Investment Strategies in Retirement

When it comes to retirement planning there are various strategies available through which one can plan for retirement. However, which strategy to adopt is the biggest confusion among retirees. DSIJ evaluates various investment strategies for retirement.

For many, retirement is the end of the earning period, unless someone chooses self-employment. Every retiree wishes to make the best possible use of the retirement corpus that he may have accumulated over his earning period which would help him earn a regular income till he survives.



However, there is a conflict between the need for safety and the need for growth to hedge inflation over the life of the retiree. A retiree having a very huge corpus may invest in a zero risk investment portfolio that primarily invests in safe investments such as fixed deposits or liquid funds. For others, it is always a challenge on how to allocate their retirement corpus that outlives them. If he adopts a zero-risk portfolio, chances are high that he may outlive his retirement corpus. At the other end, although an equity portfolio comes with high expected returns, it also carries volatility which could eventually lead to self-liquidation if the withdrawals are continued when the markets are down. For example, if a retiree would have invested his retirement corpus in the mid-cap or small-cap fund during 2017, he would have been forced to book losses to get a regular income. So, this calls out for an appropriate investment strategy which would mean investment in the right mix of assets based on individual risk profile that would help the retiree not only get the desired withdrawals, but also ensure his funds last beyond himself.

The debate always revolves around how much people have saved or how much they have set aside for retirement. However, the focus on savings amount is missed. It is to be understood that planning for retirement is not just about achieving some magical retirement corpus number, but also about generating enough cash flows to meet your financial goals, needs and wants. Before diving straight into investment strategies for retirement, it is important to understand how much you need for retirement.

Ascertain the right amount of retirement corpus

To calculate retirement corpus, it is crucial to understand the lifestyle you wish to have post retirement. This will help in determining the expenses in today’s terms that you would need post retirement. Then you need to adjust it for inflation and need to estimate the rate of return that you expect to receive post retirement on your investments. Then, with the help of real rate of returns, you need to calculate the present value of all the future cash flows. This present value is the required retirement corpus.

So, let’s say considering your lifestyle you would require Rs. 50,000 per month post retirement (this is in today’s terms). Inflation is assumed to be at 7 per cent pre-retirement as well as postretirement. Also, assume your current age is 30 years, you will retire at 60 years, your life expectancy of 80 years and expected rate of return post retirement is 9 per cent. Back of the envelope calculation shows that the corpus required at the age of 60 would be Rs. 7.63 crore. To achieve this, assuming the compounded annual growth rate (CAGR) to be 12 per cent on your current investments, you need to either do SIP (Systematic Investment Plan) of Rs. 21,600 per month for 30 years or lump sum investment of Rs. 25.46 lakh. As stated earlier, the retirement corpus (in our example Rs. 7.63 crore) is not a magical number and it changes over time with change in requirements and life events. Complicated to understand? It is always better to take the help of an expert financial planner or retirement planner who would help you to figure out your retirement corpus and would also be able to help you plan for your retirement.

Investment strategies

As you have arrived at your retirement corpus by accumulating throughout your accumulation phase, now it is time to distribute the accumulated corpus such that you are able to not just survive, but also be able to fulfil your financial goals. The investment strategies that have been discussed here are strictly for distribution phase.

Systematic withdrawal strategy

This is one of the most popular strategy adopted globally. This strategy involves investing in assets such as equities, debt, gold, etc. and then selling them periodically to generate cash flows while the rest remains invested. The systematic withdrawal strategy takes a total returns approach, which seeks greater long-term returns with portfolio re-balancing done every year. Here, the withdrawal rate depends on the risk appetite, returns on investment and the time horizon. This strategy is similar to the popular 4 per cent safe withdrawal rate strategy, wherein with portfolio of 50 per cent in equities and 50 per cent in debt for 30 years, the investor can withdraw 4 per cent inflation-adjusted and can easily survive for the period. The 4 per cent safe withdrawal rate strategy is popular in the United States and is based on their market scenario. However, Indian markets are quite different from the developed US markets, where the inflation is low and even the returns are low compared to India. To understand this strategy better, let us take an illustration.

Illustration

We will continue with the example we discussed above for deriving your retirement corpus. Assuming you have accumulated Rs. 7.63 crore and, based on all the same assumptions, at 60 years of age you need Rs. 3.8 lakh per month which turns out to be Rs. 45.6 lakh per annum. This withdrawal amount would be growing by 7 per cent every year adjusting for inflation. So, post accounting for outflow of Rs. 45.6 lakh for your requirement, you are left with Rs. 7.17 crore to invest, which is assumed to be invested 50 per cent in equity and 50 per cent in debt. It is also assumed that equity part of the portfolio would grow at a rate of 12 per cent, whereas debt would grow at a rate of 8 per cent. With these assumptions, your fund is sufficient enough to fulfil your needs till you reach the age of 81.



As we can see in the below graph, the available amount starts declining from your age of 72 and turns negative as you reach the age of 83. This means that if your life expectancy extends further, then your accumulated corpus will not be able to serve you financially after you reach 83 years.

The biggest upside of this strategy is that the long-term investment of the portfolio is in the markets. This probably gives an individual a good upside and provides opportunity to increase his/her wealth over time if the markets perform well. However, while following this strategy, the risk is that if equity market goes through sharp correction, during your yearly re-balancing, you will have to allocate more to equity and less to debt and hence you may have to withdraw lower or you will have to use higher capital to fulfil your needs. The risk of poor market returns early in retirement can cause a portfolio to quickly deplete if you need to take significant withdrawals from an investment portfolio early in retirement when the market is suffering a significant downturn. This strategy is effective when you have moderate risk tolerance and can adjust your spending.

Flooring income strategy

This is an investment strategy wherein your retirement corpus is divided between the needs and wants. This strategy is completely different from the risk and returns investment strategy adopted by the systematic withdrawal strategy. The flooring income strategy believes that the needs in the retirement phase should be met from secured source, while rest of the corpus is to be invested in equities. This strategy assumes that you can risk the non-needed part.

Illustration

We will again continue with the example we discussed for deriving your retirement corpus. Assuming you have accumulated Rs. 7.63 crore and, based on all the same assumptions, at your age of 60 years, you need Rs. 3.8 lakh per month which turns out to be 45.6 lakh per annum, which would be growing by 7 per cent every year. So, post accounting for outflow of Rs. 45.6 lakh, you are left with Rs. 7.17 crore to invest during the first year, which is assumed to be invested in equities. It is also assumed that equity would give CAGR of 12 per cent. With this, you are able to utilise the funds up to 89 years of age.



As we can see in the above graph, the available amount starts declining from your age of 82 and turns zero from your age of 89. This means that if your life expectancy extends further, then these funds would not able to financially support you beyond 89.

The biggest upside of this strategy is that it secures all the needs by investing in secure investment vehicles and the rest is invested in the markets. This probably provides opportunity to increase his/her wealth over time if the markets perform well. This strategy invests the remaining amount in equity for the long-term, which helps it to grow without any interruptions. However, the biggest drawback of this strategy is that it invests a major part of the retirement corpus in equities without any further diversification. This increases the overall risk.

Bucket Investment Strategy

Bucket strategy is something which is more related to emotions and psychology, wherein different buckets of goals are created based on duration and then investments are made or allocated depending upon the duration left for the goal and risk profile of the investor. Therefore, it is also known as time segmentation strategy. Say, for instance, you have certain financial goals in retirement like regular income, vacation, medical, charity, etc. and all are spread across various durations. Some are for short duration, some for medium and some are for long duration. For short duration goals, investments are made in secured instruments, for medium duration goals investments are made in a mix of secured and growth instruments and for long duration, growth investments are preferred.

Illustration

Connecting with the same retirement corpus example, it is assumed that you have accumulated Rs. 7.63 crore. Adding to that example, you have a vacation goal, which you wish to go every year till you turn 75 and the amount for which is Rs. 80,000, inflating at the rate of 5 per cent. You also wish to have a medical corpus of Rs. 20 lakh. So, at the age of 60, you need regular income of Rs. 3.8 lakh per month, which turns out to be Rs. 45.6 lakh per annum, which would be growing by 7 per cent. So, post accounting for the first-year outflow of Rs. 45.6 lakh, along with Rs. 80,000 for vacation and Rs. 20 lakh for medical, you are left with Rs. 6.97 crore, which would be invested. Both (vacation and regular income) are long term goals, so it is assumed that 75 per cent would be invested in equity and 25 per cent would be invested in debt. It is also assumed that equity would give CAGR of 12 per cent and debt investments would give CAGR of 8 per cent. This strategy will be able to financially support you till the age of 84.



As we can see in the below graph, the available amount starts declining from the age of 73 and turns negative from your age of 84. This means that if your life expectancy extends further, then you will not be able to support your living beyond 84 years.

The best part of this strategy is that you can account for all your financial goals and make investments for those goals accordingly. This strategy makes sure that you stick to the strategy to achieve your objectives, which also helps you to live in peace as your financial goals are being taken care of along with your required regular income. However, the biggest drawback of this strategy is that its investments are based on goal tenures and investor’s risk profile, which for aggressive investors can be appealing, but for conservative investors, it may not prove to be an appealing deal.

DSIJ Strategy

This strategy may sound similar to flooring income strategy. However, the difference is that this strategy considers expenses of three years collectively, the amount for which is invested in debt and the remaining corpus goes into equity investment. This strategy ensures that your three years of required regular income stays in safe investment avenues and the remaining moves into equity or it can even be a mix of equity and debt. In this strategy, some part deals with capital protection, which is the biggest concern in retirement, and the other part helps to beat inflation.

Illustration

Continuing with the example we discussed for deriving your retirement corpus. Assuming you have accumulated Rs. 7.63 crore, and based on the same assumptions, at your age of 60, you need Rs. 3.8 lakh per month, which turns out to be 45.6 lakh per annum, which would be growing by 7 per cent. Here, we would account for three years of cash outflow, which comes to Rs. 1.47 crore, after which you are left with Rs. 6.16 crore to invest, which is assumed to be invested in equities. It is also assumed that equity would give CAGR of 12 per cent and debt at a return rate of 8 per cent every year. This strategy will support you financially till the age of 89 years.



The good thing about this strategy is that it secures three years of your regular income by investing it in secure investment vehicles and the rest is invested in equity markets. As this strategy invests the remaining amount in equity, which stays for the long-term, it helps it to grow without any interruptions. it is flexible towards investment in other asset classes, apart from equity. With this strategy, you can also have a portfolio of equity and debt with different proportions based on one’s risk appetite. Comparative figure of all the above strategies

Accumulation Phase : Accumulation phase is the pre-retirement period, which is usually for accumulating wealth required in retirement.

Distribution Phase : Distribution phase is the post-retirement period, which is usually for utilising the wealth accumulated for retirement during the accumulation phase.

Regarding taxation: While carrying out the study, we have ignored the taxation part. However, you would be subject to taxation as per the prevailing tax laws. In our study, for all the strategies, we have assumed that you would be withdrawing from debt instrument in the beginning of the year. So, on the withdrawal from your 62nd year, you would be subject to short term capital gains tax as the gain arising out of selling the debt instrument would be added to your income and would be charged as per individual income tax slab rates. However, we also assume that you would be doing re-balancing every year and this activity can also attract long-term capital gains tax in the case of equity, and short-term capital gains tax in the case of debt.




Conclusion

From the above analysis, you may find the flooring income strategy is better than the other strategies. However, it is equally important to understand that the risk involved in flooring income strategy is higher among all the abovementioned strategies. The flooring income strategy assumes that during retirement, only one year expense is required to be protected and the rest can be invested in risky assets such as equity.

The systematic withdrawal strategy is a sort of very conservative approach and hence your retirement corpus will be exhausted fastest. The bucket strategy is something wherein it is a psychological way of investing and getting your financial goals in retirement achieved. Although a good strategy, since the retirement goals cannot be accounted in retirement corpus calculation during the accumulation phase, it may further deplete your wealth.

DSIJ strategy is something which overcomes the limitations of systematic withdrawal strategy and flooring income strategy. This strategy helps you to secure your three years of regular income by investing them in safe avenues and allows the rest to grow. This strategy is something which can be used by investors across risk profiles as it allows the amount to be invested even in other investment avenues, apart from equity. However, as everyone is unique, so are their situations. So, nothing can be generalised. It is always better to seek advice from an expert financial planner or retirement planner. He would look at your overall financial situation and help you in taking future course of action.