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Diversify your retirement income streams

Draw your retirement income from multiple sources for an efficient trade-off between risks and income needs

Retirement is one stage in life where you don’t want to have to guess the availability of income to meet your needs.

You would like your retirement corpus to not only generate an income to meet your needs but also to meet those retirement dreams that you have nurtured for years. However, all income is subject to risks.

It may be the risk of adequacy, or it may be the need for making the best use of available funds, or it may be the need for flexibility in the investment or the risk of volatility.

Keep in mind that a single product or investment may not be able to manage the different types of risks and provide the income you require. What you should do is design a portfolio of different investment products, each of which will contribute a stream of income that will help manage one or more of the risks and concerns in your retirement income.

Guaranteed; low returns

Your first priority when structuring your retirement portfolio must be to secure a level of income that is adequate to meet basic living expenses.

“Often, people put aside too little and expect astronomical returns, which are hard to get over a long period. So, getting a better sense of what the goal is makes for a good starting point," said Manish Shah, co-founder and chief executive officer, BigDecisions.com, an online financial advisory.

You should keep in mind that different needs may have different funding requirements.

The retirement corpus will depend on not one but many factors.

“Your retirement corpus will depend on monthly expenses, number of years remaining for retirement, post-retirement years and post-retirement investment returns. The first step is to set a tentative timeline for retirement and ascertain the minimum number of years for which you may need retirement income. After this, you should estimate the current monthly expenses—this will include fixed, variable and lifestyle expenses. Then calculate the current annual expenses, and project the first-year expenses post-retirement," said Prakash Praharaj, founder, Max Secure Financial Planners.

Your post-retirement income also needs to be predictable to an extent to match your expenses. So, to build in predictability of income you will need to look at fixed income products. In terms of very long term products you have the employer-linked pension and annuity products. But assured income over a long term may also mean low returns. Other low risk products include bank deposits, post office schemes such as the monthly income scheme, Senior Citizen’s Savings Scheme and bonds and debentures of highly rated companies, including government entities.

Fixed income lends predictability to income, though it is only for a specified period. After this period, the corpus can be re-invested, and accordingly the income may be higher or lower depending upon the prevailing interest rates. That is the risk with income that is not guaranteed through your retirement years, but compared to products that assure a payout for the rest of your life they would return more.

You need to bear in mind that low risk products come with low returns so unless you have a large corpus to invest for a guaranteed income, a workable solution to get a bigger bang for your buck is to seek a higher return investment to generate a portion of the retirement income. Therefore it’s advisable that you first work on a portfolio that takes care of your basic needs and then take some risk with a portion of the corpus to generate better returns.

Lack of predictability

When you tie yourself with a fixed income product, you are excluding yourself from the benefits of higher income if interest rates increase in the future. Assigning a portion of your corpus to a product that is structured to earn market returns, like a debt fund or a debt-oriented hybrid fund, will help you earn a stream of market-linked returns.

Products such as short-term debt funds provide income generated from a debt portfolio that reflects market yields, while hybrid funds like monthly income schemes aim to provide regular income from a portfolio of predominantly debt securities with a shot of equity to boost returns.

However, the flipside to earning market returns is that there is no predictability to the income from such investments.

At the risk of inflation

Fixed and guaranteed income bears the risk of inadequacy when inflation or rising prices push up costs. “Don’t overestimate its (inflation) impact when estimating expenses after retirement. The conventional approach is to take current expenses and inflate it by a given CPI (consumer price index inflation) number, say, 7%, for 15-20 years," said Shah.

For example, if your current expenses are 1 lakh per month, inflating at 7% for a 25-year period will have you believe that you will need over 5 lakh a month to provide for expenses after 60. But this approach does not take into account consumption pattern changes as a result of reduced family size, the likelihood that the house will be self-owned by then and so no rent or equated monthly instalments (EMI) have to be paid, and lifestyle changes.

On the other hand, Shah said, “overestimating the ability of safe products to help build the corpus is also a problem. If inflation is at, say, 5% every year and you believe your FD (fixed deposit) with post-tax returns of 5-6% will help provide for your golden years, that is a problem. There has to be an element of higher risk, longer term and potentially higher return instruments in the portfolio mix".

Remember, you are planning for your retirement stage, therefore, looking for aggressive investments in equity or real estate may imply more risk that you are willing to take. If you have real estate as an income source for retirement later, then buy the property early enough to allow it to become a positive income generating asset with time before retirement as loans are paid off.

Rental income will increase with inflation, and the rental income earned relative to the investment made, i.e., the yield, will improve over time and become competitive with other income generating assets. Unlike real estate, equity does not require a large outlay to begin investing. Given the volatility in equity, build the equity portfolio so that there is adequate time for the portfolio to appreciate and it is ready to be drawn when you need it.

Regular, but not flexible

Despite having an emergency fund, there may be situations that may require a bigger lump sum than what is readily available. Getting a loan may be difficult and expensive at this stage. It is important to invest some portion of your corpus in a way that along with providing an income, it also allows flexibility to withdraw the whole or a portion of the invested sum, should the need arise. For example, an annuity, typically, cannot be surrendered. Early withdrawal of a post office monthly savings scheme is procedurally complex and there is a penalty. A bank fixed deposit is easy to withdraw though there is still a penalty involved. A mutual fund provides the flexibility to withdraw without much delay, but there may be a lock-in period and exit loads.

Like everything to do with money matters, building a retirement income portfolio is all about planning. While all portfolios will face the same risks, the importance of each will vary from one person to the next. While taking risks, remember replenishing the corpus once you retire is difficult. Take time to estimate the trade-off between the risks and the impact on your income, and then select the investments from which you will draw multiple income streams.

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