Portfolio Ideas: When your goal is in 'transition'

Your investing life is marked by phases of work, retirement, post retirement needs

During your investing life, you typically pursue multiple life goals. Each of these life goals requires you to create a separate investment portfolio, as the time horizon and risk preferences for each of these goals are different.

But typically, only two of these investment portfolios turn out to be transition portfolios. In this article, we define a transition portfolio and discuss the relevance of such transition in your investing life.

Different time lines

A transition portfolio is one that is created to accumulate wealth in one phase of your investing life but is set to achieve the required life goal in another phase of your investing life.

Your retirement portfolio is a classic example of such a portfolio. You accumulate wealth in your retirement portfolio during your working life. At retirement, you must use the accumulated wealth in your retirement portfolio to buy products that will enable to meet your post-retirement lifestyle needs. Therefore, retirement portfolio transitions into retirement income portfolio.

Another such portfolio is your healthcare portfolio. Of course, this portfolio’s basic structure does not change between your working life and your retired life. But the value of the portfolio changes significantly.

The question is: Why should you care about transition portfolios? The reason is that risks associated with the portfolio change during transition. You should, therefore, create a plan to enable smooth transition of the portfolio to moderate these risks.

Take the retirement portfolio. It contains growth assets, positioned to earn capital appreciation. The retirement income portfolio, on the other hand, contains income assets, positioned to earn income returns. So, your growth portfolio should transition into an income portfolio.

What about your healthcare portfolio? Your healthcare portfolio will typically contain three tiers. The first tier is the emergency fund to take care of immediate medical expenses. The second tier is the healthcare insurance. And the third tier is all equity investments, to meet high-cost surgeries. The expected return on equity will help you meet healthcare inflation.

You should increase the value of all the three tiers when the portfolio transitions to account for the fact that healthcare costs increase with age, especially after retirement.

So, how should you transition your portfolios?

Portfolio transitioning

Your expenses during your retired life can be typically categorised into three buckets — living expenses, leisure and healthcare. You should initiate the transition from retirement to retirement income portfolio during the anxiety zone — the last five years leading to your retirement date. Specifically, you should map investments to your leisure and healthcare buckets, but not your living expenses. Why?

Your leisure expenses refer to spending on exotic vacations requiring lumpsum money. You will most likely spend on such experiences during the first five years of your retirement. So, at retirement, you could use some money in your retirement portfolio to invest in bank deposits to meet your leisure expenses. Or you could lock-in to a better rate by investing in deposits during the last five years of your retirement.

As for your healthcare portfolio, you should increase your healthcare insurance and emergency fund before you retire. The equity allocation in your retirement portfolio can be mapped to the third tier of the healthcare bucket of your retirement income portfolio. This helps you maintain the same level of equity risk in your portfolio. You should map investment products to your living expenses only after you retire because you need monthly income only then.

Remember, smooth transitioning of your portfolio is important. You could otherwise increase your reinvestment risk. What if interest rate declines at the time you retire and you have to reinvest in a bank deposit at a lower rate to meet your expenses? And two, product costs can increase as you age, as in the case of your healthcare insurance. Transitioning your portfolios during anxiety zone helps you reduce costs and risks.

The writer is the founder of Navera Consulting. Send your feedback to portfolioideas@thehindu.co.in

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