A 100 % EQUITY PORTFOLIO FOR RETIREMENT

Conventional logic has it that as people approach retirement, their asset allocation should move away from equity and into debt. For instance most financial advisors recommend that a portfolio of 70 % equity and 30 % debt should be rebalanced towards 40 % equity and 60 % debt as retirement approaches.

Take the case of a retired person with Rs.3000000 in savings and having a monthly expenditure of Rs.20000. If he puts the entire corpus into debt, currently at 8 % interest for Government schemes such as PPF, NSC and Post office deposits, he stands to make 240000 per annum, just about enough to see him through. But with inflation at 8 %, the purchasing power of Rs.240000 at the end of 5 years becomes Rs.158000. And this is considering the Government published inflation figures which are much lower than the real figures, as any shopper will testify. At some point our retired common man will be forced to eat into his capital if he is to maintain his original standard of living. Except among the very rich, ones standard of living cannot be preserved or increased without exposure to stocks.

Naturally how much you can invest in stocks depends on how soon you need the money. But consider a hypothetical Rs.1000000 invested in 3 ways for 10 years.
100 % invested in bonds.
50 % in bonds and 50 % in stocks.
100 % invested in stocks.
Assume bonds give 8 % per annum and stocks give an appreciation of 14 % per annum
(Historically in India the Sensex has appreciated 18 % per annum compounded annually since inception). Dividends accruing from stocks are ignored.

In case 1 at the end of 10 years the investor gets back his Rs.1000000 plus Rs.1160000 as interest. A total of Rs.2160000. In case 2 he ends up with a portfolio of Rs.2930000 and in case 3 his portfolio of stocks is worth Rs.3700000.

Now consider a case where the same principal of Rs.1000000 is invested and the investor requires a regular annual withdrawal of Rs.80000 for his expenses. If he invests the entire amount in 8 % bonds , at the end of 10 years he will be left only with his capital in hand even considering no inflation. On the other hand if he invests in a 100 % stock portfolio he could, after withdrawing the same Rs.80000 every year be left with Rs.2160000.

Agreed that stocks do not move up 14 % every year, year after year. So assume that the day after he invests the markets fall by 30 % and thereafter increase by 14 % every year. Even in this scenario, a principal of Rs.1000000 with a withdrawal rate of Rs.80000 per annum ends up with Rs.1050000 at the end of 10 years. This excludes dividends, and if a 1.5 % compounded dividend yield is considered, the returns would go up to Rs.1210000. This still beats buying the 8 % bond.

Investments in high dividend yield stocks would provide still better returns. Instead of a 1.5 % dividend yield, if an investor sets up a portfolio of stocks yielding 3 % dividend yield and growing at 14 % p.a. ( e.g. Many PSU banks and Fertilizer stocks are available in this range) for 10 years, with 30 % of his capital wiped out initially and a withdrawal rate of Rs.80000 per annum, he ends up with Rs.1392000.

Therefore investors would do well to relook at blind asset allocation formulae and instead question their utility against a 100 % stock portfolio.