I was talking about Sequence of Return Risk a few days ago to a bunch of new Retirees. Many of them had an adviser, and some of the retirees had no investment in anything other than debt instruments. Yes they had a variety of debt instruments – PPF, Senior citizens saving schemes, debt funds, bank fixed deposits, but no equity.

I told them that they need to worry about inflation.

Sadly investment literature (at least in India) ignores inflation during the ‘retired’ portion of a person’s life. So many of these people aged around 55+ thought that a princely sum of about Rs. 1 crore and a medical cover for life was sufficient. I had to break that myth.

I then had to tell them that they had to stay in some amount of equity till their age of 75.

I had to tell them that they could touch their capital only around the age of 80 years.  One of them had a spouse who was 11 years younger to him.

Most of them were obsessed that they would leave their ‘capital’ intact to their kids. I said you would be lucky if you do not dip into your children’s kitty once you exhaust your capital.

What is Sequence Risk?

Sequence risk is the risk of getting very poor returns from equity in the early part of your post retired life. This will break your spirit and deplete your capital so badly that during subsequent bull runs.

How does one manage that?

There are two methods of managing that:

A. Create buckets : Let us call them a)Expense bucket  b) Growth and balance bucket and c)Growth, Volatility and Risk bucket

the expense bucket has all your liquid debt money – savings account, Fixed deposits, liquid mutual fund, short term bond fund. You meet all your day to day expenses from this bucket. Ideally this bucket should have 10 years expenses in this. Let us say your annual expenses are rupees 5L per annum. This bucket should have Rs. 50L at most point in time. Wait, a minute what if you have an annuity of Rs. 1L and a rental income of Rs. 1L? This means only Rs. 3L per annum needs to be provided for. So this bucket should have Rs. 30L.

the growth and balance bucket should have all your longer horizon debt schemes like gilt funds, balanced funds, etc. How much should this bucket have? Well it should have about 5 years expenses.

All the balance money that you have should be in the growth, volatility and risk buckets – this is your second house, your direct equity, your aggressive balanced funds, etc.

Whenever you think that the markets are high and you have only 3 years expenses lying in bucket number ‘a’ you should sell off some equities from bucket number ‘c’ and put that sales proceeds in bucket a or b.

This will ensure that you need not touch your volatile assets in case of distress.

B. Withdraw and Rebalance:

The second theory of how to manage volatility is to say that you should withdraw from the bucket which is booming. So if this fictitious person had retired in 2008, he would have been withdrawing from ONLY his equity fund (bucket 3) from 2008 to 2017 as we have not seen a big fall in the market. In such a case the buckets a and b would be over flowing because they would have been untouched for the past 10 years. This would mean for this person with say 10 years expenses would be lying in bucket a + it may have doubled in 10 years thanks to good returns! His money in the second bucket would have 10 years expenses too! So he may not have to worry about expenses at all!

Both these methods work. You have to make your choice.

I deal with people who have tons of wealth – so their mistakes in balancing their portfolio is not really been felt…


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