Think Retirement is a joint initiative between Tata MF and Wealth Forum, where we discuss diverse aspects of one of the most critical responsibilities of a financial advisor towards his investors: retirement planning. Our endeavour in Think Retirement is to provide advisors with insights and perspectives that can help them understand retirement better and thus help clients prepare and execute effective retirement plans that enable them to live their golden years with dignity and financial security.

In this thought-provoking article of our Advisor Insights series, Dhiraj Mittal - one of Delhi's most successful advisors - challenges conventional retirement planning wisdom which calls for phased reduction of equity exposure as one nears retirement to enable steady income generation. Is a debt heavy portfolio really in a retiree's best interests or should you persist with an equity heavy portfolio even after retirement? When will clients be more amenable to considering an equity heavy portfolio post retirement? Read on as Dhiraj shares valuable insights on this critical retirement planning dilemma.

Equities is best positioned to beat inflation

Investing in equities over a longer period is one of the best ways to stay ahead of inflation. The popular indicator of performance for equities in India is the BSE Sensex. In the last 35 years of its history, it has delivered over 17% compound per year returns, from 100 in 1979 to over 27865 now. All of us in the advisory profession know this very well.

Traditional retirement planning approach

Now lets look at how we apply this insight in retirement planning. Every investor has two phases in life, the Accumulation phase and the Distribution phase. In the accumulation phase, she saves part of her earned income and invests the same for accumulating a corpus for the retirement years (the Distribution phase) wherein the income from such corpus (and at times partly principal too, if enough accumulation isn't done) is used for expenses. The traditional theory on retirement planning suggests that one should invest in an equity oriented portfolio in the accumulation years, but should make the portfolio debt oriented as one reached retirement, to avoid volatility in investments in non earning years. A debt heavy portfolio also offers the assurance of regular income, which equity cannot guarantee or assure. I think its time to challenge this traditional notion.

Equities right through - as much as you can emotionally stand the volatility

My belief is that prior to retirement, as close to 100% of the long term investments should be in equities as the client can emotionally stand the volatility. Then after retirement, as close to 100% of the long term investments should be in equities as the client can emotionally stand the volatility. If equity is the asset class best equipped to fight inflation, why would you not want such a player or some such players in your team to go through 20-30 years of retirement? Why would you want to pack your team with players who are most likely to lose the battle against inflation and steadily erode your purchasing power over 20-30 years of retirement?

When will investors actually buy into this thinking?

In most cases, it is fear of volatility that comes in the way of taking a rational decision on having a sizeable proportion of the distribution phase assets in equity. This fear, in my view, will not be so much of an issue only when two conditions are met:

1. The investor has personally experienced at least a couple of market cycles to truly understand that volatility is temporary erosion of capital but loss of purchasing power is permanent erosion of capital, and

2. The investor has accumulated a sizeable corpus during the accumulation phase, such that monthly withdrawals for expenses form a tiny proportion of the corpus.

What you do in the accumulation phase is critical

If one starts early in the accumulation phase and maintains investments in equities for long period of time, due to the power of compounding one is able to accumulate such a large corpus by the time one retires, that the annual requirement for expenses is only a fraction of the portfolio/it's expected annual returns. As a result, even if one is withdrawing in periods when the equities are not doing well, the withdrawal is only a small percentage of the corpus.

Let's analyze the above with the help of an example. Say Astha, 25 years old, and her husband put together earn Rs 6 lacs a year post taxes, and expect their income to grow at 10% per year. They use 50% of it for their expenses . Say another 25% goes towards EMIs etc for asset purchases and the remaining 25% is allocated in equities for their retirement, which is around 35 years away.

If they were to invest this 25% in equities and stay invested till retirement, it could accumulate to approx Rs 50 cr (at 17% compound per year) and the annual expenses (growing at 7% compounded yearly for inflation) reach approx Rs 30 lacs which is only 0.60% of the then corpus. She can then afford to stay put in equities in her retirement years and keep withdrawing her annual expenses from equities. In this distribution phase, there might be some years which may be bad for equities, and she may be constrained to withdraw, when the equities are down, since the withdrawals would be only a small percentage of the total corpus, it would not hurt.

Thus, to retire comfortably, we need to encourage clients to start saving early, save more, embrace equity and stay put through market cycles . And if you invest in good equity funds which deliver better returns than the BSE Sensex, that's the icing on the cake.

Speak to your 40-50 year old clients now about this thought process

If we really want clients to have sizeable allocations to equity even after retirement, you need to start talking to them about this at least 10-15 years before their retirement. As I mentioned, unless clients go through market cycles themselves, their conviction in equities will not be strong enough to withstand bouts of volatility. Start speaking to all your 40-50 year clients about the need to have equities through and through - prepare them now, so that they can enjoy their golden years without worrying about a steady loss of purchasing power each year, because they chose a pure debt portfolio for their distribution phase.

Share this article