Forget complicated products: The simple 2-bucket strategy for a stress-free retirement

Most people build their retirement plan the same way they build any long-term goal — start SIPs, increase them when salaries rise and hope that time and markets will do the heavy lifting.

But what almost no one plans for is how their money should behave differently as you get closer to retirement.

The ₹1.6 Crore Risk: Why Your Retirement Needs a Plan B

For example, let’s say there is a couple from a metro city who are 52 years old and want to retire at 60. This couple has accumulated about ₹1.6 crore across provident fund accounts and mutual funds. About ₹1 crore of this is still in equity funds because the SIPs have been running successfully for many years. If volatility persists in the market during the late 50s, the couple may need to delay their retirement, reduce their expected lifestyle or use savings intended for the first few years after retirement.

The 2-Bucket Strategy: Dividing Wealth for Growth and Safety

Another way to deal with this risk is to think about how you want your investment mix to change as you approach retirement.

#1. Start By Separating Your Retirement Money Into Two Buckets

Many individuals invest their retirement money based on each investment type (i.e., stock fund, etc.). Therefore, they do not have a clear picture of how at-risk all of their retirement money actually is.

A better method is to place all of your retirement money into just 2 investment categories — a growth category and a safe category.

Investments in the growth category include equity mutual funds, as well as the equity component of the National Pension System (NPS).

Investments in the safe category include Employee Provident Fund (EPF), Public Provident Fund (PPF), debt funds, and fixed deposits.

#2. Set Your Risk Level Based On How Close You Are To Retirement — Not On Market Conditions

Your portfolio will become less risky with respect to retirement (not with regard to how the market is performing) because you have fewer years for recovery after a major drop in the market. Therefore, your glide path has to be tied to the number of years until you retire; it cannot be dictated by current news or by recent performance.

For example, if you are 35 and plan to retire at 60, a higher share of your money can remain in the growth bucket. But if you are 52 and have only eight years left, keeping the same high equity exposure can increase the risk of last-minute shocks. A simple glide path slowly reduces this risk as your working years come down.

#3. Reduce Risk Gradually — Do Not Wait For The Last Few Years

The most common mistake made is keeping an aggressive asset allocation (investment strategy) for 20 plus years and then trying to make a drastic change near retirement. By waiting too long, you expose your entire portfolio to market fluctuations when it is most vulnerable (the last 2-5 years).

By using a “glide path” you can create a series of planned shifts in the asset allocation over many years, as opposed to doing one big move from equities to fixed income at age 58 or 59. By creating this gradual movement toward a conservative asset allocation (by the mid-40’s or early 50’s), you reduce the risk associated with making a large decision during a volatile period.

#4. Rebalance Once A Year To Stay On Your Glide Path

If you determine the right balance of potential for growth versus a safe investment strategy, your portfolio would not remain in that state by itself. If a market goes up, your equity investments become a higher percentage of your portfolio and your overall level of risk also rises.

For example, let’s say you want to maintain approximately ₹40 lakhs in your growth area, but after a year where the stock market has risen significantly, the amount in the growth area has risen to ₹45 lakhs. At this point, you simply remove the additional ₹5 lakhs from the growth area and place it in your safe area.

The small annual adjustments of your retirement fund will allow you to keep your investment plan on track for your desired glide path and make fewer emotional choices as you get closer to retirement.

#5. Don’t Rely Only On New SIPs To Make Your Portfolio Safer

Many investors think that their glide path is going to happen by itself because they are allocating new SIPs to less risky investments as they age. However, as time goes by, the value of your existing portfolio grows many times bigger than the amount you put into it each month through your SIPs.

For instance, if you currently have a retirement fund worth Rs 1.2 crores, but you are investing ₹40,000 every month, adjusting your current and future SIPs for risk may not really result in a meaningful reduction of risk in your total portfolio. In order to truly follow a glide path you will also need to reduce some of the risk in your existing funds — not just in your future SIPs.

#6. Keep A Small Growth Portion Even After You Retire

The money does not stop working at the end of your career either. The costs of living will continue for 20 – 25 years or longer; and there is always inflation that will increase the cost of goods and services during those years.

If you were to retire with ₹2 crore and put all the money into Fixed Deposits (FDs), you would have the initial feeling of stability in your income; however, as time goes on increasing costs can quietly take away from your ability to purchase things with your money.

There are many benefits to keeping a limited amount of money in the growth bucket when you retire which can help your money continue to grow to meet your needs in the latter years of retirement.

#7. Keeping It Simple: Why You Should Avoid Structured Products

Your glide path is about the way in which your investments are split between investment growth and investment stability, not about purchasing new or additional financial products. Therefore, you do not need to have special retirement plans, a combination of insurance and investment products (bundled), or other types of structured products to manage this transition.

As an example, you can build and maintain your entire glide path with simply equity mutual funds to grow your wealth, and EPF, PPF, debt funds, or fixed deposits to provide stability. The simplicity of your glide path will make it much easier to track, much easier to rebalance and far less likely that you will make costly errors.