How is asset allocation linked to retirement planning?

Creating the right retirement plan is not just about being disciplined about money. How you finalize your asset allocation strategy will ultimately decide whether you will have a financially secured life after retirement. Combine prudence with flexibility to come up with the right asset allocation strategy for your future.

How is asset allocation linked to retirement planning?

A happy and stress-free retirement is the ultimate sign of a successful investment strategy. While a working individual can meet financial expenses and manage emergencies by simply earning more, a retired individual can have a normal life after retirement solely through smart retirement planning. Your retirement strategy must consider the inflation, negative impact of allocation, the possibility of losses and other contingencies, and that you cannot allocate your entire income towards retirement planning.

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A very important aspect of sensible planning for retirement is smart asset allocation. Asset allocation refers to the process of apportioning limited funds to different asset classes so as to create an adequate corpus for your retired life. The money that you have in your hand is merely an instrument to generate wealth. You have multiple options at your disposal—gold, fixed deposits, real estate, mutual funds, equity markets, and so on.

The simplest way to understand the linkage between asset allocation and retirement planning would be with an example. Consider the case of Mr. X and Mr. Y. Both start retirement planning at the age of 30 years with an investment timeframe of 30 years.

The case of Mr. X

Mr. X prepares a portfolio of assets consisting of SIPs, real estate, gold jewelry, annuity policies, and equity investments.

He begins by setting up SIP investments the moment he gets his first salary. He uses his annual bonus to purchase retirement plans. He buys a bigger home at the age of 35 and plans to repay the home loan by the age of 50 years. At the age of 40 years, he starts supplementing his mutual fund investments with direct equity market investments.

At 50, he decides to shift to debt funds offering lower returns with lower risk of losses. At 55, he decides to buy a smaller house for his retired life and creates fixed deposits from the excess cash from the sale of his first home.

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The case of Mr. Y

Mr. Y begins by investing his monthly savings and annual bonuses in aggressive equity market investments. This high-risk high-return strategy is moderately successful and he withdraws the capital at the age of 40 years to purchase real estate.

At the age of 50 years, he decides to sell the home and invest the proceeds into an annuity plan. At 55 years, he is forced to consider high-risk equity investments to try and generate funds for buying a home for leading his retired life.

Both Mr. X and Mr. Y have relied on similar asset classes to plan for their retirement. The reason why Mr. X is in a more comfortable position is simple—better asset allocation.

Smart asset allocation for retirement planning

While it is impossible to come up with a universal formula for retirement planning, asset allocation must be done keeping the following factors in mind:

  • Make high-risk investments early in life.
  • Don’t focus on a single asset class. Spread your investments over different asset classes for greater safety. Since gold is preferred during recessions and equities are popular during booms, invest in both to ensure you don’t risk a financially-troubled retirement.
  • Focus on risk-mitigation even within the asset class. Balance direct equity investments with SIP contributions to reduce the negative impact of loss of capital.
  • Review the strategy at periodic intervals to provide for changed circumstances. Buying a smaller home and freeing up extra cash is much better than ending up with an expensive-to-maintain home in one’s old age.
  • As retirement approaches and you get closer to your goals, focus on assured income, higher liquidity, and lower risks, by shifting from equity funds to debt funds.
  • Have an inflation-targeted approach to ensure the real returns on your investment are adequate to provide for your retired life.

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The secret to sensible asset allocation is to combine prudence with flexibility. An ultra-safe approach where you invest only in gilt securities won’t work unless you inherit a huge fortune. An aggressive and high-risk strategy may cause a five-year recession to leave you penniless in your old age.

Retirement planning is not a zero-sum game where one is either a winner or a loser. Mr. Y can still end up with a comfortable retirement if his high-risk strategy pays off. However, there is no denying that Mr. X is in a much-better position to enjoy a happy and comfortable retired life.

So who would you want to be?


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