How to de-risk investments when you retire

Here’s a primer on how to redirect your investments so that you have the right portfolio during your retired years

Kavya Balaji Nov 15, 2019

DeriskingMost often when one hears the word ‘retirement’ one might feel a sense of dread. This could be due to the fact that one isn’t financially prepared for their retirement. Even if you would receive a pension after retirement, this pension might not be enough to meet contingencies that you might have to face as a retired person. Here’s a primer on how to redirect your investments so that you have the right portfolio during your retired years.

How much corpus do you need for retirement?

This is the toughest question to answer as it would depend on your lifestyle and your corpus accumulation until retirement. For any working person, the amount of their expenses during retirement would broadly be equal to what one would spend in the years immediately preceding retirement. One also needs to be mindful of the inflation and other major expenses one could expect during the retirement years like medical expenditure. How this can be done is the subject for a separate article.

In any case, the first thing to do is to set aside six months to a year’s expenses as emergency corpus. The rest could be used as retirement corpus. It is important to contact a financial planner who might be able to give you an idea of how much you would require once you retire.

What are the investments you should make ahead of and during your retirement?

The obvious answer is debt and equity. Retirees would need a fixed income for maintaining their lifestyle, and would also require capital appreciation of the portfolio which equities will provide. This is where de-risking comes in.

De-risking is the process wherein you start moving away from riskier assets towards safer assets as you might not have a steady income after retirement. The key point is how much to de-risk. For an aggressive investor who had a large proportion in equities in pre-retirement years, it is critical to reduce the equity exposure. But one cannot totally move out of equities.

The proportion in equity and debt would depend on important factors like sufficiency/insufficiency of the retirement corpus, risk taking ability, availability of pension and health concerns, if any. If the retirement corpus is inadequate to meet the retirement needs, one may have to continue investing in higher risk assets such as equities.

A minimum percentage in equities is extremely crucial given the rate at which health costs and inflation are going up. A person with no regular income should have at least up to 20 per cent exposure to equity (large cap stocks/mutual funds) which has a potential to give better portfolio returns to beat the inflation

So, the point is that there are no ideal allocations. Choose to continue investing more in equities if (a) retirement corpus is insufficient (b) you have high lifestyle costs (c) you are receiving regular income to meet expenses and can afford to deploy assets in riskier instruments. It is best to keep the asset allocation simple and easy to follow – so as to avoid any unpleasant surprises in the second innings.

How to ensure that you have de-risked your portfolio?

Whatever your asset allocation, you must ensure that the investments that you make have the following features so that your portfolio is less risky than it was during your working years.

Liquidity – Retirement is a time when health issues escalate and emergencies are quite possible. It may not be possible to meet these contingencies with your pension. The more liquid your investments are, the quicker you would be able to access them.

Beats inflation – Your investments need to beat inflation i.e. the returns from your investments should be higher than the average inflation rate. Usually an average inflation rate of 4 -6 per cent is taken based on one’s lifestyle. Another key consideration in managing any portfolio is beating inflation consistently after payment of all taxes. So, ensure that the after-tax returns from your investment are able to beat inflation.

Steady cash flow – Your investments need to give you regular income, especially if you would be receiving no pension.

When to start de-risking your investment portfolio?

Ideally you could start de-risking a few years before you actually retire. Gradual 10 per cent shift from risky to low risk instruments should start from 50 – something similar to a systematic transfer plan (STP) in mutual funds.

De-risking is a process that might involve expenses. Keep a tab of the associated costs attached to the conversion of portfolio from equity to debt which might take a hit on the overall portfolio return. That is the reason why a gradual approach might be best. If you have invested a huge amount in equity mutual funds, you could consider Systematic Withdrawal Plan (SWP). For a retirement portfolio, an SWP works better as there are no Long-Term Capital Gains (LTCG) implications for an equity portfolio held for more than a year.

Divide between investments that provide regular income and those that don’t. Consider a range of products starting with income funds, liquid funds, Fixed Maturity Plans (FMP) which have a potential of earning decent returns coupled with maximum chances of principal guarantee as it does not have a direct relation with the equity market.

Debt investments such as post-office schemes, bank Fixed Deposits (FD) and bonds are good places to start if you are looking for regular income.

Understand that there is a risk of outliving your retirement corpus. Keep comparing your expenses and income and ensure there is enough surplus every month. Continue investing in equities since life expectancy has risen and equities are known to give the best returns over time. This is the reason why you might need to invest in large cap mutual funds or stocks. Also, this is the time you should minimise tax outflows.

Avoid using maturing investments for household expenses. Roll them over instead. You could create an income ladder by rolling over bank FDs or post office investments. The Senior Citizens Savings Scheme (SCSS) and annuities are must-haves for any retirement portfolio.

Here’s the action plan for de-risking

• Create an emergency fund – One needs to keep six months’ expenses in a bank or liquid funds at all times, as contingency funds.
• Create a retirement corpus
• Start de-risking at the right age – Start at the age of 50 or 5-10 years before you actually retire. Sooner or later than this could mean lower returns or higher risks for your retirement portfolio.
• Invest in investments that have enough liquidity, beat inflation after tax and provide a steady cashflow in case you have no pension.
• Shift gradually – De-risking involves expenses and a slow shift is essential for eliminating the possibility of lower returns and high costs.

Looking for tax-saver fixed-income investments? Read this article: All You Wanted To Know About Tax Saver Fixed Income Investments

Kavya Balaji

Kavya Balaji is a senior contributing writer with RupeeIQ. With more than 14 years of experience in the finance space, Kavya loves everything to do with personal finance. She feels financial literacy is important for every household and likes to stick to simple language for explaining personal finance stories. She is a consultant with investment management companies. In spare time, she reads murder mysteries.

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