Will The Greek Crisis Affect Your Retirement?

By Stephen D. Simpson, CFA | July 22, 2011 AAA
Will The Greek Crisis Affect Your Retirement?

There seems to be something universal about the human fascination with disaster. Although everyone decries those who slow down to look at an accident on the highway, it is probable that everybody has done it. So it is only natural that the ongoing crisis and drama in Greece captures a lot of attention over here. This isn't just about voyeurism, though, as the ongoing crisis may well have long-term ramifications on your retirement. (Find out how to determine whether you're on the path to a comfortable retirement , or financial ruin. See Will Your Retirement Income Be Enough?)

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Defaulting to an Older Europe?
Greece has not been kicked out of the euro yet, and nobody seems to be seriously discussing the idea of Greece withdrawing (or being forced out). Nevertheless, it cannot be excluded as a potential outcome. Greece may find that the cost of staying in the currency union is just too high and unpalatable for its people and may feel that going back to the drachma, and the ability to devalue/depreciate the currency, is too useful to ignore.

With Europe being such a huge part of the world economy (the Eurozone is the largest economic entity in the world), any major shift will have some long-run ramifications. At the most trivial level, a new Greece may be a very affordable vacation destination in Europe. More seriously, it could lead to a domino effect that basically reorders the political and economic structure of Western Europe once again.

More Volatility
I happen to regard volatility as similar to aircraft turbulence - with risk having more to do with the actual chance of a plane crash - but it clearly impacts markets and valuations in the short term. At the risk of stating the obvious, the Greek debt crisis has introduced a great deal of uncertainty and volatility in the markets. All things being equal, higher volatility tends to lead to lower asset values outside of those assets seen as a safe haven. The good news here, though, is that Greece-induced volatility is unlikely to persist long enough to really alter the retirement of anyone in the United States. (How do you choose a fund with an optimal risk-reward combination? We teach you about standard deviation, beta and more! Check out Understanding Volatility Measurements.)

Specific Risk and Diversification
The biggest risks are to those people whose retirement holdings include the sovereign debt of Greece or other struggling countries like Spain, Portugal and Ireland. Although the odds are low that these bonds will be a total loss, there is still a chance that there will be a significant haircut to value (maybe 25% or more) or a substantially elongated payback period.

Ironically, there may be more for investors to fear in the owners of the Greek bonds than the bonds themselves. While Greece will likely make good on a large percentage of those bonds, a default could tip over one or more European commercial banks into serious difficulties like a distressed capital raise, shotgun merger or even nationalization. Though there aren't likely to be huge numbers of Americans with sizable stakes in banks like Dexia, Commerzbank or BNP Paribas, it'll still be bad news to those who do hold these companies.

It is also worth remembering that it is fairly rare for a national or regional economy to flourish while its banks struggle. This means that, as the problems in Greece spread across European banks, those problems then spread into all manner of European companies - and that ropes in a larger number of potential U.S. investors.

At the same time, many American companies depend upon demand from European businesses and consumers for some percentage of their sales. This is how Greece's problem can become a problem for even the average American's retirement plan - if companies like Coca-Cola (NYSE:KO), McDonald's (NYSE:MCD) and Apple (Nasdaq:AAPL) see their growth compressed in Europe, that ultimately hurts their overall growth, their valuation and the retirement prospects of their shareholders.

Monkey See, Monkey Do?
Greece's debt crisis may have even greater unexpected impact on American retirees. As part of its austerity package, the Greek government is trying to lift the retirement age by two years by 2015. Now, there are a variety of retirement ages in Greece (varying with sex, work experience and the hazards of the job), but going with a standard proposed retirement age of 63 is still well below the retirement age in Germany (67).

Unions and politicians are screaming mad about this and fighting it hard, but it stands to reason that the countries Greece needs to bail it out (like Germany) are not likely to subsidize an earlier retirement for Greek citizens at the expense of their own citizens. At the same time, Greece is pursuing significant cutbacks in pension benefits for retired workers, with some of these cuts approaching 40%.

This may be a move that the U.S. will have to consider in the not-too-distant future. The age at which Americans can collect full Social Security benefits was established at a time when people had much shorter post-retirement life expectancies and the retirement age has not kept with the lengthening life spans in this country. A later retirement age would help solve some of the solvency issues of Social Security, though at the cost of crowding out those trying to enter the workforce. Likewise, cutting benefits may be an option that the government has to consider, though it will prove extremely unpopular. (You've probably contributed to this fund, but will you reap the benefits? Find out here. See Introduction To Social Security.)

The Bottom Line
Even though Greece is quite a ways away from the average American retiree, the financial world is always smaller than we think it is. Consequently, it seems beyond optimistic to think that what happens in Greece won't have some impact over here. On a more positive note, though, the world has been through plenty of financial crises before and we're all still here. There is no question that the problems in Greece have added some chaos and risk to the markets, but a sound and diversified investment strategy will see almost any investor through this latest turbulence.

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