If you are 50 or older and plan to retire at 60 or if you retired within the last 10 years, here is a question for you. How vulnerable is your investment portfolio to market declines? This question assumes relevance, given the high level of fluctuations in asset prices in the recent past, be it in real estate, gold or shares.

In this article, we discuss why you should be concerned whether your portfolio is vulnerable to price fluctuations when you are inside 10 years of either side of retirement, a period called the retirement risk zone.

Risk zone

If you lose significant value on your portfolio between 50 and 70, you have a cause for concern- the possibility that you may end up in financial ruin. That is, you may not have enough money to sustain your lifestyle during your post-retirement years. Why?

Suppose you suffer a 10 per cent loss on a portfolio of Rs 25 lakh. Your portfolio has to gain 11 per cent to recover the losses (Rs 2.5 lakh of Rs 22.5 lakh). But suppose your portfolio first gained 10 per cent, from Rs 25 lakh to Rs 27.5 lakh.

It has to lose just 9 per cent to give back all the gains. This example shows that it takes a lot of effort to regain lost value in the portfolio while it takes little effort to lose all the unrealised gains.

Now, this effect of returns on the portfolio is high when you are in the retirement risk zone. If you are between 50 and 60, you have limited time to recover losses and are also vulnerable to giving-up unrealised gains. And the effect is more pronounced when you are between 60 and 70. Why?

Not only will your portfolio suffer from losses but will also be affected by your periodic withdrawals to support your lifestyle expenses. With such sharp fall in value, how can your portfolio recover losses and support you through your lifetime?

Moderating zone-effect

There is one way to de-risk your portfolio during the retirement risk zone. Every five years starting 45, reduce your equity investments and buy bonds that mature in your retirement year.

The advantage is that bonds have redemption value, reducing your risk at retirement.

But selling too much equity and buying bonds may lead to lower returns. And this may prevent you from accumulating enough wealth in your retirement portfolio. The truth is you need equity both in your working and your retired lives to accumulate wealth.

You have to, hence, strike a balance between reducing risk from equity investments during the retirement risk zone and yet have enough such investments to accumulate wealth. That is easier said than done.

An alternative is to invest in fixed deposits and tax-free bonds such that the cash flows from the investments will support your lifestyle during the first 10 years of your retired life. You can also buy immediate annuity at 50 (refer this column dated August 12). The objective is to lower your desperation to recover losses during the first 10 years of your retired life, should equities decline when you are between 50 and 70.

This strategy has its issues. You will have to take-out significant proportion of your equity investments to buy bonds to generate the required cash flow between 60 and 70. And to compensate for this rebalancing, you may have to take aggressive bets on your remaining equity investments.

Conclusion

You should de-risk your investment portfolio between 50 and 60 using stable-income products. Your choice of such products will be easier if you have significant unrealised gains from your equity investments when you turn 50.

In any case, you should consider converting some assets to immediate annuity to reduce the risk of financial ruin.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investorlearning solutions. He can be reached at >enhancek@gmail.com )

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