Dev Ashish
Moneycontrol Contributor
By now you should have realized that your retirement will be much longer than what previous generations had. Life expectancy of Indians is rising and as a result, we are now staring at a retired life of 20-30 years.
What this means is that the retirement savings should be large enough to last for two to three decades. Living long is good, but it costs. And this simple fact alone should wake young people up to the need to starting early to save for their retirements.
But what about those who are already close to retirement?
Their problems are slightly different. They have already been saving for years and steadily been accumulating their retirement corpus. Their main worry is whether the corpus will be enough or not. Their other worry (and rightly so) is to protect what they have already saved.
About 6 to 7 years before people actually retire, the countdown to retirement starts. This is a crucial time when they should begin the de-risking exercise. It is not just because of their falling risk appetite, but also because no one wants a bad market in later years to reduce their retirement kitty.
Imagine that you have just turned 55 and have an equity funds portfolio of Rs 1 crore. This is in addition to your PF savings of about Rs 50 lakh. So that’s 67 percent in equity and 33 percent in debt.
Now suppose an unexpected bear market in the next 3 years reduces your equity portfolio by 35% to Rs 65 lakh. At the age of 58, now you don’t have much time left as retirement is just around the corner. You might now regret the decision to be equity-heavy as you approached retirement.
This is exactly why the de-risking of retirement savings should begin several years before the actual retirement.
The idea is simple – to shield the existing corpus from any further volatility and so that unexpected changes in market conditions don’t deplete your retirement corpus drastically.
Another reason to enter retirement with a not-so-high equity allocation is the risk of being unlucky and having a series of bad returns in the early years of retirement (i.e. sequence of return risk). This can have potentially irreversible and a damaging impact on the portfolio, which might be diminished to an extent where it may be improbable to have any decent recovery.
So how do you de-risk your equity portfolio?
There is no one perfect way and the actual strategy might be governed by prevalent market conditions and other factors.
But suppose you reach the age 53 with 70% equity. And you wish to reach retirement with a lower 30% equity. So you can possibly rebalance annually to systematically reduce equity as follows:
At age 54, equity should be brought down to 65%At age 55, further down to 60%
At age 56, to 55%
At age 57, to 50%
At age 58, to 40%
At age 59, finally to 30%
Or if you are more hands-on, then you can take more situationally aware and valuation-conscious calls to reduce equity in a more tactical manner (but only if you know what you are doing or are taking advice from a competent advisor).
If this sounds complex, then take a simpler approach – gradually reducing equity funds via systematic transfer plans (STP) into debt funds on a regular basis.
Conservative retirees may still ask as to why shouldn’t they simply eliminate equity by the time they retire if it comes with so many risks? That can be done. But only if the corpus is big enough to last longer than retiree himself and even if it earns low 6-7 percent post-tax returns.
But if that’s not the case, then the corpus needs to be deployed to beat inflation and last longer (possibly 20+ years). And this is difficult if parked entirely in risk-free assets.
I know that a majority of retirees are apprehensive of taking risk with their retirement corpus. And rightly so. But in the era of gradually declining risk-free rates, long retirements and high inflation, its not prudent to completely shun equity after retirement.
Ideally, a retirement portfolio should have two components. One that takes care of regular income needs via monthly payouts and the other to invest for growth and inflation-beating returns.
Remember that in any case, you will not use the entire corpus in one go. A large chunk of the retirement portfolio will remain unutilized for several years, possibly more than 10-15 years. And such investment horizon is more suitable for equity investments.
So at the risk of sounding too generic, retirees should first of all ensure that they do not have too much equity as they get closer to retirement. But they should still try to have about 20-30% in equity during retirement.
The regular income needs can be taken care off using interest payouts from bank FDs, SCSS, PMVVY, POMIS, annual withdrawals from PPF and SWP from debt funds. Annuities can also be considered in some cases to cover the longevity risk. But since the principal invested in annuities is not accessible easily, it should be limited to a small portion of the portfolio.
As for the growth side of the portfolio, it can be invested in well-diversified, well-proven equity funds from large cap (index or active) and multi-cap space.
