In this article, we will discuss how retirees can distribute different investments, measured by sources of risk, across the various portfolio buckets to achieve the right mix of risk and returns.
What are the various sources of risk that contribute to a retiree’s portfolio?
We can use a diagram like this to visualise the universe of investable asset classes, which you can use to create a portfolio. Typically, these include:
Equity via direct investment in stocks or through mutual funds.
Debt via bonds or mutual funds.
Real estate via residential and commercial property or REITs.
Gold via jewellery, SGB, or gold mutual funds.
Alternatives like precious metals (e.g., silver funds, which are now available in India), art, private equity, etc.
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What are the different risk profiles applicable to retirees?
We will categorise the retiree population into three risk-based categories:
Low-risk profile
Medium-risk profile
High-risk profile
A high-risk profile investor typically meets multiple of these criteria:
A large portfolio relative to projected first-year expenses
Access to unbiased investment advice
The ability and willingness to manage the retirement portfolio themselves or with the help of a capable family member
Excellent physical and mental health for both spouses
One or more passive income streams (dividends, royalties, pension, etc.)
Children with stable careers and incomes
Family members who are informed and involved in the portfolio’s structuring and maintenance
Sufficient health insurance coverage
The risk profile moves from high to medium to low as more of the points above become false or inapplicable for the retiree. Ultimately, the investor’s risk profile is the less risky option based on their ability to take risks (measured by the points above) and their willingness to do so.
What are the risk factors that may be suitable for a low-risk retiree portfolio?
Bucket 1: Cash for short-term expenses (7-10 years) held in major nationalised or SIFI banks in savings accounts, sweep fixed deposits (FDs), and regular FDs.
Bucket 2: Debt assets for portfolio stability and income, held in government schemes like PPF, Post Office Monthly Income Scheme, Senior Citizens Savings Scheme (SCSS), and similar plans. Government bonds purchased from RBI Retail Direct can also be a part of this bucket. Interest (from the government schemes) and coupon (from the bonds) payments can fund the cash in Bucket 1.
Bucket 3: Inflation-beating assets like large-cap equity mutual funds can be an optional part of this bucket.
What are the risk factors that may be suitable for a medium-risk retiree portfolio?
In this risk profile, we focus on tax optimisation and take on a slightly higher level of risk. We increase the allocation to mutual funds to take advantage of professional management and tax deferral.
Bucket 1: Cash for short-term expenses (5-7 years) held in banks (as above) or in arbitrage or liquid/money market mutual funds, which are more tax-efficient.
Bucket 2: In addition to government schemes, you can make an additional allocation to debt mutual funds with zero to minimal credit risk and minimal interest rate risk. Debt funds that invest in short-dated (maturing within five years) government bonds (beyond 364-day Treasury Bills) can be an option here.
Bucket 3: Equity mutual funds investing in mid-cap (or even small-cap) stocks can be an additional investment option.
What are the risk factors that may be suitable for a high-risk retiree portfolio?
In this risk profile, we focus adding different sources of risk for portfolio diversification which will require professional management going forward.
Bucket 1: Cash for short-term expenses (3-5 years) held in sweep FDs in banks (for only the emergency fund), with the rest in arbitrage or money market mutual funds.
Bucket 2: In addition to short-dated gilt funds, you can also invest in long-term gilt funds, noting that these funds can fluctuate significantly with interest rate movements.
Bucket 3: Equity mutual funds investing in international stocks (to reduce single-country/single-currency risk) and a small allocation to alternative investments like gold/silver and REITs can be added to this mix. Direct stocks can also be in this bucket, with any dividend payments contributing to the cash in Bucket 1.
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This post titled Retirement Portfolio Strategy: How to Allocate Equity, Debt, and Cash Buckets for Maximum Security and Growth first appeared on 14 Aug 2024 at https://arthgyaan.com
