Can the rising equity glide path reduce your post-retirement risk?

Usual retirement planning strategies suggest pruning equity exposure in the portfolio over a while. Initially, as you approach the age of retirement and later at the fag end of the retirement years. 

For instance, you might hold 70% in equities till 50 years and gradually scale it down to 40%-50% by retirement (say 60 years).

So, typically, the lifetime stock allocation path mimics a falling line wherein the equity holdings are the highest when you are young. It goes lower around the retirement time and is the lowest at the fag end of retirement. This is popularly known as the declining equity glided path.

On retirement, you resort to regular withdrawals from the corpus using the five-year bucket strategy. Here, the retirement period is divided into five-year buckets, with the first bucket holding the least risky instruments.

In contrast, each successive bucket has a relatively more aggressive portfolio as it will not be tapped and can safely ride the stock market’s ups and downs.

Big sequence risk

While the declining equity glide path is a popular strategy, there are specific challenges, especially concerning the sequence risk – the danger of timing the withdrawals affecting the investor’s return.

Historically, equity has proved to be the best asset class as far as average returns go. However, it is also necessary to look at the sequence in which these returns occur.

After all, it doesn’t matter if the average of the long-term returns is ‘good’ when the retirees cash out before the ‘good’ returns arrive. 

A bear equity market, for instance, in the initial phase of retirement impacts the portfolio returns immensely. Let’s assume someone plans for 30 years of post-retirement income and a bear market checks in shortly after retirement. 

If the lousy phase persists for a long time (say 6-10 years), the investor loses out. This is because more equity withdrawals would have happened by the time the market situation improves. So, there is a significant sequence risk for retirees, especially at the time of retirement when the corpus is sizable. 

Some experts believe following a rising equity glide path could reduce the post-retirement risk under all market scenarios. 

What is the rising equity glide path?

Conventional practice suggests that retirees should reduce equity exposure with age. However, while sounding counterintuitive, the rising equity glide path asks for equity exposure to be increased during the initial phase of retirement. 

So, typically, the lifetime stock allocation path becomes U-shaped, wherein the equity holdings are higher when you are young, lowest around the retirement time and higher again later in retirement. 

How does it improve retirement outcomes? 

Let’s consider four equity market scenarios during the retirement period of 30 years. 

Scenario 1

The equity market does well throughout the retirement period spanning three decades. In this case, the rising equity glide path should improve retirement outcomes as equity values appreciate, albeit not as much as a portfolio that has been aggressively built beforehand. 

Scenario 2

The entire retirement phase witnesses poor equity market returns. Here, retirement outcomes would be challenging for any equity-laced portfolios.

However, a rising equity glide path would mitigate the downside as it gradually increases equity exposure. This fares better against a purely aggressive asset allocation. 

Scenario 3

The equity market does well in the initial phase of retirement ( first 15 years) and fares poorly later (next 15 years). So here, the rising equity glide path will work but perhaps leave less legacy than otherwise. 

Scenario 4

The equity market does poorly initially (15 years) and later does the catching ‘up’. This is the most vulnerable period for retirees since, at this stage, they have a big chunk of corpus exposed to market fluctuations. 

While aggressive asset allocation could impact withdrawal rates for retirees, rising equity paths benefit from an initial dip in valuation as they resort to rupee-cost averaging. Finally, when the ‘good’ returns arrive, retirees benefit from them. 

In contrast, in the first case, there would simply be insufficient exposure to equity when the ‘good’ returns show up.

In short, even in a worst-case scenario, retirement portfolios in a rising glide equity path should get the necessary protection. This is done simply by not liquidating stocks in down markets and letting equity exposure grow over time. 

How to go about it?

If you are following the bucket-centric approach to cash flow generation during retirement, ensure you are offloading only the debt portion of the portfolio so that it automatically increases your equity exposure over time. 

Do it systematically like that of portfolio rebalancing by increasing equity percentage by 1-2% every year till you hit the target asset allocation. By doing so, you refrain from in-the-moment decisions.

Takeaway