“Underestimated” risk can derail your retirement plans

In 2015, at age 30, Grant Sabathier, creator of the financial website Millennial Money and author of Financial Freedom, saved $1.25 million, enough to ensure he never had to work again.

Sabatier is a proponent of the FIRE movement, where people aim to save most of their income by either increasing their income or limiting their spending in order to achieve financial independence and retire well before their 60s. They generally put large sums of money into low-cost index funds or income-producing investments that can eventually replace their salaries.

Like all FIRE super rescuers, Sabatier’s strategy was based on a number of assumptions, including the amount of money he would have to live on. This number is based on a calculation that assumes the stock market will continue to return returns in line with historical averages and requires Sabatier to adjust his withdrawals for inflation.

However, Sabatier says the large risk factor means investors may not be able to rely on the same math that helped him achieve financial freedom.

“One of the biggest things that people underestimated the risk for, and that they’re starting to account for a little bit, is the growing uncertainty around the impact of climate change on their investment growth,” he says.

Sabatier is not alone in expressing concern that climate change could hurt returns in the coming years.

“It’s mainstream enough that Janet Yellen came out and said climate is the biggest threat to the financial system. “The Biden White House has said that people are seriously underestimating the future risk and impact of climate on financial markets,” he says.

While the exact impact remains to be seen, Sabatier recommends lowering your expectations for your portfolio’s returns over the long term.

“People in the FIRE movement are waking up to their growing and increasingly unbelievable expectations of the climate danger you can cause. [an annualized] 7%, he says. When it comes to holding broad stock market index funds, I think a 4% or 5% expectation is more realistic than 7%.

Some investment strategies seek to mitigate climate risks by investing in companies that score high on sustainability indicators. However, they are unlikely to address the potentially broader threat of climate change to markets, says Sabathier.

“I don’t think we can get out of this with a weasel,” he says. “Yes, you might be lucky enough to invest in the right kind of company that offsets carbon emissions. But it’s like picking any other stock. It’s more luck than anything else.”

In other words, be prepared for the possibility that my traditional portfolio will have lower long-term returns than you originally planned for.

For someone currently saving for retirement, a 4% estimated return means one of two things: plan for less income in retirement or adjust your strategy to accumulate more cash between now and when you eventually leave your 9- from 5

For FIRE savers, that probably means you can’t rely solely on your portfolio to fund your record 9-to-5 lifestyle. To achieve financial freedom, many FIRE followers rely on the “4% Rule,” which allows retirees to withdraw 4% from their portfolio indefinitely without running out of money. That principle only works if the rest of your portfolio is producing returns in line with historical averages. 4% return makes it moot.

Furthermore, the climate threat makes investing in other income-producing assets, particularly real estate, riskier.

To keep your retirement plans on track, Sabatier suggests two tweaks.

1. Diversify your income

In an increasingly uncertain economic climate, “I think a lot more people need to take their earnings into their own hands,” says Sabathier. “I’m not even talking about having a side hustle, I’m talking about being a full-fledged entrepreneur.”

Building your own business allows you to adapt to changing market demands while reducing your reliance on any one type of income, Sabatier says.

In a changing economy, marketing your skills to an online audience is important, he says. “This is the golden age of making money online.”

2. Pay attention to the location

Owning real estate, either as an investment or as a primary residence, is a common path to financial independence, but not all places are created equal. According to some climate scientists, he notes, Phoenix has the potential to be “completely intolerable” in the coming decades.

Viability, as well as the likelihood that companies will insure properties in certain parts of the country in the future, is a key consideration, he adds.

“For some parts of the country, the models don’t look great, and then it becomes, ‘Gosh, is my house a good investment? Can I stay here for a long time, or should I wait and move somewhere?’ “

There’s no guarantee that one location will necessarily be better than another, but climate science can give you an idea, Sabathier says. “Living in Duluth, Minnesota is probably significantly better than Phoenix, Arizona. So, do you want to uproot your life? Those are huge questions, but I don’t think you want to wait until it’s too late. “.

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