Planning ahead a vital strategy for retiree-to-be

De-risking an investment portfolio in the years leading up to retirement was the traditional approach for investors, but with retirees living longer and interest rates at record lows, a new strategy is needed.

I am due to retire in five years' time and my portfolio is currently heavily invested in stocks and bonds. When should I de-risk my portfolio to ensure I do not lose out when I actually retire? KL, Abu Dhabi

Expert one:

Julian Vydelingum, senior wealth planner at Killik Offshore

The main investment risk people face when approaching retirement is volatility – the chance of short-term fluctuations in the value of the investments in your portfolio. While this can occur any time, when you are close to retirement you have less time to recover from any losses.

Traditionally, those approaching retirement were advised to de-risk by gradually reducing the weighting in shares within their portfolio, switching these to government bonds and cash in the 10 years before retirement. This was recommended either in preparation of purchasing an annuity to provide a known income for life in retirement.

However, some recent retirees following this advice in the low-interest rate economic environment have found their portfolio mainly contains low-yielding government bonds and term deposits with interest payments which aren’t sufficient to support them in retirement. Being mindful of the current and future economic outlook when realigning your retirement investments has become more important while interest rates remain at historic lows, especially as you may have to live on your retirement portfolio for more than 30 years.

Instead of reducing the risk based on a fixed date, consider when to de-risk your portfolio. Work out what annual income you think you need in the first 10 years of retirement, how much you will need in the subsequent 10 years, and so on. Ensure you factor in projected inflation in the country you intend to retire to and also that spending patterns in retirement can be “U-shaped”, with higher expenditure in the early years, a reduction in the middle years and a spike at the end related to long-term healthcare costs. This will identify what portion of your portfolio could be de-risked to provide the income you will need.

Expert two:

Sam Instone, chief executive of AES International

The shape of retirement has changed. When before it was simply a case of “de-risking” your portfolio and purchasing a fixed income stream for the remainder of your life, nowadays, with increasing life expectancy, the decisions we make must be more nuanced.

KL should probably be thinking about leaving a fairly significant portion of their portfolio invested, as this will mean their capital isn’t eroded too quickly and should enable them to continue to draw an income for the remainder of their life. That said, there needs to be a balance between growing capital and ensuring your portfolio isn’t so risky as to mean your income will suffer in retirement.

The challenge is the several unknowns such as how long you will live, the returns your investments earn and inflation levels.

There are two ways KL could approach retirement. For a fixed income, he should immediately reduce his holdings in equities (stocks), which are typically only suitable for investment terms of five years plus, and replace them with cash and fixed interest investments (bonds). Each year the allocation should move closer to 100 per cent in cash – this is known as “lifestyling”. The aim here is to lock in any gains made, and consolidate your pension at a time when any losses incurred would be hard to make up.

Alternatively, leave your portfolio invested in equities and bonds and perhaps only move the amount you require for the next 12 to 18 months into cash.

This ensures you have the income you require, but also allows the remaining portfolio to be exposed to the stock market and potentially higher returns.

Next Money Clinic:

Is 2016 the best time to invest in Dubai's property market? I want to invest Dh1 million in a rental property to earn the maximum yield. MH, Dubai

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