Investment value gap is the difference between the wealth you require to meet a life goal and the actual portfolio wealth at the end of the investment horizon.

You will typically face investment value gap when the actual portfolio returns fall short of required returns. The question is: how should you fill the investment value gap in your retirement account?

In this article, we discuss why managing value gap in your retirement account is important and how you can fill the gap.

Value gap concern If you face investment value gap in your child’s education account, you will most likely transfer money from your retirement account.

The reason is simple. For one, your child’s education is time-bound; she has to enter college at 18 or thereabouts. For another, your retirement might be far away; you can contribute more to your retirement account during the last 10 years of your working life.

But what if you have value gap in your retirement account? Having just retired, accumulating wealth at retirement would have typically been your only goal. You, therefore, do not have the choice of transferring money from another investment-mapped-to-goal account to your retirement portfolio. There are two reasons why you should seriously address the investment value gap in your retirement account. First, if the value gap is large, your longevity risk is higher. Why? You have to depend on your investment portfolio to sustain your lifestyle during retirement. So, lower-than-required portfolio value means higher chances of your investments not lasting long, unless you cut your lifestyle needs.

Second, you may be tempted to buy more stocks to fill the value gap. Why? Failure to achieve goal causes pain, translating typically into loss aversion — you could take more risk to avoid goal failure. The problem is that taking more investment risk at retirement could increase the investment value gap and, therefore, your longevity risk.

Monetise assets There are three ways of filling the value gap in your retirement account. First, if the gap is large — more than 25 per cent of required wealth — you should consider taking reverse-mortgage. This solution is useful if you have a mortgage-free self-occupied house and willing to take a reverse mortgage.

If the above solution is not feasible, you should liquidate all your investments in your retirement account and buy stable-income products to fund your living expenses. You should preferably buy life-time annuity.

Alternatively, you could invest the purchase price of annuity in 10-year bank fixed deposits. But first create an emergency fund and use only the balance to fund your living expenses. Two, you can consider phased retirement; working two-three days a week for one-two years after 60. This reduces the burden of depending only on your investment portfolio to meet your living expenses. This solution is feasible if you are healthy, motivated to work and the value-gap is not large.

Exposure to equity And three, you can consider managing your equity investments through your retirement risk zone, a process called portfolio morphing. That is, you should continue to carry your equity investments at retirement for another 10 years. This gives time for equity to generate higher returns and, hopefully, fill the value gap. This solution is useful when value gap is 10 per cent or less.

Investment value gap in your retirement account has to be necessarily managed. Otherwise, you may be forced to make lifestyle changes through your retired years. You can also combine two or more suggestions listed above to suit your lifestyle requirement — choosing phased retirement along with portfolio morphing, for instance.

(The writer is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions Feedback to portfolioideas@thehindu.co.in)

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