YOUR MONEY: Ways to protect your nest egg from market downturns | The Financial Express

YOUR MONEY: Ways to protect your nest egg from market downturns

Withdrawals in a low-return phase can spoil the retirement portfolio

YOUR MONEY: Ways to protect your nest egg from market downturns
The ‘sequence’ or the order in which the investment returns are generated does not matter as long as the investor continues to hold the investment and has no interim withdrawals.

By Varun Fatehpuria

The sequence-of-RETURNS risk is the risk that the withdrawals from your portfolio will coincide with a ‘sequence’ of negative investment returns in the markets causing permanent damage to your retirement portfolio. This is because, in the absence of regular additions to your portfolio, you are essentially withdrawing from a reducing-balance account that will take a lot longer to recover from the depths. Someone in their retirement phase is more exposed to this risk as they are drawing money from their portfolio than someone who has no plans of withdrawal.

How does it affect your investments?

The ‘sequence’ or the order in which the investment returns are generated does not matter as long as the investor continues to hold the investment and has no interim withdrawals. When we invest, we often tend to put too much focus on whether we are buying/selling low/high respectively. However, over a period of time the outcome is the same. Therefore, if you are in the accumulation phase of your life and are investing towards building a corpus for your retirement, you shouldn’t be too worried about the day-to-day or even year-to-year returns of your investment. What matters is the average returns over the period.

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However, things change significantly during the retirement phase of the investment journey when you would like to withdraw regularly from your investments.

Withdrawals from portfolios often compound losses. This occurs because the drop in portfolio happens when the value of your investment is at its highest, i.e., during the start of your retirement. Thus it takes longer for the portfolio to recover. To put it simply, the timing of returns matters more than the average returns when you are withdrawing from your portfolio.

How to mitigate the risk?

While it is very difficult to accurately predict how the markets will behave, it is best to be a bit defensive and conservative when it comes to withdrawing from your retirement portfolio. Investors these days often do not have an all-equity portfolio coming into retirement – which offers a good starting point for protecting the portfolio during extended periods of downturn. Here are a few ways to effectively mitigate the sequence-of-returns risk:

Have a cash reserve: Continual down markets usually do not last beyond two years. Hence, to safeguard against a falling market, have a year or two’s planned withdrawals set aside as cash. This ensures you are not forced to withdraw when it is not the optimal time to do so.

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Higher fixed-income during distribution phase: The asset allocation of your retirement portfolio needs to have a higher fixed-income/debt allocation compared to your portfolio during the accumulation phase. Debt not only provides a hedge during extended periods of a downturn but also ensures you are not vastly affected by the sequence-of-returns risk. A balanced portfolio of 60% stocks and 40% bonds provides higher visibility and safety of return through the debt allocation while allowing adequate opportunity for growth of assets via equity allocation.

Scaling down equity exposure 1-2 years before retirement: It is a good practice to start scaling down your exposure to equity-related securities one to two years before retirement. A staggered transfer from equity to debt via a Systematic Transfer Plan is a good way to do so.

The writer is founder & CEO, Daulat

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First published on: 09-11-2022 at 01:35 IST