Make your retirement corpus work harder so that it lasts till the end

By Priya Sunder, Livemint article posted on 18 Nov 2019

Manage your portfolio dynamically to get a return that keeps pace with inflation

My 98-year-old grandfather passed away a few weeks ago. Forced to flee his birthplace Burma because of the Japanese invasion during World War II, my then 20-year-old thatha trekked thousands of miles to India, braving disease, wild animals and perilous terrain. After entering India as a refugee in the 1940s, he rebuilt his life from scratch, starting out as an announcer and going on to become the first director general of Doordarshan.

Though thatha fought intense personal and professional challenges, he still provided adequately for his family on his meagre salary. He principally grew his wealth by investing in real estate and fixed deposits and never felt the need to invest in anything more aggressive. I told him that his generation had it good because they had the luxury of being risk averse with their investments. Thatha lived in times when fixed deposit interest rates were as high as 13%. But we don’t have that luxury today.

We live in a world of falling interest rates. If imminent retirees are to stretch their money through their lifetimes, they need to generate a return on their portfolio that is higher than inflation (also known as real return) by at least 2-5%. The current falling interest rate scenario is especially worrisome for those who have recently retired, and have a good 20-30 years of retirement to fund; their real returns may decrease over time because of either falling interest rates or increasing inflation. If bonds deliver a post-tax return of 6-7% and inflation is on average around 5-6%, the real return is barely 1-2%. In other words, wealth is essentially growing at 1-2% during retirement. I shudder to think what the future holds if our interest rates drop to 1% or even negative rates that we see in the US and other European countries today.

So, the question is: how do we determine how much to draw down from a retirement corpus to not empty it before our time is up? It’s difficult to attribute a rule of thumb for retirement draw-down, since effective portfolio management is about overall return as opposed to fixed return.

In fixed-return portfolios, you earn a predetermined income, but it does not adjust itself to inflation. Exposing your entire retirement portfolio to annuities forces you into such a scenario. As real returns fall in the future, you may need to compromise on your lifestyle to adjust to the fixed annuity. Such a strategy is fundamentally flawed since it leaves you ill-prepared to handle adverse events such as medical emergencies or even routine increase in expenses. Partial investment in fixed annuities is more desirable.

In an overall return approach, you can dynamically manage the portfolio to generate a return that keeps pace with inflation, and maintain your standard of living. Your initial draw-down may be lesser at say, 3-5% of the portfolio value in the early retirement years, increasing to 15-20% halfway through retirement, and ratcheting up to nearly 70-80% towards the end of retirement. Such a portfolio incorporates regular income generation through interest, annuities, dividends and systematic withdrawal plans (SWPs); as well as growth in the form of capital gains, which provides the added fillip to handle routine or unplanned outflows.

Let me illustrate with an example. A is 60 years old, with a current corpus of ₹1 crore, looking to fund his retirement over 30 years. His annual expenses are ₹6 lakh today. Assuming an average portfolio return of 7% and inflation at 5% (real return of 2%), A’s assets will deplete by age 80. To ensure A stretches his money till 90, here are his options: 1. Cut annual expenses to ₹4.2 lakh, keeping growth and inflation constant. Hence for every ₹1 crore of investment, he can draw down no more than ₹4.2 lakh annually. 2. Retain expenses at ₹6 lakh, but increase his average portfolio return to 10%, inflation being constant. The real return needs to be at least 5% to ensure A doesn’t exhaust all assets. In both the scenarios, A’s capital depletes by the end of his lifetime. If he wishes to preserve his original corpus, A can draw down only ₹3.7 lakh annually on a 7% return and ₹5.6 lakh on a 10% return.

For most retirees, generating that 5% real return is a challenge, since such a return can only be obtained through a combination of equity and debt investments. Assuming average equity returns of 12% and debt returns of 7%, a blended portfolio must have more than half of it exposed to equity to generate such a real return!

So, what are you going to choose? Risk today or risk later? Money at the end of your life or life at the end of your money?