A reader says, “Was going through your article on “Should I withdraw from PPF to increase my Equity allocation”. I am in exactly the opposite situation. I am 51 and want to retire now. My Equity allocation is 58%, and my Debt is 42%. Should I sell my equity and move to Debt to maintain 50:50? My debt component is enough to take care of at least ten years.
You certainly should reduce your equity allocation from 58%. But reducing it only by 8% seems too little on the verge of retirement. A debt component that can handle expenses for at least ten years in retirement (inflation-indexed?) is healthy, but it is not enough, in our opinion.
The freefincal robo advisor tool requires about half the corpus to be large enough to handle an income that increases at 6% a year for the first 15 years. This half is assumed to be invested in risk-free assets.
It is tempting to invest the remaining in equity, assuming it is a growth asset. Before retirement, that is a reasonable assumption if there is enough time to invest. After retirement, it can be dangerous.
A poor sequence of equity returns, especially in the first decade of retirement, can devastate our plans. Therefore, the robot advisor tool recommends no more than 30% equity exposure for retirement at ~ 50.
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This is a sample retirement bucket strategy (Please do not copy it. This is only an illustration).
- An income bucket with 47% of the remaining corpus for guaranteed income for the first 15 years of retirement. During this time, investments will be made in the following three buckets.
- A low-risk bucket with 24% of the remaining corpus for income from year 16 to year 25 in retirement. The low-risk bucket will have an asset allocation of 30% equity and 70% debt during the investment period (years 1 to 15 of retirement).
- Corpus from a medium risk bucket with 15% of the remaining corpus will provide income from years 26 to 33 in retirement. This bucket shall have an asset allocation of 50% equity and 50% debt during the investment period (year 1 to year 25)
- Corpus from a high-risk bucket with 8% of the remaining corpus will provide income from years 34 to 40 in retirement. This bucket shall have an asset allocation of 70% equity and 30% debt during the investment period (year 1 to year 33)
- The buckets will be actively managed to reduce risk during this investment period via rebalancing and profit booking from one bucket to another. To understand how this works, try The Retirement Bucket Strategy Simulator.
- After 15 years, the low-risk bucket will be turned into 100% debt and provide income for about 10 years. After that, the other buckets will also be progressively used.
The overall equity allocation in this plan is only 30%. We recommend gradually reducing your equity allocation from 58% to 30-35%.
In summary, (1) Be conservative and err on the side of caution; (2) Appreciate the notion of the sequence of returns risk. Any stretch of poor equity returns at retirement can deplete the corpus quickly. Ideally, our reliance on equity after retirement should be as low as possible. A higher than 30%-35% equity is recommended only if the corpus is fairly large. That is, if the initial withdrawal rate (annual expenses at the start of retirement divided by the corpus value) is well below 3%.