How to manage your portfolio when you near your goal (retirement) – Part 2

This article on how to manage your portfolio when you near your goal was originally published in 2020. It has now been revised and updated and we are therefore, republishing it.

This is the second in our 2-part series on managing your portfolio when you near your goal. The first part is here: how close to your goal should you move out of equity. In this second and concluding part, we shall answer if you should have equity in your portfolio, especially in your retirement. We will cover the following questions:

• Should I move out of equity entirely?
• Which categories should I hold if I continue with equity?
• Should I move to debt funds or fixed deposits?

When you can leave your equity undisturbed

• Leaving it to heirs: If you had been investing in equities – whether through stocks or mutual funds – with the idea of leaving it for your heirs, there is no question of moving equity out of such a corpus. But here, first ensure that your own retirement kitty is adequate to meet your needs
• Have enough cashflow: Some of you may have adequate pension to cover your living expenses during retirement and hardly need any other regular income stream.

In these cases, you can continue to hold an equity portfolio and allow it to grow and just tend to it periodically. You don’t need any special rules or asset allocation principles here – the normal asset allocation and diversification that’s anyway needed for long-term portfolios apply. Do not let anybody tell you that you cannot hold high equities as you age. You can check our unique Portfolio Review Pro tool on whether your current asset allocation will work and also do a quality check on the nature of your funds.

Deciding how much equity to hold in retirement

When you have a certain corpus as retirement, you need to first decide your income generation needs before deciding how much equity to keep. So your answer to equity allocation depends on:

• how much corpus you have
• the corpus needed for income generation
• whether you are dependent on the corpus for all your expenses or you have other income sources
• your risk appetite (not discussed in this article)

#1 When it is best to quit equity

It is best to stay away from equity allocation in your post-retirement corpus, if the first point below, along with one or more of the other points hold true:

• One, and most important – you are the kind who can live within the interest income you get by sticking to the traditional income generation options of post office and FDs. 
• Two, you have never really tracked your investments or understood them and invested only because your bank relationship manager told you to. Good for you if such a portfolio delivered well for you, but in such cases, you can move to easy, safe options that you understand.
• Three, you want easier management of your portfolio, to keep it simple and with low stress, and which is also easy for your spouse to manage after you.
• Four, you are not insistent on earning high returns or growing your wealth, and you have a comfortable corpus to meet your needs with safe investment options.

In the above cases, you can simply exit your equities and shift entirely to debt. There is no point in taking excessive risks or volatility in retirement as long as your regular investments like deposits give you adequate income (which also means you have a large enough corpus).

You can check our retiree portfolios for the options. This will provide you with a combination of traditional fixed income options and low-risk debt funds based on your tax slab. You can stick to the traditional options alone and skip the debt funds if saving taxes is not a priority. You don’t necessarily need mutual funds.

#2 When you can keep equity

You may want to continue with keeping equity in your retirement portfolio if: one, you have been actively tracking equity over the years, two, you think you may outlive your corpus, or three, you simply want to continue building wealth, although your corpus is adequate to meet your income needs using traditional fixed income options.

In this case, you need to see if you can allocate some amount to equity and still have sufficient corpus for regular income. You can take the help of a financial planner to draw a cash flow plan. But if you want to do this yourself, here are the broad guidelines. You can try following them with this excel sheet.

• Draw up your annual living expenses (all expenses including medical expenses and even caregiver/attender/nurse cost for at least the last 5 years of your estimated life span) with annual inflation prevailing then. Then see if your present corpus (equity plus debt) will last for at least 10-12 years.
• You will need to assume growth in your investment as well. For this, assume the entire corpus is in debt is earning a low interest rate. This can be the poorest rate you might get on deposits – say 6-7% in current scenario.
• If your investment does not meet your income requirement, you will have to be prepared to live within your limited income and not deplete capital with higher withdrawals every year. This scenario needs discussion with a financial planner and diligent budgeting/redrawing of plans/liquidating any physical assets.
• If your investment sufficiently meets your 12-year requirement, then you can afford to include equity. So now, reduce the income generating portfolio (debt) to 85-90% and see if the corpus still lasts for 10-12 years. If it does, then 10-15% can be invested in equity. You can keep altering this to see if even a 20-25% exposure can be had to equities. The idea here is to ensure you are not compromising on safety of the income corpus.
• This equity exposure can be slowly transferred to your income generating options after 10 years and thus act as a top up for your dwindling income portfolio.

There is no thumb rule to holding an equity allocation. It depends on the residual corpus after fulfilling at least 10-12 years of your income need.

Let’s take an example. Suppose Radha is retiring at the age of 60 with Rs 1 crore and needs Rs 40,000 per month with a 6% rise every year. She can invest the entire sum in debt and earn, say, an average 7% and ensure the corpus lasts for say 23 years. Or she can invest, say, 25% in equities for the next 12 years or so and keep the remaining Rs 75 lakh in debt, for her income needs. In this case, she will run out of her debt corpus somewhere in the 17^th year.

But she can start moving her equity corpus after, say, 13 years (assuming it grew by 10%) and ensure her income corpus lasts longer than the life span of 85 years that she estimated.

You may be wondering how your corpus will not last if the principal is intact and you generate only interest. Please note you are not making do with just interest. You are looking at a higher sum of income every year, thanks to inflation. So naturally, the corpus will deplete over time.

What am I trying to say here? Simply this:

• There is no thumb rule to holding an equity allocation. It depends on the residual corpus after fulfilling at least 10-12 years of your income need. And of course, your willingness to hold equity to elongate the life of your corpus.
• The 10-12-year period of locking the income generating corpus safely is to ensure your medium-term income needs are not compromised or exposed to risk. It is also to reduce the risk of capital loss in equity.

Keep the categories simple

Once you split your portfolios as income-generating portfolio and growth portfolio, you will know what to keep and what not to. Needless to say, the income generating portfolio should have little risk. We’ll talk about this later.

Exit high-risk categories such as small caps with low liquidity or those not backed by high quality fundamentals. If you held lot of stocks, try to consolidate by exiting the ones that have run up sharply or are too cyclical or where you have very miniscule exposure. Unless you plan to actively rack your portfolio exit high valued stocks with limited fundamentals. It only takes one bear rally to reduce these to penny stocks sometimes. You don’t want such risks at this stage of your life.

Your equity portfolio should primarily consist of blue-chip stocks that you have already held for long, and/or index funds and/or multi-cap funds and an US-based international fund.

The debt portion of your growth portfolio should not take any credit risk. A combination of quality short duration and corporate bond funds or gilt fund should suffice.

Moving to deposits or debt funds for income?

Over the years, we have learnt that the (seemingly) safest of funds do not remain safe. This is true of even liquid funds. Hence, we advocate moving a chunk of your retirement corpus/income generating corpus to traditional deposit options – post office, bank FDs, RBI Floating Rate bonds and high-quality deposits. A chunk could be 75-90%, depending on your situation. You can check Prime Deposits for such options.

The remaining 10-25% (don’t up this if your retirement corpus is your only source of income) can be in very low-risk debt funds for 2 reasons:

• One, SWPs in debt funds give you flexibility to change your withdrawal amount. This is absent with regular fixed income options. For example, a 7% 5-year bank FD of Rs 50 lakh will not give you more interest income than the Rs 3.5 lakh per year, even if your own expenses go up. You will be able to change your SWP (systematic withdrawal plan) with a debt fund.
• Two, although the indexation benefit in debt funds is gone, SWP is still a lot more tax efficient, as only the gain in every instalment withdrawn is taxed. So if you get say 10,000 a month interest through your deposit, Rs 10,000 is taxed. However, a SWP of Rs 10,000 would entail tax only on the gain component of this Rs 10,000 as the remaining is your principal.

But it is important that you know the right categories of debt funds for your income generation portfolio. This is because you don’t want capital volatility when you are doing a regular withdrawal.

If you have held corporate bond funds or high-quality short duration funds for long, you could directly use them for SWP. However, make sure you have an equal amount in ultra short, low duration and money market funds.

Here, it is important to understand and finetune your return expectation from debt funds. This is important because some of you wish to keep your debt corpus intact, without capital erosion. So you try and fix a rate of withdrawal that is lower than the return rate. For example, if debt funds on an average deliver 7%, you would need to keep your withdrawal rate at 5-6%, if you do not wish to deplete the corpus at all.

But practically speaking, fixing a withdrawal rate that is lower than return may be difficult. Here’s why: When we first wrote this article in 2020, liquid funds in the previous 5 years had delivered returns of over 6% on a rolling 1-year return basis 90% of the times. This number was 88% for ultra short and low duration funds. Now if you take the block of last 5 years (2018-2023), the rolling 1-year returns of liquid funds crossed the 6% mark just 39% of the times! That mean close to 60% of the times they delivered less than 6%.

This is because we were in a low rate cycle for a chunk of these years. It is not like ultra short and low duration funds did better. In the latest 5 year period, the rolling 1-year returns of these funds were over 6% just 51% of the times. So, instead of trying to keep your withdrawal rate too low, be prepared to deplete the corpus a bit, knowing that there will be some years of higher returns and that your equity portfolio will help fill the deficit, over a period.

Equity for income

Some of you ask us why you should not do a SWP on your equity funds or simply use your stocks to generate income. If such a corpus has been built over a long period (say 20 years or more), then there no harm in doing so. In fact, a real-life scenario I have given below follows this method partly. However, it is important not to lose sight of asset allocation rules – to ensure your portfolio is not volatile. To this extent, having debt is necessary.

By shifting to debt, you are essentially locking a large part of the profits made and moving to safer options while allowing the rest of the equity to grow. This capital preservation mode has to kick in when your primary income by way of salary stops. Besides, behaviourally, investors tend to get jittery to see their ‘income corpus’ move erratically every day. This is one primary reason why debt options are preferred to generate income.

Conclusion

To conclude, equity can be a great source of cushion, provided your medium term income is taken care of through safe investment options. The rest if any, can be in equity.

To give you a real-life example of how equity comes in handy – an elderly relative in my family invested all his retirement proceeds in post office and bank FDs. But there would be times that he needed more income – for example, to deal with his wife’s illness and in later years, having a caregiver for his own needs. He would periodically sell some stocks and replenish his income kitty. These were stocks he had held for 25-30 years. So, he did not have to wait for 5-10 years before selling them. He could dip into the equity anytime to refill his ‘income portfolio’ or for emergency needs.

To this extent, trying to box your retirement planning with a set of rules is not necessary in our view. Holding or exiting equity is a choice based on circumstances and not based on financial planning rules.

This retirement calculator will help you understand how much corpus you need to create before you retire.