retirement can damage the long-term retirement plan for the household.
The reason is that most retirement plans are premised on gradual withdrawals throughout your retirement. If instead you need to spend significant amounts of money on long-term care early in your retirement, that can damage the long term retirement plan, because it often means that the withdrawal rate from retirement savings is significantly higher than expected.
In addition, younger retirees who enter long-term care will likely have a longer life expectancy than those who enter long-term care later in life. That means that younger people who need long-term care will use those long-term care services for a longer period of time, causing further damage to the long-term retirement plan.
Unfortunately, long-term care insurance is no longer a cost-effective insurance product. The insurance tends to be very expensive for the likely benefits provided, and it’s probably only appropriate for certain middle-income households who make enough money to be able to save for retirement, but don’t make enough money to be able to self-insure their long-term care needs. It is important to work with a financial planner to understand whether long-term care insurance is right for you.
Don’t Focus On Just the Positive Aspects of Financial Planning
Most parts are financial planning are a happy exercise. I work with clients to develop plans to help them achieve their goals. Unsurprisingly, clients like this! Clients are much less enthusiastic talking about hedging against risky events that are scary.
But having solid a long-term financial plan requires but a plan for success AND a contingency plan hedging against unfortunate outcomes. In addition, hedging against risk often (but not always) means buying insurance, and households aren’t generally enthusiastic about paying money for a service that that they hope they don’t have to use.
However, it’s quite usual to have unusually unfortunate events impact your finances at some point during your life. That is why it is essential to acknowledge these non-investment risks to your finances and to implement a mitigation plan. Addressing these risks is what gives households the confidence that they can achieve their goals even if unfortunate life events happen.