We recently met individuals who had 10 years or less to go for their retirement. All of them had the same concern — they were falling short of accumulating their desired wealth at retirement. The problem was that none of them had the choice of extending their retirement beyond the mandated age. This meant that they had to cut their desired lifestyle post-retirement. But should they?
In this article, we discuss what you can do to bridge the shortfall in your retirement portfolio, when you do not have the choice of postponing your retirement.
There are two ways by which you can bridge shortfall in your retirement portfolio. You can either increase your equity allocation in the hope that your investments earn higher return. Or you can increase your capital contribution during the last 10 years of your working life.
Now, increasing your equity allocation close to your retirement would be risky. What if the equity market declines? You will have limited time to recover your losses. In your effort to reduce your shortfall, you might just as well increase the gap! You could, of course increase your capital contribution during the last 10 years of your retirement. And even if you invest that additional capital in fixed deposits or such interest-bearing investments fetching 8 per cent return per annum, you can double your capital by the time you retire (applying the rule of 72 ).
But all of you may not be in the position to increase your capital contribution during the 10 years leading to your retirement. This could be due to other obligations such as having to pay your mortgage or funding your children’s college education. So, what should you do?
You should give yourself more time to bridge the shortfall without postponing your retirement! How? You can consider the 10 years before and after retirement as a single investment period and adjust your portfolio accordingly. In other words, you should manage your portfolio through your retirement risk zone.
Portfolio morphing
To understand this, divide your post-requirement expenses into three buckets—living expenses, leisure and health-care. Now, funding your living expenses immediately after retirement becomes your priority. But you are unlikely to incur major health-care expenses until you are 70. So, you do not need to accumulate at 60, all the wealth needed for your post-retirement living. Therefore, any shortfall in your retirement portfolio can be recovered during the 10 years after retirement. How?
First, sell bonds in your retirement portfolio to buy a lifetime annuity to fund your living expenses. You should do this during the 10 years leading to your retirement. Why? It gives you time to shop for annuity. Remember, annuity offered by insurance companies will be typically higher when interest-rate levels in the economy are higher.
Second, carry the equity investment in your retirement portfolio till you reach 70. Why? This investment can help you fund major surgeries in your old age. You can do this because your medical insurance along with your emergency fund offers you basic health protection during your retired years. By continuing your equity investments till 70, you give yourself time to recover shortfall in your retirement portfolio.
And third, despite the shortfall, if you want to spend on leisure, sell some of your equity investments at retirement and invest in short-term deposits. This will help you fund your leisure expenses during the initial years of your retirement.
Conclusion
You can bridge the shortfall in your retirement portfolio in two ways without increasing your risk. One, you can contribute additional capital into your portfolio during the retirement risk zone. And two, you should consider your retirement risk zone as a single investment horizon and adjust your retirement portfolio accordingly. We hope that these measures help you in bridging the shortfall. Happy retirement!
( The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. Feedback may be send to knowledge@thehindu.co.in )