Deciding a portfolio's equity allocation post retirement is essential to the retirement planning process. It must not be too low. This would see the portfolio lose purchasing power to inflation over time. It must also not be too high. Otherwise, a sequence of poor returns may compromise the longevity of the retirement corpus. Therefore getting the equity allocation post retirement right will be the topic of this post.
I will go about the topic by answering three questions that are central to the topic. These are :
A. Why is an equity allocation required post retirement?
B. How much equity is required in the portfolio?
C. What should the equity component consist of post retirement?
Why Is An Equity Allocation Required Post Retirement?
Equity is required for any goal where matching or beating inflation is a consideration. Retirement is the only goal where the corpus we build needs to last us for multiple decades past the point of retirement. This makes managing inflation a major consideration post retirement. Equity as an asset class gives us the best possible chance of matching or beating inflation. Therefore most portfolios would need to have a considerable allocation to equity post retirement.
How Much Equity Should Be Held Post Retirement?
The answer to this question involves multiple considerations. These include :
A. Age at retirement
B. Life expectancy post retirement
C. Adequacy of the corpus at the point of retirement
D. Degree of dependence on the corpus post retirement
E. Presence or absence of earned income post retirement.
Factoring in the first two considerations is fairly simple. The default age for normal retirement today is close to 55. Early retirement is typically achieved (if at all) around age 45. Life expectancy in both cases would be 90. This translates to a post retirement period of 35-45 years.
It is less common to see retirees having earned income post retirement. Where there is earned income post retirement, there is no telling how long it would last. Most retirees would therefore be highly dependent on their portfolios post retirement. The equity allocation in the portfolio would therefore vary accordingly. There are four distinct possibilities here :
Case A : Inadequate Corpus
Where the corpus is inadequate (available corpus < 90% of required corpus), there is no scope for an equity allocation. Most of the corpus must hence be used for to buy an annuity scheme. This may be combined with some cash to provide for emergencies. This would ensure that there is a bare minimum level of income available post retirement Matching or beating inflation would obviously not be possible. The retiree would therefore need to live frugally and be well prepared for unexpected expenses. An illustrative asset allocation for a retirement corpus in such a case is depicted in the graphic below.
Case B : Barely Adequate Corpus
Where available corpus at retirement = 90-100% of required corpus, it would be just about adequate. This allows a little more room for risk to be taken with the corpus, though not much. The cash component of the corpus may be replaced with low risk categories of debt mutual funds. A maximum of 30% of the corpus may be allocated to equity in such a case. But prudence would dictate that the equity allocation be capped at 20-25% of the corpus. An illustrative asset allocation for a retirement corpus in such a case is depicted in the graphic below.
Case C : More Than Adequate Corpus
When available corpus at retirement = 150% of required retirement corpus or more, the corpus may be considered to be more than adequate. The disproportionately high net worth available at retirement means that the retiree can bear more risk post retirement. They can therefore afford to run a corpus with a higher equity allocation. Of course this is not a necessity. It purely comes down to the preference of the retiree. An illustrative example of the asset allocation for a corpus at the start of retirement in this case is given below.
Case D : Early Retirement
A trivially small number of individuals build enough wealth to allow them to afford complete retirement earlier than expected. In most cases the decision to retire early is conscious and not forced. Therefore it is virtually certain that the retirement corpus would be adequate when stepping into early retirement. Early retirement is typically achieved around age 40-45. The post retirement period would be 45-50 years in such cases.
This slightly longer relative to the post retirement period for normal retirement. Therefore, the equity allocation post retirement may need to be slightly higher during the initial 15 to 20 years post retirement. This would facilitate portfolio growth over the more extended post retirement period. In later years, the equity allocation may be gradually reduced as required. An illustrative asset allocation for a corpus at the start of early retirement is given in the graphic that follows.
What Should The Equity Component Consist Of Post Retirement?
Having seen how much equity can be held post retirement, the composition of the equity component must be considered next. The composition of any retirement corpus must be simple by nature. This is no different for the equity allocation in the corpus. Cognitive impairment is a very real risk in the later years of retirement.
So there is no point in trying to load the equity component of the corpus with a variety of products. Early retirees may run a slightly more complex composition. But they too would ultimately need to shift to a simpler composition. A basic combination of large cap index funds and dividend yield stocks (for income, if required) is hence more than sufficient for the job. An illustrative composition of the equity component of a retirement corpus is given in the graphic that follows.
The answers to these three questions discussed above provide guidelines to decide the equity allocation post retirement. But it must be remembered that guidelines are not hard and fast rules. A reasonable degree of adjustments may be made to these guidelines on a case to case basis. This would ensure that the post retirement equity allocation strategy designed for each retiree is an optimal fit for the specific nuances of their case.
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