Take care around your retirement

Here are ways to protect against erosion in your portfolio value



Your investing life starts from the day you start working and continues till you live. The most crucial part of your investing life is the retirement risk zone. This is the period five years before and five years after retirement.

In this article, we discuss the importance of this period in your investing life. We also discuss how you should manage investment risk when you are entering this zone.

Zone risk

The risk associated with a core portfolio is that you will fail to achieve a life goal. That means the risk associated with a retirement portfolio is the failure to accumulate the required wealth at retirement.

Retirement risk zone is relevant in this context. The retirement portfolio has the longest time horizon among all your life goals. The target portfolio value is also the highest among all your life goals.

Suppose you set up a National Pension System account, or alternatively, a Provident Fund account along with an equity mutual fund as part of your retirement savings. At the beginning of your career, your investment in these accounts will be small, say, ₹5 lakh.

A 10 per cent decline in the portfolio will lead to ₹50,000 erosion in your portfolio value. You can recover the unrealised loss during your working life.

This is not true in the last five years of your retirement. For one, you have limited time to recover unrealised losses. For another, your portfolio value will be high. Suffering an unrealised loss of 10 per cent on, say, ₹5 crore, will have a significant impact on your post-retirement living.

What about the five-year period after your retire? That is the time when your retirement income portfolio will have maximum investment value; this portfolio will be created at or near retirement to support your post-retirement living with the corpus from your retirement portfolio.

A 10 per cent loss in this portfolio will mean you have to cut your living expenses for the rest of your retirement life. Or else, suffer longevity risk — the risk that you will outlive your investments!

The losses suffered on your portfolio during the retirement risk zone cannot be easily bridged. Why? You will be already routing your savings into your retirement account during the last five years of your retirement. And after retirement, your active income stops. So, you may be unable to make additional capital contribution to bridge the losses in your portfolio.

Managing risk

Your retirement portfolio is a two-asset-class portfolio containing equity and bonds. Your bond investments should be in bank fixed deposits and Provident Fund. Therefore, the downside risk in your retirement portfolio comes from your equity investments.

The easiest way to manage risk as you approach your retirement risk zone is to control your equity allocation.

Your equity allocation should preferably peak at age 45. Thereafter, you should cut your equity allocation till age 55 to 25-30 per cent of your total portfolio. You should maintain this allocation in the last five years of your retirement. Having lower equity allocation will reduce the risk of goal failure when you are entering the retirement risk zone.

Your equity allocation can be further reduced if you have the capacity to increase your monthly savings during the last five years of your retirement; giving-up higher expected returns on equity can be made good by higher capital contribution in bonds.

What about five years after retirement? Your retirement income portfolio should map investment products to your post-retirement expenses to manage risks. Thus, you should invest in monthly income bank deposits to generate stable cash flows to meet your living expenses.

Your healthcare costs should be met with emergency funds and medical insurance. And your equity investments should be allocated to meet contingencies including surgery costs, not covered by health insurance, perhaps, for years beyond 70.

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

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