Early retirement vs normal retirement: How much equity should I hold in each case?

Last Updated on February 12, 2022 at 6:23 pm

In this article, let us discuss how much equity one should hold in an investment portfolio after early retirement and how will it differ from normal retirement.

Equity exposure after retirement is a tricky business and requires careful consideration, the primary being, what is the retirees’ experience with capital markets? Today we have retirees mis-buying equity mutual funds and “balanced advantage” funds for “regular income” with virtually no experience of investing in mutual funds all their working life.

Already the performance of hybrid funds in March 2020 was a rude wake-up call. See: These five equity hybrid funds fell 50% less than Nifty during the crash.  Also, see: Are hybrid mutual funds less risky than equity mutual funds? So it would be quite dangerous to have first-time equity exposure after retirement.

With experience and, therefore, risk-awareness, the primary consideration, the value of the retirement corpus is the next factor. For most people, the corpus is not (will not be) large enough to warrant even 20-25% equity exposure in a bucket strategy.

Here are two detailed examples of this bucket strategy using our robo advisory tool:

• Normal retirement: I am 30 and wish to retire by 50; how should I plan my investments? Total equity exposure recommended by the robo tool after retirement is 20% after a gradual decrease in equity allocation well before retirement.
• Early retirement: How much do I need to retire by 45 in India? Total equity exposure recommended by the robo tool after retirement is 22% after a gradual decrease in equity allocation well before retirement.

A couple of these results may not sit well with you. The first probably is just the five-year age gap between normal retirement and early retirement.

Today 50 is the new 60 for corporate employees. Considering the fickle nature of their jobs, unless they are MVPs (most valuable players) to the organisation, they are working on borrowed time.

Even if they are still employable, the long years of stress will result in lifestyle diseases, lower productivity, or an unwillingness to carry on. See: How to prepare for the “new normal” in retirement planning.

If age 50 is the lower bound of normal retirement, then age 45 is the upper bound of early retirement. Why only 22% equity for retirement at 45?

What is early retirement? This is not literal retirement. It just means goodbye to salaried existence. The early retiree must keep herself engaged, seeking both active and passive income.

The best possible scenario for early retirement is the farewell to salaried existence should be permanent. This means a big fat corpus invested in such a way sequence of returns risk is managed well. See: Want to be financially free? Do not count on frugality! Worry about the sequence of returns risk!

Many early retirement discussions hover on 50-70% equity. A crash or a prolonged sideways market soon after we quit our jobs can devastate a corpus. This is why, even for early retirement at age 35, the robo tool recommends not more than 45% equity.

Don’t worry! This does not mean you need to aim for a higher corpus! The earlier you retire, the lower the corpus, with a caveat that the savings rate has to be high. See: Retire early to lower your retirement corpus!

Finally, there can be a big difference between planning and execution, particularly for those who start investing in equity early and the few who can invest more than what is required for retirement.

In such rare situations, one can consider higher than the recommended equity allocation if the total corpus is much higher than required.

In summary:

• The normal retirement age should no longer be used as 60. It should be 50 or at most 55.
• Equity allocation after normal retirement primarily depends on the capital market experience of the retiree.
• Young earners considering normal retirement should allocate significant capital to equity (50-60% of the total portfolio).
• Even for those with capital market experience, it is recommended not to exceed 20-25% equity exposure after normal retirement.
• It is incorrect to assume early retirees should have significant equity exposure. A poor sequence of returns, especially in the early stages of retirement, can wipe out a corpus and force them to update their resumes.
• We recommend not more than 25% equity for 40+ early retirees and 40% equity for 30+ early retirees.
• In addition, astute corpus management and a reasonably regular income from passive and active sources would be necessary.

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