It is a deep belief amongst Indian savers, investors and investment advisors that retirement savings should be invested with the lowest risk possible. In the abstract, this is an excellent urge to have, and one could hardly disagree with it. However, in practice, the impact of this obsession with zero-risk is terrible. The reason for that is that everyone ignores the risk posed by the biggest threat to your financial well-being, which is inflation, but if you ignore the effects of inflation in your retirement savings, then you are heading for old-age poverty.
There is a BIG difference between financial planning for retirement (accumulation phase) and financial planning during retirement (decumulation phase). Accumulation Phase: During this phase, you are trying to accumulating funds for retirement. Quite clearly, this phase is before retirement. You do not withdraw from your portfolio. Volatility can be your friend. Rupee cost averaging (through SIPs or regular investing) works in your favour, if markets move up over the long term. You do not mind lower asset prices (or market corrections) in the interim so long as things get fine by the time you retire. Decumulation Phase: During retirement (decumulation phase), you have to rely on your portfolio for your income.
You have to withdraw from your portfolio to meet your expenses. There are no further fresh investments. Volatility can be a serious enemy. You are subject to Sequence of Returns. We will come to it later. Rupee cost averaging can go against you. Sharp market corrections during the early part of your retirement can destroy you financially. What is Sequence of Returns Risk? You need to worry not just about long term average returns. You need to worry about the sequence of returns too. Since you are withdrawing from the portfolio at the time market is going down, the portfolio may deplete quite quickly. And this gives rise to another problem. If your portfolio is depleted beyond repair, there may not be much left when the good sequence of returns comes around. Reliance on long term average returns is fine when you are in accumulation phase.
During retirement, do not undermine the importance of sequence of returns. Therefore, volatility can be friend during accumulation phase. Since you are still contributing, your get greater number of units during the downturn. This rewards you when the markets turn for the good later. Apart from that, you can make adjustments along the way during accumulation. For instance, you can increase investments if you feel you will struggle to reach the target retirement corpus Actually, the time horizon of retirement savings is even longer than we generally suppose.
People take the date of retirement as the target date of the investment. However, retirement may be an event in your life, but from a savings and investment perspective, it is not an event but the beginning of a long stretch of retired life. At the age of 55, you may think that retirement is just a decade away, so your retirement kitty should be in ‘non-risky’ investments, but actually that doesn’t make any sense. You will be using the earnings from these investments when you are 65, 75, 85 or 95 years old. Retirement can be a very long time. The years from 60 to the end of a full life can be as long as 30 or 35 years. That’s as much as your working life. In those 30 or 35 years, prices would again multiply five to seven times, maybe more.
Worse, you’re likely to face unpredictable and growing medical bills, which is a major component of real inflation that people face in their lives. Planning for retirement as a single event that occurs at a point of time is a very common error. This error is even baked into the rules and regulations that govern the National Pension System. Savers who want to successfully provide for their old age must think through these issues clearly and abandon the trap that conventional thinking leads them into.