The last couple of weeks, I’ve touched upon the various aspects of retirement, the emotional preparedness of the retirees and the social obligations that impact the retirement planning. This article covers a pertinent threat to the retirement planning and ways to counter them.

Imagine, someone had planned to retire by January of this year and accordingly planned for the corpus with an allocation suiting their risk profile. As the withdrawal begins, there’s been a huge turmoil in the financial markets affecting both the equity and debt instruments. This is a rare event where the prices of equities and bonds (yields rise) simultaneously. And the prolonged volatility in the asset prices could upset the retiree’s plans into their distribution phase.

Suddenly, the rate at which the corpus dwindles versus the planned is higher and could create doubts if it lasts as planned. This is because, they are forced to cash out from their existing corpus at lower asset prices, increasing odds of running out of money through the planned period. This is also called as the ‘sequence of returns risk’, the risk of negative market returns occurring at the late stage of contribution period or early in to retirement. For instance, retiree A experiences poor returns early in the retirement and good returns later wile retiree B has good early returns and poor returns later. Even if the average returns are the same for both the retirees, retiree A is more likely to run out of money as the early poor returns meant, selling more assets (out of the portfolio) to meet the withdrawals when the prices are low, leaving fewer assets to participate in the eventual recovery.

However, this cash buffer allows the retirees to avoid distressed selling during drawdowns as the portfolio gets time to recover.

A price correction across assets is an outlier event, particularly for prolonged periods. So, a well-diversified portfolio comprising Real estate (REITs), commodities, InViTs, etc., could offer buffer against the traditional equity and bond assets. This not only insulates the portfolio erosion during market turmoil, but stays resilient to bounce back quickly. However, they come with their own limitations and complications. Hence, a risk-adjusted allocation must be considered.

Another tweak could be through retirement plans which provide a defined sum each year. This brings predictable cash balances without resorting to divesting debt assets in a rising yield environment.

Annuity plans also bring in predictable cashflows if opted for a fixed sum with an immediate payout option. These, however, are less flexible and offer limited or no liquidity (from the corpus), also are taxed as annuities are treated as income. A part of the portfolio could be allocated to these instruments that match the basic needs of the retirees.

A reactionary rebalancing could benefit, but must be done with caution. The desired risk tolerance shouldn’t be compromised, while not attempting to sell at lower prices.

Sequence of return risk is a critical concern for those about to retire and early retirees, particularly when there’re larger drawdowns in financial markets that can potentially have outsized impact on the longevity of the retirement corpus. In conclusion, they could combine the above strategies of cash buffers, adjusting withdrawal rates, portfolio rebalancing, diversification of assets and products while avoiding panic selling.

(The author is a partner at ‘Wealocity Analytics’, a Sebi-registered research analyst and could be reached at [email protected])