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The most important portfolio you will create during your working life is retirement portfolio in which you will accumulate wealth to buy investment products at retirement to fund your post-retirement living. Here, we look at why managing risk during the retirement risk zone is crucial to financial well-being.
Risk zone
The retirement risk zone refers to five years on either side of retirement. If you plan to retire at 60, then 55 to 65 is the most crucial period of your investing life. Why?
Suppose your life expectancy is 90. If you are retiring at 60, then you must accumulate enough wealth in your retirement portfolio to buy investment products to sustain your post-retirement living for 30 years. So, the retirement portfolio must hold a large amount of wealth. Imagine what a 10% slide in the equity market will do to the portfolio!
At retirement, you must use the accumulated wealth in retirement portfolio to buy investment products that will fund post-retirement living. Now, suppose this portfolio, called the retirement income portfolio, also holds equity investments. Then, a decline in the equity market by, say, 10% could significantly expose you to the risk that you will run out of money before your lifetime. But why define the risk zone as five years on either side of retirement? If your equity investments slide closer to your retirement date, you may have limited time to recover the losses. And, you need all the wealth in your retirement portfolio to buy investment products for post-retirement living. Likewise, if your equity investments decline by, say, 10% during the first years of your retired life resulting in large losses, you may not have the resources (additional savings) to bridge the shortfall. So, what should you do to moderate the risk?
Conclusion
You should reduce equity exposure between 45 and 55 years if you plan to retire at 60. This way, you will reduce the effect of a market decline in equity investments. Of course, when you reduce equity investments and move the proceeds to fixed deposits, you are lowering the expected returns on your portfolio. To make up,, you must increase your savings. As for moderating the risk during your retirement, it is optimal to invest in income-generating products such as monthly income bank deposits to fund your living expenses.
(The author offers training programmes for individuals to manage their personal investments)
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