Asset allocation is key to post-retired life

Retirement is an important goal of an individual's financial plan but what most see as a destination is actually the beginning of a journey. Let me elaborate a bit further. When planning for retirement we tend to make projections about what should be an ideal annual or monthly cashflows required to sustain a desired lifestyle. We then extrapolate it with the inflation and arrive at an asset allocation depending upon the risk profile and available inflows.

There's absolutely nothing wrong in the way we approach to attain the corpus for the retirement. What is also more important in assuming how would that be consumed and the rate of return on those funds while concentrating on the asset allocation post-retirement. The latter forms a very critical aspect of retirement planning as that would define how consistent the inflows arrive and how long would the corpus sustain.

This is what is technically known as distribution phase of retirement i.e. when the money is actually consumed and at a pace which is equal or higher than the rate of growth. Also, this is the phase when the outflows are consistent and increase with time.

Many people fail to provide the significance to the fact that the medical science is improving in leaps and the possibility of living longer (than a generation earlier) is a high now. This only puts further stress on not just creating a higher corpus but to ensure it lasts longer. With the family structures moving from nuclear to atomic, the need to have a sound retirement plan in place has turned acute.

Investors typically focus more on the rate of return, but it should on the time spent in the market. If we look at the formula for compounding, the exponential is the 'n' (period) and not 'r'(rate), so the power is enhanced (exponentially) by the number of time periods of the return and not just a higher rate of return. Compounding is a double-edged sword especially when we're at a receiving end, through inflation. When we try to create a corpus, we rely on compounding to help but the same would cut the actual returns at a higher inflation rate. Of course, we don't have much control on the movement of inflation and could hence plan for higher corpus generation.

The key for a seamless and peaceful retirement is through a proper asset allocation and the exposure to equity even in post-retirement is imperative unless someone enjoys a constant fixed source of inflows. Despite the recent tax changes in dividends and capital gains, the component of equity in the post-retirement allocation is needed. Another fact many fail to understand that the retirement corpus would be available not as a one large chunk of cash but across various instruments.

And in some of the investments, the maturity or inflows are timed to the retirement age, but these large sums of money have to find a place to be reinvested. For instance, the corpuses generated out of provident funds can't continue to remain there and have to find instruments like annuity, etc. to be reinvested while being consumed in a systematic way. Parts of the sums could be exposed to equity mutual funds with the option of systematic withdrawal plan (SWP) to provide regular liquidity to the investor.

It's not just the discipline of investing for the corpus for retirement should start from a younger age but also the offsets to various health/life risks are to be begun at an early stage. For instance, products of health, life, critical illnesses and disability are cheaper when opted at a younger age. Also, good health being a precondition for all these products, it's better to opt them at younger age & when healthy. This would act as a buffer during the tough times and wouldn't plough out the retirement corpus for medical emergencies of self and/or dependents in the retired years.

The asset allocation turns vital during retirement for productive and tax efficient use of the corpus. For some of the short-term needs, the liquid (debt) mutual funds could be utilised while the exigency need could be sufficed through cash or an unused higher credit card limit. A portion of the asset needs are to be invested in equity which would create a rate of return higher than the rate of consumption (outflow) and the rest to be in safer instruments like debt, fixed deposits, etc.