Portfolio ideas. Do the retired need liquidity?

As a working executive, your portfolio’s liquidity should be high. This is important given that it takes a lot more effort to recover unrealised losses than to lose unrealised gains, known as the asymmetric returns effect.

If your portfolio’s liquidity is low, you may not be able to book profits on your investments in good time. But do retirees need similar liquidity in their retirement income portfolio? Your liquidity needs are low if you are a retiree following the expense-bucketing approach.

Post-retirement living

Retirement expenses can be divided into three buckets — living, leisure, and healthcare.

In an expense-bucketing approach, we map each expense to an appropriate financial product to generate the required cash flow with reasonable risk.

Take living expenses. To fund this as a retiree, you need stable monthly cash flows. Your preferred choice would be monthly income bank deposits. Since this does not generate capital appreciation, you are not subject to asymmetric returns effect. Liquidity is thus not of concern to you as far as this expense category goes. Next, consider leisure expenses. If you wish to take trips in the first few years of your retirement, you should invest in bank fixed deposits to manage your expenses. But if you plan to vacation over 10 years, you may want to invest some in equity. In such a case, your equity investment should be liquid to reduce the asymmetric returns effect.

Note that your leisure expense relates only to high-value exotic vacations. If you prefer frequent short vacations, you can just as well combine leisure with your living expenses.

What about healthcare? Consider a three-tiered approach to fund this bucket. At the first level is the emergency fund. At the second is your medical insurance. And at the third level is the equity portfolio to fund major surgeries and illnesses not covered under medical insurance.

It is this investment that requires close attention. At retirement, as a preventive measure, you should set aside money in this account to fund major surgeries. Thereafter, your objective would be to earn returns to beat annual healthcare inflation.

To reduce the asymmetric returns effect, take profits on equity investment when unrealised gain is in excess of annual inflation. Of course, you may end up setting aside smaller amounts in this account than desired.

For instance, you may consider ₹15 lakh as a reasonable amount to set up this account. Yet, you may be able to allocate only ₹10 lakh. The shortfall has to be bridged through realised gains in the investment account. This makes liquidity even more important.

Spending vs accumulation You would want to generate stable cash flows during your retirement and accumulate wealth when you are working.

So, your retirement income portfolio must have assets that generate income and your retirement portfolio assets that generate capital appreciation.

As a retiree following the expense-bucketing approach, you need growth assets primarily to moderate inflation risk. Your liquidity requirement can be modest.

You will, however, need high investment liquidity if you have stock-bond portfolio to fund your post-retirement living through one master portfolio.

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

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